Corrupting risk on top of the surplus pyramid

By Lorenzo

Chairman exiting his bank

In a real sense, human history starts with the creation of a social surplus, a surplus beyond simple subsistence. Such a surplus could be used for–indeed, was required to–build more complex societies. This included the literal building of the monumental architecture, the most striking creations from the existence of such surpluses.

More food, more babies
Merely increasing production does not mean there will be a social surplus. The normal tendency has been for population growth to increase to consume the food production available; given that the best way to manage farming and ageing was to have children. This Malthusian constraint continued to operate in human societies until quite recently–the history of China from 1700-1850 is a classic example of increased food production leading to population increasing faster than food production leading to a massive breakdown in social order (one of the deadlier such in history) with the loss of state revenue and diversion of resources to warfare undermining basic management of resources.

As I noted in a previous post, it is highly plausible that expropriating elites were what originally created the social surpluses enabling the building of more complex societies. For much of human history, it was obvious what was the dominant way to get access to social surplus: political power—either having it or serving it. Control of the means of coercion provided the dominant source of wealth. (And having the backing of the dominant coercive apparatus is still pretty useful.) With considerable amounts of said surplus being invested in the priests who helped manage both social complexity and expropriation by providing rituals of belonging; norm-advocacy; narratives of meaning, explanation and rationalisation; various services (calendar management, doctors of body and mind, teachers, engineers, scribes, mediators); plus formalised signals of commitment to the expropriating rulers and their social order.

To be sure, there was plenty of trade (and wealth from trade). Nevertheless, extracting surplus from peasants or controlling trade routes (and particularly trade nodes) was much the dominant source of wealth: especially inheritable wealth. In many early civilisations, the ruler was the dominant trader. If trade collapsed, that tended to both increase the dominance of wealth-through-violence while making it harder for any particular ruler to (re)establish control over a wide area—due to a lack of sustaining surplus to pay for the necessary extensive control. Collapse of an extensive, trade-managing (and so protecting) rulership often being the main cause of the collapse of trade in the first place.

The more centralised and territorial the generation of surplus is, the more it will attract attempts to seize it (hence the long history of territorial wars). This extends to our own period: having export wealth dominated by easily controlled primary production encourages both autocracy and civil conflict (pdf). Living in a society where wealth-through-the-means-of-violence, where centralised control of surplus, is not dominant is both historically rare and desirable.

It is impossible to achieve mass prosperity without getting out of the Malthusian constraint wherein increased food output merely leads to, and is consumed by, increased population. To put it another way, to evade the Malthusian constraint, the social niches people occupy have to be larger than subsistence. The more such social niches spread down the social scale, the more general prosperity becomes.

Ever since the rise of hierarchical societies, there have been social niches which were larger than subsistence; they were the niches of elites. Indeed, as Peter Turchin points out, one of the perennial problems of hierarchical societies is precisely the size of elite niches. If the elite increases in size faster than output, then competition for elite niches will ensue. That process has been one of the great drivers of history. (For example, the tendency for the ruling clan of pastoralist empires to breed enthusiastically likely helps explain the tendency of such empires to break up after a few generations as too large an elite fights over too few elite niches.)

For elite niches to occur in a society within the Malthusian constraint, a surplus has to be extracted from those lower in the social pyramid. To be on top of a social pyramid is to be on top of a process of surplus extraction. A process which continues in post-Malthusian societies. This is obvious enough in developing world kleptocracies (pdf), but is hardly unknown in developed democracies.  Jon Corzine (CEO of MF Global, which has just gone bust in one of the largest bankruptcies in US corporate history) is an excellent example of someone living on top of the surplus pyramid:

based on his long years in the financial business, from CEO of Goldman Sachs to his current job as chief executive of the failing MF Global, Corzine is proof positive that on Wall Street you don’t have to be very good at your job to get paid a lot of money, which is why hatred of fat cats remains a bipartisan pastime—and will for the foreseeable future.

Pushing risk downwards
A standard way to live on top of the surplus pyramid is to push risk down the social pyramid. At its most brutal, it involves pushing the risk of starving downwards. But it can happen even in societies which have escaped the Malthusian trap. Consider this comment by the Rt Hon. Vince Cable MP, UK Secretary of State for Business, Innovation and Skills in a generally excellent speech about parallels from the 1930s for our times:

It is worth recalling just how brutal were the first dozen years after the First World War.  Britain attempted to return to its pre War gold level, which meant chronic deflation to bring us back with world prices (what Southern Europe is attempting today).  As a result, the price index which had risen from 100 in 1914 to 250 in 1920, fell to 180 in a couple of years and continued falling all the way below 150 in 1930.

The voices in the City clamouring for the Pound to be kept strong got what they wished.

But the consequences for the real economy were devastating; production fell by 22% between 1918 and 1921. The real value of debts rose and rose.  The exchange rate was far too high and so our goods struggled on world markets.  On some measures in 1931, our per capita GDP was lower than it had been in 1915.

No wonder Churchill made his lament about wanting industry more content, finance less proud.

That was pushing risk downwards with a vengeance.

Let us consider what “too big to fail” means. It means someone who borrows too much to buy a house can go bankrupt, but the institution which lent too many such people too much money cannot. It is a classic example of pushing risk downwards.

It is also a profound subversion of commercial society, which Milton Friedman liked to point out was a profit and loss system:

You must realize that what we have is not a profit system; it’s a profit and loss system. The loss part is just as important as the profit part. What distinguishes the private system from a government socialist system is the loss part. If an entrepreneur’s project doesn’t work, he closes it down. If it had been a government project, it would have been expanded, because there is not the discipline of the profit and loss element. If you have a really good idea, it may work. But remember, you’re gambling. That’s what makes it exciting, and that’s what makes it important. What rules out the mistakes is the possibility of making a loss.

To put it another way, any social system generates “barnacles”–resource-consuming social nodes that undermine the overall operation of the society. It is undermining or lacking a barnacle-removing process which is fatal to a social system.

But it can be very attractive to be a social barnacle. To be insulated from loss is a massive and corrupting privilege. To be insulated from loss while being massively paid for managing risk is offensive exploitation of the weaker.

What happens when the IMF moves in to do “structural adjustment” when a developing country has got into trouble from debt loaded on the polity but skimmed off within its elite? The risks are pushed downward. Debts which were allegedly to increase productive capacity get expropriated. The people best placed to assess the likelihood of that bear little or no risk from it (due to the IMF), so the risk gets loaded on to those who were not there (nor seriously represented) when the debts were negotiated and have little or no capacity to object or block expropriation. So the debt is loaded onto the ordinary folk of that society, but those who stole it get away with it and those who lent to those who stole it have the impact on them minimised. (The UN Convention Against Corruption [UNCAC]’s asset recovery provisions represent, in effect, a regulatory attempt to deal with the problem of corruption–including to block debt diversion by kleptocratic elites–and none too soon.)

Forcing ordinary taxpayers to repay stolen debt is a fairly vile worship at the altar of financier privilege. The notion that the claims of high finance are so much more important than any other consideration. Claims whereby huge salaries and bonuses are paid, justified by management of risk which is pushed off on to taxpayers and those lacking such political clout. Which, as the UK experience in the 1920s showed, can be entire industries and workforces.

There is a kernel of truth in the claims of high finance. It is important that credit keep flowing. If the flow of funds completely freezes up, massive economic harm can be done.

But, and it is a very big but, the point of supplying that credit is to manage effort across time and the risks thereof.  The point is to allocate the risks to those best able to manage them, not those least able to avoid them. If those lending funds to developing world rulers are not taking any responsibility for monitoring whether those funds are likely to be spent in way which will increase the capacity of the polity to pay back the loan, they are acting in a way strikingly different from how someone getting a mortgage or a business loan is typically treated. There, your capacity to pay, the use of the loan, matters a great deal; the asset is managed in a more typical commercial style. Hence UNCAC attempting to deal with what financiers have consistently refused to take responsibility for.

Of course, the rise of complex derivatives in the US mortgage market meant lenders were not doing that traditional role of carefully assessing use. But the model of not paying attention to the realities of use of the loan was already established in the sovereign debt market. With a similar justification in both cases–taxpayers would always be available to pay it back, house prices would continue to rise, so systematic downside risk was insignificant.

[If developing countries take on debt that is stolen, spent on patronage or simply poorly invested, the debt increases, not decreases, their economic and financial vulnerability. The contrast with ordinary business and household debt is marked–a loan which was likely not to improve the capacity to pay the loan back, whose only likely effect was to increase the financial vulnerability of the borrower, would not be regarded as a good commercial risk. Loans which increased vulnerability were also a feature of US mortgage markets, making the similarities between the corrupted public debt market and the corrupted US mortgage market even clearer.]

Unstable irresponsibility
Anything which systematically shields agents only from downside risk increases instability in the system. (And do so even if they only believe they are shielded from such–see any asset bubble of your choice.)

If risk-managing firms move from being (pdf) full-liability partnerships to limited liability corporations, that shields the actual managers of risk from downside risks. If the state makes deposit insurance compulsory, or otherwise guarantees deposits, that shields managers of risk from downside risks.

Such shielding of agents from downside risk tends to increase the private return to risk management while increasing the social costs. The obvious way to correct such systematic imbalance in downside exposure to risk is to have compensating prudential regulation. The argument for full deregulation of prudential regulation rests on firms as decision-agents-bearing-risks, but modern corporations separate risk and decision-making, leading to perennial corporate governance problems. It is actually rather foolish to analyse firms’ risk management without paying attention to their internal structures, since what institutional incentives exist will clearly affect patterns of behaviour.

There are wider grounds for prudential regulation of financial institutions, due to such considerations as herd behaviour in highly liquid markets being a rational response to limited attention resouces and to uncertainty. Uncertainty, information limitations, fluidity and the existence of financial assets meaning that demand is not an immediate function of supply (of non-competing products, to state Say’s Law [pdf] correctly)–since transacting can be deferred, leading to the “general gluts”/transaction crashes we call recessions and depressions–all make financial markets crisis-prone and crisis-generating.

Too big to fail is just an invitation to fail bigger (pdf). Unless there is compensating prudential regulation.[1] For anything which systematically shields agents from downside risk increases instability in the system.

The great fraud of the current global financial system is that quantifying risk largely eliminates it—if you are managing enough of it.

Worse, to be shielded from consequences is to be shielded from responsibility. To be shielded from responsibility fundamentally undermines moral constraints. It is, in a quite direct sense, morally corrupting. In the sense, and for the reasons, that Lord Acton meant.

If a system of financier privilege is corrupt at its core, it is hardly surprising if it generates even more blatant signs of moral corruption. Such as the Barclays Bank scandal where it systematically lied to manipulate market information, leading to scathing comments from the Governor of the Bank of England. Barclay’s corrupted social processes in quite a direct fashion, a society and economy those engaged in the corruption of are premier beneficiaries of (particularly its information flows). In the words of Lord Turner, Chair of of the Financial Services Authority:

There is a degree of cynicism and greed that is quite shocking. I think we would be fooling ourselves if we thought that some of the behaviour and culture evidenced in Libor fixing are not found in some other areas of trading activity as well.

Possibly it is shocking, but it is only surprising if you have not been paying attention to the incentives being created in financial markets for some decades now. (You can call it blowback, if you like.)

States and risk
If prudential regulation is an appropriate response to both the inherent features of financial markets and the provision of state-guarantees for deposits, then we are, yet again, confronting the paradox of rulership–that we need rulership to protect us from social predators but rulership is the most potentially dangerous form of social predator. For no institution separates decision-making and risk as thoroughly as rulership. Hence voting is a way of connecting risks facing citizenry to risks facing rulers. Alas, it is far from a perfect way of doing so.[2] To paraphrase Winston Churchill, it is the worst way of doing so; except for all the others that have been tried from time to time.

Examining the means by which financial markets have been corrupted, the operation of state power is laced through it. Whether it is the IMF loading stolen loans onto ordinary taxpayers, kleptocratic rulers, provision of implicit or explicit government guarantees, or the bailing out of failed financial institutions, states and their agencies have been major players in the destruction of prudence and so in the corrupting of finance.

The obvious political advantage for sitting on top of the surplus pyramid is in having plenty of surplus to throw around, including into political donations. It is not high finance’s only political advantage, however. The apparent complexity (and so obscurity) of what they do helps shield them from accountability while finance’s very crisis-generating capacity gives them the weapon of fear.

Which creates a perverse incentive structure–the more the finance industry can shield its decision-makers from downside risks, the greater the private return to risk-management but also the greater the social costs and so the more they are able to wield the weapon of fear to shield its decision-makers from downside risks.

While the evidence that political spending significantly influences results of election campaigns (or votes in legislatures) is limited,[3] donations do buy political access.[4] Which is clearly enough.

The first stage in dealing with a problem is acknowledging it. Markets–the operation of a profit and loss system–and voting–the imposing of “throw the rascals out” responsibility on rulers–are our barnacle-removing systems. Unless and until their interacting dysfunction is untangled, any apparent improvement will only be temporary. An industry whose central role is risk-management has become one where the management of risk is profoundly corrupted. Unless that is understood, and the implications grasped, we are set to continue to have a spiral of rising instability and ever-greater financial crises.

 

[1] Australia’s four pillars policy represents partial protection of the major banks with a trade-off of strong prudential regulation; the above analysis probably has limited application to Australia.

[2] Political competition is a rather limited Hayekian discovery procedure (pdf), for example.

[3] In the case of US Presidential elections, how much the campaigns themselves matter for the election results is something of an open question.

[4] Political donations are basically a measure of how important political access is to an industry. Hence the largest donors by industry in the US are finance, insurance and real estate (the former two industries need politicians to protect their outsized incomes by continuing to shield them from downside risks and the last operate in highly regulated land-use markets–indeed, one reason to regulate land use is to generate political funding).

32 Comments

  1. JC
    Posted July 7, 2012 at 7:37 pm | Permalink

    Lord Turner is the Chair of the regulatory body, he has ex officio authority, if nothing else.

    Is that it’s acceptable… because of your own opinions that an obviously outlandish comment comes across as fine to you? is that it?

    And, from my reading of the emails, what he said was hardly unsubstantiated.

    You saw what likely constitutes a couple of selective emails with context missing or may simply be as the WSJ suggested- big swinging dick baseless bravado. How does this suggest that what he said in basically painting every trader and banker to be in any way “substantiated”. How do you know? Wouldn’t it be better to wait and see what comes out?

    Lehman went bankrupt, so of course folk lost positions and wealth, that is what bankruptcy means. Lehman was also an exceptional case. Or weren’t you around for the outrage when the institutions receiving TARP funding proceeded to pay big bonuses?

    A humungous % of bonuses paid at the time constituted contractual compensation arrangements. As far as I understood things at the time, the people who took losses at the banks or were (workwise) close to it didn’t receive bonuses.In fact they were fired. Bonuses were also paid to people on Wall Street that work on what is essentially piece work, ie brokers who are in commission pools payable at the end of the year an don’t use capital (or in fact very little).

    And part of my point was the divorce between decision making and risk. Yes, equity holders took a hit. But that was hardly the only thing that went on.

    No it wasn’t and I’ve made the point all along which you seem to avoid. Bondholders and preference shareholders didn’t get a haircut and they perhaps should have to some extent as pertaining to some of the banks that were in serious trouble. Not all were.

    Part of my point also was that the effect of suppression of risk was to increase instability in the system.

    You need to explain that as I don’t quite get what you mean.

    My comments were much more directed to the lead up to the crisis, and why the crisis happened, rather than the crisis itself.

    Sumner has a good explanation for the crisis and although I always had a trader’s view/hunch that was similar, it was difficult to put it into academic speak and explain it/why. I had a hunch the central banks fucked up big time, as I saw them waste time or actually spook the market with oppositional talk signalling they had no clue what was going on. They were talking about inflation concerns as late as May 2008 (even after Bear Stern) And so, according to Sumner, they caused the large crisis to occur compared to what should have been a localized problem in a specialized area of the bond market- sub prime.

    The CBs were too tight going into the crisis and too slow to recognize the damage they had caused. To blame this on the banks is inaccurate in my book. Banks are margin takers in most of the stuff they do. They aren’t clairvoyants.

    As for compensation….

    Compensation has been an age old problem in finance especially. Do you go with higher salaries and anchor very high fixed costs or do you “variableize” comp depending on how the individual and the firm perform? I-banking has lots of peaks and troughs. It’s a far better idea to go with as much variable comp as you can in that sort of environment. It also fits in with the partnership days of old Wall street history where the partners took a small monthly draw and split the profits at the end of the year in order to be paid out of profits rather than what could turn out to be capital.

  2. Posted July 7, 2012 at 8:12 pm | Permalink

    There is a difference between capitalism, the allocation of resources prudently, and the financial sector, which is meant to serve the rest of the system. The oil in the engine is neither the motive source, nor the destination.

    Lorenzo’s point on risk dissolution, the lack of control … well … lefty me has a few words to that:

    …being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. … Negligence and profusion, therefore, must prevail, more or less, in the management of the affairs of such a company.

    Or … indeed … such a nation, such a world.

    Oh … yeah … not my words … I wonder which notorious lefty free-market hater wrote that? Hint … published 1776 … a little bit before Marx! Any takers?

  3. JC
    Posted July 7, 2012 at 8:27 pm | Permalink

    Dave

    There are all sort of “solutions” put forward. One interesting one, or at least I thought was interesting was unlimited liability to bank shareholders. All these sorts of things of course could work. However there are also trade-offs and this would mean bank cost of capital would rise as it is at the moment through Basel 3 (obviously Basel 1 and 2 were no good) and that means reduced lending and therefore leverage in the system.

    However a decent amount of leverage in the system has had benefits by allowing consumers to access loans to buy new cars, homes or help finance their kids through education etc. Even for allowing people to take a vacation on a loan. This stuff has had benefits to the average person.

    In other words the democratization of lending has had a beneficial impact at large.

    Now, if we go down this road (higher cost of capital), it will mean less lending at the margin and of course less potential for a higher GDP. I need to me more than a little convinced on a blog that would be an obviously good thing.

    One example of what Dodd Frank has done.

    Because of onerous regulation banks basically no longer do pay day loans. These are loans for marginal, low paid workers. The end result is that it’s basically sent these people off to loan sharks and other assorted types where the fees are sky high. As I keep saying, welcome to the world of unintended consequences where the road to hell is paved with good intentions. Stop regulating especially, most especially from knee jerk responses as that’s all we’re seeing.

  4. JC
    Posted July 7, 2012 at 10:59 pm | Permalink

    Here: I think I started commenting at Barry’s around 2009.

    I consider this to be one of the best blog threads in Australian about energy and energy needs. It was written by a guest poster there.

    http://bravenewclimate.com/2009/09/10/solar-realities-and-transmission-costs-addendum/

  5. JC
    Posted July 8, 2012 at 10:20 am | Permalink

    KVD

    It seems to me that we are fairly shortly going to be faced with a cashless society, which I actually welcome, because it will make life a lot easier.

    You then have to explain this chart as money in circulation, that is currency, totally refutes your proposition seeing it continues to rise.
    Your less-need for-currency theory seems to have been blown out the water.

    http://research.stlouisfed.org/fred2/series/WCURCIR

    Also, I don’t really understand your point- that a tobin tax would be more effective in a cashless society- seeing that 100% of all transactions such a tax is supposed to hit, are done electronically anyway.

    Lastly, no thanks. With people like Benito Conroy and the ALP in coalition with the greenslime, the last thing people should do is give away physical currency seeing Conroy wants to control the internet.

  6. kvd
    Posted July 8, 2012 at 12:02 pm | Permalink

    [email protected] it is my opinion that we will inevitably move to some form of cashless society. This has good and bad consequences. I think the good outweigh the bad, but that is just my opinion.

    The usual complaint about a transaction type taxing regime is that it will move people into a cash society – the so-called ‘black economy’. On just that point alone there are good reasons for replacing cash with some electronic means of payment and receipt. Point being, once a society is totally cashless it becomes very much possible and more effective to institute a taxation regime based upon what I earlier termed ‘independently verifiable’ data. Incidentally, I think it was Lorenzo who mentioned one particular concept which is called a Tobin Tax; my comments are directed more widely than the financial transactions that is aimed at.

    Now whether or not that is a ‘good’ thing is a separate discussion as to whether or not it is ‘feasible’. A further separate discussion is what then is done with the proceeds. For myself I see it simply as a replacement for the hugely inefficient tax regimes presently in place.

    I have my opinions on each of those things, and I’m not suggesting you change yours. But surely at least you must allow for civil discussion, and competing ideas – without the name-calling?

  7. JC
    Posted July 8, 2012 at 12:29 pm | Permalink

    You suggested the cashless society is on it’s way. The chart I linked to suggests that it’s not. You lose.

    The e-currency you have in mind though most likely won’t be the one that comes into being and you’ll find governments will attempt to snuff it out quickly. The most likely type will be some form of private E-currency that isn’t traceable and totally anonymous. This isn’t a good thing for welfare laden states by the way but wonderful for people outside the zone, or those that can manage to say inside the zone and participate.

    You seem to envisage an unreal future. It seems to be one where everyone lays down and thinks of England while governments steal their money. In fact the opposite is likely as the web can’t be controlled without a large number of heavy boots resting people chests.

    My bet is that it will appear from some country that takes a honey badgers view of things “I don’t give a shit” view of the rest of the world and is able to tolerate the abuse that will directed towards it Most certainly won”t be Switzerland as they’ve already rolled over. Could be Singapore.

    I have my opinions on each of those things, and I’m not suggesting you change yours. But surely at least you must allow for civil discussion, and competing ideas – without the name-calling?

    Selective much? Go to comment 99. Read the threat, then go to 92, see what was said prior, which of course he was aware of and then come back to me about your civility argument.

  8. Posted July 9, 2012 at 12:10 am | Permalink

    [email protected] You continue to engage in the Humpty-Dumpty theory of meaning. Lord Turner’s comments were actually quite specific and clearly not directed to every trader and banker. It is difficult to take what you say seriously if you cannot read plain English sentences.

    And getting outraged a comment about cynicism and greed when your defense seems to be that LIBOR was just a made up number anyway and who cares? suggests a great deal of cynicism.

    People’s whose contracts were written on that basis probably care, for example.

    Scott Sumner provides an excellent analsi\ys of the onset of the Great Recession which, as Lar Christensen explains nicely, had a great deal to do with central banks screwing up. But that level of economic disaster generally does.

    Explaining the GFC is rather a different matter. There had clearly been massive perverse selection in the design of financial instruments. But the apparent belief in housing prices continuing to rise meant that lots of people took positions that only made sense if they continued to do so. Obviously, they did not. This massive set of one-way bets generated great instability when prices dropped dramatically. Hence suppressing, including systematically discounting, downside risk generates instability.

    There has been a dramatic increase over time in income to finance. The evidence for commensurate social benefits from said increase is extremely thin. When you get that scale of divorce between private return and identifiable value-created you have to start looking for other explanatory factors.

  9. Patrick
    Posted July 9, 2012 at 11:12 am | Permalink

    kvd, I don’t share your certainty.

    For starters, I don’t know what you mean.

    Do you mean merely that ‘there will be nowhere to hide?’ This is already largely the case. If by the rest of the business community you mean subbies and small business, ok, they do get an easy ride. But have you seen the new Contractor Payments disclosure rules?

    As for large businesses, of course their tax liability does reconcile to their profit which does actually reconcile to their cashflow statements, and both are audited.

    Do you mean a cashflow tax? This was given serious thought by Howard following the Ralph Report (almost all of which was actually given serious thought unlike the useless Henry Report commissed by the feckless current muppetshow) but dumped as too radical, basically, and (thus) too hard.

    If so, then first, there are good reasons why it was abandoned the first time which will be just as prevalent the second time (I suspect, although I could never prove, that the biggest is that you can’t favoritise easily under a cashflow tax). Secondly, no sooner would your cashflow tax with mandatory financial records disclosure be enacted, than people would develop sophisticated financial tools on usenet or darknet or tor servers or any other form of ‘dark’ internet.

    You only have to read Robert Heinlein 😉 Seriously, he thought a lot of it through more carefully than most eminent economists, such as the Robin Hood Tax idiots DB links to!

  10. JC
    Posted July 9, 2012 at 11:37 am | Permalink

    I’m blockquoting for ease, which I forgot to do above.

    You continue to engage in the Humpty-Dumpty theory of meaning.

    No I don’t. It’s you who seems to indulge in self-delusion. You’ve basically conceded most points yet seem to think that by calling me names or making smart alec jibes will somehow help your argument. It doesn’t. For instance you conceded Lord Mudraker is not a banker after finally agreeing he’s a technocrat… (But hey, he worked at a bank for 3 odd years over 3 decades ago lol). What’s also interesting is unless LE intervened the other day you were obviously fine with comment 92. Truly amazing display.

    Lord Turner’s comments were actually quite specific and clearly not directed to every trader and banker.

    Really? Let me repeat them for you.

    There is a degree of cynicism and greed that is quite shocking. I think we would be fooling ourselves if we thought that some of the behaviour and culture evidenced in Libor fixing are not found in some other areas of trading activity as well.

    If you that’s somehow specific, then words in the English language only have the meaning you want to attach to them. Unfortunately you don’t have that right. That was a clear attempt to create to impression that it was widespread thereby attempting to tar lots of people with the same brush. This is why I continue to say he’s a zealot (in addition to writing that diabolical crap in Prospect, which even a economics luminary such as Bob Brown could have written with no one spotting the difference)

    It is difficult to take what you say seriously if you cannot read plain English sentences.

    I find it amusing now that you continue with this charge thinking that somehow it will stick when you even refuse acknowledge the fact that his statement wasn’t “specific” as you say. He was in fact lobbing hand grenade attacking all and sundry.

    And getting outraged a comment about cynicism and greed when your defense seems to be that LIBOR was just a made up number anyway and who cares? suggests a great deal of cynicism.

    Why would I possibly be outraged when I’m kind of amused seeing you lose any attachment to reality? Libor was in fact frequently made as the WSJ says. I note you don’t accept the WSJ’s claims because they don’t align with your views on monetary policy, which is supposed to be some sort of argument. It was made up because the CB’s steered the banks to making it up at times and also because the banks didn’t really lend to each other on the LIBOR benchmark. In other words, Lorenzo there was no bloody transactions on LIBOR anymore, as the banks were not lending unsecured to each other. However this seems to have gone right over your head. Yea, so pardon me for being cynical for those reasons.

    People’s whose contracts were written on that basis probably care, for example.
    Scott Sumner provides an excellent analsi\ys of the onset of the Great Recession which, as Lar Christensen explains nicely, had a great deal to do with central banks screwing up. But that level of economic disaster generally does.

    Yep.

    Explaining the GFC is rather a different matter.

    Not really.

    There had clearly been massive perverse selection in the design of financial instruments.

    How so? How was there perverse selection? Explain.

    But the apparent belief in housing prices continuing to rise meant that lots of people took positions that only made sense if they continued to do so. Obviously, they did not. This massive set of one-way bets generated great instability when prices dropped dramatically.

    Interesting, so markets are volatile. Who knew? It seems to me that you haven’t understood what Sumner has been saying. He suggests that the stress felt in the sub-prime could have been localized if the CB’s had handled things better. He says the severity wouldn’t have been anywhere near as deep.

    Hence suppressing, including systematically discounting, downside risk generates instability.

    This sentence really makes no sense. You need to re-write it or at the very least explain it?

    There has been a dramatic increase over time in income to finance. The evidence for commensurate social benefits from said increase is extremely thin.

    Do you have any evidence to your claim or will just an assertion suffice? I don’t mean linking me to someone that agrees with you, but hard raw evidence. In fact I will posit the opposite conclusion in the financialization actually helped grow the economy.

    When you get that scale of divorce between private return and identifiable value-created you have to start looking for other explanatory factors.

    What on god’s earth do you mean? Elaborate please.

    Can I make a suggestion? If you are going to use jargon, which isn’t understood in finance/economics lingo, you need to explain what exactly you’re trying to say by elaborating otherwise people have no idea what it is you’re talking about.

    If you doubt me, then lets put it to the test with an academic economist and see if they figure out what you’re attempting to say in certain parts of your last comment for example.

    Creating your own jargon without explaining what exactly you are trying to say makes it too difficult.

  11. Jc
    Posted July 9, 2012 at 1:05 pm | Permalink

    Lorenzo

    I posted your last comment at cattallaxy highlighhting the problems I had in trying to understand what you’re trying to say

    Here:

    Of course it’s English, JC.
    All those words are English.
    The construction of the aggregate parts, i.e. the sentences, are however, Swahili.

    I’ll post any others as they come along.

  12. kvd
    Posted July 9, 2012 at 1:54 pm | Permalink

    [email protected] I’d love to discuss this further, but I keep getting spittle and slurs from elsewhere, which really have nothing to do with what is an interesting subject. Briefly I guess I see our present taxation system as a confusing mass of aims and objects, which could possibly be subdivided, and ‘reset’ so that I as an individual taxpayer, do not have to bear the inevitable costs of a) avoidance b) uneconomic rearrangement so as to minimise c) entirely artificial divisions between capital and revenue and d) penalty for mis-reporting.

    It just seems to me that GST is a partial model for what might be achieved – except even with that simple base concept, there is an entire industry now devoted to avoiding or minimising one’s liability, and redefining the nature of transactions etc..

    I do not wish to be seen as suggesting a “great big new tax” – more just a rationalisation leading hopefully to less time spent on avoidance and minimisation, more time spent on productive economic activity. As to whether it is possible to replace cash, well we did it once recently – 14 Febuary 1966 – but stupidly issued yet another anonymous, untraceable means of transacting. (and I do recognise it wasn’t possible then, but it certainly is now)

    You mention that companies restate/reconcile their tax commitments to both their profit and their cashflow results. Yes they do – but I take that as an example more of the artificiality of our present system than some “good” thing that it is possible to do such reconciliations.

    I hesitate to mention the kraken, but JC instanced a graph of US printed money in circulation. He took this as a proof that printed money was indispensible; I took it as a source of untraceable, unrecorded economic activity. The exponential growth in that graph represents economic activity not paying (never mind a fair share) any share of what we poor sods ante up.

    I’ve now mentioned avoidance and minimisation a couple of times. Believe me I see both as secondary to the aim of replacing our current mess with something simple and clean and less intrusive upon economic decisions. People rave on about a “flat tax” (which I’d support) but they keep placing that concept within our present regime. There needs to be a complete rethink as to ease of collection, minimum economic bias, and maximisation of participation.

    Finally you mention “dark” internet, and JC mentioned something about “the web can’t be controlled”. Call me a conspiracist, but the internet, or the web, has never been uncontrolled. To believe in some magical untraceable flow of funds without consequent title and ownership recording really is the stuff of sci-fi dreams.

  13. Posted July 9, 2012 at 1:55 pm | Permalink

    [email protected] What Lord Turner said

    There is a degree of cynicism and greed that is quite shocking. I think we would be fooling ourselves if we thought that some of the behaviour and culture evidenced in Libor fixing are not found in some other areas of trading activity as well.

    What you said about what he said.

    Yep, kill the traders. They ‘re all evil according to this Lord.

    What I said, trying to be agreeable

    And yes, Lord Turner is a technocrat who is also a former banker.

    What you said I said

    For instance you conceded Lord Mudraker is not a banker after finally agreeing he’s a technocrat

    And so on.

    You also called Prospect a far left magazine and a former director of McKinsey’s far left because of, well, nothing really.

    On the cynicism point, arguing that the regulators knew all about it is not really strengthening the claim that there is not something deeply rotten in the global finance industry.

    How so? How was there perverse selection? Explain

    The bundling of mortgages together in common securities meant that people were not really in a position to know what level of risk they were getting into as ownership of the risk was separated from information about the mortgages. If that is not perverse selection, not sure what is.

    what Sumner has been saying. He suggests that the stress felt in the sub-prime could have been localized if the CB’s had handled things better. He says the severity wouldn’t have been anywhere near as deep.

    Yes, if you have a credit crunch and then make economic conditions much worse, the credit crunch will be worsened. Yes, quite so. But that is not why the Great Recession happened and was so severe. If that clarifies matters, fine.

    As for

    Interesting, so markets are volatile. Who knew?

    Apparently not lots of folk who were paid lots of money for their alleged expertise on precisely such matters.

    On risk and instability, if a system generates a whole lot of one way bets then it is very vulnerable to events moving in the opposite direction. I don’t know how I can be clearer.

    More broadly, policies which attempt to suppress risk can generate inbuilt inflexibility which actually increases vulnerability to large economic shocks. As Australian economic history demonstrated until we dismantled (most) of the Deakinite system.

    On private return and social benefit, if we look at finance’s share of GDP in the US, we can see it has been increasing dramatically, particularly since 1980.

    If we look at US economic growth, we can see there is effectively no correlation between the two.

    So, the return to finance does not appear to be connected to rates of economic growth. Or, to put it in perfectly sensible welfare economics language, the private return seems not to be connected to any wider social benefi.

    It does, however, seem to be connected to widening income inequality.

    [email protected] If people want to comment here, they can. Leave it to them.

  14. kvd
    Posted July 9, 2012 at 2:40 pm | Permalink

    Just so I’m clear about variously “Lord Muck” “Lord Muckrake” “Lord Mudrake” “Lord Turner” having only three years at a bank.

    Is this the guy who worked at Chase Manhattan Bank from 1979-82; was director of McKinsey & Co in 1994 after joining in 1982; then 2000-06 Vice-Chairman of Merrill Lynch Europe?

    CHASE, a leading global financial services firm with operations in more than 60 countries. Chase is a leader in investment banking, financial …

    McKinsey & Company is the trusted advisor and counselor to many of the world’s most influential businesses and institutions.

    Merrill Lynch is one of the world’s leading financial management and advisory companies, providing financial advice and investment banking services.

    Well, he’s obviously well out of his depth if placed in anything to do with banking. Not.

  15. Posted July 9, 2012 at 2:55 pm | Permalink

    [email protected] – hear, hear! Good set of links to pull the point you make together, … Etc etc

    But …

    The same disrespect for interpretation of English, logic, data and human outcomes that have been heaped on your points here, are somehow, magically, able to smell like roses once passed through the back rooms of the major parties, emerging with near papal infallibility.

    So … how and why would you (and other useful commentators of the left and unhypocritical right) say that the politicians we have all miss the point you make – one obvious to any child of enlightenment or classical values? Or maybe the politicians /do/ understand the point, but continue to support the pirates anyway? What does the lack of value created by the finance sector compared to it’s profits, say about our political system?

    (serious question …. Not rhetoric from a lefty who wants financiers in front of firing squads)

  16. kvd
    Posted July 9, 2012 at 3:02 pm | Permalink

    Diamond joined Morgan Stanley in 1977. He rose to the post of managing director and head of fixed income trading division.
    CS First Boston : 1992 to 1996
    Based in Tokyo, he was Chairman, President and Chief Executive Officer of CS First Boston Pacific, responsible for Investment Banking, Equity, Fixed Income and Foreign Exchange for the Pacific region. Diamond was formerly Vice Chairman and Head of Global Fixed Income and Foreign Exchange.
    Barclays PLC : 1996 to 2012
    joined Barclays on July 4, 1996
    the effort to purchase key assets of Lehman Brothers after its bankruptcy in September 2008, instantly giving Barclays a key foothold in investment banking.

    A lot of experience, yes, but totally ignorant of the significance of LIBOR?

  17. Posted July 9, 2012 at 3:51 pm | Permalink

    kvd, one issue I have with a transaction tax applied to the general economy (rather than just the finance industry) would be the way it advantages large companies (particularly vertically integrated ones) over smaller companies. A value added tax (like the GST) generally spreads the tax burden in a more size-neutral way.

  18. kvd
    Posted July 9, 2012 at 3:59 pm | Permalink

    [email protected] before thinking about your comment, I’d be interested to know if you had a very good day last Wednesday? Hoping so…

  19. Posted July 9, 2012 at 5:06 pm | Permalink

    [email protected] One notices that, in Australia, not so much. Admittedly, we have not had a full housing land price bust, so we have not been tested as much as other places.

    Nevertheless, the claims of finance are at a bigger discount here, with stronger prudential regulation. This I put down to:

    (1) Tricontinental, Pyramid and State Bank of SA. Our pollies and bureaucrats know it can end badly if you let it rip. On the other hand, those institutions are not with us any more. Institutions which fail will get wound up.

    (2) Trade-offs. The Big Four banks want protection, so are in a weak position to complain about having strong prudential regulation as a trade-off.

    (3) Floating mortgage rates. Voters care about interest rates and what banks cost in a very direct way. While it can lead to some egregious populism, it also is another discount on the claims of finance getting too frisky.

    (4) Lack of global pretension. We are a second rank player fairly geographically isolated and know it. Playing global role games resonates a lot less.

    (5) Pragmatism. We are just not a very overtly ideological society. Things have to be argued for in a practical way, so we are a bit less likely to be swept away by grand theories (or grand projects, like the European Project) than other places.

    But these are also particular examples of Australia just doing public policy better than a lot of other places a lot of the time in recent decades.

  20. Posted July 9, 2012 at 5:36 pm | Permalink

    [email protected], the morning was a bit of a mixed bag, but the evening event made a good end to the day.

  21. JC
    Posted July 9, 2012 at 6:45 pm | Permalink

    What I said, trying to be agreeable

    Or perhaps more accurately this what you first said.

    Lord Turner is a former banker.

    I’m wondering why you left out the first comment and picked another further down the thread?

    You later said he was ‘specific” with his criticisms. That’s just untrue. I’ll highlight the part that will help you.

    There is a degree of cynicism and greed that is quite shocking. I think we would be fooling ourselves if we thought that some of the behaviour and culture evidenced in Libor fixing are not found in some other areas of trading activity as well.

    Is the highlight any help?

    You also called Prospect a far left magazine and a former director of McKinsey’s far left because of, well, nothing really.

    No, that’s also not true. I call him a far leftist because that is what he appears to be with his scribblings in that magazine. In fact he’s a leftwing zealot. Again, you seemed to have missed what I said. Are you seriously implying that it would be somehow difficult for people’s political leanings at his level and maturity? Say it ain’t so. Now I don’t know if he always believed the things he uttered in the magazine, but he was certainly uttering leftwing slogans in the piece and at the Inquiry.

    On the cynicism point, arguing that the regulators knew all about it is not really strengthening the claim that there is not something deeply rotten in the global finance industry

    Fish rot from the head down. In this case the fish head was always rotten by the sounds of things. In fact it strengthens my case for free banking rather than what you support.

    The bundling of mortgages together in common securities meant that people were not really in a position to know what level of risk they were getting into as ownership of the risk was separated from information about the mortgages. If that is not perverse selection, not sure what is.

    Oh please, mortgage backed securities have been around in the US since the 70’s. There was nothing new to them, just more of them. The players for the most part (yes Manly council etc are the exceptions which we’ll leave aside) knew or should have known what they were buying. Where was their due diligence?

    Banks have been put back portions of the securities that were clearly fraudulent, however it’s a tiny fraction of what has been issued. Most of these relate to Country Wide, a non bank lender that Bank of America purchased during the GFC. I also suggest you reserve judgment in making these claims as there are number of put back cases going through US courts. To be frank it doesn’t look good for the seasoned investors at the moment.

    On risk and instability, if a system generates a whole lot of one way bets then it is very vulnerable to events moving in the opposite direction. I don’t know how I can be clearer.

    Tell me, Australian banks currently have around 60% of their balance sheets tied up with real estate loans. Are these one-way bets? Homeowners in lots of cases have nearly all their net worth tied up in a home. Are these one way bets?

    I think you’re confused with what you’re actually trying to say.

    On private return and social benefit, if we look at finance’s share of GDP in the US, we can see it has been increasing dramatically, particularly since 1980.

    If we look at US economic growth, we can see there is effectively no correlation between the two.

    It’s a meaningless association. You don’t know the optimum level of financialization and no one else does either. However it would be far better with free banking and people their risk, starting with the depositor on up the food chain.

    So, the return to finance does not appear to be connected to rates of economic growth. Or, to put it in perfectly sensible welfare economics language, the private return seems not to be connected to any wider social benefi.

    You have no evidence so therefore you’re just making an assertion that supports your prejudice.

    It does, however, seem to be connected to widening income inequality.

    Nonsense.

    The US has or recently had around 12 million illegals that impact wages in the lower quintiles, To ignore this is to ignore reality. And there is also globalization that certainly had an impact.

    But rather than looking at this so negatively like you are, the US also expanded it’s work force absorbing that clump and with globalization we’ve seen millions and millions of people taken out of poverty. Hundreds of millions in fact.

    If you bothered to understand it, this has actually been a golden in reducing inequality in the world.

    [email protected] If people want to comment here, they can. Leave it to them.

    I think LE and SL should make that decision. Certainly not you, unless you’re claiming to be the blog owner. As far as I understand it’s not yours.

    And you’ve yet to comment on 92 and 99 comments like I asked you before.

  22. JC
    Posted July 9, 2012 at 6:50 pm | Permalink

    Is this the guy who worked at Chase Manhattan Bank from 1979-82; was director of McKinsey & Co in 1994 after joining in 1982; then 2000-06 Vice-Chairman of Merrill Lynch Europe?

    CHASE, a leading global financial services firm with operations in more than 60 countries. Chase is a leader in investment banking, financial …

    McKinsey & Company is the trusted advisor and counselor to many of the world’s most influential businesses and institutions.

    Merrill Lynch is one of the world’s leading financial management and advisory companies, providing financial advice and investment banking services.

    Well, he’s obviously well out of his depth if placed in anything to do with banking. Not.

    KVD

    Jacques Nasser is the Chairman of BHP. He spent most of his adult life at Ford Motors.

    According to your brilliant standards, does that make Jacqes a miner or an expert in the mining business?

    Is McKinsey a bank now is it?

  23. JC
    Posted July 9, 2012 at 6:53 pm | Permalink

    A lot of experience, yes, but totally ignorant of the significance of LIBOR?

    Who’s pleading he was ignorant on how LIBOR was set?

    Do you even know who sets LIBOR at the banks, KVD. It’s not the freaking CEO in the morning for lord’s sake.

    It’s the money desk or treasury as it’s known at the times. The people that work on these desks , at least when I was there were the schelps.

  24. Posted July 9, 2012 at 7:06 pm | Permalink

    JC,

    You don’t know the optimum level of financialization and no one else does either. However it would be far better with free banking and people their risk, starting with the depositor on up the food chain.

    Do you have any evidence that ‘free banking’ would reach the ‘optimum level of financialization’? It’d help if you can do that without

    …just making an assertion that supports your prejudice.

  25. JC
    Posted July 9, 2012 at 7:37 pm | Permalink

    Desi

    What I do know is that if people understood their risk from depositor, bond holder to equity holder it would likely mean a lot less leverage. It would at least after the recent GFC and remain there for a while until people forgot again and the cycle goes around. I’m not rosy eyed to suggest it would solve all failure in the banking system or that leverage wouldn’t rise as the I-banks were leveraged to 35 to 1 before the GFC, but even here I think the regulators were the prime cause of hubris. Don’t wanna go into why.

    However the impact is we wouldn’t have to worry about too big to fail and the taxpayers taking the potential hit.

    You do realize that the US taxpayer made a profit from TARP, right? The part that lost money was as a result of using the fund to bailout the UAW* pension fund.

    *United Auto Workers union

    It’s really freaking interesting that I keep hearing about greedy bankers from the likes of lorenzo and some of the cheer squad here, but I don’t hear a freaking peep about the $40 billion lost in the TARP money bailing out the unions. They were never greedy of course. No siree. There was never even a hope in hell that money could be made back by the way. IT was a direct transfer from the taxpayer to the Administration’s buddies in the union movement. Unions greedy? Never! LOl

  26. Posted July 9, 2012 at 8:07 pm | Permalink

    I’ll take that as a “no”.

  27. Posted July 9, 2012 at 8:11 pm | Permalink

    JC, you do seem to be seeing “lefties” under every rock but I have to agree with your point about the ‘social usefulness’ of the financial sector. Any such usefulness is, in a properly free capitalist system, happy accident and a spontaneous effect of trading for private profit rather than the result of deliberate regulation. I also agree that increased regulation of market activity is inclined to reduce it (the same way means testing universal benefits ends up costing more than it saves) but we don’t have a completely 100% “free” economic system. We have a cobbled-together halfway house that has evolved over a couple of hundred years of marketised activity (in the UK at least) and I doubt that the purity of a free-for-all would be any more liberating than total regulatory control for those of us who profit or lose from the side-effects.

    For the record: I’m not a lefty and I certainly believe unions can be greedy but that’s an external value judgement by without the benefit of psychic powers. For that reason I’m less concerned with the purity of intent and more interested in the banks compliance with the rules of conduct/procedures THEY CONTRACTUALLY CHOSE to subject themselves to voluntarily as a requirement of FSA authorisation to trade.

  28. JC
    Posted July 9, 2012 at 8:22 pm | Permalink

    I’ll take that as a “no”

    If the level of leverage remains low in free banking then no, there would likely to be decreased chances of a crash of the sort we had, though not necessarily the hit. But as I said I’m realistic about human nature.

    You can’t stop business cycles.

    Despite Lorenzo’s optimism Australia’s banking system would be in serious trouble if we took a 30 40% hit to RE. There’s no escape with bank balance sheets holding 60% RE. That’s just hubris.

  29. Posted July 10, 2012 at 12:09 am | Permalink

    [email protected]

    Prospect is a far left magazine.

    [email protected]

    No, that’s also not true. I call him a far leftist because that is what he appears to be with his scribblings in that magazine

    And trying to be agreeable means attempting to find a formulation the other person is more comfortable with. That’s the point really.

    And compared to your hyperbolic misrepesentations of Lord Turner’s comments, actually, they are pretty specific.

    As for free banking, the arguments for it are quite strong. Hence my comment that

    I am agnostic on the proper level of prudential regulation, except for the principle of any systematic removal of downside risk by policy (defined broadly) has to be compensated for by increased prudential regulation.

    I agree the level of real estate exposure in Australia is not good, and have written at length about the problems of being so highly leveraged on bureaucratic approval (as land zoned for housing).

    Sill, bit of a worry if banks cannot offset their risks as well as your average bookie.

    More to the point, is the one way bets created by the “too big to fail” and the various implicit or explicit guarantees involved in the destruction of prudence.

    Your comments on securitisation of mortgages seem to be saying their spread was not a great idea. And just because something has been around since the 1970s does not make it a good thing.

    Illegals in the US may well depress incomes at the lower end, but they do not explain the surge in incomes at the higher end. And if the level of financial income jumps around in ways not at all connected to economic growth, then that is prima facie evidence that a lot of the former does not have much to do with the latter.

    As for not stopping business cycles; probably not entirely but we (or, rather the RBA) do seem to be doing quite a good job in Oz of smoothing them out.

    And, strangely, a post about the global finance industry is probably not going to have much to say about the unions. Nor penguins either. Nor global warming. Nor Julia Gillard’s vowels.

    Though I am happy to agree that bailing out the UAW was a misuse of taxpayer’s funds.

  30. JC
    Posted July 10, 2012 at 10:24 am | Permalink

    And trying to be agreeable means attempting to find a formulation the other person is more comfortable with. That’s the point really.

    Ha?

    And compared to your hyperbolic misrepesentations of Lord Turner’s comments, actually, they are pretty specific.

    So you’re saying he didn’t make that comment I’ve been quoting? That was someone else that looks and sounds like him?

    I agree the level of real estate exposure in Australia is not good, and have written at length about the problems of being so highly leveraged on bureaucratic approval (as land zoned for housing).

    Sill, bit of a worry if banks cannot offset their risks as well as your average bookie.

    They can’t

    More to the point, is the one way bets created by the “too big to fail” and the various implicit or explicit guarantees involved in the destruction of prudence.

    You do realize that prior to the GFC regulators believed that the structure of US bank balance sheets were the work of pure genius, right?

    Your comments on securitisation of mortgages seem to be saying their spread was not a great idea. And just because something has been around since the 1970s does not make it a good thing.

    Nothing wrong with the instrument as such.

    Illegals in the US may well depress incomes at the lower end, but they do not explain the surge in incomes at the higher end. And if the level of financial income jumps around in ways not at all connected to economic growth, then that is prima facie evidence that a lot of the former does not have much to do with the latter.

    If you read what I said you would see I wasn’t just “blaming” illegals. I said that clump of labor impacted wages at the bottom quintiles while demand for executive talent impacted the top- globalization caused this. I’ve never bought the inequality argument as it’s a bunch of horse shit in a relative sense (in the western world). It also glosses over the fact that millions over millions of people have clawed out of absolute poverty the last 20 odd years and as I said it’s been a golden age in reducing inequality around the world.

    Giving voice to “inequalityites” is a form of enabling people to continue with a serious pathological condition I spoke about. It is possibly the worst human trait and the most serious of the deadly sins.. Envy.

    And, strangely, a post about the global finance industry is probably not going to have much to say about the unions. Nor penguins either. Nor global warming. Nor Julia Gillard’s vowels.

    Accusing bankers of being greedy and solely the bankers is retarded. We’re all greedy or none of us are.

  31. JC
    Posted July 10, 2012 at 10:26 am | Permalink

    Fair comment Deux.

    I think you’re being a little too harsh on me with this though.

    JC, you do seem to be seeing “lefties” under every rock

    There’s only a particular strain I really don’t have time for.

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