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A market solution for market failure?

by Frank Schnittger Sun Mar 22nd, 2009 at 11:28:43 AM EST

Like most non-economists I have been following the financial crisis with some bemusement and no little concern.  The numbers seem so staggering as to be beyond imagination.  The financial instruments so exotic as to be beyond comprehension.  The scale of fiscal irresponsibility with other people's hard earned cash so huge as to be absolutely staggering.  And now the consequences appear likely to be so severe as to usher in a new Great Depression, with money being issued in quantities reminiscent of Weimar or Zimbabwe, and perhaps even a World Resource War as shadowy globalised elites seek to control what remains of an increasingly devastated planet and its diminishing resources and powers of regeneration.

To the non-expert, a perhaps over-simplified series of battle lines seem to be emerging.  Even the market fundamentalists like Greenspan appear to have discovered a flaw in their models of what should be happening in deregulated free market economies.  But most seem to accept that there are some financial institutions which are simply too big to fail and that the consequences of their failure would be even worse than the enormous costs of bailing them out.  Fiscal conservatives who baulk at even small increases in social welfare, education or public health care spending seem to have no difficulty contemplating unimaginably huge sums of taxpayers money being devoted to bailing out hugely irresponsibly if not criminally run financial institutions.

The theory appears to be that the taxpayer may get much of that money back when economies recover and asset prices eventually rise to something like their pre-bust levels.  This is where the progressives like Krugman beg to differ, arguing that the market may currently be correctly valuing many of those assets, and that there is no guarantee that the taxpayer will ever get any of that money back.  In their view some of the major financial institutions are unavoidably insolvent, and throwing taxpayers money at them now will simply reward gross irresponsibility without rescuing the current system in any way whatsoever.  In effect, it is the heist of the century where the poor are robbed by the the rich, and the most greedy and morally corrupt rich at that.


The Obama regime now appears to be siding with the "too big to let fail" argument, and preparing to spend absolutely huge sums on trying to rescue the current system.  This has progressives seriously worried that the most promising President of his generation is about to make a fatal mistake, condemning the US to impoverishment, depression and stagflation for at least a decade, and ensuring that he will be a one term President.  Ironically a McCain Presidency would never had the political capital to attempt such a massive bail-out, and would have been opposed tooth and nail by a Democrat Congress if it tried.

So what is to be done?  Jerome is depressed and has rightly pointed out that there is no argument for the taxpayer covering speculators bets that banks and Insurance companies like AIG no longer can.  Krugman is also increasingly shrill in his opposition.  And Nationalisation doesn't appear to be on the agenda.  Even if it were, would it not increase the likelihood of the taxpayer shouldering the losses after the rich have walked away with their ill-gotten gains?  I want to propose what might be a simple solution, one undoubtedly suggested by others, although I haven't seen it put forward yet.  Perhaps it is my simple mind which cannot comprehend what others have proposed.  Undoubtedly there will be economic experts here ready, willing and able to put me straight on this.

The problem, as I see it, is that no one seems to know what the toxic assets hidden on and off financial balance sheets are actually worth, or might be worth in the future.  What seems clear is that at current valuations, many financial institutions are in fact insolvent.  If the real economy does actually recover, some may be able to trade their way out of difficulty, but all will face acute cash flow difficulties as their debt obligations become due.  Asset prices will remain hugely depressed for so long as the market is flooded with forced and distressed sellers.

So my suggestion is that Governments should set up huge investment funds to buy up these assets at current market prices because then the taxpayer also has some prospect of reward should assets prices recover somewhat. Effectively Governments would be putting a floor on current asset prices and thus helping to generate the confidence necessary for any future recovery. Of course this will not help those financial institutions which simply are insolvent at the moment, but taking their toxic assets off their hands at current prices will at least stop their forced disposals depressing the market still further.

It seems to me that there is no other way that current assets can be properly priced - except by reference to current market prices - as any other pricing mechanism - e.g. linked to whatever prices are required to enable different institutions remain solvent would be different for each institution and any global premium over market prices would enable some institutions to make huge profits whilst failing to save others.

It seems to me that the "gaming the system" mentality is deeply ingrained in the culture and organisational structures of those institutions - as is witnessed by their determination to continue to pay enormous salaries and bonuses whatever the real state of their balance sheets - and thus only allowing those institutions to go into Chapter 11 or whatever insolvency provisions apply can generate the cultural and political changes required to prevent similar behaviours being continued indefinitely.

So yes, there will be further Lehmens and turmoil in the stock markets, and those who measure Obama's success via the Stock Market indices will have much to criticise him for in the short term.  However it seems to me that the sums of money required to return the major institutions to solvency are so huge as to be beyond any President's ability to deliver on an ongoing basis, and even a President with Obama's political capital has only one more shot at saving the system by getting more funds out of Congress, and when that proves to be insufficient - as it almost undoubtedly will - not only will those institutions fail in any case, but they will have brought the prospect of any sort of progressive reform and a second Obama term down with them.

I have long had a sense that the US, in particular, is in the grips of a particularly vicious class war, but that only one side is doing the fighting.  The rich are absolutely ruthless in depriving the poor of basic employment rights, social security, education and health care, whilst "progressives" are incredibly timid in terms of taking the rich on at their own game.

So my argument is that Governments should buy up assets at market prices now whilst they are cheap - whilst there is a realistic prospect of being able to sell them for more later - and screw the rich who let their greed get the better of their judgement or moral scruples.  If that results in major insolvencies and financial dislocations, so be it.  Far better to utilise Government resources in stimulating the real economy rather than poring money into financial black holes that - even when they were "healthy" actually produced nothing in the real world except obscenely rich speculators.

Obama and his European counterparts would need to have the balls to ride out a very sharp, but hopefully much shorter depression.  However they would also then not allow themselves to be outflanked by right wing populists and demagogues who will condemn them for bailing out the banks.  It's time progressives stopped being so God-damned "responsible" in trying to shore up the current system, and realise that we are, truly, in a revolutionary epoch right now, whether we want to be or not.

Sadly the EU seems to be moving in the opposite direction. As Nanne argues, there is little prospect of an effective opposition to the re-election of Barroso as President of the EU Commission and the continued dominance of neo-liberal policies and parties in the EU Parliament itself - even though neo-liberalism has been hugely discredited by the Global fiscal and economic crisis and just as Obama attempts to move the US in the opposite direction.  Is it any wonder when the EU electorates are so apathetic about the EU Parliament elections when there is virtually no alternative candidate for the EU Commission, and no significant popular debate as to the policy direction the EU should take as part of the EU Parliamentary elections?

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notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Mar 22nd, 2009 at 11:33:40 AM EST
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Mar 22nd, 2009 at 11:47:02 AM EST
[ Parent ]
Frank, you make some very good points with which I agree entirely.  However, this statement is problematic, to say the least, and it explains a lot behind the Obama administrations reluctance to just nationalise the biggest troubled entities:

Far better to utilise Government resources in stimulating the real economy rather than poring money into financial black holes that - even when they were "healthy" actually produced nothing in the real world except obscenely rich speculators.

The second part of this sentence is on target.  It is far better for the government to now be allocating resources toward directly employing people, and there is a very good reason for this based on the work of economists such as Schiller, de Long, and others who have noted the huge importance psychological aspects of markets' ability to price and allocate goods and services efficiently.  Basically, people value things more when they have more confidence in future values and their own earnings stability and growth, and they value them less when confronting ambiguity of those parameters. Government spending on direct employment can increase confidence and participation in markets for goods and services.  

However, the first part of that sentence simply can't be accepted by political authorities responsible for people's welfare in a crisis of this magnitude, because it implies that just because the financial world deals with "paper" wealth instead of real wealth, that it has no or little connection with the real economy.  In fact, it does have a very strong and direct connection to the real economy in a multiplicity of ways, some them very interdependent and complex.  A failure and nationalisation of AIG, for example, if not properly planned and executed, could entail the failure of smaller banks both in the United States and all over the world simply because AIG has been engaged in insuring the assets and liabilities of those banks and financial entitities.  While it might seem simple to just say, "So what?  Let those members of the failed financial elite fall too," that would also under-appreciate the impact on the real economy where most of us earn our family's social entitlements to eat, clothe ourselves, and obtain shelter. When banks fail, businesses fail because they can't obtain the working capital they need to cover losses during economic recessions, thus sending a cascade of new unemployment and generating further such crises in the supply chains of industries as the wake of such shocks manifests in the production institutions of the modern economy.  Typically the multiplier is between 2.5 and 3.5, meaning that for every worker laid off as a result of the recession, another 2.5 to 3.5 workers will also have to be laid off as the need for labor dries up too.  That's what makes the too big to fail argument hard to ignore without first identifying the full impact and financial cost of either letting AIG's and others' insurance commitments to expire, worldwide, or covering those commitments.  

Personally, I think that the time for saving institutions such as AIG passed when the first attempts to do so failed to prevent the world economy from falling into the crisis it now finds itself, so I am now much more supportive of simply bankrupting AIG and redistributing their assets and liabilities to other members of our society or into the future. But, I would certainly hope that people in the US treasury would be trying to study the likely impacts of such a policy by documenting and analyzing the hugely complex and interconnected web of insurance liabilities that is now, due to Basel II and other regulatory frameworks, such a critical part of the lending industry.  That kind of analysis takes months at least, not weeks or days,  so I suspect that while nationalisation is likely to end up occurring sometime soon, it's just not something that Obama can promote with any confidence right now, if responsibility has anything to do with his philosophy of governance.

by santiago on Sun Mar 22nd, 2009 at 02:05:59 PM EST
Many thanks for a well considered and informed reply.  I am aware of the downstream effects of a failure in a major financial institution - there is a risk of good banks requiring payment of an insurance claim or businesses requiring working capital in the future also going bust.  However these are separate issues.

Where a bank has a legitimate claim for a payment for an insured risk the Government should make every effort to ensure that claim (at least in part) out of remaining AIG assets.  However my understanding is that a lot of this wasn't genuine insurance claims, but pure speculative betting, as in:Daily Kos: depressed

The Economist had an article last week about John Paulson, a hedge fund manager who bet against AIG and CDSs last year, and made billions in the process:

If AIG is insolvent and can't pay out on such bets, why should the taxpayer?

In relation to ordinary businesses needing working capital, there are thousands of smaller banks which didn't invest in exotic financial instruments and who  lend to real businesses for their working capitalneeds as part of their core business.  We are not exclusively dependent on the big five for such lending.  If "responsible banks" also have liquidity problems, help them out with Government credits directly.  

Chris keeps arguing that banks as credit intermediaries are a thing of the past in any case - the real economy will find ways around dependency on a banking sector which wasn't necessarily very responsive to their needs in any case.  The whole investment/business banking model is broken and we have to find ways around that.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Mar 22nd, 2009 at 06:06:05 PM EST
[ Parent ]
great diary, frank.

the fuss about the bonuses is revelatory in it's stripping bare the shocking amounts of dosh sloshing around the trained whippets enclosure.

however seeing it in proportion, it's like worrying about a hair in a cup of arsenic.

whoever writes the regulations that will have to save us from this recurring  have a mighty responsibility, and we people have an even greater one to pass down to our descendants what happened, so the next cycle when some pols want to dismantle regulations and allow banks to play casinos, we are better immune to their blandishments.

the ability to buy pols' favours through campaign finance is the subtext to this too, until that changes, we risk replay.

the only silver lining to this i see is that sometimes systems are so tenaciously, vociferously, delusionally and mendaciously defended, only their breakdown can silence those who claim their system to be beyond criticism.

what phoenix will arise from these ashes?

"We can all be prosperous but we can't all be rich." Ian Welsh

by melo (melometa4(at)gmail.com) on Sun Mar 22nd, 2009 at 06:41:20 PM EST
[ Parent ]
The worst case estimates I have seen for possible US bank failures yet to come are under 1,000.  Most of the smaller regional and local banks are solvent and happy to make loans to willing, credit worthy individuals.  It is a lack of such borrowers that is the problem.

Hell, we are at a point where, to avoid the cost of future  bailouts, it might be cheaper to have the US government buy up the outstanding stock in Citi, BofA, etc. at market as of close on, say Friday last and then perform a thorough audit, divide the remains up into sensible new banks that are small enough to fail, inject capital as required and sell them off to private investors ASAP.  At close Friday Citi was worth less than $15 billion, and Bank of America was worth less than $40 billion, based on stock price and total shares.

There is really no reason to buy the stock.  Requiring an audit would show their insolvency and then the shareholders would be wiped out and the management would be replaced, but the (you supply the noun) in D.C. couldn't even bring themselves to BUY the banks in order to close them long enough to make their successors sound.  Words fail.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Mar 22nd, 2009 at 11:42:28 PM EST
[ Parent ]
ARGeezer:
The worst case estimates I have seen for possible US bank failures yet to come are under 1,000.  Most of the smaller regional and local banks are solvent and happy to make loans to willing, credit worthy individuals.  It is a lack of such borrowers that is the problem.
The FDIC is taking over a couple of "smaller regional and local" banks each weekend - 20 so far this year against 25 in all of 2008. See FDIC: Failed Bank List.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Mon Mar 23rd, 2009 at 04:39:05 AM EST
[ Parent ]
The problem might be a bit more fundamental than you seem to think.  The insurance claims we're talking about are the current means required by bank regulators -- all over the world now since the Basel II became accepted as the norm -- for banks to make longer term loans of more than a year or so. Banks' deposits and securitized debt is typically short term -- a few months or a year.  This means that if banks want to make longer term loans they have to find either longer term securitized debt or they have to find a way of fixing the interest rate they pay for their capital to be close to the interest rate they charge for the capital they lend. This is done, under the current regulatory regimes, with interest rate swaps and other derivative agreements which have been arranged in large part by AIG's brokers and with their guarantee, much like the Chicago Board of Trade works but with individual customized contracts instead of identical put and call options that can be bought and sold on a market.  It really is a P2P-style system that AIG runs with these customized derivatives contracts.  

You mention that there are large portions of these insurance contracts which are speculative, and this is true.  In fact, exactly 50% of them are, since in a hedge instrument, the insured party has to be joined to a speculative party, such as the billionaire in the Economist article.  The problem, however, isn't that the billionaire might lose his profit.  Rather, it's that banks will be out of regulatory compliance on risky capital if they can't be assured of their rates, they will be forced to curtail long term lending or even call in their longer term business loans, leaving businesses all over the world without capital and credit lines precisely at the time when we all need purchasing power the most.

It is even worse when you consider that many of the banks whose debt is insured through derivatives contracts arranged by AIG are not US banks and not covered by American regulators or American financial guarantees if the US wanted to start covering banks' insurance.  This could cripple many 3rd World banks especially and exacerbate their already precarious lending situation.  

by santiago on Sun Mar 22nd, 2009 at 11:43:05 PM EST
[ Parent ]
santiago:
Rather, it's that banks will be out of regulatory compliance on risky capital if they can't be assured of their rates, they will be forced to curtail long term lending or even call in their longer term business loans, leaving businesses all over the world without capital and credit lines precisely at the time when we all need purchasing power the most.

Which is why nationalisation and a state bank is the answer.

Let the middle men sink. Lend direct to the people who need the money.

Even if 75% of them default, that's still going to give a better return than trying to feed more brains to a zombie bank which will twitch a few times, fart loudly, and then roll over and stop moving regardless of how much it's been stuffed full of gold and decaying body parts.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Mar 23rd, 2009 at 07:56:43 AM EST
[ Parent ]
Even government is a form of a middleman, remember.  What you say might be true, but it also might not be. I haven't seen a reliable estimate yet on the costs and benefits of nationalisation versus bailing out.  I suspect that the benefits of bailing out are dwindling every day, but I'd like to see a good estimate before hiring the contractor for such a big and ambiguous job.
by santiago on Mon Mar 23rd, 2009 at 12:45:57 PM EST
[ Parent ]
The problem is the nature of the speculation.  As I commented in Jerome's diary, they wrote the swaps like insurance policies and then handled them like securities, which just can't work.  It's too late to start handling them like insurance policies, so the banks need to stop booking them like insurance policies.  That these CDSes satisfy the regulatory requirements only shows how weak the Basel II framework is.
by rifek on Mon Mar 23rd, 2009 at 09:04:27 AM EST
[ Parent ]
You stated the problem correctly: Basel II is a weak framework. Unfortunately, it is also the the worldwide framework upon which virtually every country now bases its banking policies.  That's one big reason why there is such a reluctance to nationalise right now, even though I think it will eventually happen.  Doing so without a good analysis of the impact first could very likely put most financial and insurance institutions in the world in violation of their countrys' banking regulations -- making them all outlaw entities and the idea of banking regulation of any kind an absurdity.  

Finally, it's not really the CDSs that are the problem for indirect effects on the rest of the banking system.  It's the interest rate swaps that are the issue. Banks can only lend long term if they can be assured that the interest they pay for money won't be higher in the future than the rate they committed to charge on long term loans.  They obtain that guarantee by a swap where a counterparty takes the other position.  None of these are in danger of default in and of themselves.  What's in danger is the ability of the coordinator of many of these complicated insurance policies -- AIG -- to continue to guarantee them and do the job of collecting and distributing payments from one counterparty to another.  Conceivably the government or other entity could do the job, but no one really knows how hard or costly this job is yet if performed by another party, so just showing up and declaring the Feds are in charge could very well cause more harm than good.  

The calculus is simple: If it costs less for the government to do it, then nationalisation is the answer.  But if the total costs of nationalisation to society are expected to be higher -- which is what Geitner now believes -- then the facts don't yet support nationalisation regardless of what everyone's gut feelings might be.

by santiago on Mon Mar 23rd, 2009 at 10:14:22 AM EST
[ Parent ]
An interest rate swap is still an insurance policy that is traded like a security and is therefore on a collision course with itself.  Consequently there is no way the coordinators, including AIG, can guarantee them.  Trying to calculate the risk is like trying to bisect a sneeze.  Assets expended trying to continue the guarantees are wasted, and the effort is detracting from the resources available to actually fix the problem.
by rifek on Mon Mar 23rd, 2009 at 03:39:49 PM EST
[ Parent ]
are not insurance - they are a series of simple forward sales - a future, unknown interest rate against a fixed one.

And the interest swap market is not at all organised by AIG - it's a assive multi-participant market, probably the deepest and most liquid in the world. The problems are not coming from interest rate swaps.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Mar 23rd, 2009 at 05:42:44 PM EST
[ Parent ]
AIG is one of the principal coordinators of IRS, but, yes, you are correct that IRS is not at all where the problem is coming from. Rather, IRS contracts are a likely unintended victim of an ill conceived nationalisation of the kinds of entities that are in the business of arranging them, with uncertain consequences throughout the financial system.  The market for IRS has actually largely collapsed along with the market for long term securitized debt because it is also highly dependent upon counterparty confidence which is at an all time low. However there are existing agreements in which major investment banks and insurers such as AIG provide counterparty guarantee services and payment transfers.

(And I disagree -- they certainly are insurance, as are all derivative instruments. They insure fixed rate lenders against the event of rate volatility for refinancing their own capital.)

by santiago on Mon Mar 23rd, 2009 at 06:16:26 PM EST
[ Parent ]
I'm afraid we'll have to disagree on this.  Under the Basel II regime, they are being booked as insurance, even though they are certainly not being handled as insurance, which is my point.  Booking something as more secure than it is is inherently destabilizing and deflating.

I didn't say AIG organized it, just that it's a player, it's a problem, and it's in the spotlight.  And to say that the IRS market is the deepest and most liquid in the world is to damn with faint praise.  Any of these instruments is only as good as the parties along its trade trail, and how many of those parties are good?  That said, I agree that IRSes are not the source of the problem.  I believe that honor (at least in this aspect of a massive, multi-sourced mess) goes to the fact that the Basel II "standards" can be gamed by a drunken chimpanzee.

by rifek on Tue Mar 24th, 2009 at 12:24:05 AM EST
[ Parent ]
I'm taking a very long view on this.  Clearly the global financial system got totally out of kilter with the real economy and produced quantities of debt so vast that they cannot be repaid out of real economic activity any time in the foreseeable future.  Trying to fix that system now would destroy many good banks/businesses and any prospect of global economic recovery any time soon.

The solution is therefor a revolutionary one - but also a classical market one - i.e. let those instiutions which "went mad" fail and focus all state rescue efforts on those businesses which are vital to future economic activity.

DXebt finance as the dominant mode of finance is dead.  The future has to be built around much greater equity, bond, and revenue sharing models linked much more directly to productive enterprises where risks and rewards can be measured in a reasonably transparent way.  

Where I perhaps disagree with Migeru et al is that I don't believe there is a regulatory fix to the current system...  we need a new one... and that effectively requires a revolutionary transformation of how business is done, financed and regulated in the future - with debt being primary a vehicle for financing short term cash-flow requirements and longer term financing done through equity, bond, and revenue sharing covenants.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Mar 23rd, 2009 at 09:51:33 AM EST
[ Parent ]
Frank Schnittger:
The solution is therefor a revolutionary one - but also a classical market one - i.e. let those instiutions which "went mad" fail and focus all state rescue efforts on those businesses which are vital to future economic activity.
The thing is you need to extricate "vital" parts out of faied monstrosities created by the repeal of Glass-Steagall

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Mon Mar 23rd, 2009 at 09:58:26 AM EST
[ Parent ]
You might very well be right, but we should have actual, fact-based estimates of the total costs involved before jumping on the nationalisation bandwagon.

The debt explosion has caused more social claims against real resources than there are real resources available.  This problem is actually not uncommon and there are always two ways to solve it:

  1. Redististribute society's resources by giving priority to some claims over others. (Which leads to a stampede to get the highest priority claim on resources possible -- US treasuries.) or,

  2. Grow the amount of real resources so that the claims can be transferred to the future and made good then.

Right now, people have recognized that many of their claims on resources are unlikely to be honored, now or in the future, given more realistic expected rates of economic growth, so redistribution is now almost universally accepted as the right answer.  Problem is, redistribution is necessarily a highly contested policy because there are always lots of losers -- some people will be forced to give up their claims on resources -- their wealth.  And those people know who they are, and they are fighting like mad to hold on to as much as they can, and they're not all rich and not all poor who are in falling in the loser category here, whether it's nationalisation or not.
by santiago on Mon Mar 23rd, 2009 at 10:29:05 AM EST
[ Parent ]
santiago:
  1. Redistribute society's resources by giving priority to some claims over others. (Which leads to a stampede to get the highest priority claim on resources possible -- US treasuries.) or,

  2. Grow the amount of real resources so that the claims can be transferred to the future and made good then.

Or in fact


3/ Change the nature of the claim

In this case from a dated debt obligation issued by a credit middleman, aka a bank, to an open undated credit obligation issued by a producer of "money's worth" in value.


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Mar 23rd, 2009 at 11:48:17 AM EST
[ Parent ]
Changing the nature of an existing claim is just another form of politically coerced redistribution.
by santiago on Mon Mar 23rd, 2009 at 12:38:53 PM EST
[ Parent ]
Not if it's something people agree to do without reference to the government.

That's what a partnership approach entails. Two way agreement.

To replace dated secured debt with undated Units of revenues leads to a better outcome both for the financier and for the user of the finance.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Mar 23rd, 2009 at 01:19:53 PM EST
[ Parent ]
Government is just one of many possible forms of collective action.  It's not an agent by itself -- it's a result of the agency of people.  If two people engage in a two-way agreement, they have, themselves, formed a form of their own "government" for their own narrow purpose, just like a marriage, or a contract to buy a home in expectation of future payments. In all of these examples, power  -- the imposition of one party's interests over those of another's -- is still an important factor. So the word "government" is a red herring here.  

Doesn't replacing dated secured debt with undated units of revenues lead to a better outcome for the financier only if the value to the financier of having a more certain payment sooner is lower than the value of having a less certain payment in the future? All sorts of things can modify the magnitude and certainty of either form of reward for taking risk, but what determines whether or not someone is injured or benefited by the change is their own personal preferences, not the structure of payments themselves.  So anything that changes how people are rewarded for the risks they take when engaging in partnerships for profit necessarily results in losers as well as winners.  The only question is the number in each category, and that's still pretty ambiguous.

by santiago on Mon Mar 23rd, 2009 at 03:24:47 PM EST
[ Parent ]
santiago:
Doesn't replacing dated secured debt with undated units of revenues lead to a better outcome for the financier only if the value to the financier of having a more certain payment sooner is lower than the value of having a less certain payment in the future?

What it does is transform the risk of non-payment to the risk of not finding a buyer. If a Unit is redeemable for production, rather than revenue, then there is the option of actually using the production.

IMHO Units redeemable in energy or land rental value score highly in terms of their use value to the owner/investor.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Mar 23rd, 2009 at 03:40:38 PM EST
[ Parent ]
What you're proposing to do is to allow remuneration for risk even when a market does not exist for a commodity, and you're right that it does provide a lot of benefits to some people who would be most susceptible to deprivation if a market for a commodity failed or didn't exist.  In Amartya Sen's terms, you're providing an exchange entitlement to something that is not as dependent upon markets, so you can smooth people's consumption patterns during periods of uncertainty or market volatility.

However, you still can't escape the issue of differing personal preferences for risk just by changing how risk is compensated.  Some people will always be more averse to risk and some will be less so, so just changing how risk is compensated necessarily rewards some and injures others.  One of the limits of your system appears to be that fragmented lending is done away with -- people can't go around anymore with the same claim on the same resource, both of them independently believing it will be there for them whenever they need it.  In a time like now such a limit seems like a really good idea because there were obviously too many claims upon the limited resources available.  However, although the risk of a period like now occurring always exists, the truth is that most of the time it's perfectly alright -- indeed, much more efficient -- to allow two or more people to walk around believing they each have entitlement to the same thing while they are not using it.  If this is the case, then societies which allow such higher risk but usually more efficient ways of organizing resources to occur can be expected to outperfom, economically, and thus politically, those societies which choose to limit themselves to a more conservative, albeit more stable, way of determining who has access to what resources, like your innovative idea does, right?  It's the ever reappearing revenge of the dismal, it seems to me.

by santiago on Mon Mar 23rd, 2009 at 04:27:23 PM EST
[ Parent ]
One of the interesting qualities about what I like to call "Open" Capital ("nth's") and Credit (redeemable Units) is that the securing of supply may be entirely distinguished from the securing of price. So you can make a supply contract, and then pay for it either conventionally or by redeeming a Unit the supplier had issued previously, and which you had bought on the open market to secure price.

Another aspect is that ownership and control may also be distinguished in new ways. Unlike in a Corporation, where it's typically one share, one vote.

"Property" is not in fact, as most people think, an object. It is the relationship between the subject (individual, or collective of them) and the object (eg land). ie land is the object of a man's property, or something which is proper to the man.

This property relationship consists of a bundle of rights and obligations, and I believe that by packaging the whole relationship up within the legal concept of an open "Corporate" we may actually then share out these rights and obligations optimally in an extremely simple but effective "co-ownership" framework agreement.

Limited Liability is a red herring.

Indeed, if you bring all the stakeholders "inside the box" - as I did with a film - then there is really no need to limit your liability at all since the people you would be protecting yourself against are now all your partners....


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Mar 23rd, 2009 at 05:00:41 PM EST
[ Parent ]
Property is not a relationship between an object and and person.  Rather, it is a relationship between people.  The object in question is proper to some and not to others -- this is the relationship that rights to property establishes.  

But more generally still, is it really possible to bring ALL the stakeholders inside the corporate box?  Even in a film, for example, the collective can be sued or otherwise attacked by an outside party who feels materially offended by the film.  Or did you find a way to include that possibility too?  It would seem that in any collective action, particularly a commercial, political, or artistic one, there will always be stakeholders who you want to exclude precisely because they have a stake in the outcome that is contrary to your own.  How do you allow for that?

by santiago on Mon Mar 23rd, 2009 at 06:02:33 PM EST
[ Parent ]
santiago:
The object in question is proper to some and not to others -- this is the relationship that rights to property establishes.  

I give you that property rights necessarily involve relationships between people individually and collectively, but the legal protocols set out the relationship between object and person, and I am surprised you think otherwise.

In fact, when you say "proper to some" you are recognising that a relationship exists.

santiago:

But more generally still, is it really possible to bring ALL the stakeholders inside the corporate box?  Even in a film, for example, the collective can be sued or otherwise attacked by an outside party who feels materially offended by the film.

The logical conclusion is for the viewer to join a "viewers club", and contract out of such nonsense by participating on the basis of alternative dispute resolution. But as it was a ten minute black and white comedy, we never got that far.

My point is that there is no reason why a consensual protocol cannot transcend all others.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Mar 23rd, 2009 at 06:31:08 PM EST
[ Parent ]
I don't agree on the property question.  Laws and other social norms pertain to human interactions and do not define a relationship with an object but rather a relationship between people regarding exclusive use of an object.  Without such a law or social norm, people could still use the object like it is, but just not exclusively, so it's the social relationship that is specified by the social rules not the relationship between person and thing.

On your main point, I think that it could be entirely possible that a consensual protocol like you are describing could transcend all others, but in order to do that it would have to provide benefits to a certain class or classes of powerful people who have an interest in seeing it happen, just like every other historical change in the way society has been ordered.  That's the part I don't quite see yet, although even without that, I do see the possibility of it becoming an additional organizational tool in the capitalist toolbox such as limited liability and traditional cooperatives.

A key benefit of limited liability, however, is that there are still lots of reasons for people to want to be excluded from risks but still participate in a collective enterprise, including many non-economic reasons, which means that it still might be more efficient do so even if there is an ongoing externality problem, which is what your system goes a long way toward solving.

by santiago on Mon Mar 23rd, 2009 at 11:54:34 PM EST
[ Parent ]
santiago:
Laws and other social norms pertain to human interactions and do not define a relationship with an object but rather a relationship between people regarding exclusive use of an object.

I think my only difference with you is semantic.

For me, a protocol defining a relationship with an object and a protocol defining a relationship between people regarding exclusive use of an object both necessarily include reference to both the subject individual(s) and the objects(s).

ie

<subject><relationship><object>

And it is the potential of consensual protocols for defining the property relationship that interests me.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Mar 24th, 2009 at 01:14:14 PM EST
[ Parent ]
I can't agree with that:


DXebt finance as the dominant mode of finance is dead.  The future has to be built around much greater equity, bond, and revenue sharing models linked much more directly to productive enterprises where risks and rewards can be measured in a reasonably transparent way.  

We are in a crisis to a arge extent because no riks analysis was performed on underlying assets, and one of the reasons this happened is that those that structured the financial instruments did not hold them - and did not really care if they were sound: they only cared if they were marketable, which is not the same thing.

Bank debt, held for the long term, based on thorough analysis of the borrower by the bank, which keeps the asset on its books, is a lot safer. Less profitable, boring, but certainly safer.

Peer-to-peer finance does not work because nobody can do the requisite risk analysis.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Mar 23rd, 2009 at 05:46:33 PM EST
[ Parent ]
Jerome a Paris:
eer-to-peer finance does not work because nobody can do the requisite risk analysis.

Peer to Peer finance strictly refers to direct investment in a productive asset by an investor without a bank as middleman, and if it works with a bank as middleman it is also capable of working directly. But clearly whether the business model is or is not intermediated is not your point.

So lets forget "Peer to Peer". It's the concept of what I refer to as unitisation which is the issue here, I think.

Are you thinking of financing development of productive assets?

Or are you thinking of long term financing of developed productive assets?

Or are you thinking of a hybrid where long term finance is raised to finance development and stays in place?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Mar 23rd, 2009 at 06:52:52 PM EST
[ Parent ]
is that you can't break down an investment into a thousand small bits that can be financed separately. You have to have the whole package in one go. The coordination role of putting that package in place is what banks do.

Whether they keep the risk to themselves, share it with a few similar banks on the syndication market (ie a bank loan), or sell it widely via a securitisation (ie a captial market instrument) is largely irrelevant.

What matters is that critical role of putting all the money on the table in one go at one single time. That's the value of banks. Nothing else.

Your unitisation is a fine way to share out financial assets, but it cannot help to create them. That's the job of bankers. One which will never disappear.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Mar 24th, 2009 at 12:57:49 PM EST
[ Parent ]
I have always said that banking as a service is necessary and creates value. It is credit intermediation that is IMHO not only sub-optimal but also redundant.

Jerome a Paris:

What matters is that critical role of putting all the money on the table in one go at one single time. That's the value of banks. Nothing else.

I agree: but money is a means to an end.

It's not the money churning out electricity and getting it to Joe Sixpack, it's the turbine and infrastructure - and everything which went into it - for which fiat credit = money was created and exchanged over the period of construction and implementation.

If the land is leased for a share of production, then no fiat money is needed - ever - for land purchase or use.

If the turbine is leased for a share of production, then you don't need money to buy the turbine either, and maybe the investors in the turbine-maker might be more interested (the way things are going) in streams of energy rather than streams of fiat money?

ie the turbime maker evolves to a service provider as well.

If - as I believe is possible - we are able to "monetise" energy then your valuable role as an investment banker will still remain the same, except that you will not be looking at projects in terms of the "cost of money" in quite the same way, since the input cost of renewable energy and energy efficiency savings is zero.

You will instead be looking at viability directly in terms of energy invested against energy produced; the likely exchange value of the production over time; and the risks that the project will be concluded on time within its budget, and so on.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Mar 24th, 2009 at 01:46:01 PM EST
[ Parent ]
If banks can do risk analysis, so can non-banks.

The difference isn't between analysis and no analysis, it's between being on the hook for the risk directly, which is likely to concentrate the mind somewhat, and attempting to palm it off on to some third party - either by direct insurance, or by spreading out that the risk so thinly that it stops appearing risky.

The irony is that to some extent this is what's been happening already. Wall St has almost been acting in a peer to peer kind of a way, but with the - valid - assumption that risk can always be shared with the government, making it almost risk free.

But there's no certain reason why peer to peer has to be this irresponsible - any more than there's a certain reason why banking can only be done in a boring and safe way.

Obviously it can be done in other ways too, as everyone has discovered.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Mar 23rd, 2009 at 06:56:39 PM EST
[ Parent ]
The banks' primary role is first to create the asset, and then only to seel it or keep it.

Of course, if the model is that they don't keep it (and note that unitisation falls into that category), then they may be incentivised to structure worse assets.

And contrary to what you think, doing proper risk analysis is actually pretty damn expensive and difficult. Bankers' pay (as highly qualified professionals) is justified, to that extent.


In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Mar 24th, 2009 at 01:00:48 PM EST
[ Parent ]
Jerome a Paris:
Of course, if the model is that they don't keep it (and note that unitisation falls into that category), then they may be incentivised to structure worse assets.

In the model I advocate, there is in fact no transaction or "sale" of an asset. The asset is created in custody, and stays in custody.

Stakeholders will participate only on the basis that any agreed profit margin is invested. It's then up to them what they do with their entitlement to Units once the development is complete.

But I suggest that they will see that their interests lie in doing a good job - whether or not they are capable of doing a good job is another issue.

Jerome a Paris:

Bankers' pay (as highly qualified professionals) is justified, to that extent.

I have no difficulty with that, albeit relative valuations are not easy.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Mar 24th, 2009 at 01:58:32 PM EST
[ Parent ]
You're the banker, so you will know a lot more about this, but it appears to the layman that part of the point of developing all these derivative products is partly to spread the risk, but also to render it so complex and opaque that risk analysis becomes virtually impossible.  Bank stopped analysing the actual assets and traded on each others reputations (and credit ratings) instead, in much the same way as people buy brands because they have a good reputation (carefully crafted by the marketing people) but which may actually consist of very crappy product.

It is this dislocation between high finance and the actual productive economy which needs to be addressed because otherwise good businesses fail for lack of finance and bad business which are well marketed to financiers get all the capital.

Risk analysis is a skilled and expensive business and requires an understanding of the real world - if banks have a value, it is that they are good at allocating capital to worthwhile projects.  When they stop doing this they become no better than casino operators.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Mar 23rd, 2009 at 07:54:27 PM EST
[ Parent ]
the point of developing all these derivative products is partly to spread the risk, but also to render it so complex and opaque that risk analysis becomes virtually impossible.

So on the one hand blame would be placed with people who designed the system this way. on the other it could be placed on people who misused the system in this way.

Surely this would be visible and provable by looking at either the amount of risk analysis staff, or the ammount of risk analysis paperwork produced in the derivative departments.  If the apropriate risk analysis wasn't built into the derivative departments as they started then it would show intent.

Any idiot can face a crisis - it's day to day living that wears you out.

by ceebs (ceebs (at) eurotrib (dot) com) on Mon Mar 23rd, 2009 at 08:11:19 PM EST
[ Parent ]
Jerome a Paris:
We are in a crisis to a arge extent because no riks analysis was performed on underlying assets, and one of the reasons this happened is that those that structured the financial instruments did not hold them - and did not really care if they were sound: they only cared if they were marketable, which is not the same thing.

Well Jerome is the banker here - if not a derivatives trader - and so I am taking his word for it - though to be honest, this is exactly what I would expect to have happened.  As I noted above, risk analysis if expensive and skilled, and if a bank wants to cut costs...

Also there is a more general trend in all businesses - the emergent dominance of the marketing department over production/engineering and even R&D.  Business now - and the larger and more complex it is - the more so - is all about managing perceptions - consumer, regulator, investors, bankers - and the actual reality of what is happening on the ground in terms of product quality is almost an irrelevance.  I would be surprised if banking were any different - and particularly the more exotic hedge fund and derivatives end of the business.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Mar 24th, 2009 at 08:14:18 AM EST
[ Parent ]
Hi Frankie.  Just gave you a 5 rating at the first link.  Your first paragraph was a stunner; loved it.  Me?  I'm waiting for someone with sense to start writing diaries on how the rules change once:

  1. Serious violence erupts in the streets.

  2. The next world war looms, this time with nukes at the front end, not at the back like WWII.  

All this crap we see now is just prologue, posturing.  I'm waiting for Chap. 1.

The good news ... it's only a life sentence. You eventually leave this planet of idiots.
by THE Twank (yatta blah blah @ blah.com) on Sun Mar 22nd, 2009 at 03:49:35 PM EST
Last time we had a descent into Fascism and Nazism.  When you look at where the GOP and Rush Limbough is going, it looks like the USA hasn't leaned the lessons Europe learned the hard way...

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Mar 22nd, 2009 at 06:17:49 PM EST
[ Parent ]
Yup.  Just had tutoring and I'm (kinda) drunk right now.  So, just maybe, we should prepare to some extent to descend into the pit.  And how do we handle it on an individual level and what do we shoot for at the end.

Time to get crackin' as they used to say.  Obama is a nice guy but he'll need some help.  I'll step up.

The good news ... it's only a life sentence. You eventually leave this planet of idiots.

by THE Twank (yatta blah blah @ blah.com) on Sun Mar 22nd, 2009 at 11:19:43 PM EST
[ Parent ]
Serious violence may erupt on many streets - but not on basically private Pacific or Caribbean islands. But it seems people can keep mum in pain quite long time.

Are World Wars real desperate brawls for diminishing riches? Or are they just human sacrifice rituals by the elites?

The rich of the world had united nicely. For proletarian folks, union thoughts are tabu.

A revolution now is much more problematic than 100 years ago. The nukes is just one reason enough.

by das monde on Mon Mar 23rd, 2009 at 01:48:33 AM EST
[ Parent ]
BBC NEWS | Business | Recession 'could trigger unrest'

Former Labour minister Frank Field has told the BBC the financial crisis is so severe that if not properly handled it could trigger civil unrest, even riots.

"I can't underestimate how terrible the financial crisis is even if it doesn't get a penny worse," he said in an interview with Panorama.

"No sensible person would sit in front of this camera and tell you there is no possibility whatsoever of disorder."

Mr Field spoke to Panorama for Monday's programme on Britain's pensions crisis.

In Who Will Save the Savers? Panorama looks at how the credit crunch is pushing Britain's long-running pensions and savings timebomb to a critical new stage.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Mar 23rd, 2009 at 07:58:48 AM EST
[ Parent ]
ThatBritGuy:
Britain's long-running pensions and savings timebomb
The old trope, unchallenged.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Mon Mar 23rd, 2009 at 09:59:18 AM EST
[ Parent ]
I touched on this a bit in my story on the G20 Summit and unions' recommendations.  I'm querying whether a state of aquiescence still prevails, even though potentially this situation could lead to a huge shift now some of the walls have been knocked down. Problem is if people couldn't see the walls in the first place, they aren't to know they've been knocked down, or at least that the door is unlocked, so they'll stay as they are unless things get really bad.

This buys time for those who have held the power for so long, to keep their grip and return to full dominance without having made any substantial changes bar buying a few people off and placating them with rhetoric.

by In Wales (inwales aaat eurotrib.com) on Mon Mar 23rd, 2009 at 10:17:52 AM EST
[ Parent ]
So my suggestion is that Governments should set up huge investment funds to buy up these assets at current market prices because then the taxpayer also has some prospect of reward should assets prices recover somewhat.
As Krugman and others keep hammering, buying the toxic waste at its "market price" doesn't make the banks any less insolvent. If anything, they can pretend they are solvent because they are not selling the assets and so they can pretend they are worth more than the market would give them for it. The problem of the toxic assets is not lack of buyers, but lack of sellers - the banks can't sell at the market price without instantly realzing losses that would render them insolvent.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Sun Mar 22nd, 2009 at 04:38:43 PM EST
However the objective of my proposal is not to try to make completely insolvent financial institutions solvent - let them go into Chapter 11.   That is a black hole so big it simply cannot be filled with any money Obama and others are likely to be able to raise, and we risk huge inflation if we simply print money to fill that hole.  The objective is to cut taxpayers in on the action at current deflated prices - and thereby help put a floor under further deflation.

Insolvent institutions have no choice but to sell assets at current prices to meet current liabilities - unless we bail them out.  In fact bailing them out helps them to pretend that it is still business as usual.  

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Mar 22nd, 2009 at 06:13:32 PM EST
[ Parent ]
As I commented on vets74's diary, I think an AIG Chapter 11 is desirable, even necessary, and impossible.  I don't think the US government has the guts.
by rifek on Mon Mar 23rd, 2009 at 09:08:20 AM EST
[ Parent ]
The problem, as I see it, is that no one seems to know what the toxic assets hidden on and off financial balance sheets are actually worth, or might be worth in the future.
You linked to Jerome's Depressed on Daily Kos where he says
Many people are worrying about the value of assets on banks' balance sheets. Is it 95 cents on the dollar? 60? less? Many people make it as if that were the biggest problem.

It is not. The worst that an happen to an asset is that its value falls to zero, so the maximum size of the problem is known.

What is not known is the size of the liabilities. ...

Again: the bigger problem is not worthless assets, it's unlimited liabilities on all the financial bets that were made.

What is so depressing is that money is being thrown at banks in the guise of solving the asset problem, when it goes to not solving the liabilities problem (because it's so much bigger) - and that markets know that it's not solving anything (they have the liabilities on their books, and guess that others have the same).




Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Sun Mar 22nd, 2009 at 04:43:56 PM EST
Insolvency arises where assets are insufficient to cover liabilities, so both sides of the balance sheet are relevant.  However Jeromes point about the unknown extend of the liabilities - possibly multiples of world GDP???!!!??? - is just another reason why the taxpayer really shouldn't go there and try to bail those people out.

By all means deal with the consequences of major insolvencies by protecting downstream business in the real economy who still have a productive role to play in generating wealth and employment and who need working capital, credit guarantees, and possibly even help write off some of their debts wheer these were caused by the "bad banks" - but such actions should be on a case by case basis - as in Ford and GM, in response to specific business plans as to how those business can remain productive/viable.

 The sums committed to bail-outs for the productive sector so far is minuscule compared to the sums which may be required to bail-out shadowy business which made speculators rich but which never made a major contribution to the real economy in the first place.  These businesses are so insolvent as to be beyond rescue in any case - we have no choice but to find other ways of meeting the legitimate financial services needs of the real economy.


notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Mar 22nd, 2009 at 06:27:07 PM EST
[ Parent ]
trying to keep the banks the way they were is increasingly reminding me of Hemingway's 'the old man and the sea'.

by the time they get back to port their fish is going to be a skeleton...

"We can all be prosperous but we can't all be rich." Ian Welsh

by melo (melometa4(at)gmail.com) on Mon Mar 23rd, 2009 at 05:17:09 PM EST
[ Parent ]
The problem is not one of market failure and your "market price" is not a solution.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Sun Mar 22nd, 2009 at 04:50:04 PM EST
Migeru:
The problem is not one of market failure

I don't understand how you can make this point- even the free market fundamentalists have come round to the view that a market failure occurred where risks and rewards became almost totally divorced from one another.  "Irrational exuberance" was based on some people being able to make a killing whist transferring virtually all risks to "the system" and now Governments and Central banks at no cost to them.  Even now no one knows the really price/value of many of the financial instruments on and off corporate balance sheets.  How is this not a market failure?

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Mar 22nd, 2009 at 06:34:06 PM EST
[ Parent ]
The problem was one of regulatory and accounting fraud, not of "market failure".

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Sun Mar 22nd, 2009 at 06:37:07 PM EST
[ Parent ]
If it's fraud, there should be criminal charges flying all over the place  - and not just for the Madoff's and Stanfords.  It's not clear to me, even now, how better accountancy standards would have eliminated the problem - mitigated perhaps - but the greater problem seems to be with the system design itself, not just with the methods of reporting on it.

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Mar 22nd, 2009 at 06:43:48 PM EST
[ Parent ]
See this comment and the three links therein.

You would have needed better accountancy standards as well as semicompetent regulators.

The "market" justification of what was going on over the past 10 to 15 years as well as of the light touch of regulation, selfregulation or even deregulation was a bogus justification. The problem with framing this as "market failure" is that then government steps in to "restore proper functioning of the markets". Which is what all governments are running around like headless chickens trying to do. But the problem is not that markets are not pricing things, it is that the money center banks would be rendered insolvent by the market price. And this is as it should be.

Your "market solution" is not all that different from the Geithner plan, and is not a solution, even if "market based".

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

by Migeru (migeru at eurotrib dot com) on Sun Mar 22nd, 2009 at 06:51:56 PM EST
[ Parent ]
Accountants are supposed to be part of the regulatory system. They are supposed to prepare 'fair and balanced' reports to both regulatory authorities (not just Tax authorities) and shareholders.

The motivations of accountants for the last few decades have shifted from 'neutral observers' to 'problem solvers' for corporations. Bad, bad, bad.

Tightening the rules for accountancy would go a long way to resolving current problems.

You can't be me, I'm taken

by Sven Triloqvist on Sun Mar 22nd, 2009 at 07:10:36 PM EST
[ Parent ]
How can there be anything other than a conflict of interest when the same group is being paid for an audit and also for advice on tax avoidance?

No one seriously believes that for all the talk of Chinese Walls and other cliches that the corporate accountancy industry is on the side of government and regulatory enforcement. Not even the SEC or the FSA do that job.

In fact no one at all does it, which may possibly have contributed a little here.

But as Frank said - the real underlying problem is class war in the US. The rich have been vicious and ruthless, and the left is only just starting to get organised again after a thirty year break.

This is fundamentally a political problem. It's about a system which includes positive feedback loops which reward and reinforces aggressive class war against the majority by the minority.

The only positive push-back has to come from the left - and it's going to take more than raising money for Obama and a bit of flag waving to create a genuine and effective left wing opposition.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sun Mar 22nd, 2009 at 07:23:23 PM EST
[ Parent ]
I wouldn't argue for a moment that we didn't have a monumental accounting and regulatory failure as well as a market failure.  But if framing the problem as a market failure results in Governments thinking that all they have to do is to "restore the proper functioning of the markets" - through better regulation - then framing the problem as a failure of proper regulation doesn't result in any better solution.  Of course better regulation/enforcement is required whatever way you frame it.

But my solution is not to even try to fix the problem by trying to cover the (unknown but almost limitless) liabilities of insolvent institutions and thus to make them solvent again, but rather to let them go into Chapter 11 and focusing your efforts on ameliorating the downstream impact on "good businesses" in the really economy which are required to get the real economy moving again.

Thus a lot of very rich speculators go very bust.  A lot of the collateral damage to good businesses/banks is addressed on a case by case basis - perhaps by "good" banks given access to federal funds/guarantees set aside for that very purpose - effectly acting as subcointractors to the Government which doesn't have the resources/expertise/locus standii to make individual banking/lending decisions.

I don't know a whole lot about Geithner's plan, but it doesn't seem to me to be about letting the most delinquent firms go to the insolvent fate they have so richly deserved...and bypassing their traditional role by directly aiding productive businesses in the real economy.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Mar 22nd, 2009 at 08:20:00 PM EST
[ Parent ]
Frank Schnittger:
But if framing the problem as a market failure results in Governments thinking that all they have to do is to "restore the proper functioning of the markets" - through better regulation - then framing the problem as a failure of proper regulation doesn't result in any better solution.
But that's not what they're doing. "Restoring the proper funcitoning of the markets" to them means pouring money into failed institutions so that when they sell the bad assets at market prices they can remain solvent.

The market isn't clearing because the bans are insolvent. The "market failure" point of view is that the banks are insolvent because the market isn't clearing at the "right" price. So to repair the "market failure" they artificially prop up asset prices.

In so many words, you have chosen the wrong frame for your diary. It is not "market" failure and your solution is not a "market" solution.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

by Migeru (migeru at eurotrib dot com) on Mon Mar 23rd, 2009 at 04:33:48 AM EST
[ Parent ]
Pouring trillions of taxpayers money into insolvent institutions to make them solvent again is explicitly an anti-market activity.  It is no different from a "socialist" propping up of "inefficient" state enterprises which cannot survive in an open market. (Ignoring for the moment the fact that such enterprises may also be fulfilling social rather than commercial mandates).  The market led approach is to simply let them fail and be replaced by other better structured, managed and regulated institutions.  

I am explicitly suggesting that toxic assets be purchased at current market prices - i.e. near zero in some cases - which will do nothing to help insolvent institutions but which will put a floor under further deflation and cut taxpayers in on the actions when market pricers recover.  The focus of "my rescue plan" is to to help the good banks/businesses vital to the functioning of the real economy which might be killed by the downstream effects of those insolvencies to remain in business.

I think we may be getting into a semantic squabble here.  I am partly using a market framing to get around the USA phobia of state intervention/ownership and also to avoid the taxpayer being stuck with almost unlimited liabilities.  I am also buying into Chris' more general thesis that the financial system as is is unrescuable and the focus now must be on finding ways to support the real economy which move away from dependency on "too big to fail" banks and from excessive debt financing in general.

Whichever way you look at it the future must move away from debt to equity, bond, and revenue sharing agreements as a way of funding productive enterprise.  Debt at the levels we have been operating is uninsurable because it is simply too vast and to removed from real productive economic activity.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Mar 23rd, 2009 at 09:37:37 AM EST
[ Parent ]
Frank Schnittger:
I think we may be getting into a semantic squabble here.  I am partly using a market framing to get around the USA phobia of state intervention/ownership and also to avoid the taxpayer being stuck with almost unlimited liabilities.  I am also buying into Chris' more general thesis that the financial system as is is unrescuable and the focus now must be on finding ways to support the real economy which move away from dependency on "too big to fail" banks and from excessive debt financing in general.
Possibly. It's not the first time I am irked by a piece you geared to a different audience...

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Mon Mar 23rd, 2009 at 10:01:43 AM EST
[ Parent ]
Yea - my problem is I don't like preaching to the converted and prefer reaching to the convertable...

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Mar 23rd, 2009 at 10:13:55 AM EST
[ Parent ]
Frank Schnittger:
If it's fraud, there should be criminal charges flying all over the place

Yep.

Did you see the FBI rap sheet? There's evidence of systematic mortgage fraud - and that's just on the surface. God only knows what would be discovered with deeper digging.

Another way to look at is that a few trillion will buy you a lot of political influence. The odds of none of that money ending up in the pockets of various right and far right groups are not high.

So Obama is literally handing the next election to Wall St.

Isn't that a cheerful thought?

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sun Mar 22nd, 2009 at 07:14:04 PM EST
[ Parent ]
ThatBritGuy:

So Obama is literally handing the next election to Wall St.

Isn't that a cheerful thought?

It would be if Wall Street were still around as we know it.

Which IMHO it won't be.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Mar 22nd, 2009 at 07:16:37 PM EST
[ Parent ]
Possibly. But Wall St's owners - the people who have used Wall St as their own personal high street bank - will be.

Inexplicably, Geithner's plan won't be making them any poorer.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sun Mar 22nd, 2009 at 07:26:53 PM EST
[ Parent ]
So Obama is literally handing the next election to Wall St.

Isn't that a cheerful thought?

Indeed!  It is the reason that, for the first time in a very long time, I have embraced the old Leninist philosophy of "The worse, the better!"

The only real hope is if the financial crisis gets so spectacularly bad so quickly and so outrageously that Obama has no choice but to dump Geithner, Summers and all of the Market True Believers and very forcefully and publicly make the case for holding the culprits in the financial sector accountable in massive criminal and civil investigations, use the I.R.S., the Fed, the SEC CFTC, etc. in such ways as to paralyze their financial capability, PUSH THROUGH CAMPAIGN FINANCE REFORM, and go after all the wealth that is recoverable.

Contrary to self serving assertions, a direct assault on the wealth of the owners of the financial sector will not harm the economy, as they have withdrawn their money from productive investments precisely because of the mess they have made of it.  The government could extend an olive branch in the form of 25 year long bonds at, say 4%, en lieu of an annual tax on total assets.

Conceptually, there are clear ways out of the current situation.  Practically, it will require a massively greater crisis for this to be possible, if even then.  But, if Obama has not brought himself to make decisive moves against the financial sector by year's end, all will probably be lost and he will have handed the looters the whip handle.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Mar 23rd, 2009 at 12:15:03 AM EST
[ Parent ]
ARGeezer:
Indeed!  It is the reason that, for the first time in a very long time, I have embraced the old Leninist philosophy of "The worse, the better!"

Absolutely spot on, ARG. That is exactly why solveig and I dance a little jig each morning when we read the latest financial news......

But my take on it is that the main part of the solution, will be P2P financing spreading virally and implemented from the ground up.

ARGeezer:

Contrary to self serving assertions, a direct assault on the wealth of the owners of the financial sector will not harm the economy, as they have withdrawn their money from productive investments precisely because of the mess they have made of it.  

There's no need to assault them. Just demonstrate to them that the solution being offered is a better one than anything else. If they agree, they join in. if they don't, they will wither on the vine.

Politicians can facilitate the process and surf the wave, I think. If Obama were to update Henry George.......

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Mar 23rd, 2009 at 08:48:07 AM EST
[ Parent ]
The regulations were implemented in the first place because markets proved with the '29 Crash that they couldn't prevent this type of fraud on their own.  Beginning with Reagan and carrying on through Bush I, Clinton, and Bush II, though, the US government let the markets run loose again and expressly kept its hands off of hedge funds and the CDS markets.  So underlying the regulatory failure was a market failure that had been identified before my parents were born and that had not been cured by the passing of a half-century.  Deregulating the markets had the same effect as taking a schizophrenic off his meds (And for every John Nash, there are thousands stumbling down the street yelling at the invisible.  Did we really want to play those odds with the world's economy?).  This is a fact that needs rammed up every neolib/neocon's nose so that we don't forget again and in another half-century listen to another Milton Friedman peddle Kool-Aid.
by rifek on Mon Mar 23rd, 2009 at 08:43:28 AM EST
[ Parent ]
Can I just say a big thank you to all the contributors here who have turned this into a very educational (for me) and well informed discussion where some serious issues have been teased out.

I am not an expert in this area but am naturally worried that the political and social implications of the financial crisis could be devastating for all of us and so it is very important that the wider public gets a handle on the issues.

My fear is that we could have the extraordinary situation where progressives like Obama are defeated at the next election by right wing populist charges of collusion with Wall Street when the reality is that he has inherited a situation created by others.

It also seems to me that financial globalisation has run so far ahead of any global political response that national politics is rendered almost helpless and hopeless in dealing with the fall out and electorates are open to the kind of woeful manipulation that gave us a descent into fascism (branded national socialism) in the past.

These issue couldn't be more important... for the future of our societies and the planet as a whole.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Mar 24th, 2009 at 08:23:53 AM EST


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