I very much feel like an idiot for having written this post. I swear I'm smart about other things, like clothes and decorating.
Well, I'm not confused about Black-Scholes or something. I'm confused about the hard parts.
Think of Wall Street as crowd sourcing. But then you can sell your bit to someone else. A third person makes a bet with you on whether you can sell your bit in the future for more or less than you bought it for. She then sells that bet to a fourth person, who wants it as a hedge for their own purchase of a different bit.
I'm clear on all that, except for the part where I can't tell if I'm being mocked.
Every point here is contentious, but it's a good, simple precis of what Wall Street is supposed to be up to.
Oh, I meant to add, you poor dear.
No, it takes balls to write a post like this.
I know, I know, that's mighty white of me.
I could just read those fucking subheadings and tell immediately that the piece in 7 was by that ignorant fucknob from Planet Money. "Gosh gee I'm just an ignorant hipster. You say credit cards can actually help people?" He, and you, Ogged, for linking to him, should be executed immediately.
Wow, is that article ever infuriating. But you're right insofar as it implies that I should stop thinking there's some nebulous part of Wall Street that I don't get.
I've heard Planet Money a couple of times and I do, in fact, hate Adam Davidson, but I felt ok inflicting him on Heebie.
So ideally, what would (well-enforced, full of teeth) regulations be? Just resurrecting that firewall that used to separate the private banks from the finance industry halves of banks?
I think I've posted 12 as a standalone post probably five times and just don't remember what answers I got.
Well, the absolute basics of what a bank has to do are:
storing value: I want somewhere to put my money where it won't get ripped off. The sock under the mattress isn't secure enough.
payment processing: I want them to sort out transferring my money to other people when I tell them to. Me going round to their offices with bags of gold is terribly inconvenient. This also includes them changing my money into different currencies so I can send money to foreigners.
maturity transformation: I want to be able to put my money somewhere where I can definitely get it back instantly to buy food; I also want to be able to borrow money and definitely not have to pay it back instantly, to buy houses.
And to that you can add insurance.
How good Wall Street is at doing its job is really a question of how much of these four things it does, and how much it skims off the top to do it. The answer is "less good than it was in 1912".
The gambling stuff is really an epiphenomenon of the banks having a lot of (my) money and being increasingly allowed to do what they want with it...
What would a financial industry ideally do, and only do?
Die.
14: I thought the late 19th/early 20th century had some pretty horrible boom/bust cycles and bank runs. Or did one of the better regulatory acts get passed in 1912?
Having read the rest of the piece and knowing who it was by, I think I could have come up with something like the last paragraph myself. Its opening sentence, at least.
So ideally, what would (well-enforced, full of teeth) regulations be?
"in this country, it is good to kill an admiral Wall Street banker from time to time, in order to encourage the others"
14 is interesting in the assumption, or demand, that one's own capital or savings should carry zero risk or uncertainty.
Those four items, except maybe/partially transactions, sure look like "gambling" to me.
FDIC is not until 1933
In hindsight repealing Glass Steagall was a mistake. But it is a lot more profitable to pay a lobbyist to lean on Congress than to actually make good loans.
19: That's an expansive definition of gambling. And why is minimizing (not the same as zero risk; I fully accept that in the event of the US collapsing, nuclear war, gamma ray burst etc. I may have trouble accessing my funds) risk in savings unreasonable?
Credit cards, on the whole, have to be a massive drain on the real economy. Hiding the transaction charges from the user is provides an amazing principal-agent problem. I wonder how profitable they would be without their cut of every purchase.
I am not recommending it, it is for economists or informed amateurs, but Piketty's Capital in the 21st Century is as good, if not as important, as they say.
Halfway through now.
Up until around 1800, Capital (income producing property, safe assets & value storage) was only land. And in some places slaves. This persisted in most of the world until ~1900, with Britain and France adding gov't bonds and overseas investment (again, mostly land and agro). Only when rich fuck income was not mostly generated by agriculture did it change.
PS:Land, housing, buildings (and the paper attached) are still around half of most rich nation's wealth.
The rise of Finance mostly means that the rich fucks feel secure about their social and political environment.
Historically the Jews were allowed were forced to handle Finance not because it was "dirty" but because it was risky and destabilizing for society (nobles falling oh no.)
I skimmed that Davidson article and Christ is it stupid. Wall Street was a much less important part of the economy in the 50s, and yet somehow we had every single thing he mentions as a feature of Wall Street.
I think that the current prominence of Wall Street is largely a result of the fact that rich people now have all the money. You have giant pools of money, and people with no idea what to do with them. Wall Street is there to "help". Sometimes that "help" will take the form of providing capital to productive enterprises, and sometimes that "help" will take the form of blowing up the world economy.
21: It's totally reasonable, but you should expect to pay for the privilege. The fact that somebody will pay you for the privilege is an occasional feature of the economy, not an immutable law.
So...23+
What is Wall Street, Finance, Capital for? What is its purpose, its social utility?
Well, what is the concentrated ownership of land for? What is a plantation or an earldom for?
The oppression and exploitation of the worker.
Glad to help.
Per 24, Is it fair to say that there is no beneficial function of Wall Street outside of what it was doing in the 1950s?
the current prominence of Wall Street is largely a result of the fact that rich people now have all the money
No. The aggregate of all the pension funds, small investors and mortgages dwarfs the holdings of the 1%, but the 1% are the ones directing the investments and taking their cut along the way.
What is Wall Street, Finance, Capital for? What is its purpose, its social utility?
To finance enterprises that require large amounts of capital i.e. factories, railroads, airlines, banks, etc.
27:Wall Street wasn't doing that much in the 50s
Historically, business expansion and much venture was financed via retained earnings. Retained earnings were stored, at a fairly late point, in stocks. Stocks were risky and represented cash-flow more than property. Property, of a business, was represented by bonds, who had first claim on assets. Still do.
Wall Street was mostly about brokerage, the selling of stocks for business and to consumers.
At the very least it's not clear that there's a beneficial function. The big change is that there many more markets than there were, so you can get forms of insurance you couldn't get before. The options market is an example -- if you're worried about a big stock market crash, you can buy insurance for it. Corporations can get rid of risks that aren't part of their core business -- for example if you're a Japanese heavy manufacturing company that sells heavily in the United States, you can use currency forwards to hedge against changes in the dollar-yen exchange rate. It's plausible that this is an improvement over the 50s.
But any contract that can be used for insurance can be used to gamble, so the net gain from insurance may be smaller than the net loss from gambling, particularly when that gambling is conducted by a bank that's too big to be allowed to fail.
Bonds also have first claim on income and cash flow, I guess, receiving a fixed guaranteed return. Dividends from stocks are variable.
Wall Street in the old days also sold bonds, but the market was much smaller and the customers smarter and more careful.
particularly when that gambling is conducted by a bank that's too big to be allowed to fail.
Preach it, brother. Did anyone even get fired ?
Seriously, burn it down, salt the earth, and send everyone involved to re-education camp. And then have a progressive income tax that tops out at 70% above 500k, with capital gains taxed as income -- so it never rises again.
25: Fair enough. Has there ever been a place/time (lets say in developed world since modern finance developed) where banks haven't paid nominal interest? (I'm sure negative real interest happens on occasion, although I don't have any examples at hand.)
I could be persuaded to go to 80% for incomes over 10 mil.
Know what we do with the money? Employ people. Who will spend their wages on actual stuff.
12. Elizabeth Warren has a newsletter. Basically imposing capital controls on banks is one useful direction of regulation, along with Glass-Steagal.
The complication is that a lot of what banks used to do is now done in an unregulated and unguaranteed contract market, the shadow banking system. I found Krugman's book The Return of Depression Economics helpful for a lot, but especially for that piece. So regulating the banks tightly won't prevent subsequent disasters, because bank-like entities that lend money will have the same vulnerabilities, and there are many more of these than there used to be.
unregulated and unguaranteed contract market,
What's the contract market? Payday lending and schemes like that?
35: I think Sweden's central bank did it during the crisis, but it's pretty rare. But that's a political choice. In recessions, sometimes real interest rates need to be negative, which gives us three options: 1) charge a negative nominal rate, 2) inflation, 3) grinding recessions that throw people out of work. As a society, we have chosen 3.
There are many who believe that Wall Streetand Finance are now the United States only available comparative/competitive advantage. As it is even more so for Britain and to a degree France.
This does to an extent involve skills and facilities, but what does it really mean? Why the British pound and British bonds advantaged during the Victorian Age?
Why were Ireland and Cyprus and Luxemburg and Lichtenstein or Japan able to become financial centers? And Iceland, but they were faking it.
In some cases it is the British Navy or 11 Carrier groups.
In all cases it implies strong domestic stability and a compliant population that will respect even protect capital and that will take the pain if needed.
bank-like entities that lend money will have the same vulnerabilities, and there are many more of these than there used to be.
True, but the money that they lend comes from somewhere. Fiduciary responsibility should be more than a advertising cacth phrase
28: While pension fund holding are big, they are less than you think. Anyway, how much of "pension funds" consists of "pension funds of the 1%"? (I genuinely have no idea.)
38: So regulate "bank-like entities" whenever they start to provide systematic risk. It only seems hard because we have a broken government, not because it's actually hard.
In all cases it implies strong domestic stability and a compliant population that will respect even protect capital and that will take the pain if needed.
You say that like it's a bad thing. Relative political stability is another reason that the US $ is the reserve currency, from which we Americans derive some benefit.
43. Great chart, but pension funds invest in much more than equities. And if you really want to get scared, just look at how underfunded most, but especially public employee pension, funds are.
39,42 Saudi money held in the Bahamas, for instance.
heebs, any sensible answer that starts from scratch isn''t going to fit into a comment box.
Here's my too big to answer finance question: Why do business cycles still exist? Not looking for an answer along the lines of wave of overinvestment leads to elevated AUstrian scented interest rate busts. Since the existence of cycles is predictable, why is there no instrument that extracts profit from this predictable phenomenon, which instrument would serve as a damper?
45: I suspect being the reserve currency is a net negative for the US. The demand for US safe assets drives up the value of the US dollar, which makes US exports less competitive. There's a reason why China buys US debt, and it's not to help Americans.
40:
4) Reduce the real return on capital by taxing the fuck out of wealth.
5) Partial or total expropriation.
6) Asset or currency deflation? Not quite the same as inflation, depends on balance of payments.
Edward Lambert, over at Angry Bear, is kind of a Kaleckian interested in capital/labor shares and leftish, and insists that real interest rates need to be markedly higher. I can't quite follow his arguments.
being the reserve currency is a net negative for the US
Certainly a debatable point. Having the Chinese buy US debt allows the US to spend more at a lower cost. Whether that is a "good thing" I'm not sure. Short run, yes. Long run, I'll be just as dead as Keynes.
In the interest of solidarity, I should mention that Wall Street, and economics in general, makes my head hurt too. But I refuse to let my shortcomings get in the way of having strong opinions.
Why do business cycles still exist?
Too much capital is the short Marxian version, fictitious or fixed.
Too much confidence would be the short Minsky version?
Interesting to combine the two. Capital = confidence.
It could be that mainstream economists would blame a lack of confidence, a reversal of expectations, a whipping of animal spirits. This would include confidence in and of governments, "only fear itself" and an unwillingness to go nutzoid Keynesian. Let's print ten trillion dollars and give everybody a job!
54.last: Brad DeLong is emotionally invested in the idea that nothing, save a few technocratic problems, was wrong with the economy before the crash.
I only recently found out that unemployment circa 1980 was remarkably similar to our current unemployment trajectory. I hadn't realized that recession was so serious.
31: But any contract that can be used for insurance can be used to gamble, so the net gain from insurance may be smaller than the net loss from gambling, particularly when that gambling is conducted by a bank that's too big to be allowed to fail.
Since Dodd-Frank (Volcker Rule), banks can't engage in proprietary trading, i.e. no more gambling. Which is not necessarily a good thing: e.g. now there are fewer institutions with big enough balance sheets and regulatory blessing to perform that helpful maturity transformation referenced at 14. This could become a source of stress in fixed income markets when rates eventually rise.
And thank G-d for gamblers maturity transformers qua risk takers. Natural longs in some asset - your baker hedging wheat prices or whatever - could almost never find natural shorts to exactly match their exposure. Modern financial markets, esp. futures and other derivatives, actually seem to make it cheaper and easier to match risks with people.
Various people: If only we could get Glass-Steagall back!
Except that a) banks taking proprietary bets didn't cause the financial crisis and b) proprietary trading never depended on retail deposits for funding. Imagine Glass-Steagall exists: you can still have banks making too many high-risk loans, and you'll still need the state to backstop them. So let's not pine for irrelevant regulatory bygones. The only way to keep banks from becoming systemic risks is through higher capital ratios, which we also have now.
57: And yet when it was hard to match risks with people, we had higher economic growth.
In the Bretton Woods era, exchange rates were basically fixed, and now they float. Floating exchange rates are pretty volatile. So now that exchange rates float, did some other financial market become less volatile? Nope -- there's just more volatility now. So introducing a new market can increase volatility.
So now that exchange rates float, did some other financial market become less volatile?
Labor (wage) market became less volatile.
match risks with people
Perfectly explains why excess deposits efficiently create salesmen peddling monstrous debt instruments like balloon mortgages to the semiliterate.
I basically do not understand 57.
58: That's not true. Derivatives have been around and in wide use for quite a while.
61: Which parts? I will try to do better.
And anyway, I know "volatility" and Vix or whatever, but I don't hear 'em screaming:
"Oh my dear God, the Dow is up for the tenth day in a row and 10% on the year! Can no one get this madness under control?"
Now if real wages were up 10% on the year...
Per 24, Is it fair to say that there is no beneficial function of Wall Street outside of what it was doing in the 1950s?
Theoretically*, the socially beneficial function of "Wall Street", as opposed to your local bank, building society or credit union, is that the profit motive incentivises Wall Street to arbitrage away inefficiencies in capital allocation and asset pricing, maximising utlity for everyone else and reducing friction costs of transactions.
*In practice, as we all know too well, this does not work, because of herd behaviour, information asymmetry and other off-model factors. Or at least it does not work for parties who aren't gatekeepers or the fantastic new Eurocrat phrase "systematic internalisers".
Since Dodd-Frank (Volcker Rule), banks can't engage in proprietary trading, i.e. no more gambling
Except as I'm sure you know, this isn't true. Banks are by definition proprietary traders. We want them to be proprietary traders, so long as the proprietary risk is a loan to a mom and pop company. What they can't do under Dodd Frank is proprietary trading in securities and derivatives.
So wow, this is like my whole professional life right now and I could write 50 pages. But no time to do so. So I'll just toss a few things that might add to the discussion.
Thomas Phillipon's work is indispensable here. Another useful Phillipon paper .
Natural longs in some asset - your baker hedging wheat prices or whatever - could almost never find natural shorts to exactly match their exposure. Modern financial markets, esp. futures and other derivatives, actually seem to make it cheaper and easier to match risks with people.
Risk spreading was one of the major ideological justifications for the growth in derivatives and securitization prior to the crisis. But what if risk flows not to the 'natural long' but instead to the 'unsophisticated outsider'? In other words, what if risk flows not to those who can bear it best, but to those who understand it least? From the smart money to the dumb money? What if financial sector insiders had every incentive to obfuscate and camouflage risks to help this process along?
Except that a) banks taking proprietary bets didn't cause the financial crisis
except it sort of did. The Volcker Rule is pretty well targeted at the causes of the crisis. The banks ran a massive proprietary carry trade that involved building up huge inventories of investment-grade securitizations on their trading books, ostensibly to service customer demand for trading but actually to take the spread between the costs of funding those securities in repo and the returns from the securities. Because the securities were held on the trading book, capital charges were low. Volcker should prevent building up those big trading book inventories. The other (less remarked on) part of the Volcker Rule, controlling connections to outside funds, is potentially even more directly targeted on the causes of the crisis. But even though I think it could have been / could be a good rule, I am still not a huge fan of Volcker, because it's nightmarishly complicated to enforce and the regulators really aren't very enthusiastic about doing it.
Imagine Glass-Steagall exists: you can still have banks making too many high-risk loans, and you'll still need the state to backstop them
The S&L crisis was the best example of a Glass-Steagall crisis. Banks got caught upside down on the interest rate spread and their regulators let them run hog wild to juice returns. Hundreds of banks failed around bad lending and it triggered the 1990-91 recession. But it wasn't nearly as bad as the 2008 crisis, in part because the Glass-Steagall division in financial functions meant the problem didn't spread into the trading markets. The 2008 crisis was NOT primarily about bad lending -- in fact, I can always tell someone who doesn't get it by the claim that it was somehow just about 'banks making bad loans'.
Volcker should prevent building up those big trading book inventories.
It should, but absent really strict controls on market making, it's nigh on impossible to prevent banks from running up effectively proprietary inventory which they will claim is in service of client trading.
Also, look at what JP Morgan has been able to get away with, even in the wake of the London Whale scandal, in their CIO. They're taking enormous, near trillion dollar, prop bets on entire economies, while claiming that all they're doing is hedging risk in their US corporate loan book.
66-67: that's why I'm not optimistic about the Volcker rule. The generalities are just too general and the regulators don't have the desire or will to crack down.
Re 67, I haven't seen newer stuff on the CIO post-London Whale. Can you either email me (linked address above) or else post a link to the info you are referring to? Thx.
The 2008 crisis was NOT primarily about bad lending
I was under the impression that it was due to shit loans being poured into a big sausage machine and AAA securities pouring out the other side until people suddenly realized that's just fucking stupid. At which point everyone on the inside tried desperately to dump their shit sausage on someone else and the market imploded. What am I missing?
In terms of shit and sausages, I mean
Derivatives have been around and in wide use for quite a while.
The global notional value of the over-the-counter derivatives market grew tenfold over the decade prior to the financial crisis. Over the years immediately prior to the crisis notional volume was growing 30-40 percent a year.
69, 70: Not a lot, that's about it. Combined with a bunch of leverage and inappropriate and ill-understood maturity transformation.
Re 67, I haven't seen newer stuff on the CIO post-London Whale. Can you either email me (linked address above) or else post a link to the info you are referring to? Thx.
It's not really newer stuff. They were doing it before, they paused a bit in the immediate wake of the London Whale, and then they carried on doing it, though they're less important as anchor investors than they were before. It's not like I think they shouldn't be doing it, but the idea that it's a hedge is preposterous. They're financing the European mortgage market to an astonishing degree. For a couple of years JPM CIO was literally half the wholesale funding for residential and commercial mortgages for some jurisdictions. And it wasn't hidden - they weren't shouting it from the rooftops, but it was disclosed on the individual transactions and you can easily find articles about it in the mainstream and commercial press.
69-70: basically, the problem was the mechanics of the sausage machine rather than the volume of the shit.
Ben Bernanke explains it pretty well in this speech (Warning, Fedspeak). Basically, they toted up total likely losses on subprime loans, said, hey, the banking system is well capitalized enough to take that impact, and weren't too concerned. But what they didn't understand is the level of resecuritizations and the ways in which banks liquidity had become dependent on the value of (re)securitizations being maintained. In other words, because of the way the financial system was structured, the drop in housing prices triggered a huge funding run/financial collapse that was a separate effect from the losses on the underlying loans.
By 'they' in 73 I mean the Fed.
Quote from speech:
Contemporaneous data indicated that the total quantity of subprime mortgages outstanding in 2007 was well less than $1 trillion; some more-recent accounts place the figure somewhat higher. In absolute terms, of course, the potential for losses on these loans was large--on the order of hundreds of billions of dollars. However, judged in relation to the size of global financial markets, aggregate exposures to subprime mortgages were quite modest. By way of comparison, it is not especially uncommon for one day's paper losses in global stock markets to exceed the losses on subprime mortgages suffered during the entire crisis, without obvious ill effect on market functioning or on the economy. Thus, losses on subprime mortgages can plausibly account for the massive reaction seen during the crisis only insofar as they interacted with other factors--more fundamental vulnerabilities--that served to amplify their effects.
It could stand to use an updating but if you're looking for a primer Doug Henwood's Wall Street is really good, simple, clear, well-regarded by those in the business and free to download here:
http://www.leftbusinessobserver.com/WSDownload.html
Incidentally here's his review of Piketty:http://bookforum.com/inprint/021_01/12987
But what they didn't understand is the level of resecuritizations and the ways in which banks liquidity had become dependent on the value of (re)securitizations being maintained.
Or quite how large relative to balance sheet insane, off-regulatory-balance-sheet, structures like Citi's liquidity puts had become.
Doug Henwood's Wall Street is great, a little bit old but great. If you've had just a little bit of Finance 101 propaganda (aka went to law school) it will shock you how much the conventional wisdom about the industry is bullshit, if not it will probably seem less contrary.
Piketty:"The inescapable reality is this: wealth is so concentrated that a large segment of society is virtually unaware of its existence, so that some people imagine that it belongs to surreal or mysterious entities."
Like corporations, banks, hedge funds, and "Finance"
CITI, JPM, Goldman-Sachs, Apple didn't and don't do anything, don't have anything. Quick: what was the name of the "London Whale?" Why don't we remember his name first?
This about reification, the abstraction beyond understanding of material and historical social relationships.
Thirdsies on Wall Street. (Did I mention it is one of th books I am Currently Reading?)
Also recommended, although more on developing your critique of capitalism than your understanding of finance.
Piketty:
Indeed, whether such extreme inequality is or is not sustainable depends not only on the effectiveness of the repressive apparatus but also, and perhaps primarily, on the effectiveness of the apparatus of justification. If inequalities are seen as justified, say because they seem to be a consequence of a choice by the rich to work harder or more efficiently than the poor, or because preventing the rich from earning more would inevitably harm the worst-off members of society, then it is perfectly possible for the concentration of income to set new historical records. That is why I indicate in Table 7.3 that the United States may set a new record around 2030 if inequality of income from labor--and to a lesser extent inequality of ownership of capital--continue to increase as they have done in recent decades. The top decile would them claim about 60 percent of national income, while the bottom half would get barely 15 percent.
I want to insist on this point: the key issue is the justification of inequalities rather than their magnitude as such.
I, repeat, Wall Street - soylent green = people.
2) Always ask yourself if you are justifying (liquidity! Risk management!) in your analysis a concentration of wealth/capital. Because unless you are a rich fuck, they don't need your fucking help.
Utopia or Bust is on my list, though I tend to avoid idealistic or optimistic stuff.
I want to insist on this point: the key issue is the justification of inequalities rather than their magnitude as such.
html fail;this was Piketty.
69-70: Does the tremendous growth in the repo market come into play here? If this had happened in, say, the '70s, would other sources of liquidity have been more important and the seize-up not so bad?
Given my Currently Reading list, I know the best I'm going to do with Piketty is get it out of the library for two weeks, read the introduction, and return it on the first hold with $1.40 in fines. Is there a good book review or a magazine article by the author worth digging into?
Piketyy then goes on to discuss the "hypermeritocratic" United States, which not has a greater inequality of wealth than Europe, but simultaneously an even more massive inequality of incomes turning into a ridiculous inequality of wealth.
If it crosses your mind for a second that Beyonce or LeBron or Miley "deserve" their incomes or that we want a society in which such success is possible...you are doing it wrong and selling your country to the Kochs and Waltons.
Lots of reviews floating around;more to come.
Krugman was/is? doing a longer piece in NYRB? Anyway he has had several columns.
s/b columns blogposts
The reviews miss a ton, sticking to the data and ignoring most of the analysis.
enough; too much from me
83,84 Here's John Cassidy in the New Yorker but I much prefer the Henwood:
http://www.newyorker.com/arts/critics/books/2014/03/31/140331crbo_books_cassidy?
If it crosses your mind for a second that Beyonce or LeBron or Miley "deserve" their incomes or that we want a society in which such success is possible...you are doing it wrong and selling your country to the Kochs and Waltons.
Guilty. If 100,000,000 people decide independently that they like the music, or the performance, or the product and give the artist, ball player or manufacturer $1.00, who am I to say that is wrong, or even undesirable. Or more importantly, who are you to say so? The only one collecting money at the point of a gun is the government.
Thanks. I'll have that NYer tomorrow. O Joy!
Hypermeritocratic success deserves its own critique & I understand how it provides cover for empire builders but it's not the same thing. Mankiw's stupid NYT article from a few weeks back tried this exact maneuver.
89: definitely written by an asshole. But an anonymous asshole.
Though, almost none of the rise in wealth inequality in the US is being driven by outsize gains to people like Beyonce (or start up founders or whatever story about achievement you want to tell). It's mostly finance people paying themselves a shit-ton of money and CEOs paying themselves outrageous salaries. The Piketty book, which I've started, establishes this.
But, on the third hand, the US is setting itself up for the worst of all worlds, in which you combine massive inescapable structural inequality with an ideology that justifies it and castigates the less fortunate as failures. Piketty says somewhere something like "At least in the ancien regime no one told you that being a peasant was your own fault."
It's mostly finance people paying themselves a shit-ton of money and CEOs paying themselves outrageous salaries
While this is true I don't know that progressive taxation is the remedy. Too much power is already concentrated in too few hands, making the corruption that much easier. More competition? Creative destruction?
93.2:Gimme a break
Wiki, 2002 I think:"...while the top 0.01% or 11,000 households had incomes exceeding $5,500,000."
LeBron: 2014 19.1 million.
Ok, if there are 100, that is 200 million in a 15 trillion economy, so, yeah it is the 1% or 10%. Who are Lebron's teamates. Just kidding. But still...
But part of the justificatory strategy is absolutely changing the narrative from "Lebron compared to the 99.99%" to "LeBron compared to the really rich undeserving fucks."
Top marginal rates at 80%. A wealth tax. A confiscatory estate tax. All used to provide subsidized housing and a guaranteed basic income. Done and done and nothing's preventing it except revolution. If we do all that we barely even need financial reform.
65: what if risk flows not to those who can bear it best, but to those who understand it least?
I'm 100% in favor of people not buying things they don't understand. Nobody actually forces you, as an individual or pension fund manager or whatever, to buy eeeevil scarrry derivatives. Corn farmers should best sell corn futures instead of brent crude. Fortunately, the exchanges usually don't keep the names of contracts secret.
65: Volcker
So in your mind, bank appetite for securitized mortgages created the bubble ex nihilo, rather than e.g. too-low interest rates. That view would be incorrect.
65: I can always tell someone who doesn't get it by the claim that it was somehow just about 'banks making bad loans'.
1. Not remotely what I said; my point is that you can still have systemic bank risk with Glass-Steagall & Volcker in place.
2. You skipped the part about how banks have never relied on retail deposits to fund prop books, hence the G-S repeal didn't matter.
3. Talk about 'getting it': in 71, you cite the "global notional value" of OTC derivatives, which betrays a certain unfamiliarity with the nouns in question. Netting.
Oooh, it's a shithead. Hi, shithead.
This, in particular, is entirely missing the point:
Nobody actually forces you, as an individual or pension fund manager or whatever, to buy eeeevil scarrry derivatives.
No, the problem is that your nice, but entirely theoretical, story about the greatness of derivatives being a wonderful, world-benefiting means of hedging risks, thus helping everyone, collapses once it's clear that the actual use is largely increasing volatility by foisting risk onto suckers to make a profit. It's always interesting how once the neat but empirically unjustifiable parable is demonstrated not to work in reality, the libertarian shitheads always turn to moral arguments about just deserts.
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Borgen is indeed great, for what it is, and for those who can tolerate "the classic Hollywood style" where the stuff behind and under the narrative is invisible. I can't say better than West Wing because I didn't watch one episode of WW.
I can't anymore, and may drop it after the fifth episode. Same ole tv shit.
OTOH, Gungrave is fantastic. Tons of long "helicopter" shots, which are of course as affordable in anime as medium shots.
I once looked into "setups" in Hollywood style to compare them with anime and there were many more per hour than I had thought. But they are probably all the same distance behind the scene in front of the scene to the side of the room etc. Twenty helicopter shots of twenty scenes at different times a day which is 2 minutes of your 23 on a television budget would be considered madness.
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66-68: market making
Inventory risk permitted for market making desks is a tiny fraction of what it was for prop teams pre-Volcker. Holding on to agency inventory for a few days != massive proprietary books in any world.
JPM Whale
That was a $4-5B loss for a bank that does $24B in quarterly revenue. "[E]normous, near trillion dollar, prop bets on entire economies" sure sounds grand but sadly, no.
72 is accidentally correct in that, if you read coverage from sources like FT Alphaville or Matt Levine, you can get a less woozy picture of what went on.
99-100: If the epithet was for me, thanks. I self-identify as pretty far left and vote and march in favor of such. Steep progressive tax rates, robust fiscal policy, tight environmental controls, etc. are totally my bag. I studied Marx and critical theory in grad school, okay?
But just because bankers make for great betes noires and giant puppets at Occupy rallies doesn't make it true that they or modern financial markets caused the crisis.
the actual use is largely increasing volatility by foisting risk onto suckers to make a profit
You keep asserting that without any evidence. In most markets, as far as I've ever seen, liquid derivatives reduce the volatility of asset prices.
Nope, you're still a shithead.
And frankly it takes some quite extraordinary shitheaditude to, in this day and age, claim that modern financial markets didn't cause the crisis. What, those CDOs just invented themselves?
And frankly it takes some quite extraordinary shitheaditude to, in this day and age, claim that modern financial markets didn't cause the crisis. What, those CDOs just invented themselves?
But I'm sure your study of Marx in grad school provides you with some solace, you pompous, ignorant fuckface.
In most markets, as far as I've ever seen, liquid derivatives reduce the volatility of asset prices.
Because the derivatives become illiquid once the shit hits the fan.
CDOs don't impoverish people, people impoverish people.
The crazy thing about financial products is that you can invent as many as you want, and they'll just sit there unbought if there isn't demand. Loose monetary policy, lax credit standards and too-low bank capital ratios are all reasonable culprits, but not the magical "complex derivative" gods-of-the-gaps that lazy people cite.
Unlike unlazy, but deeply ignorant, assholes, such as yourself.
So how is that far-left voting on environmental issues going for you, shitface?
108: listed futures and options stayed liquid throughout 2008. OTC stuff, not so much, but neither does it all need to be liquid if banks aren't over-levered. I'm all in favor of higher capital ratios.
I don't understand the hostility here. Halford, I don't see any difference between the policies you prescribed above and what I've already endorsed.
In other words, except for the derivatives that didn't stay liquid, the derivatives stayed liquid.
My hostility is because your face is literally covered in shit, shitface.
You know what's actually an interesting book on a boring subject? David Hawkins' history of corporate financial disclosure, from roughly 1900-1933, which, even if it doesn't make this argument explicit, provides a lot of evidence that the financial institutions cannot be trusted to police themselves.
But, if they could be trusted, boy would the financial market work great.
114: Yeah, the listed derivatives that individual investors and advisers use stayed liquid. Lots of assets in the real economy aren't ever liquid.
The highly tradeable, marketed to retail investors, money market fund system had to get a post hoc Treasury guarantee to avoid collapsing because they couldn't find liquidity.
Yep, and money market funds could still use tighter regulation. Neither are they derivatives. Neither were they a cause of the crisis, as you indicated (they couldn't find liquidity because it had already dried up because of the crisis).
The money market funds started collapsing because the biggest one of them was too invested in Lehman and had to break the buck. Lehman went broke because of its investments in CDOs. CDOs are derivatives.
Bank runs and liquidity crises have happened since forever, and banks go broke on all sorts of things.
I've already said a couple times that higher bank capital ratios are crucial, because that would've contained the impact of bank failures no matter what they were bingeing on.
Bank capital ratios are core capital over assets as weighted by risk. The estimates of risk were all fucked up in 2008, because derivatives hid the true amount of risk.
Bank runs and liquidity crises have happened since forever, and banks go broke on all sorts of things.
good point. I guess that about settles it.
Nobody actually forces you, as an individual or pension fund manager or whatever, to buy eeeevil scarrry derivatives.
That's a really good point. Its logic is irrefutable. But in my gut I don't believe it. What to do?
If only there were some obscure recent event where the use of eeeevil scarrry derivatives created systemic problems throughout the entire global economy, not just among the individual pension fund managers or whatever who bought them... then I could maybe build up some kind of counterargument.
Alas. Ironclad logic.
Derivatives create counterparty risk, and fancy, modern derivatives multiply that risk tremendously. Financial institutions love them because they are great vehicles for scamming customers.
I wonder (without having the energy to look it up) whether even the most vanilla derivatives, commodities futures contracts, have actually benefitted the economy much. My sense is that studies have gone either way on whether they are good for commodities producers or customers. I suppose they make things a bit more convenient. Then when you get to anything more exotic, I'd be really surprised if they've created any net social benefit. (Of course there's some short-term benefit to the parties that buy them, and there's a benefit to the parties that create and sell them.)
123: It's nice that we assign weights to financial assets based on risk estimates, but since our estimates are often wrong, even about things like Treasury bonds, it seems wiser to me to require more core capital, rather than do the thing where we have a witch hunt every decade for whatever asset most recently made headlines.
125: I mean we already went through this in the thread. You can cause just as much mayhem with ordinary bank loans as with anything else if money is too cheap.
You can cause as much mayhem with a flamethrower, if you have a good working flamethrower. But what makes it easier? I agree with your excellent point that a perfectly regulated derivatives market, in an ideal world, would be OK. But I wish you'd wipe the shit off of your face.
I mean we already went through this in the thread.
you mean, we already went through why you were wrong?
There's a gap between the smugness of your tone (very smug!) and the level of your knowledge (a half-digested mush of conventional wisdom that you don't really understand).
Lepto is probably employed by a PR firm and is consistently defending two positions: derivatives weren't the source of the crisis and Glass-Steagall never did anyone any good. Although I guess it's possible that Lepto has been lurking here forever and just has views on this one thread and just happens to have a rhetorical style that resembles someone selecting replies from a menu of options.
Interestingly, Wall St. doesn't make any money these days. The asset management business always makes money (but not as much as it did), but the broker dealers, which is where all the capital is, don't make more than 5%. The banks are holding on to their capital waiting for the old party to start up again, but it isn't happening. Eventually they'll have to return the cash to shareholders and fire a quite large percentage of the workforce. PGD gives some good reasons for the crisis, but ultimately the crisis was about overcapacity and low returns, same as in the auto industry. Overcapacity leads to overleverage and eventually a shakeout, except there wasn't a shakeout. There's actually more capital in the banks today than before the crisis. Just as Chrysler will go out of business sooner or later, Citibank and Morgan Stanley will eventually close up their i-banks and acknowledge that the 90s aren't coming back.
The "too much cheap money" may be the single most immoral argument to emerge from this crisis. Easy money is such a potent drug that Wall Street had no choice but to blow up a speculative bubble. But instead of regulations to make it harder to blow up a speculative bubble, the alternative is tighter money. Sure, tighter money prevents speculative excess by causing a recession and throwing people out of work, but your right to a job is nothing with investors God-given right to 5% risk-free yields.
JPM Whale
That was a $4-5B loss for a bank that does $24B in quarterly revenue. "[E]normous, near trillion dollar, prop bets on entire economies" sure sounds grand but sadly, no.
I'm not talking about the CDX IG9 bet itself (though by the by the notional of that was over $100bn, much larger than the eventual loss), or even the synthetic credit portfolio as a whole. I'm talking about the rest of CIO's book - the huge volumes of RMBS and CMBS it bought and still buys. Like I say, before the Whale story broke, JPM was the European securitisation market. If a new RMBS came to market, nine times out of ten JPM would take (publicly, like I said) the lion's share of it. I brought up the Whale because of the intense scrutiny it brought to the CIO - after the story broke, JPM stopped buying that stuff for about six months. But even after all that scrutiny and with Volcker coming down the pike they carried on doing it. Feel free to explain to me how going long Dutch mortgages hedges US corporate risk, but I doubt you're going to convince me. It's a prop bet putting JPM's excess deposits to work to earn money at relatively low risk. A prop bet I think global banks should be making, but a prop bet nonetheless.
Second paragraph was quoting Lepto, not me.
Inventory risk permitted for market making desks is a tiny fraction of what it was for prop teams pre-Volcker. Holding on to agency inventory for a few days != massive proprietary books in any world.
Yes it's been constrained by Volcker, but it's still permitted. Unless you limit market-making to matching orders back to back, you're going to have investement banks using inventory to make prop bets - that's their entire raison d'etre. Otherwise they might as well be brokers. For instance, the Volcker caps inventory based on reasonably expected client demand - so your trading desk says they expect an increase in demand because of tightening spreads, and they ramp up inventory, making prop profits off the tightening in spreads. Or even with static inventory, you shift your holdings within a capped bucket to the highest beta names.
I always enjoy the threads where Moby reveals that he can make serious and reasonable comments.
Sorry, Ginger: What is a "prop bet"?
Proprietary - for their own benefit (or loss) rather than on behalf of a client. Volcker tries to prevent banks from prop trading, but as I discuss, if you allow banks to hold market making inventory - and there are some good reasons to do so - it's basically impossible to stop them prop trading.
Ah. Thanks. I'd heard it spelled out but never seen the abbreviation.
Ten Worthwhile Reviews of Piketty ...DeLong
134, 136: except size matters. It's not so important to draw the ultimate metaphysical line between market making and prop trading, as long as the regulation limits inventory buildup to something reasonable compared to turnover in a stressed market then you will have done some good. Driving out the last dollar of 'prop trading' is not the goal -- market making is after all a form of prop trading (the regulators have signaled they see it this way). Anyway, as I said above, still skeptical about Volcker.
Anyway, I feel bad about not really answering Heebie's question and instead devolving into this technical stuff...
133: makes a similar point well -- maybe you saw it.
Whoops, meant to say This Rortybomb post makes a similar point well -- maybe you saw it. Also useful is the Ed Glaeser piece he links finding that low interest rates only accounted for about a quarter of the pre-crisis housing price runup.
. Driving out the last dollar of 'prop trading' is not the goal -- market making is after all a form of prop trading (the regulators have signaled they see it this way). Anyway, as I said above, still skeptical about Volcker.
I'm not really sure what the goal of Volcker (as implemented in Dodd Frank) is, at the end of the day. It seems to conflate two issues - insured banks making large credit losses on directional bets in securities markets. and investment banks profiting at the expense of their clients - and proposes a one-size-fits-all solution to both of them that doesn't really address either. If you're worried about banks messing around clients, impose a fiduciary duty. If you're worried about banks hiding risk in their trading books, tighten up the trading book rules (as Basel III in fact does) and don't let them play games with VaR.
130: Am I the first person to call you out for quoting OTC notionals or something? You keep making appeals to authority and then citing nonsense that a person in the industry never would.
131: Heh, the PR flacks I've run into usually dump a form response and then peace out, instead of sticking around for abuse. I work in a front office role in a small buy-side shop and will identify to a moderator if you really care that much. I've been reading here at least since Ogged proposed that Heidegger reading group. I just don't comment much unless it's something I know about.
132 is right re overcapacity and low returns.
133: Unless you're proposing zero rates forever, I hope we could agree that Greenspan's pro-cyclical policy (abnormally low rates at the height of a boom) was no more helpful than the Republican pro-cyclical position since 2008 (anti-TARP, anti-QE).
142 to 134-136: Right, this is what I have been saying. If we can get leverage down by requiring more core capital, I don't see the need to try to outsmart banks by fiddling with the allowable risk-taking channels or product mix.
This thread reminded me of this point from Minsky at the beginning of Pettis's Great Rebalancing. Balance of payments does a lot more explanatory work than details of institutional design.
You can cause just as much mayhem with ordinary bank loans as with anything else if money is too cheap.
You can murder someone with your bare hands, but it's easier with a gun. Derivatives increase counterparty risk and reduce transparency.
You're basically a defense lawyer at a murder trial saying, "People have been killing each other since the beginning of time, let's not pretend that my client is especially eeeevvviiiillll." Maybe this sounds sophisticated to you, you sound like a dumbass to me.
You can murder someone with your bare hands, but it's easier with a gun. Derivatives increase counterparty risk and reduce transparency.
Well, yes, but I think there's a fairly strong argument that the "gun" here is terrible underwriting standards. These were definitely exacerbated by securitisation and derivatives (the maniac in the analogy, I guess), but you've still got Fannie and Freddie underwriting 95% LTVs (and the limit was higher than that until six months ago, and still is through the FHA). There seems to be incredible institutional pressure against mandating sane underwriting practices in the US.
149- but you can have l, and have had, crises that involved shitty US underwriting for residential mortgages without taking the entire world economy down too.
I haven't looked at this in a while, but the portion of the derivatives market that's reasonably described as usefully hedging known risk in the real economy IIRC, like in the inevitable "farmer hedging the chance of a bad winter" or "company hedging risk that the plant shut down" story, is comically low, like on the order of 10-20 percent. Almost all of the market is pure speculation. Which isn't necessarily a sin unto itself, but isn't really doing anything positive for any of the rest of us and carries an ongoing risk of blowing up the world economy. Since shrinking the derivatives market to the size and product range it had in 1965 wouldn't hurt much of anyone but the profiteers and would reduce the chances of a world economy blow up it seems like kind of a no brainer. Doesn't mean other reforms aren't also useful, maybe more useful.
133: The "too much cheap money" may be the single most immoral argument to emerge from this crisis
Related, I think, to the equally immoral Everyone-Is-To-Blame (EITB). Which per this excellent Dean Stockman article is one big lie that continues to haunt the post-crash economy.
As an agent of obfuscation, EITB is a gift that keeps on giving. In October, The Washington Post's editorial board objected to a $13 billion mortgage-era civil settlement with J.P. Morgan largely because it unfairly singled out the bank, when, in fact, "everyone, from Wall Street to Main Street to Washington, acted on widely held economic beliefs that turned out not to be true."And of course hate speech outlets like FoxNews and right-wing radio* were on board with the more targeted "Blacks and Hispanics were to blame."
*Along with a fair number of my work colleagues who listen to that crap. I usually keep a low political profile at work, but that theme led to a somewhat nasty public encounter with a co-worker in which I refused to engage in a discussion of the GFC couched in those terms, but most of the racist dickwads present interpreted it as me accusing him of being a racist dickwad.
Derivatives on commodities with price fluctuations that can be well modeled, like those affected mostly by annual crop yields, seem reasonable and likely to reduce volatility. Others, not so much.
What a great thread. I wish I had seen it while it was active. No one has mentioned what I think is the main reason heebie's question is so hard to answer. Most of the people in the world talking about finance have a financial interest in lying or obfuscating about it. Hence finance is an artificially difficult subject.
At the link I blame the excessive confidence on amphetamines (or maybe cocaine). Also on self-help books, management handbooks, prosperity theology, New Age thinking, and futurology, most of which are probably also cocaine feuled.
I have no idea as to whether or to what degree excess confidence was the cause.
Elsewhere I blamed it on the invention of increasingly complicated financial instruments which no one understood at first, and then as soon as someone understood them, they milked the system dry. Pure conjecture on my part, but lots of people are conjecturing these days.
More and more I blame everything on the the elite hierarchies. Once all of the people with their hands on the important controls are joined in an old boy network, they can milk the system with impunity. Government, corporate management, or private money, not closely connected to property ownership at the beginning, thoughe veryone is rich at the end.
Bonus: before their bankruptcy, Ireland was the holy land of libertarians and neoliberals.
http://trollblog.wordpress.com/2008/11/15/how-did-iceland-go-bankrupt/
http://www.seeingtheforest.com/archives/2008/12/the_tweakers_ar.htm#.UzM4INtb9xA
What would a financial industry ideally do, and only do?
Just be venture capitalists?
That, and provide savings accounts.
Deposits for savers, and loans to people starting or expanding businesses.
That's it, in an ideal financial industry.
All the rest of this finance stuff is basically theft.
