too big to fail

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The Fed Confronts Itself

From Matt Taibbi:

Wall Street is buzzing about the annual report just put out by the Dallas Federal Reserve. In the paper, Harvey Rosenblum, the head of the Dallas Fed’s research department, bluntly calls for the breakup of Too-Big-To-Fail banks like Bank of America, Chase, and Citigroup.

The government’s bottomless sponsorship of these TBTF institutions, Rosenblum writes, has created a “residue of distrust for government, the banking system, the Fed and capitalism itself.”

I don’t know whether to laugh or cry.

First, this managerialism is nothing new for the Fed. The (ahem) “libertarian” Alan Greenspan once said: “If they’re too big to fail, they’re too big.”

Second, the Fed already had a number of fantastic opportunities to “break up” so-called TBTF institutions: right at the time when it was signing off on the $29 trillion of bailouts it has administered since 2008. If the political will existed at the Fed to forcibly end the phenomenon of TBTF, it could (and should) have done it when it had the banks over a barrel.

Third, capitalism (i.e. the market) seems to deal pretty well with the problem of TBTF: it destroys unmanageably large and badly run companies. Decisions have consequences; buying a truckload of derivatives from a soon-to-be-bust counter-party will destroy your balance sheet and render you illiquid. Who seems to blame? The Fed; for bailing out a load of shitty companies and a shitty system . Without the Fed’s misguided actions the problem of TBTF would be long gone. After a painful systemic breakdown, we could have created a new system without any of these residual overhanging problems. We wouldn’t be “taxing savers to pay for the recapitalization of banks whose dire problems led to the calamity.” There wouldn’t be “a two-tiered regulatory environment where the misdeeds of TBTF banks are routinely ignored and unpunished and a lower tier where small regional banks are increasingly forced to swim upstream against the law’s sheer length, breadth and complexity, leading to a “massive increase in compliance burdens.”

So the Fed is guilty of crystallising and perpetuating most of these problems with misguided interventionism. And what’s the Fed’s purported answer to these problems?

More interventionism: forcibly breaking up banks into chunks that are deemed not to be TBTF.

And what’s the problem with that?

Well for a start the entire concept of “too big to fail” is completely wrong. The bailout of AIG had nothing to do with AIG’s “size”. It was a result of systemic exposure to AIG’s failure. The problem is to do with interconnectivity. The truth is that AIG — and by extension, the entire system — was deemed too interconnected to fail. Many, many companies had AIG products on their balance sheets. If AIG had failed (and taken with it all of that paper, very generously known as “assets”) then all those companies would have had a hole blown in their balance sheets, and would have sustained losses which in turn may well have caused them to fail, bleeding out the entire system.

The value that seems to matter in determining systemic robustness is the amount of systemic interconnectivity, in other words the amount of assets on balance sheets that are subject to counter-party risk (i.e. which become worthless should their guarantor fail).

Derivatives are not the only such asset, but they make up by far the majority:


Global nominal exposure is growing again. And those derivatives sit on global balance sheets waiting for the next black swan to blow up a hyper-connected counter-party like AIG. And such a cascade of defaults will likely lead to another 2008-style systemic meltdown, probably ending in another goliath-sized bailout, and another few rounds of the QE slop-bucket.

The question the Fed must answer is this: what difference would it make in terms of systemic fragility if exposures are transferred from larger to companies to smaller ones?

Breaking up banks will make absolutely zero difference, because the problem is not the size but systemic interconnectivity. Losses sustained against a small counter-party can hurt just as much as losses sustained against a larger counter-party. In a hyper-connected system, it is possible for failed small players to quickly snowball into systemic catastrophe.

The Fed (as well as the ECB) would do well to remember that it is not size that matters, but how you use it.

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Education is a Bubble

A couple of days ago, Zero Hedge reported that a lot of student loans are delinquent:

As many as 27% of all student loan borrowers are more than 30 days past due. In other words at least $270 billion in student loans are no longer current (extrapolating the delinquency rate into the total loans outstanding). That this is happening with interest rates at record lows is quite stunning and a loud wake up call that it is not rates that determine affordability and sustainability: it is general economic conditions, deplorable as they may be, which have made the popping of the student loan bubble inevitable.

The reality of this — like the housing bubble before it — is that a lot of people who borrowed a lot of money can’t repay. That could be down to weak economic conditions. As I wrote yesterday, an unprecedented number of young people are unemployed and underemployed. These circumstances will lead to delinquencies.

But I think that there is a key difference. Unlike housing — which will probably never be made obsolete — it feels like education is undergoing a generational shift, much like agriculture did prior to the Great Depression, and much like manufacturing did prior to the Great Recession.

Venture capitalist Peter Thiel suggests:

Like the housing bubble, the education bubble is about security and insurance against the future. Both whisper a seductive promise into the ears of worried Americans: Do this and you will be safe. The excesses of both were always excused by a core national belief that no matter what happens in the world, these were the best investments you could make. Housing prices would always go up, and you will always make more money if you are college educated.

But earnings for graduates are stagnant, while costs continue to rise:

However, all this really shows is the (quite obvious) reality that colleges — subsidised by Federal student loans guarantees that act as a price floor — can keep raising tuition fees even while in the real world the economy is contracting.

But education is suffering from a much bigger problem: a lot of what it does is gradually (or quickly) being made obsolete by technology.

While college degrees for vocational subjects like medicine, law, architecture and so forth are still critically important (not least because access to such professions is restricted to those who have jumped through the proper hoops), non-vocational subjects have been cracked completely open by the internet.

Why would anyone realistically choose to pay huge amounts of money to go to university to learn mathematics, or English literature, or computer science or economics when course materials  — and much, much, much more including access to knowledgeable experts and professionals — is freely available online?

The answer is for a piece of paper to “qualify” the holder and “prove” their worth to prospective employers. But with earnings for degree holders at roughly 1997 levels, what’s the point? Plenty of people with good ideas, drive and perseverance are living fulfilling and successful lives without a college degree — including me. There are flashier examples like Zuckerberg, Jobs, and Gates, but that is just the tip of the iceberg.

A real estate agent trying to rent me a flat once said:

Why would people want to go to university? All it shows is that you are lazy, and can’t be bothered to find a proper job, and want to spend three or four years getting up late and getting drunk.

A useful (though not universally true) heuristic. “Education” has been turned inside out. To some employers, a degree (particularly one with a weak or mediocre grade) can in fact be a disadvantage. People without a degree can get ahead with three or four years of experience in industry.

So while we wait to see whether or not a student loan meltdown will lead to a wider financial meltdown (a la Lehman), I think we should consider that this industry may well be on the brink of a systemic meltdown itself. With severely decreased demand for education, a lot of schools and courses may be wiped off the map leaving behind a skeleton of only the most prestigious universities, and vocational and professional courses.

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Bernanke vs Greenspan?

Submitted by Andrew Fruth of AcceptanceTake

Bernanke and Greenspan appear to have differing opinions on whether the Fed will monetize the debt.

Bernanke, on behalf of the Federal Reserve, said in 2009 at a House Financial Services Committee that “we’re not going to monetize the debt.”

Greenspan, meanwhile, on Meet the Press in 2011 that “there is zero probability of default” because the U.S. can always print more money.

But they can’t both be true…

There is only 0% probability of formal default if the Fed monetizes the debt. If they refuse, and creditors refuse to buy bonds when current bonds rollover, then the U.S. would default. But Ben said the Fed will never monetize the debt back on June 3, 2009. That’s curious, because in November 2010 in what has been termed “QE2” the Fed announced it would buy $600 billion in long-term Treasuries and buy an additional $250-$300 of Treasuries in which the $250-$300 billion was from previous investments.

Is that monetization? I would say yes, but it’s sort of tricky to define. For example, when the Fed conducts its open market operations it buys Treasuries to influence interest rates which has been going on for a long time — way before the current U.S. debt crisis.

So then what determines whether the Fed has conducted this egregious form of Treasury buying we call “monetization of the debt?”

The only two factors that can possibly differentiate monetization from open market operations is 1) the size of the purchase and 2) the intent behind the purchase.

This is how the size of Treasury purchases have changed since 2009:

Since new data has come out, the whole year of 2011 monetary authority purchases is $642 billion – not quite as high as in the graph, but still very high.

Clearly you can see the difference in the size of the purchases even though determining what size is considered monetization is rather arbitrary.

Then there’s the intent behind the purchase. That’s what I think Bernanke is talking about when he says he will not monetize the debt. In Bernanke’s mind the intent (at least the public lip service intent) is to avoid deflation and to boost the economy – not to bail the United States out of its debt crisis by printing money. Bernanke still contends that he has an exit policy and that he will wind down the monetary base when the time is appropriate.

So In Bernanke’s mind, he may not consider buying Treasuries — even at QE2 levels — “monetizing the debt.”

The most likely stealth monetization tactics Bernanke can use — while still keeping a straight face — while saying he will not monetize the debt, will be an extreme difference between the Fed Funds Rate and the theoretical rate it would be without money printing, and loosening loan requirements/adopting policies that will get the banks to multiply out their massive amounts of excess reserves.

If, for example, the natural Fed Funds rate — the rate without Fed intervention — is 19% and the Fed is keeping the rate at 0%, then the amount of Treasuries the Fed would have to buy to keep that rate down would be huge — yet Bernanke could say he’s just conducting normal open market operations.

On the other hand, if the banks create money out of nothing via the fractional reserve lending system and a certain percentage of that new money goes into Treasuries, Bernanke can just say there is strong private demand for Treasuries even if his policies were the reason behind excessive credit growth that allowed for the increased purchase of Treasuries.

Maybe Bernanke means he will not monetize a particular part of the debt that was being referred to in the video. Again, though, he could simply hide it under an open market operations 0% policy or encourage the banking system to expand the money supply.

Whatever the case, if you ever hear Bernanke say “the Federal Reserve will not monetize the debt” again, feel free to ignore him. When he says that, it doesn’t necessarily mean he won’t buy a large quantity of Treasuries with new money created out of nothing.

Remember, Greenspan says there’s “zero probability of default” because the U.S. can always print more money. Does Greenspan know something here? There’s only zero probability if the Fed commits to monetizing the debt as needed. If Greenspan knows something there will be monetization of the debt, even if Bernanke wants to call it something else.

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Hillary Clinton is a Hypocrite

From AP:

U.S. Secretary of State Hillary Rodham Clinton said Monday the U.S. has “`serious concerns” about the conduct of Russia’s parliamentary elections.

She said “the Russian people, like people everywhere, deserve the right to have their voices heard and their votes counted. That means they deserve free, fair, transparent elections and leaders who are accountable to them.”

When it comes to deficits of democracy, and a lack of accountable leadership, Clinton would do better to look at America:

  1. Young people exercising their constitutional rights to protest against the disgusting, vile, anti-capitalist and unconstitutional bailouts of Wall Street financials are being pepper sprayed, beaten down to the ground and stamped on.
  2. The American Senate passed the NDAA — an act that authorises the military to arrest and indefinitely detain any citizen without trial, and that defines the entire United States as a battlefield.
  3. Banks and Washington insiders get pumped flush with cash while wider society remains in the throes of a devastating contractionary depression and crippling unemployment.
  4. The Guantanamo Bay detention camp remains open, almost three years after Obama pledged it would be closed.
  5. No Bush administration figure has been prosecuted for violating the Constitution and the Geneva Convention by authorising torture.
  6. Obama continues to renew the illiberal, reactionary, unconstitutional and widely-abused Patriot Act, a piece of legislation that mandates mass surveillance of Americans in violation of the 4th and 5th Amendments.

While it is impossible to hold up Russia under Putin as a paradigm of human rights and democracy, America today can hardly consider itself any better.

Of course, this isn’t really about democracy.

From the Guardian:

Vladimir Putin has accused the US of encouraging the protests over Russia‘s parliamentary election and warned of a wider crackdown on unrest.

The Russian prime minister said Hillary Clinton, the US secretary of state, “gave a signal” to Kremlin opponents by describing the country’s parliamentary election as rigged. “They heard this signal and with the support of the US state department began their active work,” he said.

Russia is a mineral- and resource-rich nation with the largest landmass in the world. Quite a prize.

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Zombie Economics

Occupy Wall Street seem to oppose banker bailouts because bailouts are unfair. Bankers — by and large the most privileged class in society — got at the last count over $14 trillion of interest free money from central banks and governments to keep on doing the same thing — getting rich from speculation, on the backs of workers and the productive economy. The rest of society — teachers, nurses, factory workers, entrepreneurs, the unemployed, etc — have to “share the pain” of unemployment, austerity and a depressed economy.

This is particularly unfair, because it is the bankers and speculators who caused the crisis in the first place. But there is a much deeper economic reason to oppose bailouts than simple unfairness. Bailing out failed and failing financial institutions creates a zombie economy. Why?

In nature, ideas and schemes that work are rewarded — and ideas and schemes that don’t work are punished. Our ancestors who correctly judged the climate, soil and rainfall and planted crops that flourished were rewarded with a bumper harvest. Those who planted the wrong crops did not get a bailout — they got a lean harvest, and were forced to either learn from their mistakes, or perish.

These bailouts have tried to turn nature on its head — bailed out bankers have not been forced by failure to learn from their mistakes, because governments and regulators protected them from failure.

So it should be no surprise that financial institutions have continued making exactly the same mistakes that created the crisis in 2008. That crisis was caused by excessive financial debt. Wall Street banks do not just play with their own equity — they borrow huge sums of money, too. This debt is known as leverage — and many Wall Street banks in 2008 had forty or fifty times as much leverage as they had equity. The problem with leverage is that while successful bets can very quickly lead to massive profits, bad bets can very quickly lead to insolvency — a bank that leverages itself 50:1 only has to incur a 2% loss on its portfolio to have lost every penny they started with. Lehman Brothers was leveraged 30:1.

Following 2008, many on Wall Street promised they had learned their lesson, and that the days of excessive leverage and risk-taking with borrowed money were over. But, in October 2011, another Wall Street bank was taken down by bad bets financed by excessive leverage: MF Global. Their leverage ratio? 40:1.

So why was the banking system bailed out in the first place? Defenders of the bailouts have correctly pointed out that not bailing out certain banks would have caused the entire system to collapse. This is because the global financial system is an interconnected web of debt. Institutions owe huge sums of money to one another. If a particularly interconnected bank disappears from the system, and cannot repay its creditors, the creditors themselves become threatened with insolvency. If a bank is leveraged 10:1 on assets of $10 billion, then its creditors may incur losses of up to $90 billion. Without state intervention, a single massive bankruptcy can quickly snowball into systemic destruction.

Ultimately, the system is extremely fragile, and prone to collapse. Government life-support has given Wall Street failures the resources to continue their dangerous and risky business practices which caused the last crisis. Effectively, Wall Street and the international financial system has become a government-funded zombie — unable to sustain itself in times of crisis through its own means, and dependent on suckling the taxpayer’s teat.

The darkest side to this zombification is that it takes resources from the productive, the young, the creative, and the needy and channels them to the zombies. Vast sums spent on rescue packages to keep the zombie system alive might have been available to increase the intellectual capabilities of the youth, or to support basic research and development, or to build better physical infrastructure, or to create new and innovative companies and products.

Zombification kills competition, too: when companies fail, it leaves a gap in the market that has to be filled, either by an expanding competitor, or by a new business. With failures now being kept on life-support, gaps in the market are fewer.

The system needs to change.

As Professor George Selgin of the University of Georgia put it:

Our governments chose to keep bad banks going and that is why quantitative easing has proven a failure. Quantitative easing failed because almost all the new money the government created has gone to shore up the balance sheets of irresponsible bankers. Now those banks sit on piles of idle cash while other businesses starve or cannot get started for want of credit.

It’s the same scenario that Japan has experienced for twenty years. They experienced a housing and stock market crash in 1990, bailed out their banking system, and growth never really recovered:

Ever since then, unemployment has been elevated:

That is the fate that Britain, Europe and America face by going down the Japanese zombification route: weak growth and elevated unemployment over a prolonged period of time. They face having the life sucked out of them by the zombie banks and corporations, and the burden of an every-growing public debt to finance more and more bailouts:


Instead of bailouts, we need to allow failed banks and corporations to fail and liquidate so that new businesses can take their place. Nature works best through experimentation. Saving zombie banks and zombie corporations kills experimentation, by rewarding failure, and preventing bad ideas from failing. If bad ideas and schemes cannot fail, it is impossible for good ideas and schemes to truly succeed.

The role of the government should be to provide a level playing field for experimentalism (and enough of a safety net for when experiments go wrong) — not pick winners. If experiments go badly, that is no bad thing: it just means that another idea, or system, or structure needs to be tested. People should be free to go bankrupt and start all over again with a different mindset and a different idea.

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Too Fucked to Bail

From Nassim Nicholas Taleb writing for the NYT:

I have a solution for the problem of bankers who take risks that threaten the general public: Eliminate bonuses.

More than three years since the global financial crisis started, financial institutions are still blowing themselves up. The latest, MF Global, filed for bankruptcy protection last week after its chief executive, Jon S. Corzine, made risky investments in European bonds. So far, lenders and shareholders have been paying the price, not taxpayers. But it is only a matter of time before private risk-taking leads to another giant bailout like the ones the United States was forced to provide in 2008.

The promise of “no more bailouts,” enshrined in last year’s Wall Street reform law, is just that — a promise. The financiers (and their lawyers) will always stay one step ahead of the regulators. No one really knows what will happen the next time a giant bank goes bust because of its misunderstanding of risk.

Instead, it’s time for a fundamental reform: Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed, should not get a bonus, ever. In fact, all pay at systemically important financial institutions — big banks, but also some insurance companies and even huge hedge funds — should be strictly regulated.

What would banking look like if bonuses were eliminated? It would not be too different from what it was like when I was a bank intern in the 1980s, before the wave of deregulation that culminated in the 1999 repeal of the Glass-Steagall Act, the Depression-era law that had separated investment and commercial banking. Before then, bankers and lenders were boring “lifers.” Banking was bland and predictable; the chairman’s income was less than that of today’s junior trader. Investment banks, which paid bonuses and weren’t allowed to lend, were partnerships with skin in the game, not gamblers playing with other people’s money.

Hedge funds, which are loosely regulated, could take on some of the risks that banks would shed under my proposal. While we tend to hear about the successful ones, the great majority fail and their failures rarely make the front page. The principal-agent problem they have isn’t a problem for taxpayers: Typically their investors manage the governance of hedge funds by ensuring that the manager is hurt more than any of his investors in the event of a blowup.

I believe that “less is more” — simple heuristics are necessary for complex problems. So instead of thousands of pages of regulation, we should enforce a basic principle: Bonuses and bailouts should never mix.

The ramifications of the last crisis was that a failing and failed system was saved, pretty much intact. Yes — changes have been made around the fringes — the end of prop trading, the promise to later implement the Volcker rule.

But the big picture is that very few lessons were learned: the leverage stayed, the algorithmic trading stayed, the casino mentality stayed, and the huge web of interconnected derivatives stayed. state-owned and bailed-out banks have continued paying bonuses far in excess of anything payed to public servants. 2010 was a record year for Wall Street pay.

Is there anything that can address systemic fragility — the core problem — in a system wracked with the greatest debt burden in history? I don’t mean to be fatalistic — and I think we need to try Taleb’s measure — but I think that even a ban on bonuses would be gamed around by the vultures and vampires and cannibals.

I am concerned that the only thing that will really regulate this new hyper-leveraged, hyper-fragile global market is its self-destruction — where “too big to fail” metastasises into “too fucked to bail”, and the entire system collapses, the residual debt is erased, and the system has to be rebuilt from scratch.

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Reinflating the Housing Bubble…

From my favourite arch-Keynesian provocateur (and fellow sci-fi fan):

The basic point is that the recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

He got his wish, and it ended in 2008 with the great crunching, squelching sound of death by delinquency (via securitisation).

But now the housing bubble is coming back — on steroids (or methamphetamine, whichever analogy is more appropriate).

Via the newly-extended HARP (HAARP?) program, for $100 down, under-water homeowners can pick up a $200,000 government-insured loan for “repairs” and “renovations”. That’s 2000:1 leverage — steep even for Wall Street.

A covert stimulus package by any other name — but more importantly, it’s another bailout to creditors who lent huge quantities of money to people who couldn’t afford to repay it.

From Of Two Minds:

President Obama is taking credit for a new government plan to “save homeowners.” That is of course pure propaganda to mask the plan’s true goal: the perfection of debt-serfdom. The basic thrust of the plan is straightforward: encourage “underwater” homeowners whose mortgages exceed the value of their homes to re-finance at lower rates.

The stated incentive (i.e. the PR pitch) is to lower homeowners’ monthly payments via lower interest rates.

This is the Federal Reserve’s entire game plan in a nutshell: don’t write off any debt, as that would reveal the banking sector’s insolvency, but play extend-and-pretend with crushing debtloads by lowering the cost of servicing the debt.

The key purpose of this “plan” is to leave the principle owed to banks on their books at full value while ensnaring the hapless debt-serf (the “homeowner”) into permanent servitude to the banks.

Moreover, all that easy capital will go toward (re-)inflating more bubbles beyond just housing. Bubbles replacing bubbles — just like Krugman envisioned.

Is that the model for sustainable economic development? Or is that the model for the disastrous crisis-bailout-crisis-bailout-crisis cycle that we see today in so many nations?

The problem is that with every cycle of government-driven malinvestment, productive capital gets diverted to bullshit that society doesn’t really need. Housing inventories are already overstocked — that’s why prices are weak. Blowing more money at the housing market might shore up too-big-to-fail balance sheets, but it’s not going to make housing any less overstocked. And all of those materials, time, energy and resources going into reinflating the housing bubble could go to things America actually needs — like better infrastructure, and a market-driven alternative energy strategy (sorry Solyndra) to reduce oil dependency.

But — with a financial system filled with junkies who only think about tomorrow — can anyone really be surprised that the Obama administration is employing such a short-sighted vision of economic development? Obama is just giving into the braying mob who live on speculative bubbles at the cost of America’s future.

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Fractional Reserve Banking & Fragility

Fractional reserve banking means that the money supply is not in fact determined by the central bank (or by gold miners, politicians or economists, etc) but mostly by lenders. The problem is the fragility of any such a system to liquidity crises. If 10% of investors decide to withdraw funds at the same time, banks will quickly be illiquid. If 20% of investors do, bank failures will usually pile up. The system’s stability is contingent on society’s ability to not panic.

It is my belief that this fragility has been totally overlooked. Many have fallen into the lulling notion that the only thing we have to fear is fear itself — and that that fear can be conquered by rationality. This is to ignore man’s animal nature: the unforeseen, the unexpected, and the wild (all of which occur very, very frequently in nature and markets) make humans fearful, and panicky — not by choice, but by impulse. This is the culmination of millions of years of evolution — primeval reality is unconquerable, immutable and obvious. More than half a century after Roosevelt and Keynes markets still crash, fortunes are lost, and millions of grown men and women still tremble in irrational, primitive fear.

Fractional reserve, of course, still has its defenders.

From Paul Krugman:

I thought I’d say a word about one particular idea that sounds plausible to some people but is actually quite wrong: banning fractional reserve banking.

I know that’s a popular theme among some Austrians. But it’s actually neither a good idea nor even feasible.

The crucial thing is to understand what banks do. And it’s not mostly about money creation! Instead, what banks are for is helping to improve the tradeoff between returns and liquidity.

Like a lot of people, my insights draw heavily on Diamond-Dybvig (pdf), one of those papers that just opens your mind to a wider reality. What DD argue is that there is a tension between the needs of individual savers — who want ready access to their funds in case a sudden need arises — and the requirements of productive investment, which requires sustained commitment of resources.

Banks can largely resolve this tension, by offering deposits that can be withdrawn on demand, yet investing most of the funds thus raised in long-term, illiquid projects. What makes this possible is the fact that normally only some depositors want to withdraw funds in any given period, so it’s normally possible to meet those demands without actually having liquid assets backing every deposit. And this solution makes the economy more productive, providing more liquidity even as it allows more productive investment.

Now I’m not going to dispute the idea that, at least superficially, fractional banking improves the tradeoff between returns and liquidity. But we must look at what kind of system that entails. The fractional system system is a classic example of fragility.

Debt is by nature fragile — fragile to deflation (which increases the value of debts, but makes them harder to repay so increases defaults) and fragile to inflation (decreases the value of debt). This means that when the system is stressed or shocked the stressor increases the stress on the system, multiplying small problems up into much larger ones. 

The greatest danger of a debt-based system, though, is the default cascade — one insolvent institution defaulting on its obligations, and leading to write-downs at other institutions, which can ultimately lead to systemic collapse via contagion. Post-crisis, the ongoing spectre of deleveraging (contracting the money supply) can keep growth, and prices depressed, even with huge washes of new central bank liquidity. As we saw first in Japan, and now in the West quantitative easing has not been a powerful enough tool to reinvigorate the economy after a burst debt bubble and financial zombification. Clearly liquidity backstops are still not enough to counteract the underlying business cycle.

Amusingly, this entire paradigm was foreseen by Thomas Jefferson:

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.

Fractional banking — and the inflationary-contractionary business cycle described over two centuries ago by Jefferson — is for now at least here to stay. In the boom years it is beloved of consumers, who can remortgage their house and consume their equity on consumer goods. In the bust years it is beloved of the monied who can purchase productive assets at far below fair-value.

Additionally, transitioning from a highly indebted globalised debt-based banking system to a full-reserve one, is basically impossible without debt forgiveness (not happening unless things get significantly worse). Like with austerity the money supply hugely contracts, and so in the short term GDP often collapses and unemployment soars.

Krugman concludes:

The fractional reserve thing exhibits a characteristic common to a lot of what I see in the Paulist camp: they have an oddly antiquated notion of what money and finance are about, one that misses the “virtualness” of the modern world. They still think of money as being pieces of green paper, rather than what it mostly is now, zeroes and ones in some server somewhere. They still think of banks as being those big marble buildings, in a world in which most banking is a lot more abstract than that.

This is, after all, the 21st century. Things have moved on a bit.

But without all of that abstraction — if money could not be fractionally multiplied — the system might be significantly more stable, because the money supply would not contract due to liquidity runs . Perhaps there would not be such great profits for speculators, there would be fewer free lunches, and less arbitrage. Economic health is based on human beings wanting and needing things, and using their labour and capital to obtain them — very material and earthy concerns. Abstraction does not in itself make a system better — and if it increases systemic fragility to shocks and panics, it can make it significantly worse. On the other hand, banning fractional reserve banking (and its corollaries like shadow banking) might be impossible or even exacerbate the business cycle, as a ban might just drive it into the totally unregulated black market. And historically, a lack of a liquidity backstop has never stopped bankers from practicing fractional lending, either.

So in the end, perhaps I am railing against something I cannot stop or control.

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Government Can Be Bought Cheaply

If you’re a corruption-heavy sleaze bag looking to rack up crooked profits, the easiest way to do it is by rigging the game. And what better to rig the game than to buy off government and have them offer you tax breaks while “regulating” your competitors out of business?

So how much would it cost to buy the Presidency?

Continue reading →

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Economy Tanking, Precious Metals in Liquidation

Silver is getting pummelled:


So is gold:

What does this mean?

Hedge funds and speculators who were long gold are trying to get a buffer of cash to soak up hits from the coming default cascade.

What does that mean for gold’s long term fundamentals?

Continue reading →