Comments for Boring Banking Will Not Save You

Boring Banking Will Not Save You

2009-05-07T15:42:16Z

Paul Krugman wants us to believe that by making banking boring again, we can prevent another crisis from occurring in the future. Although Krugman doesn't provide any clear definition of what it means to make banking boring again, the context suggests that he is pushing for a return to a simpler and smaller banking sector. As such, Krugman offers up a very comforting theory, since the benefits of making banking boring are twofold: ridding us of devastating downturns while simultaneously smiting those greedy bankers. So in addition to fitting nicely into the fashionable banker-bashing meme, Krugman's argument provides comfort in that it suggests the problem has already been identified and has a simple fix. Unfortunately, making banking boring again would probably have a devastating affect on the availability of credit, particularly at the consumer level, and won't do a thing to stop asset bubbles from occurring in the future.

]]> Krugman paints the recent history of banking with broad strokes - in contrast to James Surowiecki's reasonably detailed article on the subject - drawing primarily on what is little more than the coincidence of boring banking and economic stability. In essence, he claims that we did our best when banking was boring. Presumably, we are to infer that this coincidence compels us to accept that boring banking is indeed the cause of economic stability. Answering such a complex question with such a simple and obviously flawed form of argumentation would normally smack of idiocy. But in Krugman's case, it smacks of paternalism. Krugman is undoubtedly smart enough to know that abstracting from historical coincidences is an unacceptable method of discovering theories of causation, even for an economist. So, with this, I invite Mr. Krugman to explain why boring banking is superior to interesting banking. In the meantime, here are some things to consider before smashing banking back into the Stone Age.

Securitization And The Capital Markets

Securitization takes money from the capital markets and funnels it into the consumer credit market by bundling individual loans, lines of credit, and mortgages that would otherwise be unattractive to investors on a piecemeal basis. Tremendous sums of money are funneled to consumers using this process, particularly in the mortgage space. If the boring banking regime precludes securitization, we can expect this capital to either sit idle or go elsewhere, thereby depriving consumers of credit and spending power.

Bubbles Are Nothing New

Markets experienced bubbles long before credit default swaps and securitization were even a glimmer in a greedy banker's eye. And so stripping bankers of the tools and techniques of modern finance will do nothing to stop them from occurring again. Whether it's tulips, internet stocks, or spec houses, humans create investment fads that skew prices upwards and create value out of thin our. Then, once the jig is up, prices tank, and those still dancing are left holding the bag. And so, every asset bubble will create a class of losers: those who bought during the boom and held on past the bust. In my humble opinion, the severity of this bust will turn on who's in that class of losers. If that class of losers turns out to be a group of individuals or businesses that perform a vital function in the economy, e.g., lending, we should expect the effects of the bust to be pretty severe. At this juncture, a boring banking argument could be made. That is, we don't want banks to be heavily exposed to asset bubbles popping, whether it's through lending or direct ownership. But this is no different than saying that we don't want banks to make too many risky investments, since systemic bank failures have severe consequences. So even in the context of bubbles, it's not the complexity or sophistication of banking that is at issue, but rather the accuracy of valuations and the adequacy of the capital that banks set aside in anticipation of losses.

Comment from Vicious Virtue on 2009-05-07

2009-05-07T17:09:04Z

Sir! Your articles are usually reasonable and well-reasoned, but today I must take issue with two of your "points."

First, you characterize the Sham Wow as a fad. Absurd! Quite unlike the faddish bubbles you have cited, the Sham Wow has maintained a bargain-bin price despite an understandable rise in popularity. Beanie Babies and Christianity are fads; the Sham Wow is a miracle of modern science.

Second, how can you call yourself a blogger when you failed to link to a certain web comic in rebutting Krugman's fallacious correlation-causation/post-hoc-ergo-propter-hoc argument? This is the kind of sloppy oversight I expect from a rank amateur, not a seasoned veteran like yourself.

Tut-tut, Mr. Davi. Tut. Tut.

Comment from Marshall McLuhan on 2009-05-07

2009-05-07T18:53:02Z

Securitization doesn't involve money at all. You seem to have trouble distinguishing between money and credit. From what I read above you seem to have trouble understanding the difference between being a boring bank and being a financial service company. When Glass-Steagall was enacted in 1933 it was meant to remedy this very problem with distinctions between money borrowed to play a market and money borrowed to gain an asset.

Credit is not money.

And, shame on you, for referencing a link to your own explanation (however flawed or correct) on Securitization.

No one should be advocating (as you seem to be) for people who earn and save having to suffer because other people wanted better bank ratings and other ratings agencies didn't understand (or want to know) the downside risk of SPVs and those who borrowed heavily in order to make plays in the market with Swaps. All this can be operated in an open and free market so long as it doesn't drag in all those other people who never asked to be part of it.

The bailouts are about making sure the ordinary folks who worked and saved and invested in assets are not punished by the failures of those who borrowed and spent and leveraged themselves into a false wealth through the derivatives markets.

That's all.

Comment from ezberry on 2009-05-07

2009-05-07T18:55:21Z

Comment from Derivative Dribble on 2009-05-07

2009-05-07T19:03:50Z

Marshall McLuhan,

"Securitization doesn't involve money at all. You seem to have trouble distinguishing between money and credit."

Really? So, investors hand potential homeowners bundles of fruit with which they can buy their homes? No, they give them cash. In exchange for the cash, investors receive a promise to pay. The availability of credit adds to the overall purchasing power of the consumer base. Maybe you don't like credit. I think it's a fine thing.

"From what I read above you seem to have trouble understanding the difference between being a boring bank and being a financial service company. When Glass-Steagall was enacted in 1933 it was meant to remedy this very problem with distinctions between money borrowed to play a market and money borrowed to gain an asset."

Glass-Steagall was meant to prevent securitization? I suggest you read this:

http://www.marginalrevolution.com/marginalrevolution/2008/09/glass-steagall.html

The rest of your comments are simply unrelated to my post.

Comment from Vicious Virtue on 2009-05-07

2009-05-07T19:17:56Z

Mr. McLuhan, what you've just said is one of the most insanely idiotic things I have ever read. At no point in your rambling, incoherent response were you even close to anything that could be considered a rational thought. Everyone on this site is now dumber for having looked at it. I award you no points, and may God have mercy on your soul.

Comment from mgoodfel on 2009-05-07

2009-05-07T20:17:21Z

I think there's a theory of bubbles that they stop when they've pulled in all available money (found the last fool!) If that's true, then securitization hurt not because of any inherent problems with it, but just because it made more money available, and pumped the bubble larger.

But I agree that to go back now means all mortgages have to come from banks and S&L again, or from the government (Fannie and Freddie.) Seems like it would take a long time for financial flows to rearrange themselves that way again.