Making the financial system safe - a bad goal?

[Renegade Island]

Please specify rather than resorting to general attacks. I'm not here to dogmatically defend any position that I take. I will accept and process new information, if it's demonstrably true.

Economics describes economic processes. Descriptive. Not prescriptive.
It is not designed to manage something.

So the process of design (in societal structure, building structure, economic structure) has nothing to do with the process of economics?

[Norsklow]

Economics describes economic processes. Descriptive. Not prescriptive.
It is not designed to manage something.

So the process of design (in societal structure, building structure, economic structure) has nothing to do with the process of economics?

Better leave it out of it till dead last! ( Norsklow's Razor - applied to all normative considerations.)

[Norsklow]

Which thinking has led us into the mess.

Or maybe, we just listened to the wrong economists and ignored the ones who actually predicted the crisis.

Possibly. I started getting really edgy when Bush Junior started tearing up http://en.wikipedia.org/wiki/Gramm-Rudman-Hollings_Act

mind you, with overwhelming bi-partisan support.

[Rubiconic Crossings V2 rev 1f]

Technically not true. There are two forms of economics, positive economics which tells how things are, and normative economics which state how things ought to be.

Which thinking has led us into the mess.

What led us into this mess was fraud.

[Norsklow]

Which thinking has led us into the mess.

What led us into this mess was fraud.

I flatly disagree. Things started to look mighty awkward before the frauds occurred - people trying to cover their behinds when it finally dawned that it was not hunky-dorey.

[Rubiconic Crossings V2 rev 1f]

What led us into this mess was fraud.

I flatly disagree. Things started to look mighty awkward before the frauds occurred - people trying to cover their behinds when it finally dawned that it was not hunky-dorey.

They looked awkward back in 2006...that bubble was based on fraud.

[Norsklow]

I flatly disagree. Things started to look mighty awkward before the frauds occurred - people trying to cover their behinds when it finally dawned that it was not hunky-dorey.

They looked awkward back in 2006...that bubble was based on fraud.

Things started to go badly wrong CA 2002.

[Rubiconic Crossings V2 rev 1f]

They looked awkward back in 2006...that bubble was based on fraud.

Things started to go badly wrong CA 2002.

More like the slow death of Glass-Steagall until what? 1998/9? Probably even before that...

[Norsklow]

Things started to go badly wrong CA 2002.

More like the slow death of Glass-Steagall until what? 1998/9? Probably even before that...

Don't know. But I do recall lifting Gramm-Rudman-Hollings, and the disconnect between UK real estate prices and rental prices. Things started to look iffy. No crystal ball, simple observations. Tracking the price of a meal of rice, chicken and peas... that kind of thing.

[Greater Portucale]

Making the financial system safe is a good goal.
Why?

Because the deposits that i have in the bank are actually ME lending money to the bank. The bank OWES me the money I have in my current account, its not "his".

Now, I have a risk in lending my money to the bank - I understand that, its part of the game, and that is why the bank pays me interests. The risk is, offcourse, that the bank does something extremely risky, and loses the money.
There is an issue in this - although i have knowledge of said risk, i can't quantify it. I cannot observe the practices (or myself, restrict them) of the banks. I can only hope that they don't gamble the money away - thankfully, we can also get politicians that create regulatory frameworks that observe and restrict the risk that banks can take.

As this a cost? Offcourse, this will make banks less profitable. But why should i care?
I never see those profits, but i damn see the cost of bailing out the banks.
And even if i did saw those profits (as a shareholder), we have the "bonuses" problem - there is no guarantee that the manager is actually trying to create a healthy, profitable bank - he might just want to make a fast buck, at the taxpayer and shareholder expense - that is what we have seen.

So no, i disagree completely with the OP.
Making the financial system safe, and stable, is a fundamentally good goal.

[Rubiconic Crossings V2 rev 1f]

More like the slow death of Glass-Steagall until what? 1998/9? Probably even before that...

Don't know. But I do recall lifting Gramm-Rudman-Hollings, and the disconnect between UK real estate prices and rental prices. Things started to look iffy. No crystal ball, simple observations. Tracking the price of a meal of rice, chicken and peas... that kind of thing.

Gramm-Rudman-Hollings is balanced fed budget...not sure I'm seeing the connection...

The UK housing market has always been odd since the entire buying your own council house and the billions councils have not been spending directly on social housing...

[Norsklow]

Don't know. But I do recall lifting Gramm-Rudman-Hollings, and the disconnect between UK real estate prices and rental prices. Things started to look iffy. No crystal ball, simple observations. Tracking the price of a meal of rice, chicken and peas... that kind of thing.

Gramm-Rudman-Hollings is balanced fed budget...not sure I'm seeing the connection...

The UK housing market has always been odd since the entire buying your own council house and the billions councils have not been spending directly on social housing...

You unbalance the budget in an attempt to avoid the economic consequences of 911, and at some point or other all the hot air, false prosperity, puffs back out of the balloon. Keynes works - provided you engage in surplus-budgetting in the good times.

[Neu Leonstein]

Nonono - the thing to do is to separate Retail Banking from Merchant Banking. I don't want my money deposited in the Retail Branch risked by the Merchant Branch, unless there be a crapload of warrantees.

See, but that's partially my point: being a retail bank is in no way riskless. And the more you restrict retail banks from interacting in financial markets (especially interest rate derivatives) the more of a one-way leveraged bet you make them.

Imagine the most vanilla retail bank possible. It has $10 million in equity, so that's the money the owners/shareholders put up to start the bank. Then it goes and gathers deposits (say $60 million worth) and borrows another $30 million in the markets at various maturities. So now it has $100 million to play with, and all it does is lend money to people for mortgages so they can buy homes.

What you have created is a highly leveraged, badly maturity-mismatched one-way bet on the housing market, with added interest rate risk.

If house prices fall too much, you're screwed.

If interest rates rise, you're screwed. You now have to pay more on your deposits and borrowed funding and you don't get to collect any more interest on your fixed-rate mortgages.

If interest rates fall, you might also be screwed. If lots of people decide to refinance their mortgages, you could see a whole bunch of high-interest mortgages repaid early (ie less interest overall) and exchanged for low-interest mortgages. Though you'd probably be less screwed than in the interest rise scenario... to a degree. These days it's become pretty hard for anyone to invest spare funds at reasonable rates without taking much more risk.

And if any of these movements conspire to remove more than $10 million from the value of your portfolio of mortgages (and tiny slither of cash you hold), then you fall over and are bankrupt.

If you saw Goldman Sachs putting on a financial trade with an equivalent exposure, there'd be quite a few people on this forum (and beyond) who would call that an unacceptable gamble.

In actual fact, of course, this isn't what banks do. They trade in the markets, they buy and sell derivative positions that lock in interest rates for their funding, and for the payments they receive for their mortgages. They might take spare cash and invest it in things that hopefully move opposite to the exposures they normally build up.*

But it is quite hard to tell exactly where these legitimate offsetting trades end and "prop trading" begins. Certainly if you restrict retail banks to only super simple stuff, you'll make them much less safe. Even quite complicated financial "bets" using all sorts of exotic derivatives have to be looked at from the context of the bank as a risk-taking entity as a whole. It's not a priori clear at all that a plain retail bank, or a much simpler financial system for that matter, is less risky to the economy or the taxpayer.

*That's what JPMorgan's CIO is supposed to do - you know, the people who lost $7b or something recently, and for which Jamie Dimon got to listen to Congressional tirades for a while.

[Norsklow]

Nonono - the thing to do is to separate Retail Banking from Merchant Banking. I don't want my money deposited in the Retail Branch risked by the Merchant Branch, unless there be a crapload of warrantees.

See, but that's partially my point: being a retail bank is in no way riskless. And the more you restrict retail banks from interacting in financial markets (especially interest rate derivatives) the more of a one-way leveraged bet you make them.

Imagine the most vanilla retail bank possible. It has $10 million in equity, so that's the money the owners/shareholders put up to start the bank. Then it goes and gathers deposits (say $60 million worth) and borrows another $30 million in the markets at various maturities. So now it has $100 million to play with, and all it does is lend money to people for mortgages so they can buy homes.

What you have created is a highly leveraged, badly maturity-mismatched one-way bet on the housing market, with added interest rate risk.

If house prices fall too much, you're screwed.

If interest rates rise, you're screwed. You now have to pay more on your deposits and borrowed funding and you don't get to collect any more interest on your fixed-rate mortgages.

If interest rates fall, you might also be screwed. If lots of people decide to refinance their mortgages, you could see a whole bunch of high-interest mortgages repaid early (ie less interest overall) and exchanged for low-interest mortgages. Though you'd probably be less screwed than in the interest rise scenario... to a degree. These days it's become pretty hard for anyone to invest spare funds at reasonable rates without taking much more risk.

And if any of these movements conspire to remove more than $10 million from the value of your portfolio of mortgages (and tiny slither of cash you hold), then you fall over and are bankrupt.

If you saw Goldman Sachs putting on a financial trade with an equivalent exposure, there'd be quite a few people on this forum (and beyond) who would call that an unacceptable gamble.

In actual fact, of course, this isn't what banks do. They trade in the markets, they buy and sell derivative positions that lock in interest rates for their funding, and for the payments they receive for their mortgages. They might take spare cash and invest it in things that hopefully move opposite to the exposures they normally build up.*

But it is quite hard to tell exactly where these legitimate offsetting trades end and "prop trading" begins. Certainly if you restrict retail banks to only super simple stuff, you'll make them much less safe. Even quite complicated financial "bets" using all sorts of exotic derivatives have to be looked at from the context of the bank as a risk-taking entity as a whole. It's not a priori clear at all that a plain retail bank, or a much simpler financial system for that matter, is less risky to the economy or the taxpayer.

*That's what JPMorgan's CIO is supposed to do - you know, the people who lost $7b or something recently, and for which Jamie Dimon got to listen to Congressional tirades for a while.

The answer to that is to have a cold hard look at the mortgage industry. And increase the amount of equity a home buyer must put up, and likewise decrease the amount of money he can borrow.
( we went from 3 years pay to a complete de-linking in one generation. )

The part where risks accumulate on depositors because of mortgages? Start cutting it!
We need banks today to count the beans, in this post-chartal age. And not to help out with home finance. To settle accounts between economic actors, and not to help you get a home.

It All Begins Here:
http://en.wikipedia.org/wiki/Bank_of_Amsterdam

Deposits of coin constituted but a small part of bank capital. Most of the bank's capital originated with deposits of gold and silver bullion, intrinsically of higher value as bullion was not debased, unlike most of the circulating coinage.
The Bank of Amsterdam gave credit for deposits of gold and silver worth about 5 percent less than their mint price. It granted the depositor a receipt, which allowed him to claim his deposit 6 months later, upon returning to the bank the same value of bank money for which credit was given, and payment of a fee for the keeping—a warehouse rent of sorts—worth 0.25% for silver, and 0.5% for gold. This fee could, of course, be paid every 6 months, extending the period of deposit. The difference of fees has been attributed both to the difficulty of ascertaining the purity of gold and to a wish to encourage deposits of silver, it being the standard metal of the time. If a depositor did not claim his deposit back after six months, it fell to the bank, and the depositor was left with the credit he received in compensation.
The terms of deposit were such that deposits of bullion were most commonly made when the price was somewhat lower than ordinary, and taken out again when it rose. The proportions between the bank price (the credit which the bank gave for deposits of bullion), the mint price, and the market price of gold bullion were always nearly the same. A person could generally sell his receipt for the difference between the mint price of bullion and the market price. As a receipt was nearly always worth something, it was only rarely that deposits were allowed to fall to the bank through the expiration of receipts (which means the depositor neither paid additional keeping fees nor removed his deposit from the bank). This happened more frequently with regard to gold, due to its higher keeping fee.
The bank also took in coin, granting credit and receipts in exchange, and charging 0.25% for the keeping. These receipts were often of no value, however, and the deposit was allowed to fall to the bank.
The bank maintained it did not lend any of the bullion deposited in it, not even that part for which the receipts expired, and which could not generally be claimed.

Substitute bullion with chartal money, and the basic principles still remain the same.
This bank does not extend credit - period.

You can have excellent reasons for granting it, and using the Bank as the vehicle, but there is no inherent need for a Bank to be involved in granting credit at all.