Uncle Sam’s Bicoastal Tug of War: The Internet of Things vs. Too Big to Fail

By now, it’s a cliche that the Internet of Things is going to change everything. That’s right: Americans have barely had time to digest all the effects of the Internet, and now comes along the Internet of Things (IoT). If the Internet created a new order in cyberspace, then the IoT is going to create a new order in the physical world--or, as geeks call it, “meat space.”  

Some day soon, many, if not most, objects will have a bar code, or RFID chip, or a trackable equivalent. In this Big Data-fied world, everything will be known, and nothing will be lost.  

That’s the ambitious vision: now to the task of connecting the dots. And the latest instance of dot-connecting is the Industrial Internet Consortium, which describes its work like this:

The initiative—which includes big names like AT&T, Cisco, GE, IBM, and Intel—will establish design and engineering standards for sensors, monitors, networks, and other intelligent systems. The broader goal is to improve machine-to-machine communications and unite the physical and digital worlds.

So is the IoT really cool? Or is it really scary? It depends on who’s answering the question. The legendary fantasy writer H. P. Lovecraft, who died back in 1937, seemed to anticipate, in his short story “The Call of Cthulu,” the potential of the Internet/IoT; Lovecraft argued, in effect, that ignorance was bliss, and that total connectivity would equal total horror:

The most merciful thing in the world, I think, is the inability of the human mind to correlate all its contents. We live on a placid island of ignorance in the midst of black seas of infinity, and it was not meant that we should voyage far. The sciences, each straining in its own direction, have hitherto harmed us little; but some day the piecing together of dissociated knowledge will open up such terrifying vistas of reality, and of our frightful position therein, that we shall either go mad from the revelation or flee from the light into the peace and safety of a new dark age.

Lovecraft, of course, was a disturbed mind--that’s the secret of his enduring popularity. But perhaps he will also be remembered as prescient.   

Meanwhile, in our own time, fiction has extrapolated scary scenarios for the IoT. A 2012 episode of the TV show “Homeland,” for example, depicted terrorists assassinating the vice president by switching off his heart pacemaker. Yes, that show was fiction, but the prospect of terrorists--and teenagers--hacking the IoT is menacingly real. 

So of course the government will be playing a major regulatory role in the IoT. In the past, the state has worked with merchants and businesses to help set standards for commerce--standards for weights and measures, for instance, or for patents and copyrights, or for telephone and television networks.  

At the same time, the state has claimed the role of protector of the public interest, and so various regulatory agencies have sprung into existence--at the local, state, and federal level--all charged with policing these various systems and networks. And so now, with the IoT, we can expect a similar emergence of safeguarding regulations--or, as one might also label them, burdensome red tape.    

Also, of course, if the IoT becomes as all-encompassing as expected, the Department of Homeland Security will be in the middle of it all, protecting Americans. Or maybe spying on them, too--just a hunch.

So at this point in time, there’s no way to know where the IoT is headed, but there’s one thing we can be sure of: There will be plenty of unintended consequences. For example, in the financial sector, government policies that guarantee the survival of big financial institutions--the doctrine of Too Big to Fail (TBTF)--have also served to accelerate the rise of High Frequency Trading (HFT).   

How so? How does TBTF promote HFT? Here’s how: Once investors know about TBTF, they have every incentive to make riskier and riskier bets--because the bigger the risk, the bigger the potential gain. And if they lose?  Well, thanks to TBTF, they can’t lose too much. So as a result, finance has grown and grown, making bigger and bigger bets.  

In the 1940s, finance amounted to about two percent of American GDP. By the early 80s, that share had doubled to around four precent, and today, it’s about eight percent. In other words, this burgeoning financialism survived even the crash of 2007-8. And how, we might ask, did that happen?  How was Wall Street saved from the folly of its own meltdown?   

A detailed answer to those questions can be found in an insightful 2010 book by Perry Mehrling, professor at Barnard College: The New Lombard Street: How the Fed Became the Dealer of Last Resort. Mehrling takes us back to the days when big firms were going bust and the Federal Reserve Board was stepping in:

After the collapse of Lehman Brothers and AIG, and the consequent freeze up of money markets both domestically and internationally, the Fed did even more, shifting much of the wholesale money market onto its own balance sheet, more than doubling its size in a matter of weeks. In retrospect this move can be seen as the beginning of a new role for the Fed that I call “dealer of last resort.”

By “dealer of last resort,” Mehrling means, of course, “bailout of last resort,” or even maybe, “bailout of first resort.” As we all remember, the Troubled Asset Relief Program of 2008 was a no-strings bailout. And yet that $700 billion program, approved by Congress, has been dwarfed by the Fed’s multi-trillion dollar programs, which have been only barely approved by Congress. Mehrling continues:

Once it became apparent that the emergency measures had stopped the freefall, the Fed moved to replace its temporary loans to various elements of the financial sector with permanent holdings of mortgage backed securities, essentially loans to households. This is something completely new.

In 2011, Bloomberg News estimated the total value of Uncle Sam’s interventions to be $7.7 trillion, and since then, of course, the Fed has continued its efforts, notably in the form of Zero Interest Rate Policies and Quantitative Easing.  In other words, the value of all these interventions is easily north of $10 trillion.

Indeed, Bloomberg calculates the value of TBTF at $83 billion annually, and further notes that just five huge institutions--JP Morgan, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs--account for $64 billion, or almost four-fifths, of that total subsidy.  

As a result, with so much money involved in so few hands, it’s easy to justify even greater investments--to make even more money. Thus HFT has given rise to ever higher frequencies of trading; if everything is so totally connected, those with faster connections will have an edge.  

As a further result, the need for speed--or, one could say, the greed for speed--has inspired a boom in new cables, all to shave a millisecond or two off trading times. In this high-volume environment, the thinnest margin can be multiplied by billions, even trillions, and all those thin slivers add up. With enough volume, great rewards and riches do indeed go to the swift.  

Moreover, if the system can be gamed through an artifice such as “front-running”--that is, one HFT-er getting in front of another HFT-er and buying and selling the stock at a tiny bump-up in price in the nano time before the trade occurs--that’s even a further, extra way to make money. The accusation that such front-running is endemic is the point made in the new book by Michael Lewis, Flash Boys: A Wall Street RevoltThe questions: Is Lewis right? Is it really happening? And if it is, is it legal?  

The one thing we know for sure is that the financial sector is doing very well, thank you very much. In a new paper, “Finance vs. Wal-Mart: Why are Financial Services so Expensive?” Thomas Philippon of New York University calculates the annual value of all the government’s pro-financialist policies to be some $280 billion.  Once again, these numbers are subject to debate, but what can’t be argued is that Manhattan real estate is surging; the cost of an apartment has spiked 30 percent in the last year, to an average of $1.7 million.   

So once again, Uncle Sam seems destined to step in.  Having contributed to the rise of HFT, the government will likely seek new regulations on the practice, even as it seems determined, nevertheless, to protect the concurrent doctrine of TBTF.   

Now, back to IoT: It seems, then, that IoT and TBTF are destined to come into conflict; there will be, one might say, a battle of “operating systems”--that is, the operating system of West Coast-based IoT vs. the operating system of East Coast-based TBTF. The two systems are, of course, very different: On the one side, the ultimate power comes from the tech visionaries of Silicon Valley and Moore’s Law; on the other side, the ultimate power comes from Wall Street and their bailout buddies in Washington, DC.   

So who will prevail? Will it be the geeks? Or will it be the moneymen? It’s risky to bet against the power of new science and technology, but it’s also risky to bet against the power of finance and the federal government. So perhaps the two operating systems will find a way to fuse together: The IoT plus TBTF.  

And what would that be like? As an astute observer by the name of Terman--the name is undoubtedly an homage to Frederick Terman, one of the founding figures of Silicon Valley--recently observed, herehere, and here, the real powers in this future will be institutions.  

But will these institutions be public? Or will they be private? Or a hybrid?   

Moreover, what will be the role of the US Constitution? And how will public opinion shape the resulting debate?  And what, then, will be the future of our freedom?    

These are all interesting questions.  


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