We’re lucky to be deep in the money

I think it’s interesting to consider institutions in the context of option theory. When discussing options, an option holder can be in the money or out of the money. If you are in the money, that means you could exercise the option today and realize a positive payout, while if you are out of the money, all of the value of the option is in the probability that it gets into the money. Typically, underlying securities or metrics are considered to be somewhat limited in their randomness. For example, the chance that Apple is worth nothing tomorrow is best understood as zero, as is the chance that it is worth twice as much. Similarly, the right to buy Apple stock for nothing, or at .01 per share, is approximately guaranteed to be worth something tomorrow, and is therefore called deep (very deep in this case) in the money.

With regard to institutions, you can think of the way that we interact with them as a function of how we perceive them. Hopefully without sounding too cold, our parents are in many ways the first institution that we encounter. When times are good, asking for extra allowance or exceptions to the rules can seem acceptable, (particularly when we’re teenagers), while obviously it would be absurd to ask for money from a dying parent. Other institutions in our lives can be understood similarly, although we are able to see them at their infancy instead of starting in their prime. When they are weak and young, before they have become strong, we tend to recognize that they require support. We donate money, we support exceptions to rules that bind them, and ask as little of them as possible so that they can remain unstrained. As they grow, we start to withdraw support, since they don’t need it anymore. Universities are a good example of this. Instead of viewing donations to universities as noble, we’re coming to a point where they appear wasteful — what does Harvard need another billion dollars for? In contrast, we start to ask institutions to do more, and particularly to give more. Again, looking at universities, we ask them to take care of our mental health while we are enrolled, to act as a police force and judiciary system for certain infractions, and to make sure that anyone they employ is being paid sufficiently. These are all resource intensive requests, and for the most part it seems like universities are complying. If we think of institutions as options, and we feel comfortable making big asks from institutions that are deep in the money, then it seems that we perceive universities as immortal.

The concerning side of this, for me, is what happens when institutions are no longer deep in the money but we perceive them as still being there. We can see that this has happened with governments, companies, and NGOs, where the burdens we expect them to shoulder ratchet into ever expanding obligations, without typically having a safety mechanism for when they have weakened and can no longer support the expectations layered on. It’s really great to be deep in the money, but we should be wary of what happens if we slip back towards the strike price without adjusting what we ask for.