Wednesday, August 04, 2010

The Scandal

It seems to me that the scandal of the current financial system is that the closer you get the source of the money, i.e., the place where it is printed, issued, and gets leveraged into purchasing power (as credit), the more money you are in a position to make. Banking should be a much less ambitious business. Perhaps it shouldn't be a business at all. All banks have to do is ensure there is enough money to facilitate the circulation of goods. It seems obvious that if someone is in a position to make a profit simply by printing money (and keeping some of it) then "someone" will do exactly that. And this will put too much money into circulation. In effect, the "wealth" of our bankers consists in money they created out of thin air, distributing some (for show) and keeping some (for themselves). So-called "derivatives" were merely a shell game to conceal the operation.


Justin said...

What are you hoping to get out of this metaphor - that banks get to print money? Will it lead to a better understanding of how our financial system works or will it only sensationalize criticism of that system?

If it was even *effectively* true that "someone is in a position to make a profit simply by printing money" than our biggest problem would be inflation.

It is *literally* true that some are given the privilege of being able to borrow at a lower than market rate.

Money gets printed - the most important reason for this is to avoid deflation as real GDP increases.

If the money is directed to good investments, printing (not too much) money can also promote economic growth. Bankers are given this money at a discounted rate because the government hopes they'll make good investments. Their profit is the market price of money minus the discounted price of money minus defaults from bad investments. That's hardly the same as making a profit by printing money.

The problem arises when banks make bad investments that *look* good - that's where the shuffle game comes into play.

Thomas said...

I'm not sure it's a metaphor. I'm not against printing money (in part for the reasons you suggest), I think it's suspicious that the people who are in charge, not of printing it per se, but of managing its conversion into purchasing power, are the wealthiest people in our culture.

Our biggest problem over the last ten or twenty years has been inflation. It has been confined (cleverly) to classes of assets. The "bubbles" we've been watching grow and burst have all been asset price hyper-inflation bubbles. The cause has always been the same: artificially cheap credit (i.e., money) available for the purchase of particular kinds of things.

"Minus defaults from bad investments" is nice in theory. But don't we agree that the bailouts prove it doesn't happen in practice? That's moral hazard. A scandal.

Justin said...

"Our biggest problem over the last ten or twenty years has been inflation. It has been confined (cleverly) to classes of assets."

That's an interesting point.

The difference between asset-price inflation and purchasing-power inflation mirrors the difference between banks being able to print money and doing what they do.

And if the formula were "the market price of money minus the discounted price of money" then banks would effectivelly get to print money and we would have purchasing power hyper-inflation.

I agree, bailouts (to the extend that they happen) are a moral hazard - a perverse incentive to ignore risk and think in the short term. But loans are defaulted on all the time without anyone being bailed out. Right or wrong, bailouts only happen in extreme situations.

If bailouts were guaranteed for every default, banks would have no risk and the market price of money would be pushed down to the discounted price of money. Since they're still far apart, I know the bailouts only covered a fraction of banks' risk.

Thomas said...

The enormous increase in Wall Street's wealth and power over the past two decades was not based on money made off individual loans, i.e., by making money available for purchases of things people needed to live or produce other things. Rather, it was based on "engineering" very complex financial instruments that bundled things like sub-prime loans (which were essentially a policy instrument) with credit default swaps (insurance or gambling, depending on how you look at it).

We can, for the sake of argument, agree that bailouts happen in extreme situations; but the extreme situations themselves are created by the banks (knowing that they will be bailed out). So at a higher level it's exactly like bailing out every default. Think of it this way: how many times more money was "in play" in the derivatives market (which was bailed out) than in the home mortgage market (which, arguable, was not directly bailed out ... i.e., the home owners lost out)?

As I say in the post, the banks essentially printed money. They created ("derived") a pile of fake money and bought real yachts and beach houses for it. We are still waiting for the big adjustment, I'm afraid. The price of a great many things is still way too high.

Curtis Faville said...

The problem is that the system of credit (the exercise of it), which is always based on the underlying risk of resolution of the real debt, can never be trusted to manage itself.

We got into trouble by 1) thinking of the national debt as a bottomless hole into which we could put an ever-increasing IOU; and 2) extending the obligation for that debt further and further out; and 3) letting bankers create increasingly fluid and inaccurately denominated instruments (while constantly lowering the floor of "guarantee").

That fluidity was also facilitated by the rapid movement of capital across national boundaries, so regulation couldn't control it. Governments probably capture less than 15% of the real taxes which are "levied" on profit.

Theoretically, banks aren't supposed to be able to manipulate the risk by betting against it. In a classic capitalist model, debt is a risk against collateral (which may include one's confidence in the principle of honorable obligation), while interest is the reward for this risk. But if the only collateral is deception (and the government's obligation to keep throwing IOU's into the pit), then the system is doomed to bigger and bigger bubbles.

Thomas said...

I basically agree with this, Curtis. Except that I don't think we got into trouble by thinking of the national debt as a bottomless hole. I don't think we ordinary people thought very much about this, and if we had we would only have been vaguely worried and opposed to what was going on. What we did was trust the governments (all the governments) and the banks (all the banks) to be serious people.

Now, what they did was break that trust. But I really don't buy that it was some sort of mistake. I'm with the people who see the financial crisis as the Crime of the Century. A heist. In broad daylight. And still going on. With hostages.