The missing link of financial reform

20 04 2009

Throughout the entire financial crisis/meltdown the calls for reform are pretty spot on and uniform:  A more regulated less leveraged system to decrease volatility.  Fine.  Sign me up.  But something always bothered me about finance that never seems be addressed.  Its pretty clear that banks artificially raises the prices of key assets (like housing and tuition) through leverage.  In a pure market where loans are not allowed and you could only sell assets for whatever cash people had on hand, well guess how much that “million dollar” home down the street would really sell for?  The answer is likely for whatever the down payment would be – usually around 20% of the loan.  The problem is that in exchange for this artificial pricing there is no systemic payoff – only the banks realize a profit through the interest they charge.  Thats because the people who sell a million dollar home don’t share in the profit for the most part – they need to buy a new house to live in which, in turn, is also artificially inflated by the same system.  Think about the tuition rate over the last twenty tears.  Is it any coincidence that the cost of college has increased exponentially along with federally funded student loan programs?

What does all this lead to?  Well in times of crises all of this leverage makes the downturn exponentially worse and that much harder to get out of.   But how do we deal with this issue?  Is it just a necessary evil of a modern financial system?  Last week I read a very interesting NY Times piece by Eric Zencey entitled “Mr. Soddy’s Ecological Economy.”  In the aftermath of the Depression Frederick Soddy, a British nobel prize winning chemist who helped bring about the atomic age, decided to turn his attention to economics.  He was disgusted with the destructive powers of atomic energy and turned, rather brazenly, to trying to solve the inefficiencies of economics.  He was considered a kook – he used laws of thermodynamics and nature and applied them to economics.  He had 5 natural laws that he wanted to impose (see the article for a more in depth description).  He died pretty much discredited but guess what?  Four of the five are now considered mainstream regulatory necessities.  But it is the fifth, still marginalized, that I see as a possible answer of the leverage problem of finance:

Soddy’s fifth proposal, the only one that remains outside the bounds of conventional wisdom, was to stop banks from creating money (and debt) out of nothing. Banks do this by lending out most of their depositors’ money at interest — making loans that the borrower soon puts in a demand deposit (checking) account, where it will soon be lent out again to create more debt and demand deposits, and so on, almost ad infinitum.

One way to stop this cycle, suggests Herman Daly, an ecological economist, would be to gradually institute a 100-percent reserve requirement on demand deposits. This would begin to shrink what Professor Daly calls “the enormous pyramid of debt that is precariously balanced atop the real economy, threatening to crash.”

Banks would support themselves by charging fees for safekeeping, check clearing and all the other legitimate financial services they provide. They would still make loans and still be able to lend at interest “the real money of real depositors,” in Professor Daly’s phrase, people who forgo consumption today by taking money out of their checking accounts and putting it in time deposits — CDs, passbook savings, 401(k)’s. In return, these savers receive a slightly larger claim on the real wealth of the community in the future.

In such a system, every increase in spending by borrowers would have to be matched by an act of saving or abstinence on the part of a depositor. This would re-establish a one-to-one correspondence between the real wealth of the community and the claims on that real wealth.

Wall Street wankers complaining – unbelievable

20 04 2009

Great story in New York Magazine titled “The Wail of the 1%.”  Just amazing quotes.  Here’s one genius:

“People just don’t get it,” she says. “I’m attached to my BlackBerry. I was at my doctor the other day, and my doctor said to me, ‘You know, I like that when I leave the office, I leave.’ I get calls at two in the morning, when the market moves. That costs money. If they keep compensation capped, I don’t know how the deals get done. They’re taking Wall Street and throwing it in the East River.”

How did all these people make so much money?  The lack of intelligence or rationality is amazing.  Just morons.  Don’t you get it?  Your value was based on how much Wall Street made…Wall Street HAS CRASHED.  Without tax payer money none of you are getting anything.  And, believe me, the most basic job that involves manual labor is a million times tougher than yours.

Reading their crap truly embarrasses me to be a fellow American, let alone a fellow human being.  Shut the fuck up, grow up and grow a brain.  Whiny babies.

Our political system provides no solutions

21 03 2009

THIS is why nothing will ever change.  I am so fucking sick of people allowing  themselves to be temporarily outraged and Congress following suit with the proper sound bites….and then its back to the same old same old.  At what point do we stop being sheep?  At what point do we limit lobbying and money in politics?  Because THAT is what is at the heart of the current mess – we allow the power players in this country to run everything to their advantage again and again.  So pathetic.

“It’s a bullshit science”

14 03 2009

Nassim Nicholas Taleb, once again, summing up the field of economics perfectly.

Some highlights:

-Years ago, I noticed one thing about economics, and that is that economists didn’t get anything right. I wanted to find out the reason. They would say their models are not perfect. But data show that you do much worse using their models than you would without them. It’s a bull [expletive] science.

-Yes, Roubini got it right. But Roubini wasn’t right because he’s an academic economist. He was right because he is a very insightful fellow. He is so good he managed to surmount his education in economics.

-I know who should not be on his (Obama’s) team — anyone who did not understand that the world financial system included more risks than it showed. This leaves plenty of individuals outside the administration and outside the economics profession who warned about it. Aside from Roubini, the closest thing in the economics profession would be Ken Rogoff. I would also require that the person be a business person — someone who did not make a career writing papers to impress fellow economists.

-Look at [former Treasury secretary Robert] Rubin at Citigroup. He made and kept a $115 million bonus while the taxpayer has to bail them out. We should not be paying the Bob Rubins anymore. We have to have clawback provisions to make sure that we punish people for their bad bets.  I am in favor of partially nationalizing the banks for this reason and banning complex derivatives. Nobody understands them. I would also start indicting the vendors of these financial risk management systems that everyone relied upon to tell them everything was okay when it wasn’t.

-Complex systems do not like debt. So it will proceed to destroy tens of trillions in debt until society rebuilds itself in an ultraconservative manner. We are in for a worse ride than people think.  People have the problem of denial. This is one of the things I learned in Lebanon. Everybody who left Beirut when the war started, including my parents, said, ‘Oh, its temporary.’ It lasted 17 years! People tend to underestimate the gravity of these situations. That’s how they work.

-My rosy scenario is that a better economic environment will develop, a low-debt, robust growth world, in which whatever is fragile will be allowed to break early and not late.  My nightmare scenario is that the government saves Citibank once again, as well as the other banks, and business resumes as usual. Then, the next time the system breaks, it breaks much, much bigger.

Joseph Stiglitz sums up TARP 1 perfectly

21 02 2009

God this pisses me off:

On fixing financial institutions: “It is pretty clear that TARP 1 — the first $350 billion — did not work. It gets an F or F–, depending on your grading structure. What we squandered on our banks would have fixed Social Security for several generations … This is close to a zero-sum transaction. The losses are there and people are talking about moving those losses from one part of the balance sheet to another, but those losses don’t disappear from society. They are still there. Most of what’s happening is just moving things around with financial alchemy. It’s not quite zero-sum because it can be a negative sum if you don’t get it right … People talk about the greed of bankers in taking the money the government gave them and using it for bonuses, not recapitalization … Well, they were doing what their incentives told them to do … A big mistake the government has made is that it has confused its ability to make loans with its incentive to make loans.”

And another thing thats sets me off is that the way Paulson wrote TARP was that clawbacks are actually possible – Obama and Congress can go in and take back all that bonus money.  But they don’t because of politicial and societal reasons (historically in America we don’t like to take profits ex post facto – well, except for a littl institution called the IRS).  My one hope is that when they do finally nationalize these banks (and at this point with their stocks trading so low the fear of wiping out stockholders no longer – their officially wiped out) they will go back in and get that bonus money.  But I am willing to bet everything I have that won’t happen. Sometimes you need a real bastard in the White House – and Obama ain’t one.  I know there are alot of run on sentences in all that – but I’m boiling.

Interesting – the real estate collapse wasn’t caused by Fannie and Freddie

20 02 2009

Interesting analysis. As it turns out it was Wall Street’s involvement in creating subprime mortgages that created the bubble and toxic subprimes.  Not so much Fannie and Freddie Mac.  By the end financial institutions owned a far larger portion of the market.

Complicated charts made by boy geniuses to follow:

On the other hand the news is not all bad….

18 02 2009

If Roubini says its a good thing I’m listening.