Banks have returned to reckless mortgage lending.

[Chris]

OK, I agree that the whole process of buying a house is more complex, as you well describe. But the core part of the financial side is the mortgate. If you get the wrong insurance, or too much insurance it's not the end of the world. But if you borrow too much on your mortgage that's a different thing.
Ultimately I agree that the main blame for the overall financial mess rests on governments and central banks; not for lack of regulation and oversight, but for setting the precedence of bailouts, inflating the money supply and stimulating demand.
But a borrower who took out too much of a loan has to shoulder that burden. And for the record again, banks and their creditors should be suffereing the full force of their mistakes too.
Education is the one thing that can make a difference in the future, but you won't hear a single politician opint this out, as it would be pointing the finger at themselves.

 

[taxedparent]

To be honest the time has come and gone on who to blame, assigning blame will have no impact on economic recovery. Its happened, joe public made some bad decissions, joe bank made some bad decisions, and joe government made some bad decisions.

What bugs me is that I didn't buy a house, or get caught up the mess yet Im having to pay for other peoples mistakes. My children will have to pay for their mistakes too during their lifetime.

 

[AlbacoreA]

That depends if the same people are still making bad decisions. People are creatures of habit and rarely change.

 

[JoeB]

I agree.... the causes of the problems must be identified in order that they can be prevented from happening again.

For example, we're told that the banks had to be saved as they were of systemic importance... have any steps been taken so that individual banks can be allowed to fail in the future?, I don't think so..

Clearly we need a system where insolvent banks can be allowed to go under... possibly regular savers could be protected, but not investors. Has any work been done on this?, What could be done?... possibly banks could be limited in how much exposure they have to various types of things...

 

[Chris]

To be honest the time has come and gone on who to blame, assigning blame will have no impact on economic recovery. Its happened, joe public made some bad decissions, joe bank made some bad decisions, and joe government made some bad decisions.

I agree with AlbacoreA, the underlying cause has been much pontificated about, but especially governments and central banks are totally blind to the fact that it was their own policies that lead to the continuous boom/bust cycle. Instead it is merely pointed out that "banks made too many risky loans". This ignores two fundamental things: (a) central banks control the amount of money supply and (b) central banks have direct control over interest rates. It was central banks that provided the huge amounts of money at low rates that allowed commercial banks to make many high risk loans at low rates. And guess who controlls central banks?
Yes, Joe Public was suckered into the whole thing, but these extreme bubble booms are only possible due to governement intervention and central bank policy. Until that is understood by the wider public, the topic of what caused the mess is very much relevant.

What bugs me is that I didn't buy a house, or get caught up the mess yet Im having to pay for other peoples mistakes. My children will have to pay for their mistakes too during their lifetime.

I agree with you and have said the same numerous times. The mistakes of some should never become the burden of everyone. All this does is reduce the risk on individuals, leading them to take on excessive risk.

I agree.... the causes of the problems must be identified in order that they can be prevented from happening again.

For example, we're told that the banks had to be saved as they were of systemic importance... have any steps been taken so that individual banks can be allowed to fail in the future?, I don't think so..

Clearly we need a system where insolvent banks can be allowed to go under... possibly regular savers could be protected, but not investors. Has any work been done on this?, What could be done?... possibly banks could be limited in how much exposure they have to various types of things...

These are very good questions, and unfortunately the answer to them is not only No, but additional presedences have been set to make future bailouts the norm. The problem with the whole mess is that our financial system is based on fractional reserve banking, which basically means that banks are in a permanent state of insolvency protected by government guarantees and central banks. Fractional reserve banking cannot function without the implicit and explicit guarantees of bailouts by governements and central banks.
Free market capitalism's most important and fundamental tool is the profit and loss system. Profits encourage risk taking, while losses encourage prudence. When creditors are shielded from losses, then they will never put direct or indirect pressure on banks to reign in risk taking.
Even if politicians were to now turn around and proclaim that there won't be any more bailouts, nobody would believe it. Take the loss out of the system and risk taking increases; all that governements have done is show the world that losses will not be suffered.
With all the government interference and intervention it cannot be claimed that we have free market captialism, and that the current mess is a failure of free market capitalism. Such a statement blatantly ignores the facts. What has failed is crony-capitalism and interventionism, and an end must be put to it. The only way this is possible is not by regulating private industry, but by regulating governement.
We are now in a worse position than ever.

 

[Duke of Marmalade]

The problem with the whole mess is that our financial system is based on fractional reserve banking, which basically means that banks are in a permanent state of insolvency protected by government guarantees and central banks. Fractional reserve banking cannot function without the implicit and explicit guarantees of bailouts by governements and central banks.

I know this is your hobby horse Chris but I fundamentally disagree with you. One of the huge benefits that our financial system confers on society is facilitating a massive maturity mismatch. For example, pensioners with savings accumulated over many years have large sums on deposits. These are lent out to young people on 20 year mortgages. Imagine a world where 20 year mortgages had to be backed by 20 year deposits - that seems to be what you mean by being solvent.

It normally works very well because depositors in aggregate are sticky even though individual deposits are entirely liquid. It obviously requires the pensioners to have supreme confidence in their banks. Central Banks guarantee the liquidity of the banks. But we used maintain a pretence that they didn't guarantee the solvency of the banks. Pensioners by and large are not interested in fine distinctions between liquidity and solvency - they want their deposits to be absolutely safe, they never saw themselves as risk takers. There is no doubt in my mind that if and when the Bank Guarantee is stopped nobody will have any deposit greater than what is covered by the Deposit Guarantee scheme. The societal self delusion that depositors are risk takers has been blown for a very long time to come.

 

[AlbacoreA]

Maybe I've a very simplistic view. To me, the mechanism worked fine when it was controlled. The problem was banks exceeded their own rules and the regulator and thus the govt let them. People accepted something that was too good to be true, mainly due to peer pressure. You're meant to learn form mistakes, not repeat them. Blaming everything on someone, or somewhere else seems like a denial of responsibility to me. Without enforcement and punishment, no lessons will be learned.

Not everyone fell into this, either by design or luck.

 

[Chris]

I know this is your hobby horse Chris but I fundamentally disagree with you. One of the huge benefits that our financial system confers on society is facilitating a massive maturity mismatch. For example, pensioners with savings accumulated over many years have large sums on deposits. These are lent out to young people on 20 year mortgages. Imagine a world where 20 year mortgages had to be backed by 20 year deposits - that seems to be what you mean by being solvent.

It normally works very well because depositors in aggregate are sticky even though individual deposits are entirely liquid. It obviously requires the pensioners to have supreme confidence in their banks. Central Banks guarantee the liquidity of the banks. But we used maintain a pretence that they didn't guarantee the solvency of the banks. Pensioners by and large are not interested in fine distinctions between liquidity and solvency - they want their deposits to be absolutely safe, they never saw themselves as risk takers. There is no doubt in my mind that if and when the Bank Guarantee is stopped nobody will have any deposit greater than what is covered by the Deposit Guarantee scheme. The societal self delusion that depositors are risk takers has been blown for a very long time to come.

Hey Duke, yes indeed the finacial system is a bit of a hobby horse of mine and we've had some great discussions about this. I wasn't really referring to the maturity mismatch. I agree that this does give rise to certain opportunities, while it does have some very big risks.
I was more referring to the fact that if there was a run on a bank for all deposits, then that bank is effectively bankrupt, at all times, as it does not hold all deposits, rather only a fraction. In order for such a system to work, there has to be a lender of last resort and ideally some government guarantees. And these are the source of increased risk taking, as creditors are not worried about what a bank does with the money.
I agree that pensioners do not care too much about the distinction between liquidity and solvency and that their prime worry is being able to access their money. But look at it from this point of view. Imagine there is no government guarantee or lender of last resort. The pensioner with his life savings has to decide where to keep this money, and will obviously want to keep it in a bank that is as safe as possible. He would prefer a bank that says to him "we only lend money out to professionals who have proven savings for 20% down payment, in secure jobs where repayment makes up less than 15% of monthly income". This, in my opinion, would be a rather safe sounding place to have money. In the presence of guarantees, this question is not asked by the pensioner, which means that even banks in difficulty have no problem attracting savings deposits (look at the amount of people willing to still save with actually bankrupt Anglo).
My biggest gripe with fractional reserve banking is that it artificially increases the money supply, which, as we have discussed in another thread, is the source of a general rise in prices, i.e. defrauding savers of their wealth.
I've posted the following article about the effects of governemnt guarantees and bailouts in other threads, it is well worth a read if you haven't already: http://mercatus.org/publication/gambling-other-peoples-money

Maybe I've a very simplistic view. To me, the mechanism worked fine when it was controlled. The problem was banks exceeded their own rules and the regulator and thus the govt let them. People accepted something that was too good to be true, mainly due to peer pressure. You're meant to learn form mistakes, not repeat them. Blaming everything on someone, or somewhere else seems like a denial of responsibility to me. Without enforcement and punishment, no lessons will be learned.

Not everyone fell into this, either by design or luck.

I fully agree that punishment is the only way to learn from mistakes. And the best punishment is financial loss through the profit and loss system. Having governemnt come up with some form of penalty on institutions that had to be bailed out is not a good idea. Let's face it, politicians are so entwined with the financial industry that they will never punish mistakes as severely as the free market would.
Actually, the banks did exactly what the system allowed them to do. They didn't exceed reserve requirements. In Ireland and the especially the US, banks' mortgage lending practices were exactly what governemnt wanted and advocated: more people owning their own home regardless of their individual circumstances.

 

[Duke of Marmalade]

I was more referring to the fact that if there was a run on a bank for all deposits, then that bank is effectively bankrupt, at all times, as it does not hold all deposits, rather only a fraction [in instantly available hard cash].

I put in the bit in [ ]. What you are effectively saying is that the other assets of the bank e.g. credit to industry, mortgages etc. should not be funded by deposits but must either be backed by shareholder capital or by liabilites which match those assets. The inexorable logic of your insistence that a bank must at all times be in a position to meet a 100% run on its depoits is that society would be denied two of the great benefits of our modern financial system (1) maturity transformation and (2) risk transformation.

These are wonderful things but, to fall back on the metaphor, so to is fine wine and fine food and the other pleasures available to us. But our mothers have always told us you can get too much of a good thing. As the Mercatus link argues, we got too much of a good thing, we gorged ourselves on maturity and risk transformation and we finished in a very sorry state. But the response should not be to banish these good things from our lives for ever, but to learn how to control our appetites for them.

.

 

[Chris]

I put in the bit in [ ]. What you are effectively saying is that the other assets of the bank e.g. credit to industry, mortgages etc. should not be funded by deposits but must either be backed by shareholder capital or by liabilites which match those assets. The inexorable logic of your insistence that a bank must at all times be in a position to meet a 100% run on its depoits is that society would be denied two of the great benefits of our modern financial system (1) maturity transformation and (2) risk transformation.

These are wonderful things but, to fall back on the metaphor, so to is fine wine and fine food and the other pleasures available to us. But our mothers have always told us you can get too much of a good thing. As the Mercatus link argues, we got too much of a good thing, we gorged ourselves on maturity and risk transformation and we finished in a very sorry state. But the response should not be to banish these good things from our lives for ever, but to learn how to control our appetites for them.

Not quite Duke, in effect I would like to see demand deposits not used for fractional reserve pyramiding. And to demand deposits you have to add time deposits with get-out clauses, which basically means they are demand deposits with penalties. This would not really have an effect on banks ability to borrow short and lend long, as bank's could still offer deposit accounts that cannot be accessed until maturity; this would be more like a debenture. But this would have an effect on the amount of pyramiding that is possible and Murray Rothbard pointed out in "The Mystery of Banking" that banks and governemnts are vehemently against such propositions. Banks should also suffer the full force of the profit and loss system if they overstretch themselves by borrowing extremely short and lending extremely long. I think that would be the best way for banks to control their appetite for this practice.
I prefer to look fractional reserve banking and its resulting inflation of the money supply in terms of robbery. If a burglar enters your house and takes everything, that's criminal; if he comes into your house and just takes the TV, that's still criminal. Even a little bit of robbery is bad, and inflationary systems and policies are legalised fraud.

 

[Duke of Marmalade]

Okay Chris so you would require that the CB should insist on anything available on demand or effectively available on demand should be 100% backed by reserve assets (i.e. cash with the CB). That is actually not a very onerous requirement and would not prevent credit creation backed by short term (but not demand) deposits. The problem is assessing what is the relevant Money Supply aggregate in the context of inflation policy. In these days when money transmission is so easy, the narrow aggregates are increasingly less relevant. At what duration does a time deposit cease to have an influence on the supply and demand for money i.e. on inflation?

 

[JoeB]

So that seems to mean that prudent long term savers are being gently defrauded, by the government, because the government are following inflationary policies, which will result in the true value of savings being eroded.

It's interesting.

Why doesn't the government only guarantee savings in government banks (i.e post office) or schemes, and let the private banks do whatever they want, as long as it's clearly stated that there's no guarantees for savings in private banks. We could even run national education campaigns letting everyone know that there's no guarantees with private banks.

I personnaly am worried about the banks, and have moved my money to what I see as a stronger store of wealth, gold in my case... although I know there are problems with that too. Gold seems to be subject to the whims of investors, and the world markets... but at least more can't be printed at will.

It seems that every fiat currency ever used has had its value eroded eventually, until it's worthless... are there any counter examples? (besides current fiat currencies, which haven't reached the end of the life cycle yet,?, i.e being eroded to no value)

 

[Duke of Marmalade]

It seems that every fiat currency ever used has had its value eroded eventually, until it's worthless... are there any counter examples? (besides current fiat currencies, which haven't reached the end of the life cycle yet,?, i.e being eroded to no value)

That's like asking do we know of any animals who did not finish up extinct except the ones currently on the planet

 

[JoeB]

Yes, I take your point... I'm not sure if it's this, but it seems to be that it's certain that the Euro and the USD will be worthless at some stage, the only question is to when it'll happen. Will it happen in ten years, or twenty? etc

Most scientists agree that humans will be extinct eventually, it's unlikely we'll last a million years. We really need to start colonising space, although that could impact the gold market, so I'm in two minds about it..

 

[Duke of Marmalade]

Sorry if my reply seemed facetious I think you are right, ultimately they are all worthless. For a start the CBs actually target a level of inflation and 2% p.a. eventually makes the currency effectively worthless. More significantly every now and then there are shocks to the financial system simply arising from human economic behaviour. Deflationary shocks such as we are currently experiencing will be quickly snuffed out (using QE for example) but inflationary shocks like the 70's Oil Crisis stay embedded so again it is ultimately a one way street into oblivion. How long, I think current market index yields expect low inflation for at least 30 years.

 

[Chris]

Okay Chris so you would require that the CB should insist on anything available on demand or effectively available on demand should be 100% backed by reserve assets (i.e. cash with the CB). That is actually not a very onerous requirement and would not prevent credit creation backed by short term (but not demand) deposits. The problem is assessing what is the relevant Money Supply aggregate in the context of inflation policy. In these days when money transmission is so easy, the narrow aggregates are increasingly less relevant. At what duration does a time deposit cease to have an influence on the supply and demand for money i.e. on inflation?

That is an extremely good point and question!!!, and one that could probably be debated over for eternity. The problem of course is that every individual saver will have a different cut off point as to what deposit-term would still be seen as more or less available on demand. E.g. if I put some money into a 14 day depenture, I would probably still look at this as cash more or less available on demand, and it would influence my willingness to spend money and thereby influence demand for consumer products. Basically, I don't think that monetary policy makers should try to find out and use this information to "fine tune" their policies, as they cannot do so as well as a free market.
Now in the ideal world (from an Austrian Economic point of view) there would be no fractional reserve banking but a gold standard uninfluenced by government; prices would fluctuate, but there would be no inflation. In this case the length of term deposits/debentures would be completely irrelevant to the total money supply. The reason I suggested excluding demand deposits, and sudo-demand deposits, is that this would form a significant counter weight to inflationary policy. Of course, this would probably only mean that governments would increase the monetary base by even more to make up for the slack.

So that seems to mean that prudent long term savers are being gently defrauded, by the government, because the government are following inflationary policies, which will result in the true value of savings being eroded.

Yes indeed, this is exactly why I am so opposed to inflationary systems and policies. The one thing the western world needs right now is less credit based spending and more production, but the fiscal system is fundamentally based on monetary expansion without the corresponding increase in productivity, i.e. credit expansion.
Inflation allows those that receive the money first (banks and governments) to profit at the expense of those that receive it last. It creates an artificial boom which makes politicians look good and banks huge sums of money. And when it all collapses it is blamed on everything other than the system and policy makers. The problem is the boom, not the bust; the bust is the market trying to correct the mistakes made that lead to the boom in the first place.

It's interesting.

Why doesn't the government only guarantee savings in government banks (i.e post office) or schemes, and let the private banks do whatever they want, as long as it's clearly stated that there's no guarantees for savings in private banks. We could even run national education campaigns letting everyone know that there's no guarantees with private banks.

This is a good suggestion and it would also go a long way to putting some risk aversion into banks. But as you can see now, during the boom the deposit gurantee only covered €20k, as soon as trouble hit this was increased to infinity. It is not just a limited guarantee that allows for increased risk taking, but more inportantly the precendence set by "too big to fail". The only way I could see a "no guarantee" policy working is if it were made constitutionally illegal for the government or central bank to bail out banks, or more correctly banks' creditors.
I would love to see something like this, along with many other restraints put on government through the constitution. But at the end of the day, the constitution is only a piece of paper; at face value the US constitution does not allow the US government to do most of the things it is doing, but this does not stop them.

I personnaly am worried about the banks, and have moved my money to what I see as a stronger store of wealth, gold in my case... although I know there are problems with that too. Gold seems to be subject to the whims of investors, and the world markets... but at least more can't be printed at will.

It seems that every fiat currency ever used has had its value eroded eventually, until it's worthless... are there any counter examples? (besides current fiat currencies, which haven't reached the end of the life cycle yet,?, i.e being eroded to no value)

I agree, fiat currencies in history have all failed, but then they usually failed in times when there was competition from gold standard currencies. There has never been a time in history where the entire world used fiat currencies. The main problem is the time frame of the erosion of the value of money. I believe that the US$ has lost 97% of it's value since 1913, but yet it is still widely used. But what would happen if that 97% loss in value were to happen in 20 years rather than 100; or even worse in 10 years?

 

[Duke of Marmalade]

That is an extremely good point and question!!!, and one that could probably be debated over for eternity.

In fear of boring AAM contributors to death I am calling this Test Match to an end. I make it that I have a win and a draw in the series so far and I look forward to the next match.

 

[Chris]

In fear of boring AAM contributors to death I am calling this Test Match to an end.

Yeah, that is a very distinct possibility.

I make it that I have a win and a draw in the series so far and I look forward to the next match.

I believe you make it wrong