Cutting the financial sector down to size

by John Quiggin on August 18, 2019

That’s the provisional title I used for my latest piece in Inside Story. Peter Browne, the editor, gave it the longer and clearer title “Want to reduce the power of the finance sector? Start by looking at climate change”.

The central idea is a comparison between the process of decarbonizing the world economy and that of definancialising it, by reducing the power and influence of the financial sector. Both seemed almomst impossible only a decade ago, but the first is now well under way.

There’s also an analogy between the favored economists’ approach in both cases: reliance on price based measures such as carbon taxes and Tobin taxes. Despite the theoretical appeal of such measures, it looks as if regulation will end up doing much of the heavy work.

{ 29 comments }

1

Martinned 08.18.19 at 9:18 pm

Quick question: How are carbon taxes and Tobin taxes “price based”? After all, they are taxes set by government. Surely a price based measure would be carbon emissions trading? (And whatever the financial sector equivalent of that might be.)

2

Chetan Murthy 08.18.19 at 10:35 pm

Martinned:

I think “price-based” refers to “setting a price for a certain activity” and then stepping back and letting participants decide whether they wish to engage in that activity. So taxes certainly count as “price-based” in that they don’t decide who will or will not engage in burning coal, or trading forex, except via charging for the privilege.

3

Jake Gibson 08.19.19 at 1:26 am

We are in opposition to great deal of wealth and power that cannot accept the idea of the commons. And if they could accept it, would be incapable of imagining not monetizing and exploiting it.

4

bad Jim 08.19.19 at 5:43 am

Two quick thoughts: a small tax on financial transactions, as proposed by Sanders and probably other candidates, would likely not yield substantial revenue but would eliminate the apparently unproductive and occasionally destructive high-speed trading arms race.

A carbon tax has more foes than friends. It’s a non-starter in the tax-averse U.S., and, as has been argued elsewhere, it would be an insurmountable burden for developing countries. Here, thrift is coming to the rescue: coal plants are shutting down all over the country because they are not competitive with wind and solar power, and in California even cheap gas often doesn’t make the cut.

5

nastywoman 08.19.19 at 10:02 am

@“Want to reduce the power of the finance sector”?

Very much so –

”Start by looking at climate change” –

As hopeful signal that change is possible – Perhaps? –
but as the following was mentioned:
”The recent retreat of the Deutsche Bank from global banking driven in part by massive fines for money laundering could be the beginning of a trend” –
Let’s look why the Deutsche Bank went (literally) ”out of the Casino.”
The Deutsche Bank traditionally mainly financed ”real manufacturing and producing economies” – BUT then the Bankers noticed (around the turn of the century) that their colleagues -(in the US and UK) – made a lot more dough – by just gambling with money – and sooo – the Deutsche Bank hired all kind of ”Anglo-Saxon-Money-Gamblers” – and they put a lot of chips on the table – not only for Trump but also for their YUUUGEST losing bet ”a Real Casino in Las Vegas”.
(And everybody should read the ”financial” story of ”the Cosmopolitan” – as there is hardly a better example for how embarrassing it can be to be ”a Banker”)

And so the Deutsche Bank already (supposedly?) learned the lesson – WE want the world to learn –
BUT as you wrote:
The financialised global economy appears both utterly discredited and completely untouchable. But as the NOT ONLY the rapid movement towards decarbonisation shows, appearances can be deceptive. Should the economic crisis feared by the IMF materialise, the demand for change may prove irresistible”?

6

nastywoman 08.19.19 at 10:39 am

– or perhaps???…
WE just should see the whole deal as competing business models?
Like London and NY as ”the YUUGEST Casinos of the world – against countries like Japan – China – Germany where ”the people” make their money with producing NOT money but… but ”stuff” – and the banks – there – are financing the production of stuff?

AND as it first look like – that the casinos in London and NY -(and some other places) were and always will be – NOW – it sometimes looks like that ”the people” still can make money with producing… just – stuff”
-(especially since producing ”stuff” produces a lot more jobs for ”average people” than just… gambling) –
– which could bring us back to my once ”hometown” -(in 2010)
VIVA LAS VEGAS —

”The names of the biggest players in gambling — Wynn, Caesars, MGM — dominate the neon-drenched skyline of the Las Vegas Strip. But the owner of the most expensive casino ever built in this hedonistic city, Deutsche Bank, is not announcing its arrival in lights. Even before that casino, the Cosmopolitan of Las Vegas, opened in December, the German financial company was planning its exit strategy from a $4 billion investment that could take years, if not decades, to recoup.“There has to be pressure on Frankfurt to do something,” said Bill Lerner, an analyst with the research firm the Union Gaming Group. “They are a bank, and I don’t think they have any interest in running a casino.” Deutsche Bank spared no expense on the Cosmopolitan, whose casino floor is dominated by a three-story glass chandelier that encompasses a cocktail bar. Guests rave about the oversize luxury hotel rooms with wrap-around terraces, which are often sold out. And management has lured popular restaurateurs and retailers.
The investment is also putting Deutsche Bank at odds with its own clients. In 2009, it hired the general manager at Caesars Palace to run the Cosmopolitan — a move that upset the parent company, Caesars Entertainment, a crucial customer of the bank, according to people with knowledge of the situation who were not authorized to speak publicly”.

But, but, but it was such a GREAT opening party!!

7

nastywoman 08.19.19 at 11:19 am

– and how could I forget that the Deutsche Bank – by finally selling the Cosmopolitan for 1.7 Billion – made so much ”Miese” -(Minus) – that the German employees of the Bank told their management: ”We don’t do this kind of ”financializing” anymore”!

BUT! –
as the US -(and UK) Casinos are (still) going soooo incredibly strong –
-(especially for everybody with enough ”cash” – and not being driven into bankruptcy by another ”economic crisis”) – THE income from the Casinos is soooo important – for soooo many Americans -(including a lot of my relatives) – that the crisis might have to become so YUUUGE – that it firstly has to flush all of the Von Clownsticks away…?

8

Tim Worstall 08.19.19 at 12:11 pm

I beg your pardon?

“The financial sector equivalent to a carbon price is the Tobin tax, a levy on financial transactions”

An economist is stating that a consumption tax is the same as a transactions tax? Really?

The FAT might be akin to a carbon tax but an FTT isn’t.

“set at a rate low enough to have no effect on long-term borrowing and lending but high enough to render speculative trading and complex derivative transactions unprofitable. “

There’s also a slight problem or two with that. Much speculative trading performs the function of risk shifting. Risk shifting being a valuable activity. So much so that the EU’s own report into the FTT said that even at those usual low rates mentioned it would leave the economy smaller than it would be without the FTT. So much so that the FTT itself would be a net revenue loss.

“If the G8 countries introduced such a tax, and imposed a punitive rate on transactions involving noncompliant tax havens, the daily volume of financial transactions (currently around $5 trillion) could be reduced by a factor of one hundred without any impact on real economic activity.”

That’s a pretty big statement. Would be interesting to see the proof.

One prediction from me – the first thing we’d see would be the return of market makers and the market maker’s turn. Which is, of course, a straight handover from those doing real transactions to financial market insiders. The bid/ask spread would widen substantially. The major effect of HFT on the US stock markets has been to entirely eliminate it for in size transactions. HFT goes that spread will return.

Of course, that’s what you’re planning, that the spread should return. But who used to benefit from the existence? The market makers. Who will? Well, seems obvious enough. The benefit of market insiders taking their tithe again is what?

9

Zamfir 08.19.19 at 3:14 pm

@ bad Jim: that feels like premature optimism to me. I can only hope that cheap green energy works, but for now it doesn’t look enough?

Some issues, that still ask for a carbon tax or similar measures even with cheap green power:
– the closing of coal plants is partially due to fracking gas, with it’s own CO2 and methane problem. It looks rosier than it is
– wind and solar have associated costs, due to availability and geography, that will rise as they get closer to 100% . Perhaps falling costs will fully compensate for that, but that is far from certain today
– as fossil fuel use drops, so will the price of fossil fuels! Down to the production cost of the cheapest mines and wells. It is not enough to beat them on price today, but also after such price drops.
– speed! Even if cheap green energy wins in the long run without supportx it is better if it wins faster with support
– electric power is only the start, not the end

10

Stephen 08.19.19 at 4:19 pm

I am not an economist, but I do wonder if JQ has considered the reported Swedish experience with a Tobin tax? Quoting Wikipedia:

” In January 1984, Sweden introduced a 0.5% tax on the purchase or sale of an equity security. Thus a round trip (purchase and sale) transaction resulted in a 1% tax. In July 1986 the rate was doubled. In January 1989, a considerably lower tax of 0.002% on fixed-income securities was introduced for a security with a maturity of 90 days or less. On a bond with a maturity of five years or more, the tax was 0.003%.

The revenues from taxes were disappointing; for example, revenues from the tax on fixed-income securities were initially expected to amount to 1,500 million Swedish kronor per year. They did not amount to more than 80 million Swedish kronor in any year and the average was closer to 50 million. In addition, as taxable trading volumes fell, so did revenues from capital gains taxes, entirely offsetting revenues from the equity transactions tax that had grown to 4,000 million Swedish kronor by 1988.

On the day that the tax was announced, share prices fell by 2.2%. But there was leakage of information prior to the announcement, which might explain the 5.35% price decline in the 30 days prior to the announcement. When the tax was doubled, prices again fell by another 1%. These declines were in line with the capitalized value of future tax payments resulting from expected trades. It was further felt that the taxes on fixed-income securities only served to increase the cost of government borrowing, providing another argument against the tax.

Even though the tax on fixed-income securities was much lower than that on equities, the impact on market trading was much more dramatic. During the first week of the tax, the volume of bond trading fell by 85%, even though the tax rate on five-year bonds was only 0.003%. The volume of futures trading fell by 98% and the options trading market disappeared. On 15 April 1990, the tax on fixed-income securities was abolished. In January 1991 the rates on the remaining taxes were cut in half and by the end of the year they were abolished completely. Once the taxes were eliminated, trading volumes returned and grew substantially in the 1990s and 2000s.”

As I said, I am not an economist, but that doesn’t look to me as being a great advertisement for success.

11

bad Jim 08.20.19 at 5:26 am

Zamfir, I’m sorry if I came off as optimistic. I’m not. I think a carbon tax would be a tremendous help, but I can’t see it happening here. Even in California, the prospects for reforming our grossly inequitable property tax look grim.

Our grid keeps getting greener, though. A few years ago I was impressed to see one day that half the power on California’s grid was renewable. Now it’s routine. I charge my car late at night when the rate is lowest, and if it’s only modestly windy the juice is halfway carbon free (nuclear and large hydro are not considered renewable). Check it out!

You’re right that cheap gas is a major factor in making coal and nuclear power less competitive, but in the wind belt even gas isn’t competitive, which is why Texas keeps adding windmills and cutting back on gas. The prospect of a fall in fossil fuel prices is unlikely to be an issue since the cost of renewable energy is only the initial capital outlay: wind and sunlight are free. They are, unfortunately, unevenly distributed.

Storage is the main problem, and lithium batteries are not going to be the answer, though the prospect of millions of electric cars serving as both dispatchable supply and demand is certainly entrancing and not entirely outside the realm of possibility.

12

Peter T 08.20.19 at 7:21 am

“bond trading fell by 85%, the volume of futures trading fell by 98% and the options trading market disappeared”

Looks like success to me.

13

Tim Worstall 08.20.19 at 7:50 am

This also doesn’t quite chime.

“The Stern report, issued in 2006, was the first serious attempt at setting out an agenda to stabilise the global climate. But economist Nicholas Stern suggested a target of 550 parts per million of CO2, well above the level considered safe by most scientists. More importantly, his proposals assumed that we would continue to burn coal and could solve the emissions problem through the (non-existent then and hopelessly uneconomic now) technology of carbon capture and sequestration.”

Not really, no. He took his economic/emissions models from the Special Report on Emissions Scenarios. He used the A2 one. That’s what gave him both that CO2 level and also the coal use and so on. Stern wasn’t assuming, the SRES assumed that this was a possible future. Stern then worked with those numbers. That’s how we get that carbon tax as high as Stern – along with the discount rates- gives us.

If Stern had used A1FI then we’d probably have a higher carbon tax number. If B1 or A1T then a lower. And, with those last two, a lower peak CO2 level as well.

Stern was picking one of the extant pathways to work from, rather than assuming his own numbers.

There is also this:

“Less than fifteen years later, it is obvious to everyone (except those living in a right-wing alternative reality) that the decarbonisation process is well under way. Dozens of governments have already committed to phasing out coal-fired power, and ultimately to a fully carbon-free electricity supply. Even Germany, long dependent on coal, says it will close all coal-fired power stations by 2038. Going beyond electricity, France and Britain have committed to ending sales of petrol and diesel cars by 2040, and China, the world’s biggest market, seems likely to follow suit.

Whether progress towards decarbonisation will be fast enough to prevent severe climate damage remains to be seen.”

Well, perhaps we should all start using the correct models then?

If it is true – and I agree it is – that decarbonisation is well under way then we cannot use the RCP 8.5 scenario as our business as usual one. For we’re simply not going to end up in that world because the decarbonisation is already happening. We must use RCP 6.0, or maybe 4.5 – I tend to doubt we’re on 2.5 as yet – to be modelling our possible future.

Which is something that near none of the papers being issued do. There may be exceptions but it seems routine for people to be saying that BAU is 8.5. The one model we know we’re shouldn’t be using because we’ve already done enough to know that 8.5 isn’t going to happen.

Our planning for what to do next has to start from acknowledging the effects of what we’ve already done. When we look at income inequality we do take account of tax and benefits and how they change it, we don’t just look at market incomes then declare more must be done.

When we look at climate change we have to start from where we are now, not where we would have been if we hadn’t done something already.

14

John Quiggin 08.20.19 at 11:19 am

Stephen @10. What Peter T said – the correct reason to introduce the tax is precisely to reduce the volume of financial transactions and the resources devoted to them.

Tim – the evidence for the proposition and against your claim is the combination of massively increased resources going into the financial sector and no offsetting improvement in productivity, risk allocation etc.

15

Blissex 08.20.19 at 6:02 pm

There is a fundamental difference between lowering the carbon footprint and lowering the finance footprint is that the former is hugely in the interest of the elites, who are pushing it hard (just as they are pushing hard “plant based meat”).

The reason why shrinking the carbon footprint or the meat consumption of “hoi polloi” is hugely in the interest of the elite is that supply is constrained, and higher consumption means sharply higher prices; if “hoi polloi” voluntarily consume less, prices of fossil fuels and meat will remain stable or even fall, allowing the elites to jet around the wold and have huge BBQs.

However a lower consumption of financial products will severely impact the incomes of the elites, and in any case their supply has essentially no limit.

16

James Wimberley 08.20.19 at 8:28 pm

Zamfir #9: Andrew Blakers’ 100% renewable scenarios for Australia (here) are useful. He avoids technological prediction entirely by starting with just wind and solar generation, plus HVDC transmission and pumped hydro storage for firming them: all mature technologies with a large installed base and known costs. You can then add in the unicorn technologies (car batteries as a grid resource, say) as variants. As a methodology for public policy advice, it’s brilliant. There is no need to worry about feasibility, it’s entirely a matter of minimising costs by picking a good technology mix.

He estimates the cost of firming as about a 50% markup on the raw ex-farm cost of wind and solar. However, these are getting cheaper all the time, while HVDC lines and storage dams aren’t. So we will end up closer to 1:1.

His variant scenarios include accepting lower reliability, with contracted load shedding (demand response). This saves quite a lot of money. IIRC he does not model the savings from going 98% renewable instead of 100%. but the same presumably holds.

There is a huge political advantage in the simple 100% message, but my guess is we will actually end up at 98% or so. The gas turbines that will constitute the 20% safety reserve will be kept in pampered idleness, like the 1925 Bentley in the garage of a rich eccentric, oiled carefully by a greying Bunter and taken out for a spin once a year. The argument here is that net zero is not enough, and we will need massive net carbon sequestration. 2% of gas electric generation will be a mere rounding error in the totals.

17

Kiwanda 08.21.19 at 12:14 am

It might also be helpful to reduce the “leveraged buyout” activities of “private equity”, which seem to be a scam in which outside parties and top management of a company conspire to steal from the employees (pension funds) and stockholders.

18

Peter T 08.21.19 at 7:43 am

Tim @ 13

Since we are all dead at 8.5, pretty much all dead at 6, and mostly dead at 4, the differences are essentially immaterial. Since CO2 is still rising, “decarbonisation is well under way”. It’s not that a car crash at 10 kmh is much better than a car crash at 100 kmh, it’s that going over a cliff at 10 kmh has the same results as going over at 100. With CO2, it’s the absolute amount that’s the cliff.

19

Peter T 08.21.19 at 7:44 am

Oops. Make that decarbonisation is NOT well under way

20

Dipper 08.21.19 at 7:59 am

JQ “the correct reason to introduce the [financial transactions] tax is precisely to reduce the volume of financial transactions and the resources devoted to them.”

I favour a tax on all academic papers and publications from humanities and economics departments for similar reasons.

21

Landru 08.21.19 at 4:11 pm

I’m entirely with you here in spirit, JQ. But I’m afraid I lack some necessary background understanding to really appreciate the approaches and benefits to reining in the financial sector. And as I suspect I’m not the only civilian listening in, here is a teachable moment for you; and a prize to you, or anyone else, who can give a straightforward answer to a very basic question: how exactly are these people getting all this money to begin with?

My short-form understanding sees first two events:

(1) In the late 20th century a whole bunch of regulations on the financial sector were lifted. (Since I’m in the US I picture this as an essentially bipartisan accomplishment starting under Reagan and completed under Clinton, with I assume similar trajectories in other advanced countries.)

(2) The financial sector, meaning people and organizations (banks, etc.), started taking in a great deal more money in profit, ie for themselves, than they had before event (1).

Knowledgeable folk like yourself seem to think that (2) will follow (1) as night follows day, so obviously as not to need explanation. But I’m afraid I’m a bit slow here, and want to catch up at a basic level; and my basic question is: who is paying all this money to the financial sector today, and why? Put aside for the moment any consideration of whether the activity of the financial sector results in public goods or anything socially useful; just in a bare-bones, bare-knuckle, but still law-abiding, capitalist sense, how did they contrive to be getting all this money for themselves? What hold do they have over the rest of us?

As a civilian and amateur at best, I can imagine three basic answers; you can tell me if the truth lies nearer to any of them, or I should imagine something else entirely. But as you can see what I’m looking for is the short form, that gets to the essence of the thing without technical trappings; and here are my three possible answers:

(A) The financial sector is actually doing its job, re-directing capital from investments producing somewhat lower returns, to those giving somewhat higher returns, and then they take their cut for the service, e.g. catching Tom Wolfe’s “golden crumbs”. I think of this as the official story of the financiers, that deregulation event (1) simply let loose their creativity, after which the higher take-home profits of event (2) are only deserved.

(B) The financial sector is fleecing a chain of greater fools, essentially sweet-talking investors out of a larger fraction of their money by deploying the smoke and mirrors of impenetrably complicated derivatives, etc. In “Liar’s Poker”, a chronicle of the early days of financial wizards getting filthy rich, the greater fools at the end of the line always seem to be slow-witted Europeans, three steps behind the sharpies of Wall Street. This picture would put the financial sector firmly in the long tradition of charlatans and mountebanks, even if every transaction is in itself entirely legal; and the important result of event (1) is that it removed protections for the fools — a group which certainly includes me — who are now simply prey animals.

(C) The financial sector has, somehow, engineered the equivalent of a government-protected monopoly, and the money for all those third homes and second yachts are, ultimately, some form of extracted monopoly rents (is that the correct term?). I’m not sure exactly which, or which many, forms these mechanisms might take — if I did, then I’d be the one getting the money — but they could range from something low-level, like legal requirements that the rest of us have to, effectively, pay for financial sector services just to lead an ordinary life, all the way up to “privatized profits, socialized losses” forcing transfers to them from the rest of society (though, weren’t all the bailouts paid back in the US? I seem to remember reading that somewhere). I’m out of my depth on any details, but I can still appreciate the essence of an “effective government-enforced monopoly” as a wealth-transfer lever.

OK, JQ, back to you. How is a civilian to understand, how the financial sector is able to — legally — take in all this money? Give me the short form, the basic framework, the essence of the thing; and we’ll all be better equipped to help restore balance after we understand how the balance is off first.

22

Ebenezer Scrooge 08.21.19 at 8:09 pm

Tim@8:
Risk shifting is not an unalloyed good. Shifting risk from the accountable to the unaccountable creates externalities. It is a core aspect of contemporary capitalism. For a particularly stark example, consider the structure of chicken farming–small judgment-proof farmers happily polluting the land while being controlled by the big companies. The big companies, of course, are not liable for their control, at least if they have decent lawyers. In financial markets, this kind of risk-shifting is known as “legal arbitrage.” And–as far as I can see–legal arbitrage is the sole function of equity and credit derivatives.

23

Blissex 08.21.19 at 8:10 pm

«How is a civilian to understand, how the financial sector is able to — legally — take in all this money?»

In part all three of A, B and in particular C, but the overall picture is even simpler, there are the two main mechanisms:

Mechanism 1:

Try to imagine trader A and B, and they are trading the risk that tomorrow will rain, in a place where there is a 50% chance of rain, and they both have capital of 1,000 units.
* A sells an “insurance contract” to B of 10 units against the risk that it will rain.
* It rains, and now A pays and has 990 capital, B receives 10, awards herself 5 as a bonus, and now has 1005 of capital.
* B then sells an “insurance contract” to A of 10 units against the risk that tomorrow will be dry.
* It doesn’t rain, and then B pays A 10 units, A awards himself a bonus of 5, and then B now has 995 capital and A also has 995 capital, both A and B have gotten 5 unit bonuses.
* Repeat, until the central bank bails out A and B’s bank with a new round of 1,000 units of capital.

Mechanism 2:

Banker A sells a loan to B of 100 units “secured” by property or shares, with interest such that B will end up repaying 160, which means that A’s bank puts on their balance sheet 100 on assets, 100 on liabilities and capitalizes the future interest of 60 as notional assets. That means a profit of 160, and A gets a commission of 1/3 or 20 units, paid cash now. B only pays back half of the loan. A’s bank how has a loss of 50, plus 60, plus 20. Repeat, until the central bank bails out A’s bank.

24

SamChevre 08.21.19 at 8:17 pm

Landru @ 21

Here’s my account–call it (D). It’s the reason that I agree with the goal of shrinking the financial sector, but think any form of Tobin Tax will solve the wrong problem.

(D) The opportunities for profitable investment in production of goods and services in industrialized countries fell sharply beginning in the early 1960’s. (For reasons that are sharply disputed, but the trend in “industrial complexes built” is unmistakable and wide-spread.) To compensate, focus shifted to extracting more profits from existing profit streams: copyrights, increases in value of fixed income streams. From a consumer perspective, this seemed helpful–cheaper loans, lower transaction costs for stocks, and so on–but the result was a relentless rise in asset prices relative to the underlying income streams (house prices relative to median full-time male worker incomes, stock prices relative to earnings). Finance is in the business of maximizing asset prices–and having asset prices (retirement funds and houses, primarily) fall back to 1960 levels would be incredibly painful–so everyone keeps paying a little bit to finance to keep the machine of increasing asset prices running.

25

Cranky Observer 08.22.19 at 12:18 am

= = = (C) The financial sector has, somehow, engineered the equivalent of a government-protected monopoly, and the money for all those third homes and second yachts are, ultimately, some form of extracted monopoly rents (is that the correct term?). I’m not sure exactly which, or which many, forms these mechanisms might take — if I did, then I’d be the one getting the money — but they could range from something low-level, like legal requirements that the rest of us have to, effectively, pay for financial sector services just to lead an ordinary life, = = =

The purchase, I mean persuasion, of laws in various state and local legislatures requiring that retirement funds previously managed well and conservatively by well-but-not-over-paid government departments be transferred to the “superior management” of Wall Street firms, which promptly rake off a large percentage of the assets through fees and then inform the pensionholders that their fund is greatly diminished and they will have to work to age 74 before receiving any benefits, falls into this category.

= = = (B) The financial sector is fleecing a chain of greater fools, essentially sweet-talking investors out of a larger fraction of their money by deploying the smoke and mirrors of impenetrably complicated derivatives, etc. = = =

The leveraged-buyout-followed-by-bustout, as most recently seen in the fate of Sears Roebuck and the Tribune Company (excuse me, “Tronk”) are very open examples of this category. It has been a very popular system over the last 20 years and most of the instances occur privately. Extra points for looting the pension fund of the acquired entity (this is how Willard “Mitt” Romeny made his money at Bain Capital, leaving hundreds of my neighbors to literally starve in old age).

Related is to exercise the leveraged take-private scheme on a set of reasonably legitimate military or government contractors, consolidate to eliminate competition in that business category, jack up prices, then sell new contracts to government employees getting close to GS retirement. Paying oneself and one’s investors huge bonuses and dividends along the way. Extra points for taking the resulting mess back public so your next-door-neighbor in Greenwich can run the scheme again.

26

Dipper 08.22.19 at 4:40 am

@ Landru

I take a different view of most on here. The last forty years have seen a massive increase in global trade and consequent increase in global living standards, reduction in child deaths etc and this was facilitated by the kind of global financial activities everyone on here likes to lambast which enabled investment and distributed risk. Bankers like to take their cut of whatever activities are going on, so an increase in global financial activity resulted in an increase in money for bankers’ bonuses.

In the noughties the American economy was stalling but politicians needed to keep the boom going, so enabled a massive credit bubble to build up to keep the figures growing. Alternatively the trade deficit with China meant China had massive amounts of dollars that had to be reinvested in the USA, hence lots of dollars looking for a home. And as with all bubbles, when there was no-one left to join in, it collapsed.

Worth reading Joe Nocera and Bethany Mclean All The Devils Are Here which charts the rise of mortgage lending in the USA and subsequent collapse, and Michael Lewis The Big Short, in which he notes that everyone who was long mortgages made money and everyone who was short mortgages also made money.

27

Peter T 08.22.19 at 6:06 am

Landru

Good question. One answer might involve the reduction in alternative ways to maintain status and wealth. Industry demands a considerable degree of either repression or cooperation with the lower classes (quite simply, they can do the job and the managers can’t). International competition also demands deference to the lower orders (it’s really embarrassing if you start a war and your own side does not turn up). Natural resources are no longer free for the taking. Status and wealth become more closely linked as societies become more monetised.

So one turns to piling up money – present value of claims on future income. One good way to do this is to find some production system or resource that either has not been monetised or where the realisable monetary value (not the same thing as the actual value) is greater than the current price. Old-established industrial firms, where the expertise and equipment can be sold abroad, the real estate converted to apartments and the pension fund stripped. Pioneered by Slater Walker in the UK in the 60s, familiar from Bain Capital or Sears even now. Government activities – research labs, defence research, land…Reserves, national parks. When these run low you can package claims together and rate the bundle higher than the value of the individual claims (has to be less risky, right?).

The process is self-reinforcing, in that claims on production in money can lead to claims on claims, and then to claims on claims on claims (remember Paul Krugman – “for every debt there is an asset”? Well, yes, but often the asset is another debt, backed by yet another debt, and so on down).

In short, the connection between money and real goods and services needs to be constantly reinforced and maintained, else money floats free.

28

Bill Benzon 08.22.19 at 10:51 am

I’ve not read your piece, John (though I intend to), but I note that Farhad Manjoo (a tech columnist, BTW, not an economist) has a current piece on that subject in the NYTimes, “C.E.O.s Should Fear a Recession. It Could Mean Revolution.” He argues that when the next recession hits, we won’t take it any more and it’ll be “time to go full Elizabeth Warren — to make some fundamental, radical changes to how the American economy works”.

Back in 2017 Kim Stanley Robinson published New York 2140. The title gives it away, it’s a story set in and about NYC starting in the year 2140 and running to about 2143. Global warming has cranked it up to 11 and the seas have risen 50 feet, which means that most of Lower Manhattan is under water, though many of the buildings, of course, stick up above the water and people live and work in them. The institutional structure of that future world is pretty much the same as the current structure, though there’s more “gray” area activity in costal areas and lots of concentrated self-help and mutual aid. A big storm hits and we have a replay of 2008 (w/ specific references to that debacle), lots of people saddled with housing debt they can’t handle and banks collapsing. But this time the citizenry manages a coordinated outcry and resistance that forces the federal government to nationalize the banks 601-602:

Thus in February 2143, Federal Reserve chair Lawrence Jackman and secretary of the treasury, both of course veterans of Wall Street, met with the big banks and investment firms, all massively overleveraged, all crashing, and they outlined a bailout offer amounting to four trillion dollars, to be given on condition that the recipients issue shares to the Treasury equivalent in value to whatever aid they accepted. The rescues being necessarily so large, Treasury would then become their majority shareholder and take over accordingly. Earlier shareholders would be given haircuts; debt holders would become equity holders. Depositors would be protected in full. Future profits would go to the U.S. Treasury in proportion to the shares it held. If at some point the recipients of aid wanted to buy back Treasury’s shares, the deals could be reevaluated.

In other words, as a condition of bailout: nationalization.

Oh, the tortured shrieks of outraged dismay. Goldman Sachs refused the deal; Treasury promptly declared it insolvent and arranged a last-minute fire sale of it to Bank of America, just as it had arranged the sale of Merrill Lynch a century before. After that, Treasury and the Fed offered any other company refusing their help good luck in their bankruptcy proceedings. […]

Finally Citibank took the deal offered by Treasury and Fed, and in rapid order all the other banks and investment firms also took the deal. Finance was now for the most part a privately operated public utility.

Well, 2143 is rather a long way in the future, but KSR did give a rather detailed, if completely fictional, account of how it happened.

It’s in the air.

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aristos 08.22.19 at 5:33 pm

Carbon emissions are always and equally bad regardless of their source when faced with global warming, so a carbon tax makes sense. Finance is not always bad and a transactions tax may not be the best tool to reduce its harmful effects. The currency, bond and stock market transactions may reach trillions every day but they provide liquidity, create minuscule profits for the intermediaries, zero profits for the combination of buyers and sellers and do not create excessive risks for the taxpayers. It is leverage that creates risks and can crash economies. Regulation is better for dealing with an overgrown financial sector since it can be targeted towards the activities that are most harmful.

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