Saturday, February 5, 2011

We are on FIRE

Finance, Insurance, and Real Estate are still out of control

After the crisis brought upon us by the financial industry and its corruption of government regulation, we have yet to thoroughly reasses its role in our lives and economy. The recent financial crisis commission report provided a good start, despite the obfuscating, if not fatally self-interested, dissenting reports from the Republican side. With 30% of corporate profits going to finance, and even higher shares of income, we have to ask whether this sector (frequently referred to as the FIRE sector) needs to be dramatically reduced, and if so, how.
Graph accompanied with the quote: "So in essence the bank bailout was not a one time event when the US population handed over more than a trillion dollars to a select club of financial companies. It is very much ongoing behind the scenes with vast sums being transferred every day allowing the financial sector to recapitalize its balance sheet."
The recent crisis is best conceptualized by Hyman Minsky's theory of the financial cycle. After a crisis, investors and managers are risk averse, sticking to their knitting and feeling content with consistent, if modest, returns. They are so risk averse that credit creation grinds to a halt and the economy falls into recession or depression, bank credit being the primary source of low-powered money. To fill the gap, the government needs to spend (high-powered) money to raise aggregate demand to levels that restore employment.

This is rather boring, and after the financial landscape has been stable for some time, the financial industry begins gradually to take higher and higher risks, as everyone is lulled by past stability into complacency that nothing could go wrong with, say, deregulation, or arcane derivatives, or ornate hedge funds. Those money managers who are not leveraging their assets and taking risks are left behind, and the party heats up, higher and higher. In the savings and loan debacle, as in the recent mortgage debacle, lenders turned to blatently unsound borrowers to rake in deals and fees, leaving in their wake trillions of dollars of destruction and heartbreak. Fraud is the operative term.

It is a psychological cycle, unfortunately infecting the "adult" government supervisors as much as the FIRE industry itself. Through the 80' and 90's, Democrats, but more so Republicans, were con-jobbed out of boring banking with scare stories of being left behind by more hip foreign banks, combined with a resurgent Ayn Randian fervor for economic "freedom". Airline deregulation went pretty well, didn't it? Alan Greenspan and Ben Bernanke ultimately failed to do the most elemental regulation of mortgage lending, (and a zoo of other lending and leverage creation), in the ideological belief that this industry was magically market self-correcting.

The problem, of course, is that the financial industry is inherently unstable if left to its own devices. Not only does the Minsky cycle (called the "financial instability hypothesis") lead an unregulated industry to higher and higher leverage and risk, building a house of cards that inevitably collapses, but the FIRE sector is uniquely situated to also perform what Bill Black calls control fraud- using the good reputation of a financial institution and the financial system generally to rob counter-parties blind. In the recent case, predatory lenders robbed both the borrowers (of their homes and dreams) and the investors who bought the toxic loans down the line. All for short-term income that accrued to the officers and CEOs who made the deals.

For good or ill, we are awash in capital. The advent of money means the advent of financial savings, and the need to store them. Through its monetization of all our needs and desires, and its destruction of traditional forms of social support, capitalism also forces us to save madly for our retirements and other later needs, resulting in trillions in search of investment gains. The FIRE industry is only too happy to accommodate, as they engineer ways to take more fees for themselves and offload as much risk as possible (pensions, health care, real estate losses, market volitility, financial collapse) onto taxpayers and customers. Goldman Sachs's deal to rape its own customers during the housing downturn was emblematic of this practice, as were Fanny/Freddie Mac's fraudulent gorging on subprime loans. Long term risk goes to the chumps, and fabulous short-term loot to the managers.

Why do customers keep coming back? There are few other options, unless one wishes to stockpile gold. Another reason is simple human optimism. We love to gamble, and there is no casino like the Wall Street casino. Another is a vast array of official and propagandistic incentives, like mortgage interest deductions, special treatment of capital gains, adulatory magazine profiles, capture of government offices by employees of Goldman Sachs, and the like.

And what is it all for? Miniscule amounts of new capital are actually directed by the FIRE sector into productive enterprises, compared to the vast amounts churned around through the many markets and non-market deals. Currency trading routinely turns over many times physical world trade per week, and many times world GDP per year. These are not essential activities. Some amount of speculation furnishes market-makers and liquidity, but a great amount creates stampeding volatility, which has, in the currency trading world, afflicted small countries now for decades. Similarly, the Wall Street casino creates continual risk of meltdown when a risky and highly leveraged system collapses in sudden distrust. Liquidity is a wonderful product, except that it tends to disappear at the most inconvenient times.

In a broader sense, it is an agent problem- that those given custody of our money will help themselves to it however they can. That goes for corporate officers generally, whose pay has far outstripped that of workers, and specifically for FIRE, whose control of our ill-fated "investments" creates endless incentives for what in less polite society would be called embezzlement. Thankfully, it is the already-rich who bequeth their money to the most egregious hedge fund managers. The rest of us tend to go with more sober index funds and bonds. Suppose the government imposed a wealth tax of 2% per year, equivalent to what is routinely sucked away by investment "managers". The rich would be up in arms.

This frenzy of greed started in earnest in the 80's with the Reagan revolution, with its greed is good mantra, and various theories that managers needed proper "incentives" aligned with the shareholders they were serving. But a little thought shows how empty and self-serving this rationalization is. Would our corporate cheerleaders favor paying President Obama a salary of three billion dollars per year because he "runs" an enterprise a thousand times that size in revenue? Would they propose that cashiers at Starbucks skim 2% off the till because they need proper incentives for cashiering? Would they offer salaries of a billion dollars to our soldiers who handle nuclear weapons and keep global catastrophe at bay (or at hand)?

I doubt it. Our corporate class and FIRE in particular have engaged in cynical self-dealing croynism at enormous scales, abetted by their various media, academic and official acolytes. And the worst part is that this cancerous growth of financial power has seeped into our political and other public spheres, corroding public goods and public debate. Our cities are cesspools of advertising, uncared-for and crumbling infrastructure, and homelessness, punctuated by shiny bank branches. Our media are infected with ceaseless advertising, are almost wholly corporate controlled, and feature ever more shameless empires purveying the views of the business class to a naive underclass, lying freely when needed and creating a political alliance of breathtaking cynicism, mouthing the word "freedom".

The great hopes placed in the Obama administration have been dashed largely because of its capture by the same business/FIRE class that Republicans thought they had locked up. Summers, Benanke, and Geithner have been staunch FIRE backers. Their solution to the crisis caused by the financial industry was to bail out the biggest malefactors, hanging the smaller banks out to dry. Simple homeowners have been ignored completely, left to be raped on the back end by the same banks who fraudulently lent them excess mortgages on the front end. Losses are put on the feckless borrowers as far as operationally possible, using a legal system that is, in essence and in practice, blind to corporate fraud and abuse.

To top it all off, the banks have been given accounting rules that allow them to hide their losses (as unmarketable, and thus un-price-able assets). And the Fed keeps feeding them money under the table by both buying their toxic waste directly and by its interest rate policy, (offering the spread between free reserves and federal bond rates, thus enabling banks to not lend). They are following the Japan model of making a brave face while slowly and inertly melting off their vast losses at taxpayer/monetary expense.
"As long as the strength of the recovery remains uncertain, there are few other investment opportunities, after adjusting for risk and taxes, with anticipated returns greater than the near-zero interest (currently 0.25 percent) the Federal Reserve pays on deposits." - St. Louis Fed newsletter
And too big to fail? What ever happened to that "problem"? It has not been addressed. Indeed there are even fewer, bigger, banks, ready to fail at the next crisis they cook up, ready to take the next bailout with which to pay their officers the kind of "incentives" needed to clean up those darn accidental messes. The whole system which is predicated on the trust we extend along with our hard-earned savings, has turned out to be a well-oiled machine of betrayal.

It makes me sick. I urge readers to relentlessly search out low-cost, low-complexity financial products and investment options for money they may have to save, and for debt they may need to incur.

  • Sermons for slavery. We have long been a nation of greed.
  • Speaking of endemic economic-political corruption, a good review of appalling government we sponsor in Afghanistan.
  • Postmodernism runs aground.
  • Quote from the good book, on the virtues of regulation:
"... the price of the S&L bailout would have funded the presence of 10 full-time bank examiners in every thrift in the country for close to 200 years."
"Litan’s fellow economists assured us that financial deregulation was supposed to release untold energies by liberating the self-adjusting mechanisms of the capital markets. Instead, it released im- prudence, incompetence, and fraud throughout the entire system."
"Greenspan praised thrift-killer Charles Keating’s “seasoned and expert” management team for rescuing a “badly burdened” thrift through “sound and profitable” investments. Every word of this was untrue. Greenspan’s reputation, however, survived intact (just as it did his earlier demented jottings for Ayn Rand’s Objectivist newsletter)."
  • Bill Black continues his crusade, detailing fraud at Fannie and Freddy.
"In that memorandum, Pinto recorded that he had found over 25 million such [subprime] mortgages (his later work showed that there were approximately 27 million). Since there are about 55 million mortgages in the U.S., Pinto’s research indicated that, as the financial crisis began, half of all U.S. mortgages were of inferior quality and liable to default when housing prices were no longer rising."
This blog goes on to debate these numbers, as well as the dissenting Republican theories, but one wonders why investors, quite aside from the government, are not suing more of the malefactors of all this fraud. I guess that securitization has so far provided the magic dispersion of responsibility and accountability required to duck this storm. ... Fannie and Freddy managers were, and remain, culpable in fraud.
  • Bill Mitchell quote of the week. Germany's public purpose is not only to suppress its own workers, but workers throughout Europe.
"So in that context the call for some unified economic government in Europe is – as it stands – a good one. But of-course the Chancellor does not have the same conception of that idea as I have. For her, the creation of a common economic governance agreement is about imposing order – German order on the member states. It is about control – fiscal rules – and rules about wage costs and pension funding."

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