Collateralized Debt Obligations

[koganbot]

"Repackaging dubious loans into collateralized debt obligations creates a lot of perfectly safe, AAA assets that will never go bad."

The sentence is from Paul Krugman's column in today's NY Times. He's using it as an example of sophistry (which his dictionary defines as "a deliberately invalid argument displaying ingenuity in reasoning in the hope of deceiving someone"), though I'd think that putting the word "dubious" into the sentence makes it not sophistic. (The first half of Krugman's sentence describes what investment funds actually did, not what they said they were doing, right? So no one ever actually made the argument. Or did someone?)

But anyway, if I understood that sentence I'd understand how we got into the current financial situation (recession believed to be looming, is possibly here already), but I don't know enough about either economics or Wall Street to understand that sentence.

I know what "collateral" means (a car, house, etc. that backs up a debt, so that if the debtor can't pay, the lender gets to take possession of the car, house, etc.). And I know that AAA means that the asset is rated highly (considered "reliable and stable" by a credit rating company such as Standard & Poor's). But I don't know how you get from "dubious loans" - i.e., mortgages at onerous terms given to unwary home buyers whom one could not reasonably assume would be able to pay off the mortgages or understand what they were getting into - to "collateralized debt obligations" and then to "AAA assets." Which is to say I don't know what happened, or what the assets were. I gather that the cautious responsible investors who purchased (?) the "AAA assets" were, in effect, investing in the risky subprime mortgages without being told that this was what they were investing in. (Is that right?) So it's not just the homeowners who took out the subprime mortgages who are struggling for cash and therefore not spending, but also a bunch of solid citizen investors, hence a lot of people and firms are scrapping for money rather than spending or investing it. (Right?) This tends to depress an economy.

So, anyway, what happened?

(By the way, Krugman's really good, even if he doesn't always have the space to explain everything. I read his blog whenever I get the chance.)

Comments

[carsmilesteve.livejournal.com]

I gather that the cautious responsible investors who purchased (?) the "AAA assets" were, in effect, investing in the risky subprime mortgages without being told that this was what they were investing in. (Is that right?)

yes, that's what i understand also. i think this is where our good friend SECURITIZATION comes in, because property is, by default, a pretty safe bet to invest in, and should have a relatively stable cash flow. i think they were not actually investing directly in the properties, but rather in the securitised assets of the properties. ooh heck, i think just reading the wiki is probably easier than me trying to explain it ;)

[dubdobdee.livejournal.com]

the riskier mortgages were being layered in with much safer loans in ways which (supposedly) spread the risk thin -- this was the good bit (and was i think said, in much those terms)

here is the mechanism -- why it was imagined it would succeed and why it failed

the issue that's emerging is that risk assessors were being browbeaten -- if in-house -- and undercut if independent unless they presented their firm's wares as far less risky than they were: basically lack of transparency became incentivised across the board, and the degree of risk sort of got magicked from "some obviously" (bcz that was the entire point of this new way of structuring risk, and hence insuring against it) to "therefore effectively none" (if we all agree to agree and keep the bubble inflated)

the bubble being the same "run on the bank" bubble that underpins all of capitalism -- the loans can't all be called in at once but DON'T LOOK DOWN AND ALL WILL BE WELL

your life savings are a promise that can't be kept!

[freakytigger.livejournal.com]

Is anyone defending the practise now, incidentally?

We are having a big focus group at work on "Consumers And The Credit Crunch" next week - one of the qns is "who do you blame?", I will be intrigued to see what answers emerge!

[dubdobdee.livejournal.com]

i guess we should ask triffidfarmer!

i am trying to find a long post on the blog "calculated risk" (from last month i think) which clarified the key issue for me (in ref appraisal and fraud), but the net is sluggish today and BOY do those guys post a lot

[dubdobdee.livejournal.com]

here it is

(you could say this is how the commodification of a particular expertise switches it from being a good thing to a bad thing) (it's basically a weak link in the haykeian argument that the market is over time the provider of best information: once the market IN INFORMATION ITSELF becomes skewed, and bad info is incentivised etc ect...)

[katstevens.livejournal.com]

Isn't it like banker dudes betting that only 5% of people will default on their mortagages that year, and they can deal with it being 6% or 7% instead as it might be only 3% or 4% the next year, but when it suddenly turns out to be 11% then it's suddenly an AWFUL lot harder to claw back from other bits?

My brother writes I

[koganbot]

From: "Richard Kogan"
To: "Frank Kogan"
Subject: RE: collateralized debt obligations
Date: Friday, January 18, 2008 10:10 AM

The basic steps are somewhat like this. First, mortgage companies such as Countrywide induced a lot of people with bad credit to buy houses or refinance their existing houses by offering mortgages with very low "teaser" rates, which would then bump up at some later time. Countrywide's agents (and I am just using Countrywide as an example - there are other guilty parties) even helped the borrowers claim income or other assets they didn't have, in order to get the mortgage approved!

Countrywide and its agents then pocketed the closing costs, packaged the mortgages together in huge bundles, and sold those bundles to other very large financial operations (such as banks and hedge funds). Thus, Countrywide has "earned" the money it skims off the top of each transaction and no longer faces any risk if/when some or many homeowners eventually default. That risk, rather, resides in the package of large "securitized" mortgages. But those extremely large packages are assumed to be less risky than they really are because a) everyone "knows" that when a portfolio is diversified over tens of thousands of individual loans, it is less risky (but not in this case, because a huge proportion of the mortgages were risky to begin with); and b) those packages of "securitized assets" are erroneously certified as being low-risk by independent accounting firms, who merely assume that of course no mortgage company would deliberately market mortgages to people who were obviously bad risks!

Now that these huge securitized pancakes are certified as good, the hedge funds (which are not well regulated under US law, in contrast to normal commercial banks) can combine the mortgage packages with other types of interest-producing assets to make a mega-package that promises high rates of regular interest payments. The hedge funds then sell these mixed-source packages to big-market players, such as the largest banks or brokerage houses or multi-billionaires, who are seeking high rates of interest. At this point, the purchasers do not even know much about the composition of the packages - how much are mortgages, for instance - much less who originated the mortgages and how sound they really are. All they know is that the entire package is rated AAA.

Or the hedge fund can create more obscure financial instruments, such as a right to the interest earned by the package but not the principal, or vice versa, and these financial instruments are then bought as investments by big banks and brokerage firms.

My brother writes II

[koganbot]

(cont'd)

Ultimately, when the teaser interest rates are bumped up to a higher level, the poor deluded people who took out the mortgage to begin with can't make their payments. Far worse, though, is that they no longer have the ability to sell their houses on the open market and repay their mortgages because housing prices have actually fallen - they now have negative equity. As a result, the huge packages created by the hedge funds no longer can pay all the promised interest AND the underlying capital value of the package is also much less than promised - by an unknown amount.

As a result, major banks panic about how much of their balance sheets (which are really the property of their depositors) may be worthless, and start taking drastic actions to reduce their own lending even to perfectly sound business ventures because they might need to liquidate these probably-bad assets. From the point of view of the banks and brokerage houses, their biggest problem is that they have no idea how sound or unsound these assets they now hold really are, and no one can trace back the contents of the investments to figure it out, in part because no one knows how many individual mortgages will be able to keep up payments on their mortgages once the teaser rates expire and the required monthly mortgage payment explodes. As a result, the international banking and investment flow of funds "seizes up" or goes on strike, causing a lot of friction and ruining the normal function of financial markets - this becomes a big drag on international business investment, and especially US business investment.

The vice-president of the Fed kept warning Greenspan and Congress and anyone who would listen that this was coming and that the entire process needed a lot more regulation, but of course the disciples of Ayn Rand cannot hear the word "regulation" without turning blue.

Meanwhile, hundreds of thousand or even millions of poor individuals, often elderly and almost always unsophisticated, are eating into what is left of their life savings in order to pay the interest on a debt (mortgage) that is greater than the value of their houses. They have no way out except through bankruptcy.

And as you surely remember, the bankruptcy laws were "reformed" a few years ago by the Republican Congress and Pres Bush to the great detriment of individual debtors. Too many Democrats went along with this, so that the bill could not be filibustered; thank you one more time, Joe Lieberman.

[dubdobdee.livejournal.com]

in re the transparency issue, banks and other firms somewhere in the now shaky pile are caught between actually finding out what they're now worth -- ie taking the hit (which may be massive but survivable) -- and stabilising, or fronting it out in the hope that things reinflate, confidence -- with its outer layer of risk-taking -- re-emerges and the shortfall is papered over for now (cf the famous scene in IT'S A WONDERFUL LIFE): fronting it out, ir ordinary times for normal approach, currently looks like a declaration of desperation (ie admitting "we know we're worthless")

[koganbot]

I don't think this is a good analogy. The Building And Loan in It's a Wonderful Life had made no bad investments. The Building And Loan could reasonably expect that its loans would be repaid, and that its depositors would prosper. The institution was simply facing a panic: people were withdrawing their money because they were terrified that other people were withdrawing their money. Whereas in the current situation the banks and brokerages made bad investments and aren't going to get back all the money they'd put out. So in the movie Jimmy Stewart was facing a panic but not a fundamentally flawed financial situation, whereas we're facing the results of a bubble, where people were buying into things that weren't worth nearly what they'd been led to believe.

[dubdobdee.livejournal.com]

but all banks are "bubbles" -- they lend more money than they "have right now", because money in advance (capital in fact) makes all kinds of activity possible; paper money is in fact itself a "promise to pay"

the current situation is more flawed in the sense that, thanks to bad investments, there's far more exposure -- partly because lack of transparency means that the holes in the pile remain largely invisible -- and hence far greater risk; but it's not "fundamentally" differently flawed than ANY mortgage set-up: there's always SOME risk of non-payment (illness, loss of job, giant meteor lands on house, apparently great business idea is unexpected flop) and as soon as the risk becomes big enough, the institutions which manage the movement of holes in ordinary times become vulnerable themselves

the problem is the revelation of lack of value (and concomitant effects), not so much the actual lack of value -- what's frightened the market is not that they realised there are lots of scoundrels around (though there are) but they realised that the designated grown-ups who are capable of spotting the scoundrels have created systems which so rigorously obscure the scams that they literally don't know till they open the box if it's going to be full or empty

in fat times, you can get round this -- just don't open the box and sell it on -- its continued circulation keeps itself aloft (by which time the "bad investment" mortgagee may have got a new job and be paying his way again, the the hole is disappearing)

[koganbot]

I'd thought that "bubble" meant that things were valued far more than they were worth, with speculators jumping in on the assumption that things are rising quickly enough for them to make a quick killing, and their jumping in helping to inflate the bubble. "Everything is a bubble" is like saying "every sound is loud" and "every climate is hot"; is true if you define "bubble" as "anything that is 100% risk-free" and "loud" as any sound that could possibly be detected by the most sensitive instruments imaginable and "hot" as anything that isn't absolute zero. But that simply takes "bubble" and "loud" and "hot" out of the language. (Didn't yr bud Hegel say differences in degree can be differences in kind? I wouldn't know, not yet having figured out how to penetrate his prose.)

[koganbot]

"anything that ISN'T 100% risk-free"

[dubdobdee.livejournal.com]

yes this is certainly a good example of quantity becoming quality -- that at a certain point value-inflation becomes unsustainable

you're kind of saying it can only have been a bubble after we know it's burst: i think i'm saying that bubbleness should be taken to include those situations which turned out after the fact to have smoothly deflated without catastrophe, and that's there's actually a continuity across the catastrophe point, and that banks do basically work in this general area, because if you count the worth of a bank as "all the cash it could actually give out right now", this is hugely less than worth defined as "all the cash it has promised it is holding for you the depositor" -- but that in routine times of good information (which is to say trust) people are prepared to say, "ok i won't take my money out now if that will help"

the point i'm making about risk isn't that there aren't different levels or kinds of risk, which need to be handled differently -- it's that a system has been set up which (rather deliberately) obscures this fact: it WAS (i would argue) pretty much sold the way krugman says it was, tho probably the pitch wasn't collapsed into such a brutally contradictory sentence: large numbers of the buyers wanted to believe that this circle had been squared (because they were making comfy money now and didn't want to imagine they were borrowing against the future -- but of course they were...)

[koganbot]

Er, not sure you were making an analogy, actually, just a reference, but I don't think the reference works. Iirc, Jimmy Stewart was able to stop the panic by convincing enough depositors that if they held tight, enough money would return to cover them and that the people who'd withdrawn in the panic would redeposit. Whereas in the current situation the money simply isn't there to be redeposited, so to speak, since the loans were bad loans.

[dubdobdee.livejournal.com]

well in the film, the bank is a single small solo local family-run bank, rather than a multi-national trading on all the foreign exchanges, so the idea of "not enough money to cover" is a bit more concrete -- the actual bags of coins will run out

but the principle is identical -- and jimmy stewart has ABSOLUTELY NO REASON TO JUSTIFIABLY BELIEVE that ALL the bank's loans are good (or, good or not, that all the money will come back in): as you say, all he has to do is persuade everyone that they needn't worry and not to take THEIR money out (in cash)

banks are there to give people money who don't currently have it -- on the assumption that at some point they will, but of course it's not actually a problem if the debt is never repaid during the lendee's lifetime, as long as enough debts are serviced in a small enough way -- the fiction of general repayability is sustained


the issue of good or bad loans is a bit of a red herring -- the interest being charged on a loan is a reflection of the degree of adjudged risk, so a bad loan would (normally) simply be an expensive one

(in the diagram i linked to the bottom buckets are called baa i think -- the people buying into these are getting a high return becase they assume they are high risk)

the problem is that the degree of exposure are all screwed up by the system of bundling different tranchers of debt and reselling, rebundling, reselling, rebundling, reselling -- so where the flaws and holes and risks have been rendered invisible... literally no one knows where the shortfalls are going to be

this has suddenly struck home with tremendous force: so jimmy stewart today CAN'T convincingly tell the punters the lie that the debts can be covered; in the film he can convincingly tell this lie (even though in fact they can't)

[koganbot]

I give up. If you're going to say that any risk is no different from a lot of obvious risk, then we're just going to keep talking in circles.

[dubdobdee.livejournal.com]

it's too long since i saw the film so i may be totally misremembering -- isn't evil plutocrat potter withdrawing his money to start the run? -- but jimmy saves the bank by reintroducing collective mutual trust: trust that the system will continue to work, if "we all pull together", even if some default occurs (ie potter's withrawal reducing the "value" of the bank)

what i was saying is that the principle of bank ruin is identical whatever the reason for the money supply suddenly dwindling -- whether it's potter being evil, or poor people being poor... these various different levels of risk are insured against differentially, to ensure that the money can continue to flow if one or other occurs providing risk can be assessed reasonably accurately (but as a caveat here, i am arguing that this is very much a node of potential bubblification; because inaccuracy is incentivised, because you make more money that way)

nor is the general overall principle the CDO idea in itself ludicrous, that if the flow of money is generous and consistent enough, loans that would ordinarily be called bad stop being bad (or so bad); the issue in this particular instance being the extreme lack of transparency (which was in fact rather built into the magic of the sales pitch) which ensured that it was impossible to tell what the flow of money would actually be, because the risks are lousily assessed (and some of the insurers are themselves turning up bankrupt, or hugely over-exposed and over-valued)

if what you're calling bad loans had remained very visible, they would have remained boxed off in high risk areas of the money market, not a threat to the whole system -- but the way the system has been structured, when people now reach for a "perfectly safe" tap they expect to deliver flow (which is what insurance is), it's turning out to be dry: the problem has been the transfer of the "badness" into areas assumed utterly secure, far more than it's the presence of "badness" at all

instead of securitisation, it's turned out to be a system of "insecuritization": which has led to a catastrophic failure of trust, panics, runs on banks and so on

[dubdobdee.livejournal.com]

so actually where the analogy break down is this

jimmy is saying TRUST ME and making the mechanism transparent -- here's how it works, we all pitch in and the bank doesn't go under -- and despite the money not being "there", the situation is saved

the corps i'm talking about are saying TRUST ME, if we all pitch in the corp doesn't go under -- but they're NOT making the mechanism transparent (either cz they've peeked and don't like what they see, or bcz they daren't even peek) -- now this may work or it may not (because who knows what's in the box), but i am saying they are playing at being jimmy stewart here, and if they pull it off they might be in the clear (box never gets opened; full-on panic isn't engendered; debts never get called in)

besides which they CAN'T make the mechanism transparent bcz they don't understand it themselves <--- and this is where i'm arguing the most disastrous flaw lies (obviously no subprime debacle without bad loans; but the true extent of the debacle lies less in the taking on of this many bad loans, than in the salting of their effect so chaotically throughout the system)

(haha the reason i know i "don't understand economics" is that i REALLY REALLY know i find it hard to express clearly what i'm trying to say)

[blue-russian.livejournal.com]

your modesty about your economics knowledge is false, btw

[dubdobdee.livejournal.com]

thx for sayin mitya but while i do know i generally have a feel for form and shape and flow -- i am (or was once) a trained and ok-ish mathematician/geometer, and that's what we do -- i ALSO know i am totally wadin thru glue when it comes to EXPRESSING this feel for others to grasp: and of course its mathematics 101 that you don't understand the theorem if you can't publicly prove it (that public proof and understanding and clarity are actually the same thing) (in maths anyway)

[koganbot]

Well, what I'm not getting here is your contention that all banks are bubbles. You might as well be saying that all precipitation is a hurricane. Or that all currency is a bubble. I mean, currency depends on the social agreement that people will honor it. If you take the position that anything based on social agreement is a bubble (because who knows when an agreement might not break down!), then yes, banks are bubbles; so is language; so is pretty much anything having to do with human culture.

But "bubble" means something specific: not that someone is taking a risk by loaning money to someone else, but that assets are hugely overvalued and rising in price at such a higher-than-usual rate that speculators are investing in them on the assumption that the rise will continue.

BANKING AND BUBBLES

[dubdobdee.livejournal.com]

ok franks' question is interesting -- to me -- maybe less bcz our differences tell us a whole lot about economics; more bcz it shines a light on how my own lizard-brain works:

to recap:
i am (rhetorically but insistently) arguing that we should think of banks and bubbles as co-terminous; frank wants to keep the word bubble for "when banking goes bad"

(instant caveat: ok that's already an reliable simplicatifcation on my part: "banking" used there a redux for a whole spread of modern institutional practices which might be better if less euphoniously named "institutional money management in toto" -- of course these institutions are indeed inextricably locked together, by no means the quasi-autonomous agents that jimmy stewart's bank probably much more seemed it was)

there is a bunch of ideas all mixed up in my position -- a bit of hurried reading round and distinction-making last night led to the following de-mixing:

what's behind my original bluntly wild claim:
i: not-quite-reliable memories of the stories galbraith tells of the founding of modern banking in the 17th century, in "money: whence it came and where it went"
ii: my thumbnail sketch for myself of galbraith's position on "sober vs intoxicated banking"
iii: a thing we pulling apart on i think is, which element of the metaphor bubble is the key to a situation's getting called a bubble -- the issue of "over-inflation" or of "well look it burst" (a the burst or crash being a high-speed deflation); i am stressing over-inflation, which i'm arguing is a key to all banking, sober or otherwise, and frank is stressing speed (of fall but also of the rise before the fall), which is a feature of intoxicated banking --- banking off at the far end of the dubious behaviour spectrum

(wiki on bubbles): "The cause of bubbles remains a challenge to economic theory... Because it is often difficult to observe intrinsic values in real-life markets, bubbles are often identified only in retrospect, when a sudden drop in prices appears."

what's behind my refusing to back down and be responsible and sensible
iv: i'm balking at the deep-level implication of frank's line in analogies -- i think i would say out of "geometrical instinct"
v: in general i don't want to cede (without a discussion) that "ordinary usage" (if ref the relationship between bubbledom and bankdom) doesn't carry dodgy ideological baggage -- in other words, that to accept "good banking is sober banking" is something i ought to be building into my political institutions...)

the overall point:
vi: the issue of value, and how it's achieved --- the issue of last resort, reserve turtles all the way down and a VAST BLACK HOLE at the bottom...)

BANKING AND BUBBLES II

[dubdobdee.livejournal.com]

To expand on these one by one:

i: HOW IT ALL BEGAN
john law was a scotsman on the lam -- he ended up in a 17th-century france dogged with a VERY overspent and miserably stymied state, and proposed AN MAGNIFICENT SCAM --- he started up a bank with royal blessing, began issuing notes, cleared the state's debt by loans, turned the economic situation around, was created COMPTROLLER GENERAL of ALL FRANCE and (better still!) the first and last Duc D'Arkansas... parallel with the bank, in fact absolkutely plugged into it and yes co-terminous, he set up a joint stock company offerign shares in a project to dredge up the vast reserve of gold nuggets that (surely?) lay for the taking in the muds of the Mississippi -- in fact the money from the shares was ever diverted from setting up this glorious expedition, to provide loans for all and sundry to purchase more and bigger shares in said expedition --- and of course eventually some miserly sourpuss smelt a rat, demanded his cash back in METAL not notes, and the whole thing unravelled at high speed, leaving the median French citizen powerfully suspicious of banks for centuries to come; meanwhile in the UK, the newly founded Bank of England and a bold private start-up the South Sea Company were vying to service the British state's vast and miserable debt -- the South Sea Company being so successful that the more sober and timid Bank of England eagerly helped finance its rise, as it promised the reap all the Treasures of Ind, East and West: similar deal; thrilling speculative inflation, sudden comico-tragic collapse, followed by a century-long ban, the Bubble Act, on JOINT-STOCK COMPANIES, which is to say, on any bank run as a private company. At the time of the founding of the US, which falls within this century, the villain in the piece was essentially the BIG SCARY CHEAT that is PAPER MONEY: Jefferson disapproved of a bank's issuing notes; every bank bill issued, wrote John Adams, in excess of the reserves in vaults (ie gold and silver to hand),"represents nothing, and is therefore a cheat on somebody." But the kinds of banks Jefferson and Adams desired are NOT the banks we have.
[for expansion on the "represents nothing" point see v]i

ii: AGAINST SOBRIETY
Galbraith's line i think -- doubtless somewhat distorted by my own perversity and plus tendency to use the prankish contrarianism of others as a mnemonic to their thought -- is that sober banking is BY NO MEANS the undiluted good it seems; that MUCH SOCIAL VALUE has arisen in eras when banking has been very wildstyle indeed; perhaps unusually for a liberal, he's an anti-puritan (and very funny on the airs that bankers-as-moral-arbiters give themselves); he has a huge fondness for the piratical -- given the system we have chosen, crookery and liquidity and excitement and general prosperity and good feeling (and indeed successful revolution, at least in the American and French senses) are all bound up in one another; sober banking is stuffy bureaucratic repression if not depression, tamped-down status quo same old same old....

iii: EUCLID AND ME
(very much in redux form) frank wants to cleave to ordinary useage, because for him the issue is "when banking goes bad"; i want screw with ordinary useage somewhat a bit, because i am more interested in the question "when BUBBLES go bad" ---> not assume that bubbles are inevitably bad, let alone that it only counts as a bubble after the bad stuff (the crash) has happened -- to me this is just too like saying "it's only a crime if you're caught"... i want to open up the issues of a. bubbles-that-didn't-burst, and b. bubbles that AREN'T BAD; to shift focus from "when banking goes bad (and when it isn't)" to "when bubbles go bad (and when they aren't)" ---> if the complaint is, but your pushback takes it way too far, my response is, "so let's find the point along my pushback when it hasn't gone too far yet"

BANKING AND BUBBLES III

[dubdobdee.livejournal.com]

iv: DISCRETENESS IS THE BETTER PART OF VALUE
by comparing "risky" say with "hot", Frank brings in an excellent rule of useage in respect of comparatives: that a wordshift that builds in an absolute spells ruin and uselessness for a comparative; yet what i instinctively feel here, and doubt, and react against is the implicit if embedded assumption about LINEARITY --- clearly with heat we can move uncomplicatedly along a smooth scale from hot towards hotter; but "risk" is not a simple category or quality -- it's a combination of several distinct elements, in different proportions, and shifts from small risk to large risk can be a generalisation of very different kinds of change, along different elemental axes, NOT ALL OF THEM SMOOTH... [in a sense, though in practice broader tolerances are likely built in, the jump from all OK to RUIN is one last tiniest of steps: one cent's worth of difference...] -- my definition of bubbleness, which accords more with the fact of value-inflation than the measure of rate of change, is ONE of the elemental axes; i guess i am saying -- let's not assume this is the only one which matters, and budget all our patrols and controls for this terrain...

v: THE POLITICS OF METAPHOR
er what i already said in the short version i think! (and plus what you just said): yes indeed, because -- at some point -- value is measured via metaphor, that banking is -- at that point -- a "bubble" rather than a sober technical measured institute of enumeration, storage and exchange... the appropriate respectable sober proper useage of bubble is itself -- at certain moments -- vulnerable to significant (social) value-deflation; i don't at all mind "well but this doesn't happen very often so can we set it one side while we examine the precise measurable nittygritty of the situation to hand" but i DO mind "this can never happen so let's make its discussion unacceptable" ---> is the current economic-political set-up in the west on the brink of ruin? (probably not but what do i know?); is this "brink" merely mythological? (er no i don't believe so -- the US imperium is VERY overstretched, militarily economically and politically, and its many until recently very effective correcting mechanisms most of them seem to be grinding wildly and ineffectively at the moment) (addendum: largescale wars are a REALLY BAD IDEA just to toss around as part of a correcting mechanism, because they introduce all kinds of hard-to-monitor chaotic elements, not least in the transformation of monetised value to social value and back) (<--- huge unthought-through point i'm not going to expand on in this comment)

BANKING AND BUBBLES IV

[dubdobdee.livejournal.com]

vi: "OF LAST RESORT" IN THE FINAL ANALYSIS: "IT'S TURTLES ALL THE WAY DOWN, YOUNG MAN"
As goldbugs everywhere yell, without the metal reserve SAT IN THE VAULTS READY TO HAND BACK TO THE DEPOSITORS the issue of "notes of promise" (pounds or dollars or yen) -- whether on paper as in days of yore or as electronic ink today -- is a declaration that value is what we say or think it is; that there is NO "true" or "proper" or "intrinsic" value to fall back to, other than "what we largely all agree on currently". (Other units of measure are sometimes invoked or assigned as the site of "intrinsic value" -- such as the Smithian-Ricardian-Marxian "labour theory of value" -- but all of them end up at a point where the atomic unit of measure is being assigned a value extrinsically, by a social choice or decision, rather than an objective act of scientific measurement.... )

The breakpoint or crux that I'm returning to every time is the point where SOCIAL value shifts (as opposed to issues of MONETARY over-valuation): ie confidence flicks over into panic. Historically this comes at the moment when the depositor doubts that what's been deposited is "still there" --- and what I'm pointing out is that, for anything we'd usefully want to call a bank, there's a sense in which what's been deposited is NEVER "still there"; yes it can be conjured back via a complex set of dances and cheats and fictions and displacements and delays, but absent these, the heart of a bank is an absence not a presence; and its valuation is a promise against the future not a truth about right here and now. A bank is a GOOD BUBBLE, if you like; and a "bubble" merely a good bubble gone bad --- but good and sober banks can also be ruined, if the circumstance are just so.

Fundamentally the problem with theories of actual real material reserve -- viz goldbuggism -- is that the totality of gold and silver in the world is minute compared to the current needed liquidity to enable world trade to flow EVEN AT A SOBER RATE: you'df have to make a choice to over-value the reserve. High-street banks don;t have the metal ready somewhere; they have an agreement with the national central bank, that -- if catstrophe looms -- THEY can borrow. The national central bank probably DOES have vast reservces of metal ready somewhere (certainly the Fed does); but these reserves don't REMOTELY cover all the central bank's promises to pay -- if these were all called in at once the Fed would go bust. In addition to any reserves of metal it may have, the central bank can borrow abroad -- via the IMF, via the banking and loan systems of other states (states considered as vast corporate conglomerates), via any number of other multi-national institutions and even individuals... currently (notoriously), the US is hugely in hock to China, Japan, Europe somewhat, to a lesser extent Saudi Arabia...

While the dollar remains -- through cultural inertia, for a variety of other political reasons, the currency of last resort, at the core its last-resort capabilities, as a reserve to pour into any given failing bank, there is a huge hole that's all promise and no content...

BANKING AND BUBBLES appendix a (wildstyle and possibly bogus)

[dubdobdee.livejournal.com]

Over-valuation and the most basic bank of all:
koganbot needs a quarter. I offer to loan him the quarter I just borrowed from carsmile. Ignoring the complications of interest -- which is how carsmile gets enticed to deposit with me, and I get rewarded for my social helpfuness -- at this point, the bank of dubdobdee is publicly valued at ONE QUARTER (where the public is carsmile, who knows he deposited a quarter; koganbot, who knows he owes me a quarter; and me, because a majority of those concerned agree so to value me... but my actual liquidity value and reserves value AT THIS PARTICULAR MOMENT is zero...)

(actual real economically literate foax plz to poak hoals in the above as i just kinda made it up in bed last night?)

Re: BANKING AND BUBBLES

[koganbot]

frank wants to keep the word bubble for "when banking goes bad"

Where did I say that?

Here's an analogy, not necessarily one I'll stick to, but think of "Frank wants to keep the word 'hurricane' for when weather goes bad." But first, I want to reserve "hurricane" for specific events that aren't, for instance, tornadoes or blizzards or droughts. And second, hurricanes are recurring events, even if rare in relation to a particular town. So they're not aberrations. And whether they're "good" or "bad" is a question I'll bracket.

Or think of forests and forest fires and rivers and floods. I can think of any forest as potentially at some point developing into forest-fire conditions, but I'd still reserve the phrase "forest-fire conditions" for particular conditions that make a fire in the near-term a real possibility, rather than saying that "all forests are potential forest fires." You could say the latter, but then you could also say that all forest fires are potentially lush and florid forests, since the forest fire will burn out eventually, leading to the conditions for new growth.

My point here is that if you want to use "forest-fire condition" for any forest in any of its states, then what word would you use for what we're currently calling "forest-fire conditions"?

Another analogy might be electrical grids and blackouts (this maybe being a closer analogy - I'm not sure - since electrical grids were created by humans, just as banking is). If I understand Duncan J. Watts correctly, he is saying that the overload that causes blackouts will keep occurring no matter how well you prepare, since random events at some point will cause a cascade effect where the electrical overwhelms the system. And of course another example Watts gives of a cascade effect is a financial bubble. In this instance, he's not saying that blackouts are an integral feature of electrical grids, but he is saying that they are unavoidable. (Whereas there is a school of thought that says that forest fires are integral to forests, and if we want to manage the fires we've got to give up our zero tolerance policy towards fires, or else we'll end up making them worse.)

Re: BANKING AND BUBBLES

[dubdobdee.livejournal.com]

forest-fire vs blackout -- haha i keep changing my mind about which is a better analogy

neither of them seem quite right: not least because a bubble is NOT the actual crash, it's more like the conditions moving towards a crash, and there's some disagreement whether a bubble has to end in a crash to be a bubble --- triffidfarmer, not a banker, but works in the city, read this whole thread and said, "yes, 'bubble is a bit of a my weed is your flower' type word...")

but integrality is i think key to what i'm getting at; so that's helpful

Re: BANKING AND BUBBLES appendix a (wildstyle and possibly bogus)

[koganbot]

a wordshift that builds in an absolute spells ruin and uselessness for a comparative

Yes, and this is true whether there's "linearity" or not, so whether or not you think there's linearity, you have to make a comparison rather than build your idea of "bubble" on an absolute. And you haven't done so, since this is an absolute:

for anything we'd usefully want to call a bank, there's a sense in which what's been deposited is NEVER "still there"; yes it can be conjured back via a complex set of dances and cheats and fictions and displacements and delays, but absent these, the heart of a bank is an absence not a presence; and its valuation is a promise against the future not a truth about right here and now.

Again, if you're going to define things this way, then any social practice is a promise against the future, the heart of any social practice is an absence not a presence, and all social practices can only be reanimated by fictions, cheats, displacements, and delays. The problem here is that you've made the terms "presence" and "absence" vacuous, since nothing is present and everything is absent - you've turned them into what I call "stupor words" - and for your own purposes you've shot yourself in the foot, because you've really said nothing more than "banks are social practices, and social practices are based on social convention." Whereas what you're really wanting to figure out is whether banks are wilder and more speculative than other particular social practices, and wilder and more speculative than its reputation. Which is to say that if you're going to develop your predilections into actual ideas, you're going to have to make actual comparisons to actual social practices that you don't consider to be at heart an absence, preferably financial ones.

Re: BANKING AND BUBBLES appendix a (wildstyle and possibly bogus)

[dubdobdee.livejournal.com]

"if you're going to define things this way, then any social practice is a promise against the future, the heart of any social practice is an absence not a presence, and all social practices can only be reanimated by fictions, cheats, displacements, and delays" -- i don't think i follow this... i'm not defining "things" this way, i'm defining banking.... i don't see how this definition (or "type of definition"?) automatically applies to every other social practice as a result of what i've done here (which is making a distinction between this and other social practices)

(obviously there are other social practices that this [type of?] definition -- at least if taken separately from the various concrete historical elements i also discussed -- might describe)

Re: BANKING AND BUBBLES appendix a (wildstyle and possibly bogus)

[dubdobdee.livejournal.com]

oh! i just got what you mean i think -- but i am not going to try and make the definition clearer tonight!

(yes the way i've defined it assumes stuff about the basic difference between money and barter, and also skips very quickly through the difference between "metal" money, where historically there was a reserve backing the coinage, and paper money where there isn't) (to oversimplify the history of it rather a lot!)

anyway the stages i'll be distinguishing are these:
barter <--- heart of barter is presence not absence
coinage <-- being the equivalent value in metal to the object of exchange
notes or paper money <-- ie a chit which states a "promise to pay the bearer" the note's value in metal
electronic

shall we start another thread for it?

Re: BANKING AND BUBBLES appendix a (wildstyle and possibly bogus)

[koganbot]

Whereas what you're really wanting to figure out is whether banks are wilder and more speculative than other particular social practices, and wilder and more speculative than its reputation.

My pronouns got confused. Change "banks" to "banking."

Re: BANKING AND BUBBLES IV

[dickmalone.livejournal.com]

But metals aren't intrinsicly worth anything either, are they? If people decide that they have no real need for gold then you couldn't use it to get useful material goods and the whole thing would collapse on that level too. The moment economics stopped being about bartering cows for grain, we reached a level of fundamental abstraction, right? The idea behind metals seems to be that we all agree that they're worth something, and that's the point we've gotten to with paper money too--there's a limited supply of it, people will give you food in exchange for it, and it seems "precious." The system hasn't really collapsed-collapsed at any point in the Western countries (there are depressions, yes, but people don't suddenly stop valuing paper money as a whole--of course this has happened in third-world countries but that seems outside of our current discussion).

So while I think it's interesting to think about the value of non-sober banking, I don't know if speaking of all banking as bubble is necessarily helpful. When people were warning of a housing bubble before the current crisis, they weren't arguing that eventually those houses would not be exchangable for gold, they were arguing that people were being enticed by artifically (i.e., non-transparently) created short-term gain to engage in an activity that would result in a net loss, plus all the concomitant social problems that would entail (i.e. since it would look like a good investment people's retirement funds would be tied up in it, that new home buyers would be forced to get these risky mortgages because the price of new homes had risen so high, etc.). Bubbles aren't a site of unreal value--you're right in saying that almost everything is a site of unreal value given our current setup--but are things that pop. The reason we can't be sure a bubble was a bubble is that bubbles have to pop. If housing prices just slowed down in their growth a bit everything would've been fine (-ish), but the predatory lending practices and shady investment strategies caused people to suddenly think they had no idea how much these things were worth.

I do think that things are much more stable now than they ever have been--certainly bad things still happen, but there a ton more controls in place and the current crisis isn't the result of some fundamental flaw in the system but retarded supply-siders not listening to legitimate calls for regulation. That said, one of the reasons I am somewhat gloomy about the likely prospect of a Democrat for president is that there are three giant messes they will have to clean up. Not just Iraq, but two huge problems the administration has been totally ignoring: the environment (where they're being outpaced by the states, who have now gone so far as to take the federal government to court over its refusal to enforce environmental regulations) and the defecit. A lot of the (perceived) weakness of the US economy comes from the weakness of the dollar, and (as I understand it) the weakness of the dollar stems in large part from our ginormous national debt. Foreign investors look at our debt, doubt our fiscal stability, and value the dollar down. So the next president is going to have to do something the GOP hasn't been willing to do since it got into power, ironically: cut spending. They're also going to have to eliminate tax cuts and, probably, raise social security taxes, none of which is going to be popular but all of which is absolutely necessary for the continued health of the US economy and the value of the dollar. (This is one of the reasons I'm so big on Obama--dude can make shit sound like Shinola, whereas Hillary makes you suspect that maybe cake is not so delicious after all. But she's still gonna win. Sigh.)

no future no future no future for we

[dubdobdee.livejournal.com]

"But metals aren't intrinsicly worth anything either, are they?" er no -- i didn't mean to suggest goldbugs are right; stable monetised value has always been a product of a (sustained) collective act of imagination

"I do think that things are much more stable now than they ever have been" -- but ARE they? ok, so the old-skool sober official defn of a bubble just revealed itself (tho not yet its scale) by bursting (it's ALREADY a pretty big deal, with a lot more to surface)

but much bigger (value) bubbles also sometimes burst: WW1, for example -- total collapse of european stability and order, unthinkable after the longest period of stable peace since euro-records began; there and unstoppable not quite overnight, but VERY quickly -- ie months rather than years... the gruelling assumption, thorugh the next quarter century, was that the old guard (the 19th century euro-empires that remained standing) could right themselves, rebuild shattered confidences in themselves (their own and the world's) and set something workable up again... this is totally not what happened

[koganbot]

I actually don't remember, but I think the bank run was a random event - not Potter-induced - the role of which in the plot was to prevent Jimmy Stewart from going on his long-dreamed-of vacation/honeymoon to Europe.

I do think that "bubble" has a way narrower definition than you're giving it. People were calling the tech and the housing bubbles "bubbles" before they burst, saying that prices were way overinflated and that the people who were investing expecting the prices to keep rising at the same rate were in for unhappiness. I think a bubble that doesn't burst so spectactularly is called a "fad." But I do think that a bubble will feature people investing on the assumption that a much higher rate of growth than the previous norm is now the new norm. Obviously all lending depends on the expectation of some growth or at least not a major contraction.

Sorry for being impatient above.

[dubdobdee.livejournal.com]

don't be! it's an excellent sign i'm still fuzzy abt things -- i *think* i know what i'm trying to say here, in a jargon-free way (and i suppose at root i regard the whole of capitalism as more of a risky flimflam than say krugman does) but i'm absolutely certain i'm not making it clear, to myself or anyone else

[koganbot]

Actually, what Capra is doing is more subtle than having George Bailey/Jimmy Stewart saying "Trust Me." It's been years and years since I've seen the film, but the way I remembered it, the bank wasn't simply small and family run, it was something of a credit union. And what Capra was having Jimmy say was, in effect, "Trust Us," meaning trust your neighbors, whom you know, who are your fellow depositors and the ones who are building homes on the basis of the money - our deposits, from you! - we lend to them. So he was saying, "Trust us 'cause we are you, and we are the small guys and you know us." (And now I recall for sure that Potter wasn't invested in the Building And Loan, 'cause later, when Jimmy's uncle loses the $8,000, Jimmy goes to Potter to bail him out, and Potter refuses). Whereas the people who are hoarding the money now are large institutions who, if my brother's account is right, are - with reason - not trusting their own assets. They're holding onto their own money because they don't how much money they've got. In the movie you're not assuming that Bailey has suckered Martini into a mortgage at rates that Martini can't afford, whereas in the current subprime mess you have institutions who've (sometimes unknowingly) invested in "assets" that turn out to be based on the solvency of suckered Martinis, many of whom are going to end up insolvent. Even in Bedford Falls (was that the name), a certain number of Martinis are going to fail, but because of the housing bubble and unethical and highly nontrasnparent dealings, you know that way more Martinis are failing, but you can only wait to see how this plays out.

Notice how I'm now writing with great authority about something I was clueless about several hours ago, and may well still be clueless about!

[koganbot]

Oh, and Potter was involved in the Building And Loan. I just checked Wiki:

An avaricious and opportunistic board member of the Building & Loan (and owner of most of the town), Mr. Potter (Lionel Barrymore) seizes this opportunity to gain control of the Board of Directors and end the "nonsense" of home loans for the working poor. George makes a reluctant but impassioned plea to keep the company independent, moving the board members to agree, but only if George remains to run the business.

But Potter has nothing to do with causing the (later) run on the bank, I don't think. But he does try to take advantage of it by offering 50 cents on the dollar to anyone who wants to sell out.

Re: My brother writes II

[dickmalone.livejournal.com]

that's really interesting, thanks for posting it.

[koganbot]

By the way, my brother writes here for a living: http://www.cbpp.org

E.g., Claim That Tax Cuts "Pay For Themselves" Is Too Good To Be True

[koganbot]

Wow! All this action on an economics thread. If only I could get you all to comment on Taylor Swift covering Eminem.

[justfanoe.livejournal.com]

I find economics confusing, because for all the intelligent, qualified people like your brother and Krugman who believe and "prove" one thing, there are (apparently) equally intelligent and qualified people who believe and "prove" the opposite. Most people, like myself, lacking the ability to really understand the arguments in play, just believe what they want to believe anyways.

[justfanoe.livejournal.com]

For the record, in case it isn't clear, I am not criticizing economics/economists in general. I have some interest in the field and work in a vaguely related field (insurance). It's just hard because I can read equally convincing arguments for two mutually exclusive viewpoints, and I just don't have enough of a knowledge base to determine which argument is flawed.

Comparing me to Richard

[koganbot]

Well, I have a feeling that the arguments in music criticism are even harder to test than arguments in economics.

Re: Comparing me to Richard

[justfanoe.livejournal.com]

True, but a lot of interesting music criticism is non-academic in nature. Whereas, somebody without a rigorous background in economics has zero to add to any economics discussion worth having. Or that's my impression at least.

Re: Comparing me to Richard

[dubdobdee.livejournal.com]

the famous exception to this is john maynard keynes who arrived in the discipline, utterly self-taught, and turned it on its head (obviously that was a long time ago, and what constitutes the Discussion today is in some ways very different)

(but in others, not so much: there's currently a furious debate raging within economics departments -- or rather on the fringes of them -- about the degree of political bias that is built into what constitutes "a rigorous background in economics": i think the buzzword for the argt is "heterodoxy"; and a good deal of it is about how you approach the "economics" of values that haven't been monetised, or -- even more knotty -- that resist being monetised)

Re: Comparing me to Richard

[koganbot]

This ties into the diversity thing we were talking about yesterday: the fact that Keynes was self-taught meant he wasn't as tied to what everyone else was taught. But that didn't mean he didn't master what everyone else was saying. (I assume he did, but I don't know enough about it.)

Re: Comparing me to Richard

[dubdobdee.livejournal.com]

the issue today is -- somewhat -- about whether what's required for entry into the "seriousness enclosure" of the Economics Discussion CAN be mastered by an (obviously bright and determined) amateur; economics is much more technical today, and the sheer reach of the range of techniques required to prove you're "one of us" probably militates against anything like this

(all specialist departments face a similar issue of course -- there are arguably branches of science which can no longer be quite considered "commensurate" in the kuhnian sense, because they've evolved hermetically in opposite directions -- but the question is more obviously urgent in respect of economics, which has such huge political impact, wrapped in such rebarbative justification)