Opaque finance, again, and solutions
There a few people whose work I more respect than Yves Smith at Naked Capitalism. She is a tireless researcher, remarkably immune to the bleary-eyed depression I experience when digging through the obfuscatory minutia of financial industry predation. I have and will continue to hold Smith in very high regard, whatever her regard for me.
However, in a recent post, I think I have been treated unfairly. I think no fair reading of my financial opacity piece, alone or with its two followups, could characterize my position as “extoll[ing] deception and theft”. The first piece is not satirical, in the sense of advancing a position which its author does not hold. But it is hyperbolic and sardonic, in the sense of laughing into ones execution. I think it is true that the business of banking, in order to effectively perform its social function of mobilizing resources at scale, necessarily involves a degree of deception. It must work to persuade a variety of stakeholders that their claims are very close to risk-free when in fact they cannot all be. That a degree of deception, or at least obfuscation, is inherent to banking does not justify all possible misbehavior. If you must lie for some greater good, you are especially bound to put the proceeds of the lie towards the greater good, and not just run off with the cash. Nothing justifies the sort of looting to which no one has called attention more assiduously than Smith. However, the opacity built into the very structure of modern banking systems, irreducibly if they are to perform the work we now delegate to them, renders it nearly impossible to prevent the pillage. Far from hagiography, in my mind this thesis is bitter eulogy for the hope that a banking system like ours can be “reformed”. I think that we need to find other, very different, means of performing the functions that status quo banks currently perform, so that we can encourage the institutions that currently dominate to wither into obscurity. I know this is a tall order.
That existing institutions are difficult to police doesn’t mean that we shouldn’t do our best while we are stuck with them. It certainly doesn’t mean that when we discover violations of the rules we impose to manage this conundrum, the violators shouldn’t be held accountable. On the contrary, ordinary principles of deterrence suggest that difficult-to-uncover crimes should be punished much more harshly than crimes for which detection is likely. I have never advocated any lenience. I think we should expose and punish relentlessly. But I don’t think we’ll get very far, because bankers will respond with capital strikes, motivated both by both cynical politics and genuine fear. Without alternatives, we will find ourselves unable to tolerate credit slowdowns, and we’ll end up with politicians who help engineer cover-ups. Over the short term, we are addicted to bubbles and bezzles. Over the long term, opaque finance makes important contributions to economic development. We need new institutions that replace existing banks, or we will lack leverage to effectively police the old ones.
This is a judgment call about which reasonable people can disagree. Smith thinks that finance prior to the 1980s worked well, and represents a model to which we can return. Carolyn Sissoko, who knows more about the history of banking than I ever will, thinks eliminating limited liability for banks will resolve the problem. I enthusiastically support that reform, but believe it would leave us in a painful state of macroeconomic withdrawal absent other changes. I think we are in a bind.
Since my opacity posts, I have been thinking more macroeconomically, and trying to come up with solutions. I do have some ideas. I think we should we rely less on personal savings and more on a basic income for insurance by ordinary households against economic risk. I think “risk-free” savings should be placed directly with the state, rather than via the Rube Goldberg machine of bank deposits and a state guarantee. Quantities of truly risk-free savings should be carefully rationed. Beyond that ration, systemic risk should be borne by savers via toleration of inflation. I think we should regulate aggregate demand (in practice, probably target NGDP) by modulating the flow of transfers to the public (“quantitative easing for the people“, “monetary policy for the 21st Century“, “helicopter drops“), and emphatically not by adjusting the price or regulatory scrutiny of bank credit. To replace the role of banks in ensuring sufficient availability of investment capital, the state should subsidize investment by riding along, directly and explicitly, with very simply constituted private investment funds that meet certain criteria. (The state would do so as a senior creditors or via some form of matching equity. However, we will have to be wary of letting more explicit state involvement politicize the investment process. A legal, commercially-viable abortion clinic or gun range should have the same access to government supported, privately allocated credit as a flower shop. The criteria for government co-investment should be as mechanical as possible to prevent quid-pro-quos where politicians exchange investment subsidies for promises of having favored projects funded.)
I don’t know whether any of this will ever become politically possible. In the meantime we are stuck with a system that has “criminogenic” built into its very roots. I don’t applaud this; I can barely live with it. But I do think it is a fact. We’ve got to police the system we have with as much muscle and tenacity as we possibly can. No one contributes to that more than Yves Smith does, and for that I thank her very much.
If you do want to evaluate my opacity theory, I ask that you include the third piece of the series in your reading list, which is written with more care and gentler rhetoric than the first two. The first two posts probably were too belligerently written. Still, this series really did feel like violating a taboo.