Thank Goodness the Banks Aren't Lending! 21 comments
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I have a little secret. Please don't tell anyone. I am glad that the banks, for all the hundreds of billions of dollars we are giving them, are not lending. That is not because I want banks to improve the quality of their balance sheets. On the contrary, I don't want banks at all, at least not banks anything like what we've had. I don't want to "use all of our resources to preserve the strength of our banking institutions". Since we have already bought and paid for our nation's banking institutions, we are within our rights to, um, transition them to a different business model. Let's do that.
But credit is the lifeblood of a capitalist economy, right? I keep hearing that line. It's a dumb line.
Credit, also known as debt, is one of several arrangements by which a party with the power to command resources but lacking aptitude or interest in managing a productive enterprise delegates wealth to another party who is capable of creating value but unable to command sufficient resources. You would be forgiven for not noticing, given how habitually we misuse credit, that supplying credit is really just a subspecies of the practice that used to be called "investing". There are a variety of other arrangements that serve the same economic function. Perhaps you have heard terms like "common stock" and "cumulative preferred equity"? In fact, credit is to investing what heroin is to painkillers: Unusually appealing, in a certain way. Hard to kick once you're on it. Almost certain to, um, cause problems, eventually. Our overall goal ought not be to kick-start the credit economy, but to kick the habit and move towards financing arrangements that are more equity-like than debt-like. That's going to be hard to do, because historically, we've subsidized the hell out of debt financing, especially bank credit, and alternatives are underdeveloped. But with the exception of war, no still-practiced human institution provokes catastrophe as regularly or as grandly as the misuse of debt. We ought to phase out banks as we've known them since before Bagehot's time, and move to a regime of what are lately referred to as "narrow banks" (banks that lend only to the government that issues the currency of their deposits). We should encourage the development of fine-grained equity markets and local-market investment funds to replace bank financing.
The rush to ramp up "consumer credit" is particularly dumb. Usually, financial investing involves funding wealth-generating projects in exchange for a share of the anticipated wealth. Consumer credit funds current consumption in exchange for a share of, um, what exactly?
In theory, there's a good answer: consumer credit funds current consumption in exchange for a share of anticipated future wealth that is believed to be endowed already. Economists talk about consumption smoothing, how it may be optimal for a consumer whose income is volatile to borrow during periods of low income and repay (or save) during periods of high income in order to maintain a constant standard of living. That's very well in models where consumers know the true distribution of their future income, where the spread between borrowing and lending interest rates is not very large, and where consumer preferences are time-consistent. In practice, none of these conditions holds even approximately. As we are learning, the future is a very uncertain place. Consumers, like Wall Street quants, may inadequately extrapolate the distribution of their future income from recent observations. They have no access to the true distribution. The interest rates consumers pay for unsecured credit (think credit card rates) are often several times what they receive on money they save. In the world as it is, consumers ought to borrow only to counter severe downward shocks to income, pay off borrowings quickly, and build buffers of precautionary savings, since the cost of dis-saving is much less than the cost of borrowing. (You lose 4% interest on your CD, rather than paying 12% interest on your credit card.)
Some consumers behave this way, but very many do not, suggesting that consumers are myopic, overvaluing consumption today in a manner that they themselves will come to regret in the future. If consumers are myopic, if self-today has different preferences than self-tomorrow, then whether taking on credit is a good idea is beyond the comfort zone of positive economics. Credit availability creates winners (self-today) and losers (self-tomorrow), while interest payments reduce the size of the overall pie available to the time series of selves. In the way that economists suggest "free trade" to be good — winners, losers, gains overall — myopic consumers imply that the absense of a credit constraint is bad. Thank goodness the banks aren't lending!
There are obvious wrinkles and objections: What about credit for cars, or home mortgages, or education? The analysis changes when the borrowing is exchanging one pre-existing long-term liability for another. (We are born short basic shelter, and, in much of America at least, short a cheap car as well.) Education can be viewed as an ordinary, wealth generating investment project that in theory could be equity rather than debt financed, but that might be too tricky in practice. It's not my intention to suggest that consumer credit is always bad, only to defend the commonplace notion that for many people and under many circumstances, even loans that will be never be defaulted can be positively harmful, and as a matter of policy we should not be exhorting banks to issue or consumers to accept credit.
But if we let consumer credit contract, and if investment demand is derived from consumption demand, doesn't that spell macroeconomic disaster? There is an alternative. It is called "transfers". What's good about credit from a simple Keynesian perspective isn't that loans get repaid tomorrow, but that they get spent today. If what consumers would do with funds would be better for the economy than what banks are doing with funds, we ought to stop the massive transfers of funds from buyers of government debt to banks, and transfer the funds directly to consumers. If you think that Americans consume too much, and that we need to grit our teeth and endure a "reduction in our standard of living", fine. I disagree, strongly, but at least you're consistent. Then the government shouldn't transfer to anyone, banks shouldn't be encouraged to lend, consumption, investment, and GDP should be allowed to fall until we find a new level. I think that's foolishly pessimistic, though. Americans may need to change the mix of our consumption, but overall I think our standard of living is not only supportable, but improvable, and that our goal should be to get the rest of the world to live as well as we do, rather than to reconcile ourselves with some pseudomoral poverty. The world is full of human want, which we should strive to meet by working to increase our capacity to produce. Problems arise when want and purchasing power are misaligned. We can improve that by redistributing some of the purchasing power from those with lesser to those with greater use for current consumption. If that sounds Commie to you, note that is precisely the function that consumer credit traditionally serves, just without all the residual claims, a large fraction of which will prove to be illusory (at least in real terms). That is, transfers are just a more honest way of doing precisely what a credit expansion does, except without the trauma that comes from learning that much of the money lent to fund current consumption will never be repaid.
I'm trying to come up with a reasonable opposing view, a case for pushing consumer credit but opposing transfers. Perhaps you can help, because I just can't do it. One might argue on philosophical grounds against coercive transfers, but coercive transfers are a precondition of restarting bank lending, and we've already made transfers to banks on such a scale that banning them now would be like robbing a jewelry store, then piously arguing future looters should be shot. One might argue that bank lending is "smarter" than public transfers would be, that the patterns of consumption and investment that result from private sector credit allocation will lead to superior productive capacity and more sustainable patterns of consumption than direct transfers. Given the awful quality of aggregate investment this decade and the volatility now faced by consumers who were recently credit flush but who under any reasonable lending standard must now be credit constrained, it is hard to be enthusiastic about the special wisdom of bank-mediated credit allocation.
Of course, once we start redistributing purchasing power, there's the thorny question of who gets what. I have an answer to that, it is my new mantra. Transfer flat. Cut checks to every adult in the economy of interest, regardless of whether they pay taxes or have a job. Flat transfers are easy to understand and they pass the smell test for "fair". As an income source unrelated to work, flat transfers increase workers' bargaining power with employers by reducing the cost of refusing a raw deal. (Supplementary income is a better means of enhancing labor bargaining power than unionization, which serves the same purpose but may limit the flexibility and efficiency of production.) Finally, flat transfers align purchasing power in the economy with the problem that we want markets to solve: We want an economy that serves some people dramatically more than others, in order to preserve incentives to produce and excel. But we also want an economy that meets every person's basic needs, even those of people who are unable or unwilling to offer marketable goods or services. We won't let people starve, so why not fund a basic income, however miserly, rather than relying on an inefficient social services bureaucracy or taxing the virtuous by relying on charity?
Tax Pigou and progressive. Transfer flat. Encourage equity. Contain the banks.
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This article has 21 comments:
1) Force the current margin rule for ALL stock/equity transactions.
2) Remove interest deduction from income tax.
Bingo.
And while you're at it. RE: the trade deficit.....
Remove tax credit for capital investment outside the USA.. EASY!
Describing debt as an arrangement "by which a party with the power to command resources but lacking aptitude or interest in managing a productive enterprise delegates wealth to another party who is capable of creating value but unable to command sufficient resources" suggests to readers that what follows is not so much a thoughtful analysis as a personal vendetta.
That being the case, I think it's essential that you tell us more about yourself, who you are,what you've done, where you've been, and most importantly, what experiences you've had with the banking system. It should be done in the article, or at least in your Seeking Alpha blog, or at the very least on your personal blog site. We need this so we can place your points into some sort of obviously-needed context.
As things stand now, use of such language by an unknown author (the name, without more, tells us nothing useful) removes credibility from your argument.
Perhaps you might get away with it if the argument was so persuasive and meticulous as to have obvious merit to anyone who reads it. While the rest of your piece is well written, it does not rise to that nearly-impossible standard.
Meanwhile, bank lending standards need to be tightened; consumers should be allowed to be have as they wish with the caveat no one will bail them out; there should be no supra body to either prevent purchase of government bonds issued to make loans to banks or to redirect global capital flows.
I think you are calling for a new economic regime and I think it will require further thought. Thus far, your arguments are less than convincing.
It is a dumb line, sort of like, "water is the lifeblood of the human body." The mere fact that water is indeed rather important tells us nothing about who should own the water, how to distribute it properly, or anything else of significance. The fact that finance is crucial does not mean that some financier (or group of them) should take a piece out of my paycheck.
"As a matter of policy we should not be exhorting banks to issue or consumers to accept credit"
Well...if credit is done properly (without carefully hidden risks), then credit is a functional device for maximizing "trustworthiness" in society - a good thing. The problem is that society consists of humans, rather than angels, and rather than maximizing "trustworthiness" - credit is a mishmash of various activities captured or uncaptured.
Since the records are the ultimate basis - one could most easily obliterate the whole "consumer credit system" if one abolished social security numbers or nationalized credit reporters (Equifax/Experian/Tran... That way - you achieve all of your objectives through the cheapest possible mechanism - wiping out the data-producers who grease the wheels for the whole system...
Of course, then big brother would have your credit report (as if they don't already have it now) - and that would strike many as being even worse than transfers (or handing their children's paychecks to a banker).
They were not intended for Morgan Stanley to own $80 trillion of, which is 5 times the GDP of the USA. If companies are too big to fail, they should not be allowed to get this big!
We have had enough to government transfers from those of us who work or worked, to those who did not.
Agreed about interest rates - but 4% interest on a savings account is 3% or less after income tax;, and many people are paying way more than 12% on credit cards. Years ago, our daughter paid 26% interest on a gas card. We had to bail her out when she got married. Such interest rates are usury and drve people into bankruptcy. My credit cards give cash back so long as I pay in ful before the due date.
Anyway - please, no more redistribution of income by our beloved government!
Then, long before banks loaned to ordinary folks, consumer finance was born. This model worked very well.
It would be difficult to go back to something like that, but not impossible. The biggest problem I foresee in getting from here to there is emptying out the lobbyists from Washington and the politicians who rely on their contributions for their re-election campaigns. Good luck with that!
Any one who didn't see this coming had thei head up their arse...
On Jan 18 01:54 PM jksisco wrote:
> Since our so-called economic experts in our Federal Government didn't
> see this Mortgage meltdown coming (doubtful imo) I have very little
> faith that the TARP funds are being used in the best possible way.
> If improving the economy is the goal and in essence the FED is rewarding
> bad behavior anyway, why not transfer money to the end user in the
> first place i.e. consumers, home owners, taxpayers, etc. Wouldn't
> that stimulate the economy, forestall foreclosure, pay down credit
> card debt?
I have seen situations where support money is fed straight into the pokies, with a beer on the side, or where the kids beg for scraps while "adult", um, buys feed for the greyhound.
Food for thought though, thanks.
"But if we let consumer credit contract, and if investment demand is derived from consumption demand, doesn't that spell macroeconomic disaster?"
Your article implies we just need to keep both types of demand elevated by increasing aggregate purchasing power. And you suggest putting that power in the hands of those with more "human want" than their fellow citizens. You suggest wealth-transfers as a means to increase aggregate demand and promote your notion of economic fairness. I hope this accurately summarizes your position.
Your idea of fairness and mine are different. I contend that's why we have charity; so that each of us can express our own personal notions of fairness. But leaving the moral issues aside, taking money from those that are not spending as much as you would like, and giving it to those that will, is a temporary fix at best. It does not address the core issues. I think you make the mistake of all followers of Keynes: the root cause of the consumption slowdown is not addressed before solutions are proposed.
Consumption is basically income minus savings, right? We know that saving can't go much lower in the U.S. than it did in the recent past. So more income, if sustainable, would seem to be the solution for a slowing economy. But how do you boost income?
Netted out, income is equal to wages and profits on invested capital. Only increases in productivity can boost these. It is generally understood that this requires increased the saving and investment of capital. That can't happen if the government is busy trying to force up consumption.
Rather, I would argue that consumption, mostly driven by low interest rates and easy access to credit, rose above sustainable levels. Creating money out of thin air has a way of doing that. The unsustainable consumption caused substantial malinvestment by business (and government). It may be that we have too many auto-dealerships and strip malls in the U.S. Who knows?
Thus, I would argue that the solution is for savings to increase which, in the short term, requires a fall in consumption. This is exactly what consumers are trying to do. Much of the malinvestment needs to be liquidated and (when possible) re-deployed to where it is needed. Relative prices need to re-establish profitable relationships based on sustainable consumption patterns. Will this be painful? Absolutely! And we should hold our politicians accountable for the pain they've caused us with their system in which money created by the central bank masquerades as sustainable demand and available capital.
Keynesians want a short-cut to cleaning up the structural mess built during a credit boom. Throwing more paper money at consumers might dupe them and business people into making economic mistakes for awhile longer, but it will not make the mess go away. Eventually, the economy has to move back to a set of sustainable relationships. While I agree that more credit is not the answer, I don't think wealth-transfers are either.
let's try to get it right:
1. total spending = consumption + investment. The more you consume, the less you invest and vice versa. By definition - consumption is figuratively and literally the act of eating the wealth. This is the ultimate economic goal of every human being. investment is the opposite - it is creating the wealth, that later can be eaten.
From this follows - the more you consume now, the less you invest. The less you invest now, the less there will be to consume in the future. This is true for individual, for the whole country and for the whole world.
In my opinion this simple truth invalidates all Keynesian arguments that consumption should be increased at all cost. On the contrary - investment should be increased! This is how all rich countries got there - they were saving and letting the free market invest the funds profitably. Why then not invest by... printing money? That's why:
2. money <> wealth. think of wealth as time. Everyone has 24 hours / day. you may decide to spend 16 hours consuming and 8 hours investing. or just 12 hour consuming and 12 hours investing. you cannot consume for 16 hours and invest for 12 hours - there is simply not enough time to do it. You can "save" some time if you come up with a way to do the same thing but more effectively - i.e. wealth is growing mainly by techological innovation (this includes the use of natural resources).
Or - actually you can work for 12 hours and have fun for 16 hours. The way to do it is to make day have 28 hours. Does it mean that you will have more wealth? No! All it does is to reduce the wealth that can be created (or consumed) in one hour. The day will last the same amount of time as before. Hence - inflating time (increasing the total amount of time) is not a wealth generating activity.
This simple illustration rendres all inflationary policies ivalid.
3. You should be careful with inflationary policies, however, because if they get into the system in the form of credit expansion, they will cause more damage than just higher prices (=lower value of one hour). Imagine that suddenly you are told that day is 28 hours long, but noone gives you the new watch (this is inflation coming from one source). This will mean that you will work for 12 hours thinking that you still have 16 hours to sleep and have fun. Of course - you have fun for the usual 8 hours and then go to sleep. However - you wake up after 4 hours completetly tired (not only you worked more, but you also slept less) and you are told you have to go to work again. The additional 4 hours that you worked was the economic boom. The fact that you are tired due to not enough sleep is the economic bust. the only way to fix this is by sleeping at least the missing 4 hours (if not more) in the following day to come back to equilibrium. This is the recession.
4. Actually Keynes considered the relation between consumption and investment/saving and he concluded that there is no relation between how much people save and how much is invested. In fact - there can be an increase of saving that is not invested (he called it "the paradox of thrift"), this however is the case only in times of big economic reshuffling, when people are seeing revaluations of all investment opportunities. It is normal, natural and economically healthy for people to wait in this time with their investment decisions (actually Keynes called it "animal spirits" of the business people - no doubt he didn't like entrepreneurs).
In this sense the behavior of banks (and all other businesses) is normal and desired - wait to see what will come out of this mess once the dust settles.
You wrote "Americans may need to change the mix of our consumption, but overall I think our standard of living is not only supportable, but improvable, and that our goal should be to get the rest of the world to live as well as we do, rather than to reconcile ourselves with some pseudomoral poverty." I agree with the improvable part. God forbid the rest of the world lives like we do.
There is a magnificent difference between quantity and quality and the choice of quantity has most often been the undoing of quality. Food is one obvious example although we could pick almost any industry from automobiles to toys. We are clearly a society suffering from too much of a good thing, so much so, that obesity, for both adults and now children, is a national malady. Much of what now ails us is diet related. I'm thinking diabetes, hypertension, heart disease, cancer, arthritis, and sleep apnea. Moreover we have replaced germs in our food with poisons. Created a food manufacturing and distribution system that requires prodigious amounts of fossil fuels. A system that tolerates ungodly living conditions for the animals we raise and slaughter. Most of our "food products" are not food at all but conglomerations of food like chemicals engineered by scientists rather than farmers. Their purpose? To "add value" to substances that would be cheap and healthy if only left alone. We are alienated from real food preparation, historically one of the foundations of civilized living, out of the necessity of having every able bodied earner in the home working full time to sustain this "standard of living". Don't even ask what happened to the family meal and why children don't spend time with their parents anymore.
I suggest that in many ways less is actually an improvement over more. Consider some trade-offs: Less work, more free time. Less food, increased energy and health. Less house, lower utility and maintenance costs. Less debt, more peace of mind. Less stuff, more spirit.
Modern Credit really orignated in the middle ages to foster trade ( contrary to the holding of the Church) - a commercial entrepreneur used letters of credit, trade credit or bills of lading to finance his risk business. Credit also permits production of resources ( e.g. ag) with revenue streams that vary temporally from the timing of investment . Credit cards and HELOCs are the bastard children of these more elevated parents
Now you are seeing even normal trade finance credit relationships suffer , including A/P - not just these involving an intemediary . Barter and hard cash simply don't provide suffincient transactionallubircati... and support for a modern economy . Hence the concern for a real economy death spiral