Did the Bankers Kill Capitalism? or Was it the Fed?
uhh who does the pic credit go to on this one? no idea, sry
An incredible article series by Richard A Posner, currently serving his 28th year as judge on the United States Court of Appeals for the Seventh Circuit in Chicago, IL, may be found via The Atlantic; I highly recommend Posner's "A Failure of Capitalism" in case you're looking for some "light" reading that doesn't contain as many F-bombs as what you might find here on Jr Deputy Accountant.
Skeptical CPA was kind enough to point me to Posner's works some months back and feels he is one of the best judges of our time. With an endorsement like that, I cannot help but concur.
On Monday, Posner covered the failure of capitalism from the "blame poor risk management" standpoint and I cannot really add anything to his thoughts except to say that I do know a few dumb bankers. Most of them of the "central" variety. Posner does not say so directly but it can easily be inferred from his comments about bankers being incorrectly blamed in the media for this mess. It should not be bankers in general, of course, but a specific set of bankers installed in a particular quasi-governmental agency somewhere in Washington D.C. that you may have heard of called the Fed. At least that's my translation.
The tendency in the media and the Congress has been to blame the current depression on "stupid, greedy, and reckless" bankers. I believe that that is a mistake. I know bankers. They are not stupid; most of them are smart, and many of them are brilliant. If they are "greedy," it is largely so in the sense in which most Americans (most anyone, I imagine) could be called "greedy": they like money a lot. I read somewhere recently that bankers (a word I use loosely to cover financiers in general) derive their job satisfaction entirely from their monetary compensation, unlike other workers. But that is wrong. Rich bankers derive satisfaction not only from making a lot of money but also from a sense of outsmarting competitors, and in that respect they are not unlike highly paid athletes; in both cases the money the stars are paid do not merely enhance personal welfare, but also are indicators of relative performance. Money is a scorecard of success. Professors are different, it is true--but only in that their scorecard is different: for money income are substituted citations, prestigious appointments, honorary degrees, and prizes.
With "reckless" we get a little closer to the truth, which is that banking is an inherently risky activity. The basic reason is that bankers borrow most of their capital, then turn around and lend it, and cover their expenses and make a profit by lending at higher interest rate than they borrow--and the higher interest rate is generated by the bank's assuming a greater risk of default than the people who lend the bank its capital. Typically, banks borrow short term and lend long term, and by doing so they generate a spread because lending short is less risky than lending long and so short-term interest rates tend to be lower than long-term rates.
The taking of business risks implies a positive risk of bankruptcy. Bankers cannot be criticized for risking bankruptcy, because they couldn't survive in business otherwise; they would lose their capital to nonbank lenders willing to take risks, such as hedge funds.
In fact the bankers took too many risks from an overall economic standpoint, and that is the immediate cause of the economic hole we're in. They made too many risky loans, especially in real estate, and when the risks materialized the banks' assets, which included many real estate mortgages and securities backed by such mortgages, plunged in value. The banks found themselves undercapitalized and reduced their lending, which slowed economic activity, which began the downward spiral that we're in.
They were permitted and indeed encouraged to take risks that were too great from the standpoint of economic stability by the government itself, in two major respects. First, the regulatory controls that had once limited the amount of risk that banks could take, in recognition of the potentially catastrophic effects on economic stability of a collapse or near collapse of the banking industry, were gradually dismantled, beginning in the 1970s. Not completely dismantled, but enough dismantled to allow competition almost free rein to push the bankers toward taking more risks than were good for the nation's economic welfare.
Posner is all that and then some. Point to him for this particular beauty...