Jérôme: have a look at NBBooks diary 'No choice now but depression or hyperinflation'

You can't be me, I'm taken

The last time the banksters went crazy (in 1981) several of them got shot for their sins.  But they were little fish. This time around, maybe even some of the seriously guilty parties will get treated to a real hard justice.

But that is NOT the solution.  The solution is to severely restrict the power of the banksters.  They have been running things (badly) for the last thirty years.  Now they should be allowed to run nothing at all for (at least) the next 30.  The folks who gather in Davos should be recognized for who they are--low-brow criminals rather than oracles with great wisdom.

"Remember the I35W bridge--who needs terrorists when there are Republicans"

is the financial system broken

Yes, irretrievably. The mathematics of compound interest on a deficit based money supply are inexorable. Money as Debt is unsustainable in a world of finite resources.

Fortunately the credit intermediaries which create this Money are, like all other intermediaries, obsolete in a "Peer to Peer" world.

Another conflict of interest that has become pronounced is between banks' shareholders and their employees.

The "Principal/Agency problem" implicit in the sociopathic structure of "the Corporation".

Fortunately, there are new frameworks out there which enable Labour to work with Capital rather than for Capital and that realisation is beginning to sink in.

IMHO those enterprises - whatever legal form they use - which do not use these structures will be at a disadvantage to those that do.

As you found out during the conference you attended, not only there's an uphill battle to fight, but the hill is even steeper than we feared: heck, even among our fellow progressives...

You keep stating the truth (i.e. just the facts and figures from the WSJ, FT, The Economist...), but the truth is obviously no match for the thruthiness permeating your interlocutors (They call you Colbertian, they surely mean Stephen Colbert, right?).

As much as we hate to admit it, it's most likely to get worse before it gets any better.

Europeans think a hundred miles is a long way. Americans think a hundred years is a long time.

If this second view is right then regulators have failed. They will have to change the rules to try to eliminate the conflicts that imperil the financial system.

This is, IMO, one of the most dangerous memes and it needs serious debunking.

The implication is that regulators were "asleep at the wheel" and "failed us."

The reality is that regulators were handcuffed by lobbying and pernicious propaganda from free-market ideology economists and politicians, whose stated aim was to eventually end regulation altogether.

So, yes, regulators have been imperfect, but the blame lies with those who sought to undermine regulation in the first place. Some of those people were in fact regulators (e.g. Greenspan) but we should never lose sight of the fact that this is a disaster bred at Cato and the "Adam Smith Institute."

[To tie it to another meme, the anti-regulation people thought only of the efficiency of the market, never the robustness or resilience.]

European Tribune - Tiptoeing around the Anglo Disease

If the US suffers a recession in 2008 or 2009 it will not be due to an industrial decline or an oil price shock. It will be a recession that began in the financial system. The response of the general public is confusion, tinged with horror, at how intangible finance can impinge on their daily lives.

As usual, the Financial Times editorialists have forgotten or never knew their economic history. How about the bank panic of 1873 leading to the "long depression" or the crash of 1929 leading to the "great depression"? This time arount it'd better be short and shallow or we'll have to rename the lot.

We have met the enemy, and he is us — Pogo

Complexity also adds to the danger that any one part of the hyper-financial system can bring down the whole. (...)

I can't count the times I've heard it said that we were no longer in danger of a 1929-type scenario because, precisely, today's financial system was more sophisticated -- risk was distributed, the multiplicity of instruments permitted hedging of a kind that guaranteed resistance to shocks and stability.

Now none other than the FT is breezily saying the opposite?

When locusts move on, they leave nothing behind

When I telephoned one fund to ask if we could interview some of their quants, the receptionist told me that I was unlikely to get permission, partly because of the secretive, commercially sensitive nature of their work but also, because many of them in that fund are autistic.

BBC NEWS | Business | Mathematicians' role in market mayhem

What a metaphor...

Somewhere in cyberspace, the ghost of de Chardin is smiling.

European Tribune - Tiptoeing around the Anglo Disease

Complexity also adds to the danger that any one part of the hyper-financial system can bring down the whole.

No, it is not the complexity of financial instruments that is responsible for this, but the greater degree of interconnectedness in the financial markets. The complexity of financial instruments is a result of the pursuit of efficiency above all other considerations. Efficiency does bring complex, interconnected systems closer to "the edge of chaos" and makes system-wide crises more likely.

If capital flows were contained by national borders (as they were until the 1980's) any one part of the system could only bring down a national economy. An analogy with wildfires and the role of firebreaks is apt here.

We have met the enemy, and he is us — Pogo

European Tribune - Tiptoeing around the Anglo Disease

Now, money market funds buy asset-backed securities from conduits filled by banks originating loans from brokers. The advantage of this system is that no one entity need be overexposed to any one borrower. The disadvantage is that the seller at each step has the ability and incentive to offload bad loans to the buyer.

The mistake in this case was for the regulators to allow loans to be sold to unregulated (non-bank) entities. Banks should be able to sell on the cash flows if they want, but the loan should remain in the banks' books.

We have met the enemy, and he is us — Pogo

European Tribune - Tiptoeing around the Anglo Disease

Another conflict of interest that has become pronounced is between banks' shareholders and their employees. This is the more cynical interpretation of Société Générale. If employees make profits they are paid bonuses; if they make losses, they are sacked. Their incentive, from graduate trainee up to chief executive, is to take more risk and so increase the potential profits. (...)

And the FT discovers this now?

This is from Nassim Taleb's Dynamic Hedging, published in 1997 and apparently sold very well in the 10+ years since.The book is peppered with things like

It is often easier to arbitrage one's accounting system than the market

But even without having to assume a failure of accounting systems, profit-based compensation is fraught with problems.

A trader with a "synthetic capital" of $10 million (i.e., the virtual capital allocated to him by the bank) has often more earning power than a manager with a higher amount of capital under him, because the manager will have to face the "diversification" - the offsetting returns from traders

This is a consequence of the lopsided performance-tied compensation: everyone profits from the upside but doesn't lose from the downside, and the individual trader has larger volatility than the manager of a team of traders.

At any rate, when the trader owns an option on his profits (i.e., gets a cut of the upside without having to share into the downside), as is the case with traders using other people's money, it is always optimal to take as much risk as possible. An option is worth the most when the volatility is highest.

Now, hasn't it occurred to anyone that the banks, who are in charge of money and credit on behalf of the economy at large, enjoy an option as well? When there are huge profits they get a cut. When the economy crashes because they inflated the money supply and ran extreme risks with it, they get bailed out or they go out of business, but they get to keep whatever fraction of their previous profit they didn't spend on oversized champagne bottles.


We have met the enemy, and he is us — Pogo

by asking the question - What is the PURPOSE of the financial and banking systems?

My reply to that question is "To supply capital to the physical economy." Ie, loans and equity to build new physical plant and equipment, fund research and development, and finance consumer purchases.

Anything else should either be prohibited outright (ie, program trading; I'm not sure how wise or efficient such prohibitions are) or taxed to discourage them. Ie, the Tobin Tax, which was originally proposed for forex, but which could be applied to other financial markets as well.

In The Federalist Papers (Number 15, if I recall correctly), Alexander Hamilton had a simple test: "Is private credit the friend and patron of industry?" And at that time, they understood "industry" to mean the actual production of physical goods -- they never would have called banking an "industry."

But to add to our difficulties today, at the same time we grope for a solution to this mess, we also need to be mindful of reshaping "aggregate demand generation" in a sustainable and environmentally sound direction. In my mind the past month or so I have been thinking of the concept of "malconsumption."  Malconsumption by the wealthy and the upper middle class is fairly obvious: massive homes that are too expensive to heat, SUVs that get only 12 miles per gallon. Among the poor and working class, you find malconsumption such as bad food rather than healthy food (which is usually more expensive) and an unwillingness to purchase more environmentally sound products (again, usually because  the initial purchase price of green products are more expensive, even if the life cycle cost is less). At the social level, in the U.S. at least, there is malconsumption of infrastructure, with an unwillingness to invest in water and sewer systems, for example, or the preference to build suburbs rather than more dense urban cores (an idea James Kunstler has developed at length). The political problem, of course, is how do you deal with someone who insists they have the "right" to indulge in malconsumption?

But the key question in this thread is: What is the PURPOSE of the financial and banking systems? And what incentives and penalties can be put in place to ensure those systems fulfill their proper functions?

the blame in the right place: politicians.

If I read you correctly, you avoid any mention of business´ responsibility in the entire disaster.  It obviously looks away from banking, finance and all the highly-placed, ethically bankrupt and overrated types.  Remember at the ´elite´ level, politicians and businesspeople are one and the same, (white) old-boys network.

It is a lot more credible and realistic to put the blame on both and their ´connection´.

_Our knowledge has surpassed our wisdom. --Charu Saxena._