Archive for the 'Banks' Category

Financiers help bring about decline and fall of money

Friday, May 1st, 2009

In earlier posts I noted that even if “Wall Street” is temporarily saved and more carefully regulated, it will be difficult to prevent a meltdown similar to the current one from happening soon again. The reason is that it will be impossible to prevent new risky ways of playing tricks to obtain high returns by manipulating digital money streams. This is under way already. Banks have found apparently legal ways to cook their books to make it look as if they are very profitable, when they still have plenty of toxic assets. This allows them to plan large bonuses so that their “talented” employees don’t head off to greener pastures (or pig farming). Paul Krugman has pointed out the dishonesty in this, but can anyone prevent this kind of shell game? The more it is played, the faster money in any form will cease to be useful. …

Here comes Facebook feudalism! …even sooner than I expected.

WHY THE CRASH? —Part 4 BANKS, POSEURS, and HOMES

Friday, October 31st, 2008

Having discussed the new strangeness of money as such, I will now turn the most money-dependent sector— finance. But before getting into details, let me make a point about banks and attention. Money flows in the same direction as attention does, and so, right now stars — that is, large scale attention getters — generally have high monetary incomes. But having money incomes doesn’t lower the net attention they have, because attention itself can be thought of as being “stored” in the memories of those who pay it. The more attention you pay someone the more you remember and the more likely you are to pay additional attention. And whenever you do pay attention you tend to have a certain urge to satisfy the attention-getter’s wants.

So despite their high money incomes, stars do not really require conventional banks, because their attention is stored in others’ minds, to be tapped more or less at will. The more attention you have gotten in the past, the easier it is to do this. At the same time, if you have never had attention, your money is not a very good guarantee that you will get attention when you need it. So, as attention transactions gain increasing prominence, the entire financial sector will have a less and less important real role to play. But instead of shrinking, this sector has burgeoned of late, which brings up a second mystery.

The Banking Mystery and the Suspects

In the next-to-last post, I discussed the rapid growth of productivity in typical industries that provide standardized goods and services. The financial sector, you would think, is among the most amenable to automation, since all that is involved is handling and recording the digits that represent money. And that has happened in practice:ATMs; automated credit card accounting; electronic stock exchanges and brokerage services; online banking: etc. In other words, most parts of normal financial transactions are exceedingly automated and require very little actual human attention.

However, the relative size, income, and employment of the financial sector — in this country and others — has grown and grown. Investment banks now spend an increasing portion of their efforts on trading for their own accounts. As with most hedge funds, this typically involve using sophisticated computer programs to find ways to cash in on slight fluctuations or small trends in the financial markets. Banks also package and trade in derivatives that are connected by complex algorithms to the underlying investments in such entities as standardized goods-producing companies, government bonds or real estate.

Derivatives are supposedly financial instruments intended to help minimize risk. If risk really were minimized, the possibility of gaining vast profits would presumably disappear, since profit is supposedly a reward for successful risk taking. To put it another way, if risk were so minimal, many would enter the market for the relatively small gains, which then become even smaller on average. But risk is of course not actually minimized. One reason is that the mathematics of risk minimization, like other mathematical economics, assumes that the basic conditions they describe or even just assume are somehow fixed and unchanging, or that everything had been taken into account in finite equations. Of course everything has never been taken into account; soothing generalities stop working; small risks can add up to huge ones; and risk takers, on average end up with what they came in with or less.

These risks can be taken only because the huge fund of worldwide savings that have no reasonable way of being invested in safe industrial growth  still search for growth somehow. The financial manipulations offer the appearance of such growth, even though it would certainly seem that unless they create money out of nothing, all they earn is merely taken in a game of poker in which someone else — someone with less good financial choices — actually loses.

I am agnostic about whether money is or is not in fact created, since central banks can increase the money supply through lending, and the financial houses who sometimes obtain amazing-appearing returns do so by being highly leveraged, hugely borrowing. Of course, if money can be created out of nothing, it can also disappear just as easily, and there is no reason to suspect that on net that does not happen, so as to balance everything out. (One way it disappears is when overall markets —whether of stocks or housing —  fall, certainly wiping out “paper gains.” A recent report I saw stated that two trillion dollars worth of “actual wealth” has been wiped out with declining real estate prices? Actual wealth? The houses of course are still there, for the most part, and standard economics teaches that the actual value of something is the current market value, so of course the wealth that disappeared was entirely notional, even though it was a notion central to many people’s financial planning. So much for finance, I guess.)

Of course, even if the money that is destroyed equals the money created, most players do not end up even. The banks, hedge funds, and brokerage houses probably have enriched their shareholders, and certainly their main partners and and a large subset of their employees, essentially by grabbing for themselves an ever-larger share of total incomes in each country. These unequal shares of income then head back into the global money fund, for they mostly are not used for buying things.

The Home-Run Kings

A considerable proportion of people employed as “quants,” analysts, traders, and brokers receive many times the monetary income of others with similar talents employed outside finance. They receive much of this in bonuses, supposedly connected with the profits of the firms or the departments of firms they work for. Yet, of the hundreds of billions of dollars made in the last few years by the major investment banks, even more has been lost this year alone. Nonetheless, far from being expected to pay back their past years’ oversize earnings, those still employed might even be paid similar bonuses this year. Some percentage of these bloated bonuses are however used for buying luxuries of all sorts, which does increase employment and to an extent greater than the mass-produced goods sector can do does spread wealth around a bit. (As I discussed last time, luxuries are highly attention-related.)

To some extent the financial stars seem to think of themselves in a manner analogous to sports superstars. The latter generally sign multiyear contracts with teams that offer high remuneration even if the player or team should experience a prolonged “slump.” Similarly, financial stars, good at playing a game of their own, think they deserve healthy bonuses even if they have lost fortunes instead of  gaining them.

Another way to look a the rococo rise of the financial sector and its complex and unstable “products” and its “masters of the universe” is in the same terms as that of the nobles in say the period of Louis XIV of France. He had inherited a country full of the heirs of actual fighting feudal nobles, but he confined them to Versailles and turned them into dandies who did his bidding as they vied with each other for the most luxurious and remarkable clothes and hairdos, the best coaches and castles, etc. The competition that had taken the form of fighting was now both exaggerated and highly artificial. As they strolled through Versailles and its environs , the nobles wore bejeweled and beauteous swords and daggers, and in some cases knew how to use them, but these swords were no match for the muskets, pistols, and cannons in use by that time by actual armies. We can think of the stars of the financial sector as for the most part playing comparably decorative roles, even though apparently involved in what is most central and important for the old economy, namely money.

“Safe as Houses”

I think the complicated play-acting of the financial sector was bound to lead to an eventual fiasco, many orders of magnitude larger than, say, the Long-Term Capital Management fall of 1998 or the Enron catastrophe of 2001. As the finance sector continued to grow in apparent wealth,  more and more people would have come to depend on its inherent fallacy, until some point was reached where it proved quite incapable of actual delivery. However, the fact that the actual fiasco involved ordinary people’s homes and their putative value only helped both prolong an untenable situation and led to the effects oft ultimate crash being far more far-reaching.

If someone were to tell you that some standardized kind of good — whether it be a car, a computer or a corkscrew — could never go down in price but will always grow in value, you would consider them insane. After all, ordinary industrially produced goods become ever easier to replace,  wear out, become obsolete, or just lose their panache. But for some reason when similar optimism was expressed about very nearly mass-produced homes, too many people were willing to take the pronouncement as quite sane. “Real property” requires land, and supposedly “they aren’t making land anymore.”  Unfortunately, that statement is nonsense in several ways.

In the first place — as anyone who has ever looked at open houses offered by realtors or developers should know — much more than with ordinary mass-produced goods, they aren’t selling material objects, they are selling dreams. These are dreams of refuge, privacy, independence, marital concord, healthy and happy children, visits by friends and family, comfort,  warmth, praise from one’s friends, attention from strangers, beauty, ease, neighborhood, community, good schools, convenience — along with other emotionally tinged and historically contingent prospects. Dreams are subject to change, and the reality that supposedly underlies them can easily change too. An easy commute can become congested and overlong; neighbors can turn out not be nearly as nice as the ones one left, community spirit may not exist or may not welcome one; or an area with enough water for nice lawns can be affected by permanent shortages, especially as climate changes. And the gadgets, appurtenances, style and substance of a house or condo can become obsolete, come to seem ugly, or just fall apart.

What about that idea that the amount of land is fixed and invariable, so that, with a growing world population it is in increasingly short supply, and therefore intrinsically worth more and more? It just doesn’t hold water. The value of land, quite obviously, depends on where it  is and how it is looked upon, and both those things are subject to change, down as well as up. Land that was once highly desirable can become noisome and polluted, or just out of fashion, as home designs or sub-divisions can.  And, in effect, new land can be created every time it seems desirable — say — to live closer in to other people — perhaps in high-rise buildings rather than in a suburban houses. (Some land actually is “reclaimed” — created— from bodies of water or marshland, and though ecologically that might be undesirable, it still happens.)

Clearly though, real estate and housing related securities have a certain aura of security among people who don’t stop to think “concretely” of how very abstract the notion of ever-rising home prices is and always has been. The twenty-somethings who serve as the basic laborers in the field of investment banking may have had no knowledge or experience of land bubbles, but more mature people in those businesses seem to have been equally willing to be fooled by what they should certainly have understood better.

What makes mortgages even less reliable investment was little examined: in a typical case of foreclosure,the costs and right offs apparently can amount to upwards of 30% of the face value of the mortgage. The sliced, diced packages of mortgages seemed to lower the chances of such danger, while in fact making any analysis of risks much harder. The invention of newer and newer mortgage “products” that allowed introductory teaser rates with later sharp rate increases simultaneously gave investors the feeling that they would get good returns while greatly enlarging the pool of new home buyers. This further inflated housing prices, making the investments seem even more reliable. The chances of catastrophic failure grew ever larger.

And of course, all this would not have happened had it not been that all this funny money were chasing good investment opportunities while actual industrial growth could not offer nearly enough of an outlet. At the same time, the mortgage mess, etc.,would have been much less problematic if incomes had been less unequal. In that case, there would have been less money chasing investments, but more chance for ordinary people to pay more ordinary mortgages. That, however, is just what things once were like, in the US anyway. Whether they can be like that again, I tend to to doubt.

In a subsequent post, I will add to the prognostications and solutions I offered earlier.

WHY THE CRASH? — Part 1.

Thursday, October 9th, 2008

As I write, the stock market is flatlining, credit has seized up, no one seems to know what to do, and bad times seem in store. What caused it? Not what you think. Not, basically, greedy Wall Streeters, ordinary consumers taking on loans they could not pay off, bad accounting requirements, faulty credit ratings, failures of regulators to regulate, nor a formerly too rosy outlook from the Fed. These were all surface phenomena.

What lay beneath then? One way to put it: too high a worldwide savings rate. Consumption too low. And, partly causing both of those, the rise of the Attention Economy (as I define it,  not as it has been defined by others).

We have been told for years that the savings rates of Americans are too low, that we are over-spending on consumption, and  that there is too much reliance on credit. That’s not impossible, but worldwide, the savings rate in fact has been too high, and I suspect it may have been unrealistically high in this country as well. And certainly, to have such a high worldwide savings rate, consumption has been too low. I am embarking on several posts to explain.

Swimming in a Pool of Money

Let’s talk about “savings” first. What most Americans understand about saving today is that it it really means investing one’s money or one’s retirement account (or paying into a pension plan that will invest for one, of relying on one’s employer to do the latter) in such a way that the total nest egg will grow to a tidy sum by retirement. Not everyone is fortunate enough to have such savings, and I don’t have the figures right now, but certainly a sizable proportion of people near retirement do have substantial savings — or did.

To that domestic pool of savings must be added similar things from Europe, plus, from the “developing world,”  the so-called “recycled petrodollars” and the savings of capitalists and to some extent even workers. Also we should add in the growing pies of savings held by non-profits, such as universities and foundations.

Take one example: the country of Singapore, which has experienced a very high rate of growth has a large investment fund to spend abroad. Why? Why not invest at home, or use the extra money to buy goods and services now? First of all there is no crying need or desire for more goods and services now, and second, Singapore seeks a nest egg for its own “retirement” or to take care of its own aging population.

Saudi Arabia’s population isn’t aging, but it also parks a considerable portion of petro dollars in the accounts of small group of ultra-rich princes and commoners, and also invests money abroad for its own post-oil future. (As if.)

All these investment pools seek more or less reliable “growth stocks” to invest in. It’s too much money chasing too few stocks. Even under ideal capitalism, we can’t all be capitalists; we can’t all get even moderately rich on the basis of investments in productive industries of any kind.  (Of course, the average financial planning advisor will be happy, even now to claim the opposite. It can happen for some, or at least it could, so the FA is only necessarily misleading in the aggregate. )

The more we save, the less we consume of course. Also, the more money is distributed unequally to the few rich and the many too ill paid, the less net consumption there is . The rich have money to burn, but most of them don’t want to. They want to get still richer, and of course their extra funds are part of the same investment pool.

Speedup

Meanwhile, however, firms keep improving efficiency. Labor productivity keeps going up. But overall consumption does not increase that fast. (I’ll explain what I term “consumptivity” and how it connects to attention in my next post. ) Capital productivity keeps rising too. That means that in terms of industrial-era investments, there is not enough to invest in with any realistic hope of substantial profits. And not enough industrial type jobs either.

Hence, what the NPR program “This American Life” in a special broadcast last May about the sub-prime mortgage mess calls the “Giant Pool of Money” — to wit, about 60 trillion dollars cruising the world in search of ways to become much more. That money, feeding into the collateralized debt obligations along with credit default swaps, hedge fund shares and so on, helped propel the overheated financial sector and the overheated housing market, and much else besides.

You know the rest in that regard: the silly assumption that housing prices would rise forever, the super-easy, turn a-blind-eye mortgage offerings with huge built-in rate hikes; the speculators seeing a killing buying extra homes for nearly nothing. Many Americans, some having already developed a nest egg in investments they didn’t want to touch, and others with no money to their name at all, taking on new credit based on home -price appreciation.

Many had to do this because they simply were not paid enough to support families or send kids to college. Why so little cash? One reason: no executive “worth her or his salt” wants to overpay workers or keep more on the books than necessary. That is out of fashion throughout  the profit- and non-profit sectors alike. It was partly by paying workers as little as possible that executives and investors could grow rich, after all. That led to more money in the investment pool that could find no sensible target.

Arrrrgggh! Who Stepped on the Brakes?

The old realities had given out, and the spiral might have kept on going if all those involved had forgotten all about those old truths. Instead, rates did reset; borrowers suddenly could not pay. Foreclosures began; housing prices stopped rising and began to fall, and more foreclosures ensued. Then the entire overheated banking edifice came crashing down, to be explained more carefully in my third forthcoming installment.

Such Golden Years

As to hopes for pensions and retirement status: Republicans shed crocodile tears over the supposed “underfunding” of Social Security based on the fact that retiring baby-boomers will not leave enough younger workers in the system to pay the taxes to fund the program. Democrats defend Social Security but also believe pensions and 401k’s, etc., are good bets. Of course younger workers have to do the work that will lead these investments to be profitable. If the investments are in other countries, those countries’ finances have to stay good and accessible. More fundamentally, what retirees really will need is actual attention paid to them. No national policy on pensions can guarantee that in advance, which neither party ever thinks about. Savings and pension funds and perhaps Social Security too were if not lies based on a false notion that the system as it was could keep going on on forever.

Still to come:

2. The Limits of Consumptitivty;
3. How the Attention Economy is (Semi) Incompatible with Money;
4. One Result: Banking Has to Go Bonkers
5. Any Chance of a Soft Landing? Possible humane policies for the new era