Integrals

Business progress requires transitions from existing to projected states of affairs. In accomplishing those transitions, objective facts are what firms need to take account of. One of the challenges of complex environments is that the value of our recognizing objective facts becomes increasingly important, even as the ability to do so becomes more difficult. 

Objective facts are highly structured. The higher degree to which data can be synthesized, the more the data indicate an objective fact, and hence the more likely it is that the data should be taken account of as indicating the existence of something 'real'. If the extent to which integration sufficient to generate objective facts is unclear, it is useful to consider whether alternative paths exist that lead to the same truth. 

This idea is illustrated in a notional way below. The facts in question relate to the instruments at the heart of the financial crisis. The alternative linguistic pathways are two resources of Pragmatica:  translations in the framework of mathematical logic and translations in the framework of metaphorical language. 

In the early 2000s, collateralized debt obligations transformed the mortgage market by creating a new source of demand for lower-rated tranches of mortgage-backed securities. Tranches rated other than Triple-A were often hard to sell. Wall Street’s solution was to build new securities that would buy the hard-to-sell tranches. Bankers took the low investment-grade tranches, largely rated BBB or A, from mortgage-backed securities and repackaged them into the new securities – CDOs. The majority of those tranches turned out to be rated Triple-A.

How could a pool of mortgage-backed securities rated BBB be transformed into a new security that was mostly rated Triple-A? The securities firms argued, and ratings agencies agreed, that if they pooled many BBB-rated mortgage-backed securities, they would create additional diversification benefits. The ratings agencies ostensibly believed that if one security went bad, the second had only a small chance of going bad at the same time. To estimate the probability of default, the ratings agencies relied mainly on their own ratings of the mortgage-backed securities purchased by the CDOs; they did not look-through the securities to the underlying sub-prime mortgages. 

With respect to the objective quality of CDOs, it is useful to attempt to 'translate' the cluster of ideas that comprise these instruments into coherent linguistic frames of mathematical logic and of metaphor. As it turns out, it is virtually impossible to do either. Interestingly, the explanation for this is the same for both languages. Metaphor, like mathematical logic, is effective precisely because it is an integrated pattern of elements and relations - a version of the transmission of utilities and probabilities that is the foundation for information theory, much of biology, probability theory, and other fields. Our Pragmatica ontology develops this principle, which can be profitably applied in a variety of settings to assess whether relied-upon facts are objective.