The Folk Psychology of Money.

I recently read a blog post about the coming catastrophic collapse of the U.S. economy and the destruction of all our wealth. This genre of writing is familiar, but it author’s errors are nonetheless instructive. While the author may be what Keynes called a “monetary crank,” his errors highlight some of challenges we face in understanding what money actually is. In this post I hypothesize that a folk psychology underlies our theory of money; a psychology based on anxieties about our interdependence, and the conditions of contingency that shape our experience.

The post’s author writes, “You see that 300 percent increase in the money supply we've experienced . . Much of it is sitting in excess reserves at the Fed and with the big banks. These funds haven't made it into the markets and the economy yet. But it's a mathematical certainty that once this dam breaks, and this money passes through the reserves and hits the markets, inflation will surge.” (http://www.moneynews.com/MKTNews/billionaires-dump-economist-stock/2012/08/29/id/450265?PROMO_CODE=110D8-1)

The metaphor of the dam breaking suggests that money is a physical force, not unlike a raging river, which operates under its own mathematical laws, much as a gravitational field exerts an inexorable pull on objects in its field.  But nothing could be farther from the truth. It is useful to ask if this misconception is simply a question of ignorance, or is it motivated? Does it serve any purpose?

It is useful to look at the numbers behind the metaphor. Banks are required to hold a minimum amount of reserves in their own checking deposits with the Federal Reserve Bank (“the Fed”). The following chart traces the amount of excess reserves that banks held in these checking deposits with the Fed since 2009. It has grown by the astounding amount of $1.8 trillion. 

 

 

As the post we quoted suggests, the bank system has been flooded with money. But how did the money get there and what does it consist of?  The Fed buys treasury bonds, bills and mortgage-backed securities from mutual, hedge and pension funds and deposits the money in sellers’ bank accounts. This means that this money is now available to a seller’s bank as the basis for lending to borrowers, and thus counts as its reserves. (Recall that banks can lend out far more than their reserves because it is unlikely that all the depositors will demand their money at the same time. When this happens, we say that there is a “run on the bank.”)

But where did this money and the subsequent reserves come from? The answer is from nowhere. The Fed created it with keystrokes. Reserves are like points in a football game. The Fed bought the bills and bonds and credited the seller by adding points to both the seller’s account and to the bank’s “score,” or the amount of its recorded reserves. When game officials add points on the scoreboard in a baseball stadium, we never wonder where the points came from. We should not in this case either. Moreover, in the first instance this does not change the money available to the public. Bonds and Treasury bills are ways in which institutions, non-profits, households and mutual funds can earn interest on the money they own, much as individuals do with a savings account. When a pension fund sells bonds to the Fed for money, it is in effect moving its money from a savings account to a checking account. The amount of an individual and institution’s financial assets, at least initially, remains unchanged.

There is a common misconception, held even by some economists, that banks are intermediaries, linking people with money to lend, to people needing money to borrow. This is called the “loanable funds doctrine.” This is not right. Instead, banks create money whenever they make a loan. This is why the process is called credit creation. In this of way of thinking, as modern monetary theory emphasizes, loans create deposits, deposits don’t create loans. (See Modern Money Theory, by Randall Wray, Palgrave, 2012). If a bank gives me a loan it does not give me a barrel full of cash. It simply creates an account on its spreadsheet and marks down the requisite “points” in dollars. Keystrokes again. This also means that when the Fed increases a member bank’s score – the measure of its reserves—the banks do not automatically give out more loans. The money is not sitting there creating pressure. It is denominated in keystrokes. Instead, banks lend only when they can identify credit worthy borrowers. One reason that banks had so much excess reserves in the years after the Great Recession is that they were wary of extending credit. This is also why the Fed’s program of “quantitative easing’ – buying bonds and bills and crediting member banks with reserves, has not caused inflation.

The seeming mystery of how money can come from nothing is resolved by recognizing that economic life is lived forwardly. Businesses have to spend money, before they earn it, and credit, or what is sometimes called “working capital,” makes this possible. This is why sometimes a fast growing company goes out of business. It cannot get enough credit to finance its growing expenses in advance of its hoped for revenues. Credit in this sense is a measure of a bank’s and business owner’s shared conception of the future, which by definition does not yet exist. It is a signal from the future, as the bank and borrowers imagine it together. Money instantiates this signal.

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In this sense credit represents a victory of abstraction. Human culture has found a way of representing numerically something that does not exist materially. It is not unlike, the way in which Newton’s theory of gravity accounted for the observed motion of objects, by abstracting from its physical manifestations and positing a force that could only be described mathematically. We can’t “touch” gravity. Instead, it is instantiated only in the numerical relationship between objects. 

So one question is why do people persist in thinking about money as a “thing,” as a force that can break through a dam, or as an object that is passed like a tennis ball from a lender to a borrower. I can think of two hypotheses that draw on psychoanalytic thinking. Both presume that human culture creates “social defenses” against anxiety, which if experienced directly would be distressing and discomfiting.

Consider the extreme case of “gold bugs.” These are people who believe that the only basis for a national currency is gold, and that the Central Banks of all countries should promise to redeem their national currency into gold upon demand. This was in fact the basis for the historic but now defunct international gold standard. The conviction underlying this idea is that states and their representatives cannot be trusted, that left to their own devices they will “print money” in order to confiscate our real resources; our houses, cars, televisions, coal and gas. If political and economic elites are foresworn to redeem paper into gold they will be constrained by the amount of extant gold and the amount that can be mined. Never mind that the amount of gold available as backing is in some degree arbitrary. Never mind as well that if there is insufficient gold, countries will experience deflation because there is too little paper currency to support the desired volume of exchange. Gold bugs discount the salience of these likely problems partly because their larger vision is tinged with paranoia. They worry that a cabal of unseen forces, call them Jewish bankers or Freemasons, controls us, and that only gold will free us.

I suggest that we can generalize from this extreme case. The gold bug has a fantasy of a social relationship, albeit a paranoiac one. Once we understand that money is nothing but the expression of our relatedness, we must recognize the ways in which we are interdependent in world wide circuit of exchange. So one hypothesis is that we want to see money as thing, as a defense against the anxiety we feel when we see how interdependent we really are.  Karl Marx’s conception of “commodity fetishism” is helpful here. He argued that we tend to see an economic exchange as the relationship between money and goods, rather than what it ultimately is, a relationship between people. We treat money as magical, as if it can conjure up objects without considering the underlying social organization that money sets into motion. Thus for example, we buy cheap clothing from Bangladesh imagining that we are exchanging money for clothing.  But in fact we are setting in motion a social process through which poor people work under unsafe and sometime life threatening conditions.  It could very well be anxiety provoking to acknowledge our personal connection to this social fact. That is why of course activists insist that trade be fair as well as free.

Marx’s use of the term, “fetishism” is also suggestive to the psychoanalytic listener, and may provide some additional insight. For example, many men are comfortable in a sexual situation, at least initially, only if they can focus on a body part, for example, a woman’s breast, leg, buttocks or foot. This is very common, as is evident in most commercial pornography.  In the extreme, a male fetishist may need a prop, for example a shoe, in order to become sexually excited. He endows the fetish or shoe with magical properties. One hypothesis is that the this focus on a part, rather than the whole, and on a material object, rather than on the relationship with the woman,  enables the man to exercise control over the conditions that excite him. Absent the fetish his excitement would turn into anxiety. The conception that money is a physical object, that is separate from the complicated relationships it sets into motion, and from the relationships it exposes, shares some of these features. (Note to my skeptical reader. Invoking sexuality does not mean that people's relationship to money is sexualized  Rather, by drawing on sexual experience in its vividness and specificity we gain insight into motivation and its constituents more generally. This is one way to interpret psychoanalysis' privileging of sex as a key to motivation.) 
 

The term “magical” points to another and perhaps more speculative hypothesis. I came across the following video, which gives a coherent presentation of credit creation, emphasizing for example the creation of credit out of nothing and the system of account settlement and clearing. (http://www.youtube.com/watch?v=KyDU4X8GSmE) Yet the tone and import of the video suggests conspiracy. It is introduced with dark sounding music, and images of a grim reaper type of figure chained to a rock of “debt” and swinging a mallet to break the chain. The video scrolls through a quote by Woodrow Wilson, the 28^th president of the United States, “Some of the biggest men in the United States, in the field of commerce and manufacture, are afraid of somebody. They know that there is a power somewhere so organized, so subtle, so watchful, so interlocked, so complete, so pervasive that they had better not speak above their breath when they speak in condemnation of it.” The video’s central message is that there is something nefarious about the fact that credit is created “ex-nihilo,” or to translate the Latin, “out of nothing.”    

The phrase “ex-nihilo” is in fact linked to the idea of credit creation (http://en.wikipedia.org/wiki/Ex_nihilo),  but was originally a theological description of God’s powers.  In Judeo-Christian theology only God can create ex-nihilo. This is why the Old Testament counsels the Israelites to avoid magic and magicians, “No witch shall you let live,” (Exodus, 22: 17).  Moreover, the economist Fredrick Hayek argues that in the early stages of capitalism, “Activities that appear to add to available wealth ‘out of nothing,’ without physical re-creation and by merely rearranging what already exists, stink of sorcery.” As David Hawkes notes this was one basis for the revulsion against usury in Renaissance England; not that it was simply unjust but that it was supernatural. Money “procreated” so to speak, in the form of interest payments added to capital. Yet it was lifeless. As he writes, “Usury was magic perfected by other means.” (The Culture of Usury in Renaissance England, Palgrave, 2010)

Today most of us do not believe in magic. Instead we enjoy magic shows in which stage magicians makes objects appear out of nothing -- ex-nihilo -- but only in fun, though we are often astonished. I want to suggest nonetheless that there is an experiential basis for our anxieties about "ex-nihilo," particularly in a secular age. If we think seriously about our own existence, it must seem that we came into the world, ex-nihilo. Of course we understand how babies are born, but our own existence is so arbitrary. After all, none of us have existed since the beginning of the universe and yet here we are now, suddenly! How can that be?  

The arbitrary can be frightening. It is a portal to chaos. But we should also remember that the other side of arbitrary is “contingency.” Our world is not determined, and this becomes the basis for creative work of all kinds. That is why credit creation can support entrepreneurship, which is, after all, the creative arrangement of resources in new ways.

One speculative hypothesis is that that we project these existential anxieties onto a “folk-theory” about money. At the extreme, some people develop a theory of money in which “hidden forces,” who create credit out of nothing, use this power to enslave us, in other words to eliminate contingency and the capacity for creative work. This fantasy paradoxically provides relief because it suggests that someone, some shadowy network, is actually in control. All is not chaos, and if we are smart enough, we can control the controllers. A larger number of people, less likely to be drawn to conspiratorial thinking, persists in thinking of money as a physical object that operates mechanically, as a way of avoiding the uncomfortable idea that the course of our lives, like our birth, is entirely contingent and unpredictable. The laws of money like the laws of physics provide scaffolding, an “invisible hand.” This may be one reason why economists did not anticipate the financial crisis that led to the Great Recession. This sense of contingency is also the basis for  the criticism that George Soros, the famous investor, has of modern economic theory. His name for it is "reflexivity." The challenge then, is to accept the arbitrary, and then see the creative opportunities in contingency, both in our individual lives and in the social world we create together. We can use credit and money creatively.

The Indictment of the hedge fund SAC

  Last month, federal prosecutors indicted the large and profitable hedge fund SAC, labeling it a criminal enterprise. The indictment charges that the firm and its portfolio managers, under the direction of its owner, Steven A Cohen, engaged in substantial insider trading; that is, soliciting and trading on material information about companies that was not in the public domain. As the indictment reads, “This insider trading was substantial, pervasive and on a scale without known precedent in the hedge fund industry.”

While the charge is severe, it actually reflects the prosecutor’s failure to indict Steven Cohen directly as someone who solicited and or paid for inside tips. This, despite the fact that the prosecutors wiretapped his home phone for two weeks and the Securities and Exchange Commission combed through all of the firm’s trades and emails. Instead, they took the unusual step of arguing that the firm’s purposes were criminal and that its ill-gotten gains, when mixed with legitimately acquired profits, was evidence that it was laundering dirty money. The last time prosecutors charged an enterprise, rather its officers or employees, was when the accounting firm Arthur Anderson was charged with helping executives from Enron, the energy company, to cook its books. Anderson collapsed shortly afterwards, as its clients took back their business. Thousands of people lost their jobs. As a result, prosecutors have been very reluctant to charge enterprises rather than individuals. However, had they not filed these charges in July, the statute of limitations against the firm and against Steven Cohen would have expired this summer.

The indictment notes that four one-time SAC employees pleaded guilty to insider trading while at the fund, while five others have been implicated in such conduct. In the most damming instance, a portfolio manager, Matthew Martoma, got information from a physician, who was privy to the results of a trial of an Alzheimer’s drug. The physician has admitted giving Martoma this information. Believing at first that the drug would prove to be effective, Martoma had urged Cohen to buy shares of the two drug companies sponsoring the trials.  But when the physician tipped Martoma off that the drug trial had failed, Martoma, the prosecutors charge, told Cohen, during a twenty-minute phone call, to sell his shares; this only days before the trial results were to be presented for the first time publicly at a scientific conference. (Prosecutors know the timing of the phone call, not its contents.) As one journalist notes, “The indictment describes a sudden, massive, and highly confident change in sentiment on the part of SAC. The hedge fund didn’t just sell off its large position in the two companies, it put new money at risk by shorting them.” As the journalist notes, when an investor shorts a stock, “it exposes itself to potentially unlimited losses,” since it is borrowing shares and then selling them, betting that its price will fall, when it fact its price could rise without limit. It takes considerable conviction to short a stock. SAC avoided losses of $194 million by selling its shares, and made $82 million on the short sale. Prosecutors charge that Martoma’s conviction was not based on good detective work but on inside information. Few observers doubt Martoma’s guilt, though he is pleading not-guilty. But no one but Martoma and Cohen know what they said to each other during that twenty-minute phone call. 

Prosecutors have taken the risk of charging SAC with being a criminal enterprise in part because SAC, under Cohen’s direction, has earned extraordinary returns over its lifetime. For example, SAC earned 70% returns, “riding the high tech wave of 1998-99 and then even a more mind boggling 70%, betting against the very same stocks in 2000.” In 2006 his fund returned 32%, and in 2007, 14%, while the S&P index earned only 16% and 5% in those same years. The fund has had only one down year, 2008, in the midst of the financial crisis, and since 1996 has averaged annual returns of 25%. This compares favorably with Warren Buffet’s earnings of 8.5%. If, as many academicians argue, stock prices move for the most part randomly, SAC, prosecutors concluded, must be getting inside information.

Yet few people doubt that Cohen is a preternaturally gifted trader. As one person noted, “Let me tell you, as his clearing agent, I’ve seen all his records, hundreds of thousands of trades, all of it, and my conclusion is simply that the guy is an artist. He looks at a stock market in chaos and sees order. He was just right over and over and over. I’ve sat and watched him trade, watched him stare at his terminal in silence, and I can tell you, without a doubt, he is the best that ever was at what he does.” Cohen, like many great traders, was a master poker player in high school and college and became fascinated by stocks when he was 11 years old. When he began trading he was characterized as a superlative “tape reader." He could look at the “ticker-tape” as stock names, volume traded,  prices and price changes moved across the screen, and discern organized patterns of buying and selling. As he once described it, “I’m not looking at anything. Just the numbers on the screen. I couldn’t even tell you what the company did, and I don’t care. I’ve always been intuitive like that. It was always seat-of-the-pants.” In his early years he developed a day-trading style, moving in and out of particular stocks, cutting his losses quickly and speculating on movement and catalysts. As he once noted, “We trade fast. It’s not growth investing. Its short term catalyst investing.” Similarly a colleague describing his trading style, said that, “He is fundamentally a speculator. He does not care if a stock is worth 10 or 100, he wants to know if it going from 10 to 11 or from 10 to zero.”

His skill may appear less magical if we think of its as a feat of abstraction, seeing in numbers themselves, without reference to their substantive meaning, the signatures of emotions that drive trading. In some degree this is what “chartists, (people who look at charts of stock movements without reference to the underlying value of stocks) try to do. But it appears that Cohen can do this close to instantaneously. Certainly, there have been famous mathematicians, such as Benoit Mandlebrot, who had a preternatural ability to see patterns in pure numbers. It is also plausible that his poker playing skills, the ability to control impulses and play purely based on probabilities, helped him regulate his feelings as he watched the tape.

Yet, if we believe that his artistry was the precondition for his early success, it also seems reasonable to conclude that he could not grow a firm based on his talent alone. It would be impossible to train others to trade as he did, so his profits would be limited by his own available time and attention. Interestingly, it appears that he tried. He hired a psychiatrist and performance coach, Arie Kiev, to help his traders regulate their feelings as they bought and sold stocks. But sometime in the early nineties, he developed a new conception of his firm as an “information gathering machine,” and described his trading as “information arbitrage.” According to a marketing document SAC circulated to investors, SAC by 2009 had more than 90 research analysts covering two-dozen industry sectors.” The firm's “edge," the brochure added, included, "over 60 portfolio management teams with deep industry networks."

In addition, by paying investment banks and brokers good money for their trading services, Cohen got good market information from them. As one journalist writes, “SAC is different because it is of the Wall Street system. The firm reportedly pays more total brokerage commissions every year than any other group on earth…brokerages and analysts bombard SAC with ideas, edges, speedy fills and every other micro-advantage that comes with being a target customer.”

Similarly, another journalist writes, “SAC was able to demand preferential treatment from its friends on Wall Street. These were not even illegal confidential tips but the stuff the average investor can’t get at home, such as market chatter about large trades and other bits of trading intelligence available only to the big Wall Street firms and shared with only their best customers.” In addition, “Former traders and rivals say one way Cohen built his business and relationships with brokers was by buying secondary offerings, when public companies decide to bring more shares to market, on which brokers receive around 40 cents to $2 a share on a built-in sales commission. ‘If you take down a million shares of a secondary, you've just paid your broker $1.5 million,’ says a fund manager. That's how Stevie started off paying the Street." Finally, “former SAC employees have started at least 31 other funds, in which Cohen often invests, and the expectation is that the former traders will continue to feed SAC information, which is why one SAC alumnus calls Cohen 'the Godfather.'”

We can consider this business model the outgrowth of Cohen’s instinctive game playing ability; the willingness and ability to use inducements, and the threat of withdrawing them, to stimulate cooperation and reciprocity. Combined with his capacity to absorb information and see patterns in numbers, one can see how he was able to build an information arbitrage machine.  

But in 2000, the context for gathering information on Wall-Street changed significantly. In that year the Securities and Exchange Commission, released a regulation that forbad companies, investment bankers, Wall Street analysts, company employees or a company’s lawyers from releasing material information selectively to some investors or traders before informing all potential investors. For example, if they held a conference call on their earnings, everyone had the right to dial in.

But yet, to gain an edge, traders need to acquire non-public information. The question then becomes whether that information is “material enough” to give a trader an unfair advantage. Many traders advanced what became known as the “mosaic theory,” which holds that traders could obtain non-public information, for example that a company’s shipments by rail have slowed down, which becomes material only when added to other pieces of information. The SEC did not intend to quash traders' and analysts' everyday activity, such as attending conferences, tracking companies and speaking to experts, Indeed, as the following chart shows, after the regulation was passed there was a significant increase in the number of firms, called “expert firms” that hired experts, often employees of fortune 500 companies, to consult with analysts and traders on industry and company trends. Indeed, the physician who tipped Martoma was in the employ of an expert firm. 

 

It is a common phenomena that when rules and injunctions are unclear, it falls upon individuals to do the work and take the risk of interpreting them as best as they can. But if my colleague Ben Hunt is right, the SEC has also, and perhaps unwittingly, criminalized the process of obtaining any private information on public companies. As Hunt notes, “Obtaining private information on public companies has been largely criminalized today. Since the SEC's adoption of Reg FD in August 2000, any investment perspective based on 'getting to know management really well' has skirted the borders of legality…” (http://epsilontheory.com/schrodingers-portfolio/).  But we know what happens when typical behavior is criminalized, such as pot smoking or prostitution. It creates either contempt for the rules and/or moral quandaries and psychological conflicts for individuals. 

Contempt may account in part for why SAC’s compliance department, despite its size and the reputation of its head, had limited impact on trader’s practices. A former employee, Noah Freeman, who gave testimony in another insider trading case “suggested that some SAC employees were adept at evading compliance efforts. They seem to have routinely used private e-mails and kept notes on encrypted drives ‘so that in the event of a subpoena or government investigation, there wouldn’t be notes on the central corporate servers that the government could get their hold of,’ Mr. Freeman testified.” This may be one reason why, despite the number of SAC portfolio managers and research analysts who have pled guilty to insider trading, “SAC’s compliance department contemporaneously identified only a single instance of suspected insider trading by its employees in its history.”

One question is how did Steven Cohen respond to this change in the legal context for acquiring information. What did he think of the day-to-day dilemmas now facing his own portfolio managers and research analysts? The prosecution’s theory, is that as the head of a criminal enterprise he organized the firm and its flow of information so that he could deny knowing that traders’ and analysts’ ideas came from insiders. This enabled him to keep the pressure on his portfolio managers to supply with him good trading ideas without risking his own legal standing. One fact supporting this theory is that, as one author writes, “Sometime around 2002 SAC began decentralizing the information flow among the various specialized groups at the fund, moving Cohen, who would directly manage just a portion of the SACs money, away from the center of information flow.” (Charles Gasparino, Circle of Friends) In addition, Cohen pushed his managers to specify with what level of conviction, on a scale of 1 to 10, they believed in a particular trading idea. From the prosecutor’s point of view this was a veiled way for a trader, who answered with a  “9” or “10,” to communicate that his idea was based on private information obtained from trusted insiders.

I want to propose an alternative to the prosecutor’s theory, based not on Cohen’s presumably criminal impulses, but rather on this character and psychology. As a master poker player, committed to winning, Cohen’s relationships with others were transactional, based simply on whether a person could help him win. In this setting one employee noted, “The rules here are simple, “win and you get rich and lose and you get fired.” Matthew Martoma who helped Cohen make the $82 million on the pharmaceutical short sale, got a $9.5 million bonus, but was promptly fired the next year when he failed to come up with a new winning idea. As the journalist notes, “Mr. Cohen, a mercurial master, has been known to fire money managers for making one bad trade even if they had made him billions before.” Cohen as I have suggested, learned to see his corner of the world through numbers, without considering their link to substantive truths, He could translate the emotional drama that underlies investing -- the cycles of hope, greed, fear, elation and panic-- in a manner that could not touch him emotionally. Indeed, his trading room is famous for the fact that phones never ring, they flash, and that the temperature is kept cool to keep people alert.

In addition, as a reporter who interviewed Cohen notes, “(in this early years) Cohen quickly became known for the volcanic temper he displayed when anything went wrong. ‘People say they’ve never been spoken to the way I spoke to them on the phone,’ he says with a shrug.” In other words, he is not burdened by concerns for other people’s feelings, at least not when they are willing players in the trading game and become obstacles to his winning.

It would be too rash to conclude that he is in general indifferent. He has four children with his second wife to whom he has been married for 21 years. Rather, if you are in the game, you’re meaning is assessed along only one dimension; are you a winner or a loser.  Thomas Conheeney, SAC’s president, once remarked that “Steve doesn’t really understand his own persona, this iconic status he has. We try to get him to go talk to these business groups, and he goes, ‘Why would they want to hear anything I have to say?’” I don’t think this is a matter of modesty. Rather I suggest it reflects his disinterest in what most people think and feel about him.

So consider my psychological hypothesis. If I am right about this character, Cohen would have limited or no interest in the complexities and challenges his traders, analysts and portfolio managers faced in threading the needle between material and non-material information. He was not tuned to their experiences, only toward their utility. This enabled him to sidestep the meaning of the new regulation while continuing to pressure his employees to give him “high conviction” trading ideas. Or let me put it this way. A different hedge fund owner, an alternate Steven Cohen, may have had the same impulse -- to deny the substantive impact of the regulation on his traders’ everyday experiences, -- but his psychological connection to his traders and analysts would have quashed that impulse. Empathy would link him to their quandary, so that should he benefit from their misconduct ,he would feel guilty and burdened. This alternate Steven Cohen would have had to have faced the implications of the new regulations and take some responsibility for his subsequent stance.

This hypothesis helps account for Cohen’s disinterest in the issue of insider trading and in his fund’s policies on compliance. Giving testimony in a deposition on a different case in 2011, Cohen said, “The way I understand the rules on trading on inside information, its very vague.” When asked about his firm’s compliance manual he answered, “..when you’re trading securities it’s a judgment call. Whatever the compliance manual says, it probably doesn't take into account every potential situation.” There is of course a sense in which these answers are correct. But they reflect I suggest a lack of interest in the rule’s impact on decision making and behavior.

Frequently, people benefit from the misconduct of others while feeling no direct responsibility for the misconduct itself.  For example, employees of Apple benefited when Apple executives conspired to fix the price of e-books with publishers. After all, Apple’s higher profits created more resources and rewards for its employees. But I imagine that very few Apple employees quit rather than benefit from the company’s unlawful conduct. They felt far too removed from the decision to fix prices. Many of us benefit from the unethical conduct of clothing manufacturers who give business to factories in Bangladesh, where costs are low because factory conditions are unsafe. Yet many of us continue to buy this clothing on the presumption that we are bystanders.

I hypothesize that Cohen, rather than being the mastermind, as prosecutors saw him, acted as if he were a bystander, failing to connect the pressure he put on his employees with the constraints they faced in navigating a messy ethical terrain. This failure I suggest was motivated by his emotional detachment from people who like him were “playing the game” though it also advanced, at least in the short run, his self interest. If my hypothesis has merit, it was Cohen’s character flaw to be so close to the action, yet experience himself as a bystander. It is striking in this regard that when the investigators tapped his home phone they discovered to their surprise that he had few friends. They expected a mastermind to have a wide network of friends and acquaintances. This had been true of
Raj Rajaratnam,  a hedge fund owner who, with the aid of wiretaps, was successfully convicted of insider trading. Rajaratnam had in fact a keen interest in other people's psychology, if only to assess their weak points and seduce them into conspiring with him. This is how he ensnared Rajat Gupta, the one time head of Mckinsey, the consulting firm, and a person of high repute. 

It is useful to ask why we should consider the psychological hypothesis at all, when an explanation from self-interest, call it the politics hypothesis, is sufficient. Moreover, the politics hypothesis often has the merit of being simple, whereas the psychological hypothesis is not. Cohen, the prosecutor argues, benefited from insider trading and so he developed a system of extracting it from his traders while maintaining his “plausible deniability.”

But the merit of the psychological hypothesis is that it stimulates our  empathy and identification and helps create a more human understanding of someone else’s decisions and motives. For example, following my hypothesis we can come into touch with how at times we are all bystanders who benefit from the misconduct of others. Ironically, the prosecutor’s theory shares the same limited or “transactional” view of human behavior that Cohen brought to his experience of trading. In this view, a person’s self interest is the best guide to understanding his behavior. A person has either broken the law or has not. Perhaps this simplified understanding of human motivation explains why, to their frustration, the prosecutors could not find direct evidence of Cohen’s culpability despite the wiretap, and at least five years of investigating him and his firm.  It was just not that simple.