Wednesday, 23 July 2014

Goldman Sachs doesn’t like Dodd-Frank – shock.

The “Goldman Sachs Global Markets Institute” says Dodd-Frank has curbed growth, according to today’s Financial Times. Oooh gosh, does it? Well for Gawd’s sake: what else do you expect them to say?

But to be fair, let’s look at their arguments. According to the Financial Times, GSGMI’s main argument is that small businesses mortgagors have been hit by increased charges made by banks as a result of Dodd-Frank bank regulations. Well I’m sure they have. But that doesn’t prove any effect on growth.

Of course the banksters’ poodles who infest Congress and the UK’s House of Commons fall hook line and sinker for the argument that less lending means less growth. And one of the leading, most gullible and vociferous poodles in Britain is Vince Cable, the so called “business secretary” (who clearly knows nothing about business).

The first monster flaw in the idea that higher interest rates or bank charges mean less growth is that mortgagors in Britain at the end of the 1980s were paying THREE TIMES THE RATE OF INTEREST that they’ve been paying over the last two or three years. Yet (and this will be incomprehensible to poodles), economic growth in the 1980s was far better than it’s been over the last five years or so during which we’ve “enjoyed” record low interest rates. And even with the substantial drop in unemployment in the UK and US recently, PRODUCTIVITY improvements have been FEEBLE.


Next, the fact that the price of something rises (whether its apples, interest on borrowed money, hamburgers, etc etc) tells you NOTHING WHATEVER about possible effects on economic growth. In particular, if the price of the relevant commodity was previously SUBSIDISED, and the price rise stems from a removal of that subsidy, then it’s reasonable to expect IMPROVED GROWTH as a result: it’s widely accepted in economics that subsidies distort the market and REDUCE GROWTH (unless there are very good social reasons for the subsidy).

And half the point of Dodd-Frank rules and similar rules being implemented around the world is to REMOVE the various subsidies enjoyed by banks.

The bloated bank industry.

Next, the size of the UK’s banking industry relative to GDP has expanded TEN FOLD over the last fourty years. I.e. there’s been a HUGE INCREASE in loans / debts over that period.

So according to the Goldman Sachs hogwash / deliberate lie theory of loans and growth, economic growth should be far higher than forty years ago. But it’s not!!!!!!!!!!!!!!!!!!!!!!

Incidentally, I AM NOT SUGGESTING that Dodd-Frank is a brilliant bit of legislation. I agree with Richard Fisher, head of the Dallas Fed who said, “We contend that Dodd-Frank has not done enough to corral “too big to fail banks” and that, on balance the act has made things worse, not better”.

Conclusion: if you believe anything coming from Goldman Sachs or any other bankster you have to be phenomenally stupid.

Tuesday, 22 July 2014

I prefer Kotlikoff’s full reserve system to Positive Money’s.

The two systems are the same in that those who want a sum of money to be totally safe have it lodged or invested in a way that is totally safe: ie. they put it into an entity or account where relevant sums are simply lodged at the central bank (and perhaps also invested in short term government debt).
In contrast, where someone wants a sum of money loaned on so that they can earn interest, under Kotlikoff’s system that person buys into a unit trust (mutual fund in the US) of their choice. If the unit trust makes poor loans or investments, then those with a stake in the trust take a hair cut assuming they sell out when the poor loans or investments become apparent. A stakeholder can of course hold on in the hopes that the value of their stake recovers. Obviously the value of that stake constantly varies, as is normal with stakes in unit trusts.
However, under PM’s system, those wanting their money loaned on invest in what PM calles “investment accounts”. Investors, as with Kotlikoff’s system have a choice as to what is done with their money. But that’s where the similarities end.
Under PM’s system, investors are promised £X back for every £X they put in (plus interest and less expenses).  Plus investors cannot sell out whenever they want: they invest for some pre-determined amount of time (just as with so called “term” accounts). And the “£X in / £X out” promise is kept unless the bank goes bust, at which point it is wound up and depositor / investors get less than 100p in the £.
As PM puts it on p.184 of “Modernising Money” (I’ve put quotes in blue):
“Investment Accounts will be risk-bearing: If some borrowers fail to repay their loans, then the loss will be split between the bank and the holder of the Investment Account. This sharing of risk will ensure that incentives are aligned correctly, as problems would arise if all the risk fell on either the bank or the investor. For example, placing all the risk on the account holder will incentivise the bank to make the investments that have the highest risk and highest return possible, as the customer would take all the downside of bad investment decisions.”

The conflict.
Now hang on. That conflicts with the paragraph at the bottom of the same page which says investors have a choice as to what is done with their money, and that the categories of assets that investors can go for will be set by government. As the book puts it, “The broad categories of investment will need to be set by the authorities”.
So, assuming banks obey the law and only put money into say relatively safe mortgages where that’s what investors want, then there is no possibility of banks being “incentivised to make the investments that have the highest risk and highest return possible..”.

Existing unit trusts.
In fact with EXISTING UNIT TRUSTS ( a system where it’s essentially those who buy units who carry all losses and profits) there doesn’t seem to be a need for government to interfere: that is, existing unit trusts which declare that a particular trust will invest in say German and French government debt or the chemical industry DO JUST THAT: invest in German and French government debt or the chemical industry. I.e. they don’t try to allocate money in some sort of underhand way to riskier investments.
The only slight reservation to the latter point is that existing unit trusts normally put their managers on some sort of bonus dependent on the performance of investments made by managers. Ad there’d be no harm under PM’s scheme in banks putting investment managers on some sort of bonus. But bonus schemes are two and six a dozen: that is very roughly half the employees in the country are on some sort of bonus scheme.  So in that sense it could be said that “banks” share profits and losses. But any such bonus, both with existing unit trusts and under PM’s scheme would be a small proportion of total amounts invested and total profits and losses on those investments. So all in all, the latter “bonus” point is a near irrelevant detail.

“Incentivise” bank shareholders?
Another way of “incentivising banks” would be to make bank shareholders share some of the loss and profit made on individual investment accounts. But it is patently obvious that the typical holder of stock exchange quoted shares knows very little about the details of the business they invest in. Indeed, prior to the recent crisis, about 99% of bank shareholders clearly hadn’t the faintest idea what was going on.
To summarise, the whole business of “incentivising banks” collapses.

Where banks carry all the risk.
PM continues:
Alternatively, if the bank takes all the risk by promising to repay the customer in full regardless of the performance of the investments, then the account holder would face no downside and would consequently only be motivated by high returns, regardless of the risk taken. This would force banks to compete by offering higher interest rates in order to attract funds, which they would then need to invest in riskier projects in order to make a profit.
Well that scenario is to all intents and purposes what the EXISTING bank system involves! Indeed, the last sentence of the latter quote the effect that the existing system tempts banks to take excessive risk is spot on. I.e. the latter quote is not, as “Modernising Money” implies, a way of running a full reserve system: IT IS THE EXISTING SYSTEM. 

Kotlikoff’s system is simpler than PM’s and better. Indeed, the basic rule governing K’s system can be reduced to one short sentence as follows. “Entities that lend must be funded just by shareholders, not by depositors”.
That’s beautifully simple. But half the economics profession hates anything resembling simple solutions to complex problems, like E-MC2. A simple solution means less work for them, and as Upon Sinclair put it, "It is difficult to get a man to understand something, when his salary depends upon his not understanding it."

Monday, 21 July 2014

Biagio Bossone criticises full reserve banking.

The world is awash with incompetents criticising full reserve banking (FR). I dealt with a large number of these here.
However, this paper by Biagio Bossone entitled “Should Banks be Narrowed” is in a different league: he has obviously studied the subject in detail, and the first few pages are faultless.
However, as soon as he starts to criticise FR he goes off the rails, and for the following reasons.

Bossone’s first argument.
His first argument in favour of the existing banking system (i.e. against full reserve) starts as follows (his p.13). Incidentally, I’ve put all his words in green.
“An important strand of research, following Diamond and Dybvig (1983), stress the role of banks as insurers against liquidity shocks.”
Dear oh dear: it was the banking system itself which around 2005 was the MAJOR CAUSE OF a “liquidity shock”. The banking system itself didn’t “insure against” that “liquidity shock”. It failed in spectacular and disastrous fashion in that regard. It was TAXPAYERS who provided TRILLIONS OF DOLLARS of “insurance money” to deal with the “liquidity shock”.
Incidentally, it’s not entirely clear when his paper was written, but it looks like it was around 2000 to 2002. Perhaps Baggio wouldn’t have said the above were he writing today.
Anyway, Baggio continues:
“In a setting where all individuals are initially identical but learn only subsequently to have different intertemporal consumption preferences, banks are shown to generate liquidity to help individuals who discover to be “patient” consumers to satisfy their needs. (Is that English?) They do so by transforming illiquid assets into liquid deposits. This is possible because the averaging out of the withdrawal demands from a large number of depositors allows banks to stabilize their deposit base and transfer deposit ownership without liquidating the assets. From this angle, the social benefit of banking derives from an improvement in risk-sharing, i.e., the increased flexibility of those who have an urgent need to withdraw their funds before the assets mature (Diamond and Dybvig 1986).”
Now what on Earth makes Baggio think that under FR households and firms can’t borrow, as the above passage implies? The only difference between the existing system and FR is that under the latter, lending is carried out by “banks” or “entities” that are funded just by shareholders, as opposed to the existing system under which lenders are funded mainly by depositors. Indeed, as Baggio himself put it a page or two earlier:
“Commercial banks having to switch to narrow-banking regulation could be expected to transfer their credit exposures to existing or newly-established finance companies, which typically operate with higher capital ratios and fund themselves with relatively larger volumes of long-term debt.”
Baggio then repeats the above error (i.e. assuming that no one can borrow under FR) when he says:
 “In fact, the benefit of banking cannot be fully appreciated if the asset and the liability side of the bank balance sheet are not considered connectedly. The benefit derives from the banks using their stable deposit base to finance production technologies that increase output over time.” 
To repeat, under FR, (if we have to use large numbers of pseudo technical words, a tactic much favoured by academics trying to hide their ignorance) “production technologies” can be “financed over time” perfectly well under FR.
Baggio then claims “This crucial link between liquidity and production is explicitly recognized in Diamond and Rajan (1998, 1999), where banks are regarded as superior devices to tie human capital with real (illiquid) assets, and where the sequential service constraint ordering the way in which banks service withdrawal demands (up to when they become illiquid) work as an incentive for bankers to behave prudently.”
Gosh: bankers behave “prudently” under the existing system do they? Baggio clearly lives in cloud cuckoo land.
The point remains, however, that production requires patient money and involves risks, while agents with money may not be as patient and risk-inclined to lend it to firms: banks do provide a mechanism to reconcile both sets of preferences by generating liquidity. Narrow banks are designed precisely not to do so.
Baggio doesn’t give a definition of “patient money” but presumably he means money which relevant owners or holders are prepared to lock up for significant periods. And clearly the existing banking system does what Baggio claims it does in the passage quoted just above: that is, it enables long term investments to be funded from short term deposits (or from “unpatient” holders of money to use his terminology). However, that argument is easily demolished, and as follows.
There is no escaping the fact that borrowing short and lending long, which is what traditional banks do, is risky: the brute and undeniable fact is that banks have failed regular as clockwork throughout history. And there are a limited number of ways of dealing with that problem. Let’s run thru them.
First, taxpayers can stand behind banks (the “solution” adopted in the UK). But’s just a subsidy of banks, and subsidies misallocate resources, i.e. reduce GDP. Plus regulators the world over are agreed that bank subsidies should be removed: an objective they’ve spectacularly failed to achieve.
Second, government (i.e. taxpayers) can simply abstain from helping failing banks (the policy adopted in New Zealand, and tried in Cyprus in 2013). But that means that depositors take a hair cut when a bank fails, which effectively means that depositors become very near to being shareholders. And that pretty much amounts to full reserve banking!! Or to be more exact, where depositors take a hair cut when a bank fails, that bank is effectively one of those “existing or newly-established finance companies” to which Baggio referred above.
And if one assumes that in addition to those risky deposit takers, there is some form of ultra-safe deposit taker or savings bank (like National Savings and Investments in the UK), then that all amounts to FR to all intents and purposes.
Third, banks can be allowed to fail, but depositors are reimbursed via a self funding FDIC type insurance system. Now that is very near to FR, at least in the sense that bank subsidies are removed. In fact the only difference between a FDIC insured banking system and FR (far as I can see) is that under the latter, commercial banks do not issue money, whereas under an FDIC system they do. I dealt with the relative merits of those two systems here and concluded that FR is better than an FDIC insured banking system.

Given the obvious defects in Baggio’s first few criticisms of FR, I can’t be bothered reading any more of his paper.

Sunday, 20 July 2014

De Grauwe plagiarizes MMT.

See here.
Reminds me of the refrain in that Tom Lehrer song "Lobachevesky": “plagiarize, plagiarize, plagiarize, only be sure to call it research.” See below.