In our society, we determine much behaviour, and most economic behaviour, through the medium of money. This is not universal: many societies have not used money as their main means of determining who received goods, but we do.
If someone receives money for doing something, it is also a message which says “do more of this.” The more money, the stronger the message.
The most potent message, and the strongest effect on behaviour, is when someone has the right to create money. Money, in our society, is created by borrowing. Banks and other financial institutions which have the right to lend thus have the right to create money. They have to have some form of collateral, even if that collateral is just an expectation of future earnings “great business idea, we’ll lend you money, and use your expected profits as our collateral.”
This money can be loaned out at multiples of the underlying asset. During the 2000s some brokerages were allowed multipliers (leverage) of over 40X. Even better, often whatever you buy with a leveraged loan can then be used as an asset for another round of leverage, leading to extremely high levels of effective leverage.
Some organizations also have access to very low interest rates: they can borrow at close to “prime” the rate the central bank offers to the very best credit risks. Major banks are amongst those who can borrow at this rate. They can then lend out to other people, again, at a higher interest rate, and with leverage.
If you, personally, could borrow money at 1% annual interest rate, and lend out ten times that, do you think you could make a profit? What is your mortgage rate? What is your credit card’s interest rate?
This is as close as it comes to free money, and it takes a special genius to lose money when given these advantages.
The first rule of money is the rule of profits: if a group of people are making more profits than everyone else, they will come to control more and more of the society. Not only can they buy up other companies, but they can afford to donate to politicians, give politicians and regulators cushy jobs between government gigs, and they can afford to set up think tanks and endow university chairs and buy newspapers and television stations and so on in order to control the dissemination of ideas.
In theory profits are supposed to be self-limiting. If an industry makes more money than other industries, outsiders should see an opportunity, start up businesses, compete and drive down prices.
In the real world, that doesn’t happen as often as it does in theory, because you can’t just start up a bank with access to the Central Bank’s window. You can’t easily start up new pharmaceutical businesses, because it’s vastly expensive and there are huge regulatory hurdles. And when it does happen, why would you compete? Why not take the outsize profits? Why would you drive down profits? How does that benefit you?
The other check is supposed to be diminishing returns. The more money you have, the harder it is to find something to invest in: you run out of mortgages, or you run out of businesses to invest in which can make those returns. This does work, somewhat. It is at the heart of why the financial collapse happened: there weren’t enough assets for all the money chasing them, so widespread fraud occurred (liars loans, for example) and many people were given loans who couldn’t pay them back, while artificial assets were created which were not worth what they were sold for. Eventually this collapsed, but because the financial industry had already bought the political world, they were bailed out at a cost of trillions.
Behaviour you reward, is repeated. Bankers made millions of dollars, personally, in bonuses. This told them that what they did was valued, and they should do more of it. They did.
The fact that Wall Street and Fleet Street salaries and bonuses were so large also made financial executives not care about the future. When you make millions in a few years: enough to live on for the rest of your life, in high style, it isn’t important if you’re driving the firm to bankruptcy. You don’t need the bank or the firm to be there, you’ve already made your mint.
Now, as a politician, if you do what the financial industry (or any other wealth industry) wants, they donate to your reelection campaign. They make sure your friends and family have jobs. They invite you to the best parties. And if you’re defeated, and have voted the right way, well, they’ll take care of you afterwards as well, with a cushy job. Bill Clinton, who deregulated Wall Street, is worth 100 million dollars.
Because bankers control a lot of money, they control what other people do.
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David Kowalski
The most obvious brake on the bankers, investment bankers and Wall Street in general would be to actually apply real, multi-year prison sentences for bad behavior. Even this, unless applied somewhat frequently, won’t work. IIRC, one of the few people to do prison time for the 2008 collapse was a whistle blower who informed the Federal government of his bank’s shenanigans. The man worked for a big Swiss firm (maybe UBS) and got four years for violating the confidentiality of investors.
The message that sends is that showing a higher loyalty to ethics or to society in general will be punished. Money speaks and big money speaks quite loudly.
Celsius 233
Okay fine. I want solutions, real solutions and that’s what’s lacking…
Because most Americans are either ignorant or scared or just stupid.
How to fight ignorance and fear and stupidity? Now that’s a challenge.
And why I feel it’s hopeless…
Willful ignorance is a Pox Humanum and not easily fought…
Julien
Or put more succinctly: “He who has the gold, makes the rules.”
Greg T
Because most Americans are either ignorant or scared or just stupid.- Celsius 233
That’s true. The problem is there is no powerful counter-movement in the society at present. There are rumblings of it, but nothing coherent has yet formed. People know something isn’t right, but they can’t put their fingers on it, and there is no organized push to inform them. In the 30s, labor provided the push, along with the elites’ fear of communism.
The next financial/economic crisis will toss more people out of the middle class. The ring of opportunity will close further, excluding more people along the way. I suspect we’ll start seeing a real boiling over at that point.
There has to be a grand unifying message that people can relate to, along with a clear distinction of interests. I see conditions similar to pre-revolutionary France. You can sense the discontent, but nothing has yet exploded.
Ian Welsh
That was the reference Julien 🙂
But sometimes the mechanics need to be explained at length.
David Kowalski
Greg T,
One problem in the US of today is that the wealthy and corporations can control the media and put out deceptive messages to soothe the people or, even worse, distract them from actually thinking about real problems. This can be as simple as planting a paid operative at a political rally or to “comment” on blogs or in letters to the editor.
We haven’t yet reached the point where things are boiling over but even then nothing may happen. Fear of the other or comparison to blacks or Hispanics or any other group can prevent any real response, too. In the 1890’s the populist movement in the US south was destroyed by co-opting poor whites who got a “better deal” by working in textile factories while poor blacks were consigned to agriculture and stripped of the vote (the last step of removing blacks from the voting roles in the south occurred in Louisiana in 1896).
Jessica
“it takes a special genius to lose money when given these advantages”
Stupidity is not the problem. Well, not always. There are two forms of predation going on here. Financial firms steal from everyone and those running financial firms steal from the firms. Sometimes what they steal is even more than the rules of the game give the firm. Then it may look like “special genius” but it actually personal fraud/theft within institutional predation.
Jessica
@David Kowalski
Debt and high interest rates and restricted access to credit played a big role in holding down Southern whites and blacks.
Barmitt O'Bamney
Not only do bankers have a lot of money, but they exercise the unique function and privilege, in the private sector, of creating the money (from thin air). Money creation therefore follows at a pace of their choosing. (Moar, moar, moar!) Attempting to hold your wealth in cash presently subjects you to losses arising from their rapid dollar creation (inflation). This impels all wealth into riskier forms of investment (financial sector casino gambling overseen by the banks). You may be wealthy but you can only remain so by dancing to the tune called the banks. If you are poor, of course you dance all the more frenetically. Maybe you have a mortgage hanging over your head, or a car loan. Or your college education depends on student loans. Even if you have no bank loan, you work for someone who does, both to operate their business and in their own personal life, and everything you buy is financed on the supplier’s side by credit and its required interest. No one, not even the homeless woman slowly dying under the highway overpass is not caught in the web of this system of indenture.
The debit or credit card in your pocket is privatized money. But the green dollar bill is privatized too.
It’s difficult for us to see this system because it surrounds us so completely and its workings are hidden by imaginary boundaries (eg: capitalism is an economic system, democracy is a political system). The rules never come up for a vote and therefore are rarely spoken of in their systemic aspect, usually only in their individual aspect, personal finance, which is the study of how you try to avoid being crushed by the system. It is however completely man made and constructed by rules designed above all to ensure and preserve the supremacy of capital. So yes, they make the rules and the ostensible rulemakers in our political bodies slavishly serve and obey them. Capitalism is the dictatorship of the owners of capital. And it’s vital to understand it as an -ism, because our shared belief in it routinely outweighs any of its claimey are insolvent, they are still the ones in charge. Our leaders continue to defer to them and cater ts to deliver the best of all possible worlds, or its claims to “deliver the goods” by comparison to other systems. Even when the owners of capital flub things so badly that they are insolvent, they are still the ones in charge. They are still presumed “creditworthy” despite their titanic frauds and their flaming red balance sheets. They are still allowed to create money at whim. Nothing is taken from them, and they do not go to jail. The spell is not broken, the organs of power shield them from all question or reprisals from the defrauded little people. They spin the wheel again and we continue to believe that the game is not rigged for the house.
Barmitt O'Bamney
Correction:
And it’s vital to understand it as an -ism, because our shared belief in it routinely outweighs any of its claims to deliver the best of all possible worlds, or its claims to “deliver the goods” by comparison to other systems. Even when the owners of capital flub things so badly that they are insolvent, they are still the ones in charge. Our leaders continue to defer to them and cater to them. They are still presumed “creditworthy” despite their titanic frauds and their flaming red balance sheets. They are still allowed to create money at whim. Nothing is taken from them, and they do not go to jail. The spell is not broken, the organs of power shield them from all question or reprisals from the defrauded little people. They spin the wheel again and we continue to believe that the game is not rigged for the house.
Strangely Enough
@David Kowalski- That would be Bradley Birkenfeld. Recently released and awarded a $104 million award by the IRS Whistleblower Office.
But, like Kiriakou and torture, the only person to do time was the whistleblower.
Jonathan
@David Kowalski, did you happen to see that GCHQ has a whole 150-strong company of trolls? And, presumably, the software to allow them to operate at maximum efficiency?
@Greg T, by coincidence, the Archdruid wrote an illustration of “Weimar America” for this week’s Report. A grand unifying message is one thing, but just as processors fail to reset when power ramps up too slowly, so do societies. A positive message would have to ramp up more quickly than Occupy to disgorge some change, and the sort of power that could ramp up so quickly as to not be crushed is the sort of power that answers to nothing.
Better to work on shadow institutions, preferably cleaned to the bone of St. Augie and especially conspicuous competition culture.
David Kowalski
@Jessica,
Thanks for the interesting point about debt and high interest rates. What comes to mind is “Sixteen Tons” , a song with the refrain “I owe my soul to the company store.” The politics of “rewarding” poor whites with mill worker jobs in the cotton industry is from oldie but goodie books like The Strange Career of Jim Crow and The Mind of the South.
The pattern in the south was unique due to a wide variety of factors: the spectors of slavery and losing the Civil War, lower income and lack of immigration.=, a political establishment that for at least fifty years was pretty much entrenched and could do whatever it wanted to. In on election in the 1930’s, 70 congressmen from the south were unopposed in the general election including 19 of 21 from Texas.
In the northeast and industrial midwest, the political control was less certain at the state level. Here the debt played a role. Here, too, there were strikes and violence especially in thbe midwest and Pennsylvania ( the Haymarket Square bombing and riot in Chicago, the Carnegie thugs in Pittsburgh, mine strikes and the Molly Maguires in PA, the auto strikes in the 1930’s with the long sit-in, in Michigan, peaceful strikes elsewhere including the rest of the northeast). In the west, the violence and strikes centered around miners in Cripple Creek, Colorado (1903-04) and Coeur d’Alene , Idaho in 1892. The only violence in the south was from West Virginia (Matewan, for one). West Virginia was notably a state that had seceded from Virginia during the Civil War (in 1863). There was no support for slavery and there were and still are few blacks so the distraction of race couldn’t be played.
Violence and strikes, at least the memorable ones, seemed to peak in the 1890’s and the 1930’s, both times of economic distress.
Chris Bonner
Ian, I really love the way you lay these things out in a way that any thinking person can understand with relying too much on jargon or the subtleties of this or that ideology. It’s not an easy thing to do.
Thank you.
CMike
Ian writes:
Some organizations also have access to very low interest rates: they can borrow at close to “prime” the rate the central bank offers to the very best credit risks. Major banks are amongst those who can borrow at this rate.
Speaking generally that’s the gist of it but just to make sure some Brad Delong type doesn’t get in a snit, here it is more precisely. According to moneycafe dot com, “The Prime Interest Rate is the interest rate charged by banks to their most creditworthy customers (usually the most prominent and stable business customers). The rate is almost always the same amongst major banks.”
More tediously, fedprimerate dot com says:
Every U.S. bank sets its own Prime Rate. However, the Prime Rate is invariably tied to America’s cardinal, benchmark interest rate: the Federal Funds Target Rate (also known as The Fed Funds Target Rate.) The Fed Funds Target Rate is set by a committee within the Federal Reserve system called The Federal Open Market Committee (FOMC)….
Prior to mid-December 2008, the WSJ Prime Rate was determined by polling thirty (30) of America’s largest banks. When twenty-three (23) of those 30 banks had changed their prime lending rate, The WSJ would respond by updating its published Prime Rate. Effective December 16, 2008, however, the WSJ now determines the Prime Rate by polling the 10 largest banks in the United States. When at least 7 out of the top 10 banks have changed their Prime, the WSJ will update its published Prime Rate….
The Current Wall Street Journal Prime Rate is: 3.25% (the last rate change — a decrease of 75 basis points [0.75 percentage point] — occurred on December 16, 2008).
Commercial banks engage in fractional reserve lending, they only keep on hand a fraction of the money customers have their have on deposit. The Federal Reserve determines the minimum fraction of total deposits banks have to have on hand either as cash in their vaults or on account at a regional Federal Reserve bank. (Currently the reserve requirement for large banks is at 10% of any of the “demand and other checkable deposits” they’re holding). A bank’s excess reserves can be lent out overnight to those other banks which are also members of the Federal Reserve and which have insufficient reserves of cash on hand and money on deposit at the Fed.
In the healthiest situation in which this arises, a bank may have a shortfall because they’ve made unexpected loans to credit worthy borrowers and instantly credited those borrowers accounts with deposit balances for which they must have a fraction in cash or on deposit at the Fed to meet their reserve requirement. If the bank has insufficient reserves it then has to borrow from other banks overnight, or over a series of nights, while they are expected to sell paper (borrower IOUs it is holding, e.g. car loans or mortgages), other assets (e.g. a building it owns outright), or equity shares to raise cash to meet their reserve requirement. (MMTers stress the point that banks make loans, i.e. create money by crediting the deposit accounts of the borrower, independent of the banks current reserves- banks make any profitable loan that presents itself and then make arrangements, if necessary, to have additional reserves the cover the new deposit they have created.)
These loans from one member commercial bank with excess reserves to another with a reserve shortfall are drawn from what are called Federal Funds as they are funds on deposit at a regional Federal Reserve bank. The current Federal Open Market Committee target range for the Fed Funds rate is 0.00 to 0.25% with the actual going rate at 0.07%.
Basically the system is now so awash with excess reserves that Fed Funds are able to meet the overnight demands of all other banks in the system. That was not the case during the meltdown, and where there were banks with excess reserves, they did not trust other firms enough to lend to them. Even today there are some Federal Reserve member banks that are not seen as credit worthy to loan to at the target Fed Funds rate. Those banks must go to the lender of last resort, the Federal Reserve, itself, to borrow from what is called the “discount window” which has a primary lending rate 0.5% above the target Fed Funds rate and a secondary lending rate for borrowers deemed less credit worthy which is 1.0% above the Fed Funds rate.
Astoundingly, during the ’08 crisis the Fed decided to open the discount window to non-commercial bank entities like the investment bank Goldman Sachs and the industrial manufacturer turned financial wheeler dealer General Electric granting them borrowing rights from that source which those entities still retain. At the Fed discount window the Fed is lending money it creates by fiat. The current Federal Reserve discount window primary rate is 0.75%, the secondary rate is 1.25%.
All that said, the Fed’s discount window is pretty inactive these days. If you look at these balance sheets from January, 2009 and February, 2014 you’ll see the Fed’s holding of Mortgage Backed Securities (MBS) is where the action has been. In the week ending on Wednesday, January 14, 2009 Fed holdings of MBS showed up for the first time on the Fed balance sheet with an entry total of $1,542 Billion (with a “B”) for MBS [fn. 4], the week ending on Wednesday, February 19, 2014 Fed holdings of MBS are at $1,564 Trillion (with a “T”) total [fn. 4].
footnote 4: Guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. The current face value shown is the remaining principal balance of the securities. [Ha, ha, ha.]
Larry
“The fact that Wall Street and Fleet Street salaries and bonuses were so large also made financial executives not care about the future. When you make millions in a few years: enough to live on for the rest of your life, in high style, it isn’t important if you’re driving the firm to bankruptcy. You don’t need the bank or the firm to be there, you’ve already made your mint.”
I think it is this salient point that those who defend the free-market at or near the bottom of the income scale fail to see how great wealth can lead to one’s disconnect from reality. The result is that millions suffer by those who simply can’t identify with why other “lesser” people are dying from polluted air and water and chronic diseases. Don’t we after all have the greatest health care system in the world and the brightest people to design new technologies to save us all? Never mind that these things are only available and affordable for the most wealthy of us all.
CMike
Whoops, those should have been “points,” not commas: $1.542 Billion and $1.564 Trillion in that last paragraph.
Celsius 233
And here we sit; impotent/powerless and feeling victimized.
I refuse to be a victim.
Talk, talk, talk, and the blogs roll on. Talk, talk, talk; and here we are; many years, YEARS, later, still talking.
I’m pretty much done with this shit.
There has been so much verbiage and some of it is really good, Ian as an excellent example, but so what?
Nothing is being DONE!
America is a wasteland of hope and promises not fulfilled. A wasteland of a history perverted and made legend and lie.
A wasteland of faux democracy writ large to the world, who has realized the utter hubris of its claims.
One’s government can wax eloquent of the dreams and hopes for the future; but it’s all been long identified as bullshit to sooth the masses and continue a barbaric policy for its citizens.
We are breaking every covenant of the Geneva Convention regarding war crimes unscathed.
The world is asleep and dreaming, refusing to step up to the present reality.
May the god’s damn this world!
CMike
Celsius 233,
This one’s for you.
Malcolm Baker
It’s nice to run across a relevant site. I would like to return the favor.
Tao Jonesing
http://taojonesing.blogspot.com
Possibly you two could cook up something together.
I ran across your complaint about economics. It is addressed here:
http://taojonesing.blogspot.com/2010/11/economic-theory-is-pathological-lie.html