Summary:
London Banker argues that the core problem leading to the current seizure of the credit markets is the misallocation of credit into unproductive works during the boom years. Markets all over the world carelessly followed the path of under-production, dis-savings and over-consumption as the path to prosperity. No amount of new credit will solve the problem unless the distortions promoting misallocation are redressed through fiscal and regulatory policy changes. Bailouts and recapitalisation of failed policies of the past are only digging a deeper hole, betraying more capital of younger generations into the unproductive works financed by the current generation. Correcting the bias toward betrayal of capital will not be popular or easy. Correcting the bias toward unproductive investments will require a massive change of political structures, financial intermediation channels, savings and consumption habits, and economic incentives. Savings must be encouraged and must be allocated to productive investments that will yield not just future prosperity but social equity to minimise political conflicts. But those who sold us or imposed on us the current set of policies and practices will be re-bottling their snake oil under new labels. (Published: 08/08/08)
Notes:
- “Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works”. - John Stuart Mill
- obvious facts
- borrowing short through commercial paper to lend long on mortgages and credit cards to bad credits with inadequate collateral is not a sound business model
- yet somehow the alchemy of securitisation with a sprinkling of AAA pixie dust was widely accepted as turning financial lead into gold
- a house, once built, is not a productive asset as it produces no revenue but instead absorbs a high proportion of its owner’s income on mortgage interest, property taxes, maintenance and utilities
- credit card debt, once consumption goods are purchased, produces no productive income stream for repayment of the debt but instead becomes an obstacle to future consumption as debt service eats up a rising proportion of stagnant wages
- a car that weighs twice as much and uses twice as much fuel is not as productive as a car that is small and fuel efficient, and costing twice as much will harm more productive savings and investment with the excess debt borrowed for its purchase
- the financial sector, as intermediaries between savers and productive ventures requiring capital, should never rise to the point where it alone represents over thirty percent of economic activity
- Nonetheless:
- markets all over the world carelessly followed the path of under-production, dis-savings and over-consumption as the path to prosperity,
- in fact: path to a betrayal of capital into hopelessly unproductive works
- core problem leading to the current seizure of the credit markets is the misallocation of credit into unproductive works during the boom years
- no amount of new credit will solve the problem unless the distortions promoting misallocation are redressed through fiscal and regulatory policy changes
- bailouts and recapitalisation of failed policies of the past are only digging a deeper hole, betraying more capital of younger generations into the unproductive works financed by the current generation
- Correcting the bias toward betrayal of capital will not be popular or easy
- correcting the bias toward unproductive investments will require a massive change of political structures, financial intermediation channels, savings and consumption habits, and economic incentives
- challenge virtually every assumption made by at least two generations of American businessmen and consumers and exported globally
- Regulatory policies promoting misallocation of capital
- elimination of restrictions on bank dealing and brokerage of securities and derivatives
- self-determined models-based capital adequacy calculation
- ratings-based weightings of capital assets
- accounting reforms that permitted off-balance sheet financings
- acceptance of ill-transparent corporate structures
- Savings must be encouraged and must be allocated to productive investments that will yield not just future prosperity but social equity to minimise political conflicts.
- Those who sold us or imposed on us the current set of policies and practices will be re-bottling their snake oil under new labels.
- We must be wary before buying bulk lots in the tens of billions of dollars worth of the same old snake oil that has sickened our economies and political processes already.
- In the US: bailouts of Bear Stearns/JPM and Freddie/Fannie; perpetuates the subsidies to speculation and unproductive housing markets.
- In the UK: talk of a cut in stamp duty (a transfer tax on house sales)
- Snake oil, unfortunately, wins elections because it appeals to constituencies that are politically important
- as a result, we may be entering a dangerous phase where the democratic structures are biased to economically damaging policies that further harm future growth and prosperity
- because investment in unproductive works is so widespread as to form part of the popular culture
