European Tribune - Community, Politics & Progress.

Regulatory arbitrage brought us here - time to make it go away

by Jerome a Paris
Sat Mar 7th, 2009 at 10:57:02 AM EST

Top U.S., European Banks Got $50 Billion in AIG Aid
The insurer generated a sizable business helping European banks lower the amount of regulatory capital required to cushion against losses on pools of assets such as mortgages and corporate debt. It did this by writing swaps that effectively insured those assets.

So AIG got into a mess by helping international banks get around applicable rules (the CDSs that AIG sold are regulated neither as banking instruments nor as insurance, even though they are actually both). The Economist, naturally, blames government (no link for now, their site is down):

Although politicians made the mistakes that allowed Sir Fred [of RBS] to get away with his cash, the row sustains the comfortable fiction that the government's sensible policies were traduced by greedy bankers. (...) Avoiding future disasters means allocating blame acurately; and most of it lies with bad policy, not with greedy bankers.

This, of course, coming from one of the publications that have most consistently pushed for de-regulation of financial instruments, in the name of "freedom" and wealth "creation," and supported investment banks' lobbying efforts to get rid of policies that put any kind of restraint on what financiers did (arguing along the way that bankers are smarter than regulators and will always find ways around rules)

The above explains why the Economist has officially become a joke (the Rush Limbaugh of finance?); thankfully, some financial publications are showing a bit more sense:

The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. (Martin Wolf in the FT)

In other words: either banking is necessary, and it has to be made boring, or it is not, and we should let its current incarnation die.

The problem is that freedom has been equated with "freedom to make money", and "freedom to use money to influence and corrupt those in power", and that those that have been entrusted with the ultimate public good, money, have been busy siphoning off an increasing portion of it, while presenting this as being "successful" and as a desirable outcome. It was certainly successful within the narrowly defined vision of that word they have managed to impose upon society, but it was rather not desirable.

In any case, it's time to talk about the heart of the matter: the place of money in society, and how to trust those that have the power to move it around, for themeselves or on behalf of others.

Which fundamentally means getting rid of the grip financiers and financial analysts have on "Serious Opinion." That means keeping politics away from money, policy away from financial analysis, and journalists and politicians away from bankers. The way to do that is to (i) bring back high rates of marginal taxation (because they make the pursuit of high incomes possible, and lobbying to make that both possible and easy a core activity), (ii) separate completely and hermetically regulated utility banking from the unregulated gambling/"investment" kind (break up the existing behemoths accordingly, identify regulated activities and send to prison anyone that does unregulated activities within a regulated entity), (iii) put up enough money for regulators to attract capable people (and fordid them from ever going to work for the industry they regulate), (iv) provide enough public money to fund political parties and campaigns so as to make private money irrelevant, (v) break up media groups.

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Regulatory arbitrage brought us here - time to make it go away | 61 comments (61 topical, 0 editorial, 0 hidden)

Can we please... (4.00 / 4)

... do away with the term "regulatory arbitrage" and go back to the original terminology: Tax evasion, fraudulent bookkeeping, flying the flag of convenience, and so on and so forth?

Those are perfectly good English terms that as far as I can tell completely cover the subject at hand, with no need to confuse things with legitimate arbitrage.

- Jake

"Terraforming your own planet to make it uninhabitable hardly counts as epic win." - ThatBritGuy

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Mar 7th, 2009 at 11:03:54 AM EST

Fair point (4.00 / 3)

The way to do it, is, I think, to show that this "regulatory arbitrage" did amount to all the things you say in fact, if not in law, plus had other unpleasant side effects.

Thus the need for the straightjacket on the people that abused the public trust.

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

by Jerome a Paris (etg@eurotrib.com) on Sat Mar 7th, 2009 at 11:07:51 AM EST
[ Parent ]

Re: Fair point (none / 1)

I agree completely.

I just jumped on this one in particular, because it's a bit of financial newspeak that's starting to annoy me. Arbitrage arguably has a legitimate function, so "regulator arbitrage" looks a lot like a newspeak term designed to conflate flying the flag of convenience with legitimate arbitrage.

- Jake

"Terraforming your own planet to make it uninhabitable hardly counts as epic win." - ThatBritGuy

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Mar 7th, 2009 at 11:11:19 AM EST
[ Parent ]

well, it's a two-sided weapon (none / 1)

by including "regulatory," they explicitly acknowledge that this about going round regulations to find the most convenient (ie lest constraining), ie it is about avoiding the rules.

Avoiding the rules is pretty damn close to breaking the law. Maybe the solution would simply be to reverse the burden of proof on whether that's the case...

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

by Jerome a Paris (etg@eurotrib.com) on Sat Mar 7th, 2009 at 11:14:45 AM EST
[ Parent ]

Point (n/t) (none / 0)

"Terraforming your own planet to make it uninhabitable hardly counts as epic win." - ThatBritGuy

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Mar 7th, 2009 at 11:20:24 AM EST
[ Parent ]

Re: well, it's a two-sided weapon (none / 0)

Financial commentators also talk about "Tax arbitrage" as if it were a legitimate investment strategy.

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 Sat Mar 7th, 2009 at 12:39:01 PM EST
[ Parent ]

Re: well, it's a two-sided weapon (none / 0)

But it's a misunderstood word among the masses. What if the words 'Shadow Banking' was substituted for 'regulatory arbitrage'?

I think it's easier for talking heads at places like CNN & CNBC to understand and explain to viewers.

by NvDem (Ed@igreno.com) on Sat Mar 7th, 2009 at 12:40:42 PM EST
[ Parent ]

Re: well, it's a two-sided weapon (none / 1)

Do any of the masses know what arbitrage actually means?

Voodoo banking or zombie banking is probably even more accurate than shadow banking.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sat Mar 7th, 2009 at 07:05:21 PM EST
[ Parent ]

Re: Nope (4.00 / 2)

European Tribune - Regulatory arbitrage brought us here - time to make it go away

The way to do that is to (i) bring back high rates of marginal taxation (because they make the pursuit of high incomes possible, and lobbying to make that both possible and easy a core activity), (ii) separate completely and hermetically regulated utility banking from the unregulated gambling/"investment" kind (break up the existing behemoths accordingly, identify regulated activities and send to prison anyone that does unregulated activities within a regulated entity), (iii) put up enough money for regulators to attract capable people (and fordid them from ever going to work for the industry they regulate), (iv) provide enough public money to fund political parties and campaigns so as to make private money irrelevant, (v) break up media groups.

The system's fucked. Kaput.

Modern conservatives engage in one of man's oldest exercises in moral philosophy: the search for a superior moral justification for selfishness.Galbraith

by ChrisCook (cojockathotmaildotcom) on Sat Mar 7th, 2009 at 11:12:45 AM EST
[ Parent ]

Thanks (4.00 / 2)

I saw that graph earlier, and wanted to link it to this story, but couldn't remember where I had read it. The shadow banking system is exactly what my post is about: a way to avoid the rules, and this is exactly what we need to kill: the ability of the shadow system to contaminate the "real" one.

Now, it's too late, as you note. which means that the government has to grab the whole industry, take the bits of infrastructure that are vital, put it in a shape that can survive, call that the utility bit, regulate it stringently, and let the rest to its sorry fate.

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

by Jerome a Paris (etg@eurotrib.com) on Sat Mar 7th, 2009 at 11:18:28 AM EST
[ Parent ]

Re: Thanks (4.00 / 2)

This is out of "the Government's" hands. There are trillions of dollars (and pounds and euros) worth of financial claims out there with the creditors of the US, EU, UK etc. The steps you outline may well be correct, but are based upon an assumption that they would be accepted by creditor nations.

How many Barrels and Btu's has the G7? The G7's creditors are not just going to press the reset button if there is a viable alternative, and I happen to believe that there actually is.

I think that the era of the middleman is over: Humpty Dumpty simply cannot be put back together again. We need a 21st Century solution to a 21st century problem, and I am quite sure this is already emerging.

Modern conservatives engage in one of man's oldest exercises in moral philosophy: the search for a superior moral justification for selfishness.Galbraith

by ChrisCook (cojockathotmaildotcom) on Sat Mar 7th, 2009 at 11:43:07 AM EST
[ Parent ]

Re: Thanks (none / 1)

These particular creditors didn't invest their money in government guaranteed instruments. The problem is not that the creditors might not accept the default of financial institutions. It's that they are likely not to put their new (or remaining) cash into Western financial institutions.

by vladimir on Sat Mar 7th, 2009 at 12:01:38 PM EST
[ Parent ]

Re: Thanks (none / 1)

vladimir:

It's that they are likely not to put their new (or remaining) cash into Western financial institutions.

Exactly.

Why should they accept $, € and £ in exchange for something with actual worth?

Modern conservatives engage in one of man's oldest exercises in moral philosophy: the search for a superior moral justification for selfishness.Galbraith

by ChrisCook (cojockathotmaildotcom) on Sat Mar 7th, 2009 at 12:05:16 PM EST
[ Parent ]

Re: Thanks (4.00 / 2)

Because:

They lack imagination
These are the currencies they can still buy things in
These are the currencies dividends are paid in
If you want rice, you can't buy it from a hedge fund - you can only buy a first or second derivative bet on the sums involved in a possible rice deal, which you can't usually cook in a microwave and eat

In spite of all expectations, people still trust the Western financial industry more than that of most other countries.

This makes no sense - but since most of us live in the West, I'd suggest that perhaps it's better than the alternative.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sat Mar 7th, 2009 at 07:12:01 PM EST
[ Parent ]

It does make sense (4.00 / 2)

because your money is still treated worse in other venues (it's confiscated in cruder ways, let's say).

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

by Jerome a Paris (etg@eurotrib.com) on Sun Mar 8th, 2009 at 05:09:48 AM EST
[ Parent ]

Re: Thanks (4.00 / 2)

True but reality has a way of biting back.

Pretty near everything on the Eurasian continent east of the Urals has no hope of feeding itself. Crash the global financial system and the global trade in coarse grains and other foodstuffs crashes.

No one could have predicted

by ATinNM on Sat Mar 7th, 2009 at 12:59:12 PM EST
[ Parent ]

Now on dKos (none / 1)

http://www.dailykos.com/storyonly/2009/3/7/105718/1904/69/705731

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

by Jerome a Paris (etg@eurotrib.com) on Sat Mar 7th, 2009 at 11:06:38 AM EST

Re: Regulatory arbitrage (none / 1)

Martin Wolf's got it right, and I think the first option is the more reasonable. Banking, like utilities, should be boring and predictable. Even more boring, in fact.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (myfriends@thisispancakes.com) on Sat Mar 7th, 2009 at 11:23:34 AM EST

I agree (none / 0)

but you can't prevent people from gambling (and nor should we, I guess), and financial industry from caterign to such demand... What matters is making sure that gambling losses never can take down the regulated, necessary bits of the industry.

Thus you need to define the border, and to make damn sure that it cannot be breached.

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

by Jerome a Paris (etg@eurotrib.com) on Sat Mar 7th, 2009 at 11:29:43 AM EST
[ Parent ]

Re: I agree (none / 1)

Right. I've no problem with Wall Street firms getting involved with this silly shit, but the rules need to be laid out saying, "Okay, Mr Trader Guy, you get to do your thing, but you don't get to play with Mr Banker Guy."

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (myfriends@thisispancakes.com) on Sat Mar 7th, 2009 at 11:54:23 AM EST
[ Parent ]

Re: I agree (4.00 / 2)

And I still think that if we hanged Ken Lewis and Jimmy Cayne from the facade of the New York Stock Exchange, along with implementing a Parasite Tax on trading, it'd send the right message.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (myfriends@thisispancakes.com) on Sat Mar 7th, 2009 at 11:56:11 AM EST
[ Parent ]

Re: I agree (4.00 / 4)

Guess what, that was the point of Glass-Steagal after the Crash of 1929: to separate banks from "securities firms". It took only 10 years after it was repealed in its entirety for the Crash to repeat itself.

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 Sat Mar 7th, 2009 at 12:36:32 PM EST
[ Parent ]

which makes it a rather costly (4.00 / 2)

way to re-learn a lesson we already knew...

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

by Jerome a Paris (etg@eurotrib.com) on Sat Mar 7th, 2009 at 12:53:54 PM EST
[ Parent ]

Re: which makes it a rather costly (none / 0)

At the cost of repeating myself...

The repeal of Glass-Steagall, initiated in 1980 and completed in 1999 has given us the savings and loans crisis and the subprime crisis, both with a lag of about 8 years. Regulation works. It worked for 50 years. But, as John K. Galbraith said in the foreword of the 1975 edition of his 1954 classic The Great Crash 1929,
In the wake of the 1929 crash, and with a view to preventing another runaway boom and the associated abuse, the Congress passed some tolerably astringent legislation including the Securities Exchange Act of 1934. It was not, at the time, especially necessary. Markets and financial adventure were then and for a long while after restrained not by the S.E.C. but by the memory of what happened to so many in 1929.
By the sixties this memory had dimmed. Almost everything described in this book had reappeared, sometimes in only a slightly different guise. Instead of the investment trusts there were now the mutual funds. Matching Blue Ridge and Shenandoah in general scope and financial peril were the International Investment Trust and the Fund of Funds. Matching and possibly surpassing the vaulting imagination of Harrison Williams and Waddill Catchings, of Central States Electric and Goldman, Sachs was that of Edward Cowett and Bernard Cornfield, the miracle men of I.O.S. The admiration for skill in deployment of corporate capital that was once lavished on Samuel Insull and Howard Hopson settled now on the men who were parlaying smaller firms into big conglomerates. There were glamour stocks in both periods; in both periods glamour was a substitute for substance. Scholars and politicians lent their names and blessings to the new promotions as had their counterparts forty years before. In the sixties as in the twenties men intended by nature for mentally undemanding toil became rich for a while. It was only that the market was going up. Some things in 1970 were worse. Wall Street houses were markedly more incompetent in their management than in the twenties and expanded much more recklessly. The consequences when the collapse came were far more troublesome than in 1929.
...
Yet the lesson is evident. The story of the boom and crash of 1929 is worth telling for its own sake. Great drama joined in those months with luminous insanity. But there is a more sobre purpose. As a protection against financial illusion or insanity, memory is far better than law. When the memory of the 1929 disaster failed, law and regulation no longer sufficed. For protecting people from the cupidity or others and their own, history is highly utilitarian. It sustains memory and memory serves the same purpose as the S.E.C. and, on the record, is far more effective.
It's been another 40 years...

(my emphasis)

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 Sat Mar 7th, 2009 at 01:51:47 PM EST
[ Parent ]

Re: I agree (4.00 / 4)

The Economist

Avoiding future disasters means allocating blame acurately; and most of it lies with bad policy, not with greedy bankers.

But the banks, through their lobbyists and their political contributions, have bought the deregulation that constitutes this "bad policy." It has been a 30 year effort starting with Reagan. It only took 10 years after the repeal of Glass-Steagel along with the continued efforts of the Bush 43 Administration and Greenspan's Fed to pop the bubble and reveal the inevitable end of said "bad policy."

Jerome

Thus you need to define the border, and to make damn sure that it cannot be breached.

That cannot be assured by even the most stringent regulations. Any solution must involve a return of the repressed "political" component of "political economy" and must involve simultaneous reform of both the regulation of the economy and of campaign finance to insure against future repurchases of the same or improved "bad policy" by financial interests in the future.

As best as I can tell, we are nowhere near to even considering effective reform of either component. Nor do I think either reform is highly likely to emerge in the next year. The best hope for an effective solution might be the sort of transformative organizations proposed by Chris Cook, which would only have a chance if strongly backed by a coalition of the Chinese and resource exporting nations. Even given that backing, without campaign finance reform, forcing such bitter medicine on the financial sector, at least in the USA, will be beyond the ability of the political sector. The whole situation will almost certainly get much worse, but this is more likely to produce smoke and dust than to provide any clarity that could lead to resolve.

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

by ARGeezer (ARGeezer at eurotrib.com) on Sat Mar 7th, 2009 at 12:45:25 PM EST
[ Parent ]

Re: I agree (none / 1)

The Economist
Avoiding future disasters means allocating blame acurately; and most of it lies with bad policy, not with greedy bankers.
But ...

By saying "But..." you are conceding that what they are saying is substantially true, which it isn't. The right answer to The Economist begins with "No, you obfuscating liar".

The greedy bankers did subprime lending, securitization, credit default swaps, off-balance-sheet items and contingent liabilities all by themselves, with the intent to do an end-run around the regulators.

So it was not "bad policy" that caused the crisis, though there were quite a few policy-makers who were apologists for deregulation or "industry self-regulation". And if the problem was self-regulation, it was the bankers that failed to self-regulate anyway.

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 Sat Mar 7th, 2009 at 01:48:04 PM EST
[ Parent ]

Re: I agree (none / 0)

I don't see the "but" doing that. I am saying that the financial interests, including the ownership and management of the big banks, are responsible for both the specific actions that produced the current collapse and the policies which enabled those actions, which they bought, with their "think" tanks and, before that, with their Neo Classical Economics which was largely constructed by their paid retainers from the 1880s onward, with the often unsuspecting products of the captured "education system," such as Ron Reagan, economics major, and with their out-sized contributions to the election process.

It is their natural tendency to use their wealth to skew all aspects of national policy to their favor, along with the actual actions that brought disaster that I am descrying. We won't prevent a repeat or a continuation of the current problems until we take steps to curb the influence.

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

by ARGeezer (ARGeezer at eurotrib.com) on Sat Mar 7th, 2009 at 03:00:51 PM EST
[ Parent ]

Re: I agree (none / 1)

You are right. From what I see in the news, the Congress is nowhere near anything like reform. The Republicans (almost to a man/woman) and some Democrats are ready to tear up anything that looks like change from the current system. It's just unbelievable arrogance. As I and others have said many times before, time to clean House, and Senate.

I can swear there ain't no heaven but I pray there ain't no hell. _ Blood Sweat & Tears

by Gringo (stargazing camel at aoldotcom) on Sat Mar 7th, 2009 at 02:34:09 PM EST
[ Parent ]

Re: I agree (4.00 / 3)

It's unbelievable corruption.

Trillions in public cash have been handed out to the financial industry. At least some of those trillions have been handed out with no oversight at all.

Which part of 'The Senate and Congress are a wholly owned subdsidiary of Wall St' isn't clear yet?

And don't ask who owns Wall St. That's not a question with a popular answer.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sat Mar 7th, 2009 at 07:17:14 PM EST
[ Parent ]

Re: I agree (none / 0)

ThatBritGuy:

And don't ask who owns Wall St. That's not a question with a popular answer.

But the collapse and discrediting of Wall Street and the losses of its owners could in fact allow progress to be made on one or two hitherto intractable geopolitical problems....

Modern conservatives engage in one of man's oldest exercises in moral philosophy: the search for a superior moral justification for selfishness.Galbraith

by ChrisCook (cojockathotmaildotcom) on Sat Mar 7th, 2009 at 08:14:28 PM EST
[ Parent ]

Re: I agree (none / 0)

So we pray.

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

by ARGeezer (ARGeezer at eurotrib.com) on Sat Mar 7th, 2009 at 08:50:59 PM EST
[ Parent ]

Re: I agree (none / 0)

The question is will it be "discredited" or will the media be able to continue to play it as just another downturn as here?

I can swear there ain't no heaven but I pray there ain't no hell. _ Blood Sweat & Tears

by Gringo (stargazing camel at aoldotcom) on Sun Mar 8th, 2009 at 12:03:51 AM EST
[ Parent ]

Re: I agree (4.00 / 2)

separate completely and hermetically regulated utility banking from the unregulated gambling/"investment" kind

Exactly how are the utility and investment kinds of banking defined?

Is utility banking everything but M&A's, alphabet soup securities and legalised tax evasion, which are investment banking? Or what?

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid (arvid.hallen at gmail.com) on Sat Mar 7th, 2009 at 04:36:51 PM EST
[ Parent ]

Re: I agree (4.00 / 3)

That's a good question. Glass-Steagal was a workable answer, but it may not have been the best one.

I'd actually like to see gambling and speculation eliminated completely. If stupid rich people want to gamble, they can go to a casino.

The markets should be reserved for investment in the real economy, not in multiply leveraged risk-engined machineries of financial self destruction.

Projects and ideas will always have enough risk to make basic investment interesting enough for the talent which currently wastes its time trying to pull profit out of noise to be doing something useful with its time.

Finance has been a double tragedy - not only is it an epic fail financially, but it has also sucked the life out of engineering and research, which are always more likely to create stable and reality based prosperity.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sat Mar 7th, 2009 at 07:22:33 PM EST
[ Parent ]

Re: I agree (none / 0)

But how do you discriminate between "speculation" and investment? Ban leverage, that is, debt?

Certainly not.

So what does this mean, in practice? Limits on leverage maybe? But will that then fall in the investment or utility banking sector?

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid (arvid.hallen at gmail.com) on Sun Mar 8th, 2009 at 05:10:02 AM EST
[ Parent ]

Re: I agree (none / 0)

The primary market (buying securities when they are issued) is investment. This includes IPOs (initial public offers on when a company first goes public by issuing stock); rights issues/shares issues/raising capital by listed companies; issues of corporate or sovereign bonds/notes/debentures...

The secondary market (trading existing securities) is speculation. This is so because trading stocks or bonds has no impact on the capitalization of the underlying companies/treasuries; buying securities in the primary market does expand the working capital of the issuer.

The secondary market exists to provide liquidity so investors have a way out of their investments. Without a liquid secondary market, it would be much harder to convince people to lock their money in the primary market.

There is a long quotation by Keynes in The General Theory about this, ending with his famous When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.

I diaried the long quotation here.

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 8th, 2009 at 05:48:06 AM EST
[ Parent ]

Utility banking (none / 1)

is the payments system, taking deposits, and making loans to corporations (that you keep on your books and for which you allocate the relevant regulatory capital, as set by a simple external model).

And that's it.

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

by Jerome a Paris (etg@eurotrib.com) on Sun Mar 8th, 2009 at 05:07:59 AM EST
[ Parent ]

Re: Utility banking (none / 0)

So mortage and consumer loans should be considered investment banking, unlike loans to corporations who need money for say, opening iron mines, which would be utility banking?

I don't see the logic in that.

And in your model, what is the role of the investment banks? What do they do?

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid (arvid.hallen at gmail.com) on Sun Mar 8th, 2009 at 05:14:00 AM EST
[ Parent ]

Re: Utility banking (none / 0)

Further, what kind of banks get to help firms with corporate bonds, credit lines, issuing convertibe bonds, who does savings management for private indivuals (funds and the like) etc?

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid (arvid.hallen at gmail.com) on Sun Mar 8th, 2009 at 05:23:00 AM EST
[ Parent ]

Re: Utility banking (none / 1)

Underwriting corporate bond issues, shares issues, etc is investment banking. So is what you cal "savings management". All this involves trading in the securities markets. Glass-Steagall separated "banks" from "securities firms".

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 8th, 2009 at 05:34:19 AM EST
[ Parent ]

Re: Utility banking (none / 0)

There are two kinds of credit created by credit institutions: unsecured and secured.

Unsecured credit allows the circulation of goods and services, and the creation of productive assets with a value in use (productive Capital). Where unsecured credit creates productive assets it ceases to circulate, and must be replaced by more credit to keep the wheels of the economy turning. This process gives rise to a continuous flow of dynamic value.

It also explains why the National Debt - that piece of accounting insanity - can never be paid off.

C H Douglas - an engineer by background - had an interesting analysis which was a core part of his Social Credit movement - which went the same way as Henry George's Single Tax, being discredited and airbrushed from history

The A plus B Theorem of Social Credit

My analysis is that secured credit is qualitatively different from unsecured credit in its effects. It is a claim over a productive asset with a value in use. In particular, land which backs more than 60% of credit created today. The creation of secured credit to acquire existing productive assets is likely to cause asset price inflation and often, a Bubble.

Secured credit does not circulate. It is static. It cannot cause inflation of prices other than the prices of existing assets it is used to acquire. Having said that, further credit secured on the productive asset (Equity Release) could perhaps cause retail price inflation. Discuss.

It is a form of Investment, which I consider as a claim over a productive asset purchased for the revenue stream. ie the investor is looking for income, or an increase in the value of capitalised future income which he may sell for income.

Speculation, on the other hand, is buying - not for income - but to sell on at a profit. So is trading, but the former is held to be undesirable, and the latter an essential component of global trade.

The other form of Investment - with which secured credit is in conflict, is the claim of equity ownership, particularly the financial claims incorporated in shares in the legal person/protocol known as a Corporation.

It follows that there are two different types of banking.

Firstly; that relating to the creation and clearing of credit. This in turn distuinguishes two separate disciplines.

(a) credit used for circulation ("time to pay" or working capital); and

(b) credit used to create a productive asset (development credit).

The former requires analysis of the ability of an individual or enterprise (a group of individuals) to repay debt used for working capital; the accounting and clearing of debt obligations; and the handling of debt defaults.

The latter (Jeromes's discipline) requires consideration of the use value of the productive asset once complete, the likelihood that it will be developed on time and within budget. And so on.

Secondly, investment banking relates to the use of secured credit as investment in an existing productive asset through a process of appraisal of the ability of:

(a) the productive asset to create sufficient value in exchange to meet the financial obligations imposed upon it; and

(b) the capability of the user/owner of the asset to meet those financial obligations.

The recent property bubble was essentially caused by essentially lending to the property, and forgetting the person, because secured credit is a hybrid.

But Jerome's discipline - which is the extremely necessary one of financing productive assets - is essentially a hybrid. The development risks attaching to the creation of a productive asset, are very different to those of the long term financing of that same asset once complete.

I believe that there is no longer a need for credit intermediaries, which is just as well, because the capital necessary to rebuild the collapsing system, while it exists in the hands of investors (albeit dwindling) will not be deployed, and governments cannot replace it without the consent of their global creditors.

I believe the emergence of

Peer to Peer Finance

will solve the problem, and in so doing reinvent banking into two disciplines distinguishing between Credit = Time to Pay and Investment.

Banking as credit intermediation will gradually (or more likely, rapidly) become obsolete. Banking as service provision will replace it.

The entire edifice of economics is based upon an assumption that money is necessarily credit, whereas the truth is that credit is implicit within a monetary relationship, but need not - indeed should not, because interest creates instability - be monetised. Moreover. conventional economics does not make the necessary - IMHO - qualitative distinction between unsecured credit, which may be static or dynamic, and secured credit, which is static, and is unlikely to cause retail price inflation.

In other words conventional economics is entirely unfounded on the real world and is, in technical terms, complete bollocks.

Modern conservatives engage in one of man's oldest exercises in moral philosophy: the search for a superior moral justification for selfishness.Galbraith

by ChrisCook (cojockathotmaildotcom) on Sun Mar 8th, 2009 at 07:13:39 AM EST
[ Parent ]

Re: Utility banking (none / 0)

You need to contact that kid from that art school who did the clever (though flawed) motion graphic explanation of banks loan securitizing.

I can follow the traces of what you are saying, and some of the implications...but some graphics would certainly help. As much as I can appreciate the conclusions, I have never been able to completely grok all the steps that get you there.

I don't mean to imply that I am your target audience, but I've always been able to take an IQ test that put me in the top few percent (being the test makers target market helps) and can probably find other criteria which might imply that you have to be more clear for your target audience, who may be less clever than even me.

Never underestimate their intelligence, always underestimate their knowledge.

Frank Delaney ~ Ireland

by siegestate (siegestate or beyondwarispeace.com) on Sun Mar 8th, 2009 at 10:45:54 AM EST
[ Parent ]

Re: Utility banking (none / 1)

Mortgages and consumer loans you also keep on your books and need to back with regulatory capital.

I suppose credit cards are also utility banking - that and a whole class of "revolving credit" lines to both individuals and corporations including simple overdraft allowances on current accounts.

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 8th, 2009 at 05:32:16 AM EST
[ Parent ]

Re: Utility banking (none / 0)

sorry: most of the traditional activities of retail banking would be in the utility bit. And the utility banks would be required to remain the formal counterparty to mortgages...

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

by Jerome a Paris (etg@eurotrib.com) on Sun Mar 8th, 2009 at 06:41:01 AM EST
[ Parent ]

Re: Utility banking (none / 1)

In particular, banks should not be allowed to engage in securitisation of loans subject to regulatory capital.

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 8th, 2009 at 06:45:00 AM EST
[ Parent ]

Re: Utility banking (none / 1)

And securitisation is investment banking.

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 8th, 2009 at 06:55:29 AM EST
[ Parent ]

Re: Utility banking (none / 0)

Jerome a Paris:

Utility banking is the payments system, taking deposits, and making loans to corporations

Are utility-banking "loans to corporations" only short-term revolving credit, or do you include (in a not-entirely-disinterested way) project finance?

I'm thinking long-term credit, whether mortgages, long-term consumer loans or project finance, is not part of the "payment clearing system and revolving credit" infrastructure banking and so is not actually "utility banking" even if it needs to be backed by regulatory capital.

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 9th, 2009 at 05:16:41 AM EST
[ Parent ]

Re: Utility banking (4.00 / 3)

I guess the point here is that we are trying to isolate the part of the banking system that must exist for society, as currently configured, to function. And we want that group to be as small as possible, because we want to build a very tall was with a very deep moat, with sea mines and electrified barbed wire around that group of activities. And all else being equal, that's easier with a smaller number of activities.

So I guess what we should be asking is "if this service crashes and burns, and it takes - say - two years to rebuild it, will society survive the transition?" For payment clearing, the answer is clearly "no." For building factories, the answer is clearly "yes. It won't be pleasant, but we'll survive." So project finance goes outside our airlock.

(Although I'm all in favour of building walls between project finance, insurance, real estate and so on and so forth. But they aren't absolutely need-to-have must-be-bailed-out-in-the-event-of-catastrophe parts of the banking system, so I can live with the compartmentalisation being less than completely airtight.)

- Jake

"Terraforming your own planet to make it uninhabitable hardly counts as epic win." - ThatBritGuy

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Mar 9th, 2009 at 05:26:37 AM EST
[ Parent ]

Re: Utility banking (none / 1)

Make this discussion a Socratic Economics diary...

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 9th, 2009 at 05:30:54 AM EST
[ Parent ]

Re: Regulatory arbitrage brought us here - time to (none / 0)

See this earlier thread on "regulatory arbitrage".

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 Sat Mar 7th, 2009 at 12:41:34 PM EST

Marginal tax rates are the absolute key (4.00 / 2)

If it is possible to earn $50M in a few years and keep even half the proceeds, the temptation of risking OPM and looting the firm is enormous.

There is no way that it makes good social policy to permit employees of large firms to take home 10s of millions of dollars/euros.

by rootless2 (redacted) on Sat Mar 7th, 2009 at 02:05:52 PM EST

Re: The idiot speaks ... that's me. (4.00 / 4)

I think I see a flaw in the plan. Aren't you expecting the people who CAUSED this mess to take the necessary steps to CORRECT this mess? Do I expect the bacteria/viruses which make me ill or potentially kill me to suddenly say, "Oh God, if the host dies, I lose my home. I've got to knock this crap off."

Before we see implementation of ANY significant remedial actions I think other events will have to transpire.

The Idiot Has Spoken! Back to cooking pasta sauce. Important stuff first.

I love the smell of roast chicken in the morning!

by THE Twank (yatta blah blah @ blah.com) on Sat Mar 7th, 2009 at 02:10:40 PM EST

Re: The idiot speaks ... that's me. (none / 1)

...well, I think the Idiot's right on this one.

Modern conservatives engage in one of man's oldest exercises in moral philosophy: the search for a superior moral justification for selfishness.Galbraith

by ChrisCook (cojockathotmaildotcom) on Sat Mar 7th, 2009 at 03:12:52 PM EST
[ Parent ]

Re: The idiot speaks ... that's me. (none / 0)

Oh sh*t, we're worse off than I thought. I was expecting either someone to shoot me down or at least to tell me to be quiet and make sauce. Bummer.

I love the smell of roast chicken in the morning!

by THE Twank (yatta blah blah @ blah.com) on Sat Mar 7th, 2009 at 06:25:58 PM EST
[ Parent ]

Re: The idiot speaks ... that's me. (none / 0)

Well, now Obama has replaced the Fool on the Hill, there might just be an outside chance...

Modern conservatives engage in one of man's oldest exercises in moral philosophy: the search for a superior moral justification for selfishness.Galbraith

by ChrisCook (cojockathotmaildotcom) on Sat Mar 7th, 2009 at 06:37:25 PM EST
[ Parent ]

Re: The idiot speaks ... that's me. (none / 0)

Are "WE" suppose to be doing something to save our bacon? Quite honestly, nothing about my life has changed for the past 5 years. Am I missing something? Are "WE" missing something that we should be doing? Please don't say "Write your Congressman."

I love the smell of roast chicken in the morning!

by THE Twank (yatta blah blah @ blah.com) on Sat Mar 7th, 2009 at 06:43:41 PM EST
[ Parent ]

The Shrill brigade grows (none / 0)

The Fed's moral hazard maximising strategy
The reports on the evidence given by the Vice Chairman of the Federal Reserve Board, Don Kohn, to the Senate Banking Committee about the Fed's role in the government's rescue of AIG, have left me speechless and weak with rage. AIG wrote CDS, that is, it sold credit default swaps that provided the buyer of the CDS (including some of the world's largest banks) with insurance against default on bonds and other credit instruments they held. Of course the insurance was only as good as the creditworthiness of the party writing the CDS. When it was uncovered during the late summer of 2008, that AIG had nurtured a little rogue, unregulated investment banking unit in its bosom, and that the level of the credit risk it had insured was well beyond its means, the AIG counterparties, that is, the buyers of the CDS, were caught with their pants down.
Instead of saying, "how sad, too bad" to these counterparties, the Fed decided (in the words of the Wall Street Journal), to unwind ".. some AIG contracts that were weighing down the insurance giant by paying off the trading partners at the full value they expected to realize in the long term, even though short-term values had tumbled."
(...)
It is unfair, deeply distortionary and unnecessary for the maintenance of financial stability.
Don Kohn ackowledged that the aid contributed to "moral hazard" - incentives for future reckless lending by AIG's counterparties - it "will reduce their incentive to be careful in the future." But, here as in all instances were the weak-kneed guardians of the common wealth (or what's left of it) cave in to the special pleadings of the captains of finance, this bail-out of the undeserving was painted as the unavoidable price of maintaining, defending or restoring financial stability. What would have happened if the Fed had decided to leave the AIG counterparties with their near-worthless CDS protection?
"I'm worried about the knock- on effects in the financial markets. Would other people be willing to do business with other U.S. financial institutions...if they thought, in a crisis like this, they might have to take some losses?"
Let's step back a minute and ponder this. US banks and shadow-banks (like AIG's Financial Products Division) took on excessive leverage and excessive risk. There was not only too much careless lending by US banks, there was too much careless lending to US banks. When this crisis is over and when, in the fullness of time, the real economy has recovered, we want to see less lending by and to US banks than we saw in the years 2004 - 2006. How do we get those who provided US banks and other financial institutions with too much funding at too low a cost to behave with greater prodence and caution in the future? Presumably by making sure that they pay the price for their reckless financial decisions. The counterparties of AIG who had been unwise enough to buy insurance against default on debt instruments they held, by acquiring CDS written by AIG should have been told to eat it.
So, like Mr. Kohn, I too am worried about the knock- on effects in the financial markets of the Fed's actions. I, however, am exceedingly worried about the Fed's bail out (at full face value) of the counterparties of AIG. I am deeply worried that other people may, as a result of this, be willing to do business with other U.S. financial institutions on the same ludicrous terms that brought us the current crisis. And why wouldn't they be happy and relaxed about once again taking wild and crazy bets? They now know that, should their bets fail, in a crisis like this, there is some sucker-institution in Washington DC that will make sure that they don't have to take some losses.

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

by Jerome a Paris (etg@eurotrib.com) on Sun Mar 8th, 2009 at 05:03:05 AM EST

Great article. Spot on sur le fond. (none / 1)

One quibble. I am not sure we want to detach financial analysis from policy analysis, as it is one (of many) very important tools for setting prioritisation of policy and of asset allocations for everyone's benefit.

Rather, I'd argue that the important thing is that such analyses be grounded in an outlook which takes the whole of our society into account, from the interests of the working class first and then moving up. Much of today's problems can be traced to an Anglo-American societal defect which imposes tops down solutions bearing first and foremost the interests of the wealthy.

And, they must pay for this.

PS - The Economist (for whose parent company I worked for) made themselves irrelevant in the late '90's by going after the US market for growth. A good short term strategy but it required them to tqck ever further to the neo-liberal right in order to stay relevant in America. And, as we are seeing now, relevant in America is bad business for all.

Mais c'est un scandâââle!!

by redstar on Sun Mar 8th, 2009 at 06:55:38 AM EST

Re: Great article. Spot on sur le fond. (none / 0)

The problem that "financial analysis in the public interest" shares with things like, say, looking for a cure for cancer, is that it is much less profitable (in the short term) than financial analysis for wealthy gamblers.

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 8th, 2009 at 07:00:38 AM EST
[ Parent ]

Re: Great article. Spot on sur le fond. (4.00 / 2)

There is no problem with that which cannot be solved by confiscatory taxation of wealth.

- Jake

"Terraforming your own planet to make it uninhabitable hardly counts as epic win." - ThatBritGuy

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Mar 8th, 2009 at 07:23:14 AM EST
[ Parent ]

Re: Great article. Spot on sur le fond. (none / 1)

Beat me to it.

And, long overdue.

Mais c'est un scandâââle!!

by redstar on Sun Mar 8th, 2009 at 07:32:04 AM EST
[ Parent ]

Regulatory arbitrage brought us here - time to make it go away | 61 comments (61 topical, 0 editorial, 0 hidden)

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