"The Western Financial System We Knew Has Collapsed"
That's a quote from William Buiter, courtesy of naked capitalism. You should read the entire naked capitalism post, but a couple of things in it got me thinking about this interesting discussion between ohio and badger on the idea of bubbles in essential goods and services (like housing, energy) as opposed to bubbles in non-essentials (like tech stocks). And about how we decide in times of crisis - or collapse - what we save and what we don't.
One of the ways to think about what's happening in the banking industry is to see the entire industry as a bubble. It's not just that there are too many CDSes and CDOs or that the subprime market went crazy, it's why it happened. And it appears to me that one of the main reasons it happened was to support a bubble in the financial industry. And, looked at in this way, the big bailout makes more sense because the aim is to keep that bubble going, even if individual bubbles like housing and energy collapse and hurt the "real" economy with it.
As our industrial base has collapsed, we've built an entire system up around financial institutions. This system hires a lot of people (although not as many as the industrial base once did) and creates - I refuse to say earns - a lot of money. But the system is built on nothing, or nearly nothing, because there's no substantive economic activity underlying it. As Yves puts it
Buiter does not address this issue, and I do not recall seeing it parsed anywhere, but it also seems that a disproportionate amount of effort in the financial system has been devoted to portfolio management, with effects anticipated by Warren Buffett in his stories about the Gotrocks.
Why does the media obsess over the capital gains tax or our 401ks? Because we now have an entire industry built around managing (or more accurately feeding off of) other people's money. You should read the link on the Gotrocks, but the basic point is this:
A record portion of the earnings that would go in their entirety to owners – if they all just stayed in their rocking chairs – is now going to a swelling army of Helpers. Particularly expensive is the recent pandemic of profit arrangements under which Helpers receive large portions of the winnings when they are smart or lucky, and leave family members with all of the losses – and large fixed fees to boot – when the Helpers are dumb or unlucky (or occasionally crooked). A sufficient number of arrangements like this – heads, the Helper takes much of the winnings; tails, the Gotrocks lose and pay dearly for the privilege of doing so – may make it more accurate to call the family the Hadrocks.
Today, in fact, the family’s frictional costs of all sorts may well amount to 20% of the earnings of American business. In other words, the burden of paying Helpers may cause American equity investors, overall, to earn only 80% or so of what they would earn if they just sat still and listened to no one.
But now the helpers are in trouble and we're rushing to help them. But we should be careful how we help the helpers because as Buiter straightforwardly puts it:
Banks that don’t lend to the non-financial enterprise sector and to households are completely and utterly useless, like tits on a bull. If they won’t lend spontaneously, it is the job of the government to make them lend. Banks have no other raison d’être.
So, it's important to get banks back to the business of banking. This is not Buiter's main point, he's focused on how to get them lending, but I agree with Yves that this point - what banks are really there for - is essential and has been lost. It is not important to save banks simply to save banks. It's important to keep some banking functions - specifically those related to servicing the non-financial enterprise and household sectors - working. In other words, going back to the discussion between ohio and badger, we must save what is essential and let the rest fall.* We cannot afford to save the rest and it's built on nothing. It is a bubble and all bubbles fall, when is simply a function of how much you're willing to pump into them.
But instead of rushing to save the essential, we're rushing to save the entire thing, including the banks and bankers we don't need because they're more about earning fees for some new service or product we don't need and not part of the essential financial services industry we do need.** (Note that the Treasury plan to help consumer borrowers is aimed at buying the securities created from the borrowing instead of helping borrowers directly, the plan is aimed at helping the people by first helping the helpers.)
I suspect the reason we're rushing to save the entire thing is a combination of fear - having lost so much ground in the real economy, there's a feeling that we need to save this fake one or what will we have? But it also is about salvaging the system we put in place to deal with worker unrest after World War II where we slowly build an economy where we don't pay anyone. Or rather, we don't pay "workers." Corporate management and the professionals who serve them can still be paid, often at record levels, but earnings are done through cutting costs and lowering wages. Of course, that guarantees a bubble economy because you can't really grow an economy without increasing the incomes of the people in it. Everything else is fake. But another word for fake is fantasy and fantasies can be hard to give up.
You can see it in the debate over bailing out GM. The focus on breaking the UAW and cutting workers wages instead of dealing with the systemic problems (like lack of government healthcare) and bad management. Common sense would tell you that the workers won't be able to buy GM products if they make less money. Of course, GM will loan them the money and then make more off their backs twice - in less wages and in interest. That cycle is unsustainable, but that doesn't matter to many, they just want to get through this bubble and start the next.***
The problem with that plan (other than its manifest injustice, which our leaders surely won't care about) is the one badger and ohio nailed, IMO. This time they've fucked up the essential markets, the things people actually need (energy, houses) and the service industry that helps them buy those things (banking). So it's not going to be so easy to keep the bubble going or start a new one. They've gone through this cycle so many times, those workers really are tapped out and won't be able to afford their cars or their houses or their energy.
And in that wake of collapse, it seems to me that what we're left with is this simple proposition: we're either going to take this moment to save what is essential (after pissing away trillions of dollars chasing the fantasy) or we're not and we descend further into authoritarianism and oligarchy, which is all that will be left of the fantasy (it's amazing how quickly fantasies can turn to nightmares).
* Or as Andrew Bacevich put it:
What I would invite [the American people] to consider is that, if you want to preserve that which you value most in the American way of life, and of course you need to ask yourself, what is it you value most. That if you want to preserve that which you value most in the American way of life, then we need to change the American way of life. We need to modify that which may be peripheral, in order to preserve that which is at the center of what we value.
** And we can't listen to what bankers say we need, we have to figure it out for ourselves because as Yves pointed out in that Gotrocks post:
With supposed professional management has come a lot of faux science. For instance, the academic literature has repeatedly found that investors benefit from being diversified by asset class (stocks, bonds, foreign stocks, foreign bonds, cash, real estate, perhaps commodities, although some research has found that CTAs fail all tests of being an asset class; the term of art is that it puts you on the efficient investment frontier). The notion of asset class is broad categories. Yet the industry has gotten investors to confuse styles with asset classes and produces all sorts of cute analyses over pretty short (by historical standards) periods of time which show low covariance of X fund versus, say, the S&P 500. Since I used to work for firms that were adept at cutting the numbers in ways to prove their points, I have little confidence in anything not produced by someone who has no skin in the game (and the pension fund consultants have every reason to promulgate this methodology, since it is how they justify their fees).