THE GOVERNMENT REALLY DID IT: BANKING, BLAME, AND A COMMON TRAGEDY
April 11th, 2009
Dean Baker, on The American Prospect, posted an article entitled, The Bank Bailout: Were Bankers Victims of Predatory Lending by the Government?. But I don’t agree with him (for once), at least entirely.
Dean,
I hate to disagree even if slightly, but by creating so much money, and encouraging bankers to lend and failing to regulate (prescribe) the uses of that money, the government created a “tragedy of the commons,” where the only choice a business in a market has is to participate, lest he be put out of business by the competition of his rivals.
This is simply another application of the Keynesian strategy: that printing money will compel people to spend (take action), because they will be harmed if they save (wait).
But the problem is much deeper than that. It’s not a moral problem. It’s not a judgment problem. The level of understanding of the banking industry among bankers and mortgage brokers has become so trivial since we centralized banking using computing technology that any understanding of the banking industry was held in very limited hands, making them cumulatively ineffective hands. If you are the minority conservative voice in a company of others who seek to exploit opportunity, even opportunity that they don’t understand, you simply comply or get replaced.
Early retirement caused by the use of all that credit money and its resulting asset inflation caused a lot of wise and older bankers to exit. The period of expansion caused by that money and the breadth of it led to the exit of the seasoned veterans who understood the consequences from the last time we did all this silliness.
The educational system and its emphasis on quantitative risk evaluation created the equivalent of an inhibition in younger bankers against actually learning the business and understanding what kind of economic activity they were engaged in. They sought to become day traders rather than investors.
There were a set of erroneous beliefs, and technical errors, and basic human foibles, that contributed to this problem:
The economy (and housing) was flooded with credit in order to recover from 2001, in the hope that this would keep the consumer, and 70% of our economy, spending.
The low cost of credit money, the high demand for people, and the profit opportunity for bankers, mortgage brokers, real estate developers, and construction labor rapidly expanded the number of people in the mortgage and banking fields.
This increase in the size of the credit industry meant that the average person in it had less skill in understanding his or her actions, and their only logical means of competing with their peers was to participate in the feeding frenzy despite their lack of knowledge and experience.
The senior banking talent either retired, had no memory of previous crises, or had no knowledge of economic theory, and if they were conservative they were overwhelmed by the profit-seeking majority.
Reselling loans as packages made it easy for individuals to to mitigate personal risk.
Information to estimate the current value of those securities when packaged and resold was lost.
As a result, the meaning of the credit rating system when this packaging occurs was lost.
The centralization of banking through the use of computers allowed executives to apply calculations to centralized lending, under the assumption that risk calculation is a scalable process.
Society was deprived of knowledgeable bankers with whom they could interact at local branch offices.
A class of “financial advisers” developed who misled consumers and savers with a pretense of knowledge, and the belief that any financial product is forecastable, when in fact, it is not.
The educational system emphasized quantitative analysis, rather than deep knowledge of the industries, geographies, or people that they lend into.
The banking culture emphasized risk, expressed using the convenient shorthand of market-priced collateral, rather than as risk expressed by understanding of opportunity versus the risk a lender estimates by virtue of his knowledge of the FUTURE of prices in a specific industry or geography.
The only regulation that would have solved that problem would have been to require that 20% of the loan be held by the originating INDIVIDUAL, not bank, but INDIVIDUAL, so that the individual had the incentive to maintain sufficient knowledge of his properties, so that he could adapt to risk.
But the cause of all those contributions was fiat and credit money.
Banking is an art, not a science. It never will be a science. It cannot be. It is the process of funding entrepreneurship. It is not the science of evaluating risk, because we can never know that risk or that opportunity by any means other than experience, which is TESTED by quantitative analysis. That experience must be in the property and products and people we evaluate, not their presumed assets and collateral. It’s almost hard to say anything else out loud and not feel simply ridiculous for having done so.
Any entrepreneur of any experience will tell you that bankers are noticeably from the bottom of their graduating classes, they are disastrously ignorant of both their industry and the economic importance of it, and they have too little general knowledge to evaluate risk OR opportunity. Bankers simply aren’t very wise. They are notoriously ignorant. We are all aware of lawyer jokes, in which the lawyer is immoral. But there are plenty of banker jokes. They’re just not that funny. Jokes about dim people simply aren’t funny. But, like all stereotypes, such bits of cultural analysis are indicative of an underlying semi-truth.
Investment bankers are generally very young, very bright opportunists who have won a lottery. But they have little or no understanding of business. The few that do are older and in smaller companies. Those same people in the larger companies are simply final decision makers. But investment banking has become a variant of movie production: the trick is to put together any deal that you CAN – not any deal that you SHOULD. Instead, the operating principle of investment bankers is that you SHOULD put together any deal that you CAN get away with. This tragedy is only possible because we have allowed the creation of instruments that divorce the person who evaluates the opportunity from the risk inherent in the opportunity. Instead of facing that risk, he simply resells the product and escapes from the effect of his judgment. His incentive is to do what he CAN, regardless of his knowledge, instead of what he SHOULD because of his knowledge.
In a world of credit money, the recursive effect of lending and asset price inflation means that our perception of risk as mitigated by collateral is simply WRONG. Bankers are not in the collateral business like they seem to think they are. There isn’t any rational concept of collateral when prices are determined by the momentum of credit money. There is no collateral to measure, so bankers are not in the collateral business, they are in the insurance business. They just don’t know it.
I don’t blame bankers at all. I blame the government for its use of fiat and credit money in a century-long attempt to foster entrepreneurship and increased productivity (and therefore the illusion of full employment), and the political expediency of social programs (the need for which was caused in no small part by the use of credit money) by the use of general liquidity rather than targeted liquidity (loans for a specific purpose not just for any purpose).
We did NOT get the productivity increases. That same credit money, when regulated by the use of the concept of collateral, forces money behind mature commodity businesses that are calcifying, and starves smaller, more innovative and niche-serving businesses. It reduces consumer choice, hinders innovation, and forces investment capital into high-risk, high-reward opportunities (gambling) instead of production increases.
We all know that capital chases capital to the point of failure. Some of us know that excess capital creates failure. But very few of us know that risk and collateral are concepts whose value lies in the assumption that few people are lending and prices are relatively stable over the course of the loan. That value does not apply to a circumstance where everyone is loaning for everything and therefore the collateral cannot be priced. When collateral cannot be priced, and the entire credit system depends upon a system of calibration between collateral, loan, and risk, then the entire system simply rests on an erroneous assumption.
The economy is a representation of human memory. The stock market is an expression of overlapping “forgetting curves” and “learning curves.” Individuals, families, companies, industries, governments, cultures, and civilizations require common knowledge, or general understanding, in the form of memories, in the form of narratives, for general planning, organizing, forecasting, and acting in the real world. They need memories, in all their richness and complexity.
They need property, too. They need property to break the world up into actionable components. The world is as incomprehensible without property as it is without numbers, money, time, technical knowledge, and mythology.
We have invented a lot of tools that allow us to make more precise or complex COMPARISONS of our choices between multiple, complex things. But these comparisons are REFINEMENTS of our GENERAL KNOWLEDGE that is far less precise. We use analysis to TEST our more general comparisons. Just as we use accounting to test whether we made a profit from a sea voyage or from a month of complex activity, we use our other quantitative tools and logical tools to test our perceptions, both post and ante. But before we can make comparisons, we must first have perceptions. And to be of actionable value, those perceptions need to be of some sort of thing we can act on that’s unique in space and time, it must have a production cycle (property), and it must be scarce or specialized enough that acting upon them in a division of knowledge and labor is meaningful (profitable).
In other words, we have to have memories and habits that we compare to test or determine small improvements. And we must make those decisions in real time during whatever cycle of production we participate in. This real-time participation means that we are limited in the number of things we calculate. It means those things we calculate must not change much over time. It means that there are no general rules external to our experience that help us form our theories, only our experience and knowledge. It means that our methods and tools simply test and refine our more general habits and judgments. It means that we simply cannot have purely scientific knowledge of assets and banking. We have to have knowledge and wisdom about the behavior and use of property and people that is marginally sufficient for us to compare against alternatives by the use of those tools.
In other words, banking is not a process for applying scientific knowledge. It is a process of entrepreneurship and accumulated wisdom, tested by methodological tools so that we can reduce our errors.
The physical world stays the same while we pass our highly perishable scientific knowledge from generation to generation and increase its depth and complexity, falsify it, add to it, or whatever we do with it. The thing we have knowledge about stays constant. We are researching a universe that is invariant.
The human world is not invariant. It is inconstant, kaleidic, and created by our actions. It is the cumulative expression of human memories and all our market activity both creates and reflects it. The stock market is not scientific, nor is banking, risk, or any other aspect of the economy. It is not rational in the sense that we often use the term. It is not only a function of incomplete knowledge and asymmetrical knowledge, but of the learning curves and forgetting curves of each participant, who has limited processing power and who, in a division of knowledge and labor, benefits almost entirely from specialization that ensures his processing power necessarily fosters ignorance of some other aspect of human life.
Knowledge of property and its use does NOT SCALE. That’s the reason we have property: to break the world into comprehensible and known components that we can use to cooperate with each other by exchange and therefore specialize and increase production. This is the most important principle. Knowledge of property cannot scale and the stability of any price, including any collateral, is an illusion. There is no numeric or formulative substitute for personal human knowledge of economic activity. None.
Risk is not measurable AT SCALE, because we cannot measure the unknown, nor can we predict large corrections. In other words, risks cannot be summed if they make use of prices.
Priced collateral is not meaningful in a world of credit money, which at every moment invalidates any price.
We should seek to maximize opportunities at lowest cost, not maximize interest at minimum risk.
Banking is a knowledge problem, not a mathematical problem.
We need to de-financialize savings and retirement, because there are no means of forecasting such things over time, and any assumption of perpetual growth is fantastic.
Our educational system seeks to treat finance, economics, and sociology as disciplines open to quantitative analysis in order to establish rules, rather than the virtue of collected history and wisdom, and a record of the quantitative analysis and expressed rules as a history that is constantly open to interpretation.
Our educational system seeks to teach people formulae which are invalid so that they can avoid collecting accumulated wisdom, rather than seeking to endow them with accumulated wisdom and the analytical tools to interpret currently collected data for comparison to accumulated wisdom. Educators make this mistake in order to simplify the job of TESTING students, who, if subjected to tests of accumulated wisdom rather than technical expression, would fare far worse and consume much more of the educator’s time.
Our educational system seeks to grant social science the same argumentative weight as physical science, confusing the fact that in physical science we discover something that exists already. In social science we manufacture the future, and that there is nothing to be discovered, only created.
Our political system seeks to replace governance by religious conformity with governance by economic efficiency as a means of justifying the accumulation of power in order to advance the interests of groups, and to do so when economic efficiency is impossible to determine and risk is impossible to measure. This is instead of increasing the rate of production and seizing and exploiting every possible opportunity for every individual independent of his class or group membership, which would allow all groups to benefit by the success of other groups by the use of credit, rather than for some groups to profit at the expense of others by privatizing wins and socializing losses.
Our political system seeks to pit groups against each other by the use of laws, to hold themselves unaccountable for production by the use of tax, and to tax people according to income so that they can keep them servants of the state, rather than facilitate group cooperation by the use of credit , to hold themselves accountable by funding the state by the collection of interest, and to tax tax citizens by their balance sheets so that they can become independent of the state.
Some classes in society use banking, credit, and interest to socialize losses and privatize wins, using fiat and credit money that is paid for by all, but offers rewards that are collected by few. This does decrease prices for all. But it also creates class warfare.
So, bankers are what we made them. The blame is ours, not theirs.
Source date (UTC): 2019-08-16 09:28:00 UTC