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"The Western Financial System We Knew Has Collapsed"

BDBlue's picture

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).

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Submitted by ohio on

"...we're either going to take this moment to save what is essential...or we're not and we descend further into authoritarianism and oligarchy..."

Much to ponder, BDB. As usual.

BDBlue's picture
Submitted by BDBlue on

The economic crisis brings values to the forefront since that's one way we decide what's essential and what isn't. In a world of finite resources (money, time) it's critical we figure that out as a nation and not just accept what our leaders tell us we value. As you say, it's what we value or don't.

Lately I've been doing a lot of thinking about values and myths. When I say myths, I don't mean lies, I mean mythic narratives (which can be a lie, but can also be based on truths and can be destructive or affirming, depending on the mythic narrative and how it is used). It seems to me we've allowed America's mythic narrative - which is a way to tie our values to our past, present and future - to be co-opted and misappropriated by the corporatists and the right-wingers, but it really belongs to us. Part of reasserting our values is reclaiming the American myth. I hope to write more about this later, but I think liberals have forgotten the value of myth. We're so quick to (rightfully) denounce the right-wing, twisted version of America, we've forgotten the need to push our own narrative. Again, by narrative, I don't mean lying or pretendng x is really y. Instead, it's about taking facts and making them part of a larger story, about giving meaning to your history and your future.

Hard to explain in a paragraph, which is why I need to take some time and do a larger post.

badger's picture
Submitted by badger on

and maybe it's just fantasy, but I've read enough about early entreprenuers (the Fords, Edisons, Teslas, and if you're from Milwaukee, the Bradleys and others) to think it's not. The idea is that once upon a time, people formed enterprises to earn a profit by performing some useful task: making cars or light bulbs or generating electricity or making electrical gadgets (or lending money to support those tasks). Profitability and production were, if not coequal, tightly coupled as reasons for the existence of enterprise.

The change - that started maybe in the 60s with conglomerates, maybe as an echo of the late 1920s - is that the entire system shifted to one in which the profit motive was retained but the idea of doing something useful was cast aside or at least devalued as some pretense that had to be maintained so you could concentrate on the real activity of showing a profit for the next quarter. Never mind what manipulations you had to engage in to accomplish that, as long as it wasn't actually producing something people were willing to pay for (exhibit A: Enron).. So XYZ Mfg was valued, not for its innovation or the quality of its products or for the livelihood it provided to its employees (many of whom were simply cast aside), but for its value as collateral or as an undifferentiated asset on a balance sheet, or simply as a instrument of speculation. For example, think of how often companies' stocks fell when they showed substantial profits, but rose when they laid off thousands of workers - actually decreasing their future productive abilities. Thank you, MBAs.

This had the effect of not only destroying our manufacturing base, it destroyed the essential wealth producing engine that underlay our economy, since our extractive industries (mining, forestry, agriculture, etc) were no longer enough to drive the economy (and economies based primarily on extraction are either third world or oil producers or both), and most service sector industries don't provide anything exportable that we can exchange to acquire things produced by other countries.

Eventually, through enough deregulation, the financial sector succumbed to the same conversion - rather than deal in sound mortgage lending or the stocks and commercial paper of viable industry (the task that sector exists to perform, as pointed out in the articles), they switched to shuffling fictional assets to produce profits, hoping (or not even caring) that no one would find out there's no there there in most of what they call "assets". In this century we're doing to housing (and health care too) what we did to manufacturing in the last century.

The Obama proposal of largely using infrastructure rehabilitation to stimulate the economy doesn't do anything except, again as noted in the articles, keep the bubble going. Yes, it provides real jobs and tangible results, and yes, it's necessary, but it's a little like expecting to advance your economic well-being by redecorating your living room. We can't export interstate highway bridges to Eurpoe or Asia in exchange for the goods that now only they manufacture (and increasingly so if the domestic auto industry goes under).

I think your first footnote gets it exactly right, and among that which is peripheral that needs to be modified at least or abandoned at best is the financial industry as it exists today, and the ideology or attiudes that underpin it.

I hope this makes some sense, as I don't feel I'm stating it that clearly.

BDBlue's picture
Submitted by BDBlue on

One of the more damaging things tha "innovations" of the financial markets have given us is to separate profits from true economic activity. If you can make money without having to earn it, so much the better.

The other thing that got separated, as George Soros has pointed out, was risk. The people who were slicing and dicing the securities were far removed from the risks associated with the securities. That made the risks almost impossible for those on the later ends of the transactions to ascertain or understand (a feature, not a bug, IMO). But that's a large part of what made this crisis happen - the "helpers" got paid fees to repackage risky assets so that they looked like non-risky assets (a process once quaintly known as fraud). So now not only are they not producing anything beneficial for their money, they were being paid to take an essential part of the financial system (lending to business and households) and make it riskier and less stable, all in the name of hyping profits and supporting the every growing financial sector. Or rather, they were being paid to hide the fact that the banks have overleveraged themselves and could no longer support the essential function they are supposed to do. And now they're using that essential function to try to save all of it. The markets need credit, so you have to save us to provide it (even the over-leveraged part of us). When really all we need to save is the essential function of banks. The rest can go (not without pain, but there's going to be pain no matter what we do).

If that makes any sense.

badger's picture
Submitted by badger on

I forgot about that part. The executives of major coroporations - sevice, industrial or financial - have created little risk-free fiefdoms for themselves.

They manage to stack the board of directors with friends and fellow-travelers (and serve on their friends' boards as well) who vote them enormous salaries and stock options and the sum total of their accountability is more millions paid as a golden parachute if by some miracle they get ousted.

William Crapo Durant, the founder of GM and Chevy, lost his shirt in the stock market crash and spent the rest of his life managing a bowling alley in Flint, MI. Nothing similar will happen to the executives who've driven GM into the ground today.

Submitted by ohio on

In addition to the erosion of manufacturing, we've seen a fundamental cultural shift of demeaning those people who still make things (autoworkers) or do necessary services (say, plumbers) as too stupid not to get a better job. So who gives a damn if the people who work at the air conditioner factory have decent wages or healthcare? If they were smarter, they'd have those things because they'd have better jobs, see? Contrast the reality to the romanticizing of the trades in the good old days. Bah---these things drive me nuts and are beside the point.

There's Maslow's hierarchy (I miss FrenchDoc) for identifying essentials, and frankly, perhaps the base of its pyramid identifies the things which will be hoarded and speculated about next. Unless this housing mess shows us we've already begun. Traffic in clean water has been going on for awhile and certainly, the US public has been conditioned to accept that a necessity like drinking water must be purchased from plastic bottles. So potable water has become a branded product beyond being a necessity---otherwise there wouldn't be five billion kinds of bottled water.

Food? That's always been an issue. My drywall guy Russ and I had a conversation a couple weeks ago about how it's impossible for him to buy food that is healthy. He just can't afford it. I highly doubt Russ considers himself poor, and yet if he doesn't have clean water and decent food, and he may very well lose his home because there's no work...

But the poor have always gotten the shitty end of the stick, so there's nothing new here. Unless it is the potential scale that has changed.

I am thinking as I type (and thank you for indulging me) because I am trying to balance the idea of what is essential with what I value, which isn't just fundamental needs. And I'm seesawing back and forth on large-scale infrastructure projects as a means of economic recovery because such projects can also be another form of financial terrorism if wage scales aren't decent and the contracts are in the hands of too few people.

(I just read an article I can't find, of course, that contrasted real wages of relief work versus infrastructure projects during the Depression. Projects handled by contractors meant better wages because the private contractor paid union scale, which was significantly higher for infrastructure projects as opposed to relief work, which paid people directly. I think there were a lot more factors than private contrator versus government paymaster scenario the author laid out, but it may be worthwhile to lomk at the machinery of these efforts to see if they can be reproduced with minimal waste.)

Infrastructure projects require a tremendous amount of time to get going, so this strikes me as an important and long overdue effort that won't help in the next 6-24 months, and that's the timeframe that really matters, IMHO*. I also agree with badger that unless we are able to export goods and service (outside of financial services) to the rest of the world, we are screwed. The money has to come from somewhere and printing it and throwing out of airplanes, like Bernanke** likes, will not work.

If money is portable labor, and labor is the expression of time x effort, then the export of manufacturing is essentially the export of our money. All our money. But we still have the labor pool. We still have some skills. And we still have a need for goods and services.

The down and dirty "hey, let's hire kids to caulk your windows" always sounds to me like a joke, embraced by people who have never done this kind of work or hired people to do this kind of work. These are the kinds of jobs that should be well paid because they're hard and they suck. And they don't bring in money from outside the local economy. OTOH, we have to start somewhere and maybe this is the place to start.

Pardon me if I am expressing myself in as baffling a way as I think I am.

*I am trying to listen to the Buiter warning not to just do something. It is completely against my nature, but I.must.resist.

**I have no source for this, other than that my dad tells the story over and over about Bernanke saying to solve certain finacial crises, we should just fly over the Midwest and drop bagfuls of money out the airplane windows.

herb the verb's picture
Submitted by herb the verb on

That is what I posted about the other day.

But then I happened to stumble on Frenchdoc's post on her blog (sorely missed here is Frenchdoc) where she comments on Paul Jorian's article about the collapse of global Central Banking (written early in October).

So they have long been on this and I urge you to read their essays.

Bottom line, the banks have been leveraging wage earners ability to borrow (consumer credit, home equity, fees, etc.) and selling and repackaging loans to make short term profits, rather than earning less money off the merely "real" value earned by either interest paid on loans or on the increased value of entrepreneureal enterprizes. Example a business is worth x, a bank or investor buys 20% of x giving them cash to expand, when through entrepreneurship that business is worth 1.1x the next year (a 10% increase in equity) the investor has earned 10% on their money. To double your money in that time in business is very difficult. A commercial loan is now somewhere around 7%, that's boring too. On the other hand, if you are a bank making your income by selling loans rather than investing in business, you can very easily double your revenue, just double the line of credit limits, bingo, you now have twice as much loan value to sell and your revenue has doubled.

bringiton's picture
Submitted by bringiton on

The tab thusfar?

The federal government committed an additional $800 billion to two new loan programs on Tuesday, bringing its cumulative commitment to financial rescue initiatives to a staggering $8.5 trillion, according to Bloomberg News.

That sum represents almost 60 percent of the nation's estimated gross domestic product.

And that isn't the half of it:

Given the unprecedented size and complexity of these programs and the fact that many have never been tried before, it's impossible to predict how much they will cost taxpayers. The final cost won't be known for many years.

Lame duck my ass. A lot can happen in 54 days, and none of it will be good.

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BDBlue's picture
Submitted by BDBlue on

No one. Not the infestment bankers who fucked this all up. Not the "regulatory" heads who encouraged them. Certainly not Paulson or Bush or Cheney or Greenspan or anyone else who helped engineer either the bubble or the bailout. Not any member of Congress. No one.

The executive is robbing us blind and Congress, which has a constitutional duty to control the purse strings, is letting it. Given that just about everyone is in on it, I don't see much chance for anyone to be held responsible or accountable.

Because accountability is for you and me. It's for the people, not for the ruling class. Not any of them.

Yes, 54 days is a long time and a lot can happen. All of it bad, I'm guessing. Not that I have much hope for the days following the next 54, even if Obama and the Democrats are willing to do the right thing then, it's likely to be too late to avoid a lot of the damage. And nearly all of this was avoidable. It's a complete failure of both the private sector and government. Not that any of them have enough self awareness to feel any shame.

bringiton's picture
Submitted by bringiton on

As you say, a collusion between the private sector and the government - or, more precisely, a portion of each, sufficient to be controlling.

This combination is what the people, collectively, have put into political power consistently for the last 40 years. Until the people decide to free themselves, they will continue to be enslaved and exploited.

There is no "somebody" who will do it for us. This election was a start, a shift from the maximally exploitive wing of the Corporatist Empire to a more benign wing. Possibly we can put this shift to use and press the change in a truly Progressive manner. Doing that and exacting criminal penalties for the economic pillaging is perhaps more than can be accomplished.

If there is an effort to hold people accountable for their actions, I'd prefer we stay focused on other political activities such as torture and false testimony to Congress. It will be the same people, at least the same political people, so there is some satisfaction in that, and we will have to take our broader revenge by disassembling the economic structures that made the looting possible and replacing them with others that are more equitable.

"We, the people" will have to do that if it is going to get done, and there is the challenge - motivate the people to follow and Progressives can make a difference. Fail to motivate them, and we will fail.