As I mentioned in an earlier post, the book I’ve been listening to on the long drive to PA is Niall Ferguson’s “The Ascent of Money,” a history of finance. It can be tough going for someone like me, but it’s mostly an excellent example of explanatory history — that is, of explaining how we arrived at the financial practices and institutions that we have today. It can be a really exciting story. Take the rise of the Medici family, for example. I had no idea that they were basically a pack of medieval Sopranos who were ruthless and smart, and made themselves indispensable to the society of their day, and therefore bought immense respectability. Or take the truly amazing story of the Rothschild banking family, and how the genius of N.M. Rothschild, combined with the close-knit family network spanning the European continent, made the family wildly rich, and massively powerful. Ferguson quotes a harsh letter N.M.R. wrote to the Prussian finance minister when the latter tried to change the terms of an agreement he’d made with the Rothschild bank. That the son of a man (dynasty founder Mayer Amschel Rothschild) who had been born in the Jewish ghetto of Frankfurt would be able to speak that way to a Prussian minister of state shows you how very, very far they had come on their wits. As Ferguson tells it, the revolution the Rothschilds helped make with their financial innovations helped doom the ancien regime, in which wealth was tied to land.
Listening to Ferguson’s stories impressed upon me how very much the stability of states depends on finance. He tells the startling tale of John Law, a Scottish gambler and rapscallion who weaseled his way into the good graces of the last kings of France, and became an immensely powerful state minister in charge of the economy.He pumped up a massive bubble based on investment in France’s Louisiana colonies, and when it burst, the effect was catastrophic on the French economy, leading to the bankruptcy of the royal house, and to the French Revolution. This story, as well as Ferguson’s discussion of what hyperinflation and other drastic economic instability did to the lives of ordinary people — and how it panicked them — made me appreciate much more why the Russians support Vladimir Putin. His extensive discussion of Pinochet’s dictatorial rule in Chile, and what it accomplished economically (versus the wreck the Marxist Allende made of the economy), gives me a more sure grasp of how liberal democracy depends on economic stability. Ferguson also writes well of the moral complexities involved in finance (of which the Pinochet story is one). Though people can be cutthroat when dealing with money, ultimately the entire global economy, which is based on credit, is in turn based on trust. And because it is based on trust, there is an inseparable moral core to finance — and indeed a psychological dimension as well. If people do not believe they can trust the system to act fairly, they will lose faith in it — and this can lead to revolutions. It certainly has done.
(To be sure, Ferguson’s book is by no means a moral indictment of financiers; in fact, he praises them throughout the ages for having made us all freer and more prosperous. If not for finance, we would all be living much poorer, riskier, anxious lives.)
Anyway, tonight I logged on to get the news and saw that the stock market is way off this week, in part because of the populist victory in the Massachusetts Senate race, and in part because it looks like Ben Bernanke might not get a second term at the Fed. Floyd Norris, writing in the Times, says this instability — which might cause a huge selloff on Monday — might have been avoided had the following things occurred:
* If the Fed had shown a lot more contrition for its errors of monetary policy and regulation.
* If the banks had shown similar contrition, and accepted the idea that people who — as a group — almost sank the financial system did not deserve to return quickly to mega-bonuses.
* If Goldman Sachs, in particular, did not insist that it never needed a bailout and was never in danger of collapse.
* If the Obama administration had chosen to include only people with no ties to the past errors.
See? It’s all about morality, in particular, accountability for incompetence and greed, the people’s righteous disgust that the class most responsible for our current misery are refusing to take meaningful responsibility for what they did, and our government being unwilling to meaningfully hold them accountable. Faith in the system must be restored, and I don’t see how it can be restored without some sort of reckoning — which the political class seems determined to prevent. This could get real interesting, real fast. Which, if you’ve read Ferguson’s book, is not something to look forward to.
UPDATE: I’m with Megan McArdle in wondering how come people who are mad at the banksters are taking it out on Ben Bernanke? If he were Alan Greenspan, sure. But as Megan writes:
Bernanke didn’t become Fed chair until 2006, long after it was realistically possible to do much about the bubble except wait for it to pop. He shepherded us through the financial crisis without another Great Depression–maybe not perfectly, but no Fed chair would have been perfect.
I’d say a lot of this is about displacing blame. How many sitting members of Congress voted over the years for deregulatory policies that made it much easier for bankers to take foolish risks? How many of them took campaign money from financial interests that wanted this to happen, against the public interest? And now they’re going to scapegoat the Fed chairman??
posted January 22, 2010 at 10:15 pm
Thanks for sharing your thoughts on The Ascent of Money as it helps to clarify some of what’s going on today. I’ll be adding the book to my reading list.
Safe travels.
posted January 22, 2010 at 10:32 pm
Goldman Sachs was forced to take TARP money to stave off a financial panic, along with ALL other large banks. They repaid there TARP money on the first day the government would allow them to, at a nearly 23% profit to the government. They paid back their forced loan AND 23% on top.
posted January 22, 2010 at 10:43 pm
Good book. We did the audiotape on our vacation trip last year. Pay extra attention to the part on bonds.
Steve
posted January 22, 2010 at 11:06 pm
I’ve been reading that China is tightening up on new loans. That’s worth noting
posted January 22, 2010 at 11:26 pm
I think it would have been hard for the Obama administration to avoid hiring guys with ties to the past errors – the finance system is very incestuous – Goldman Sachs in particular has lots of “relatives” all over. Seems like that is part of the problem – too much inbreeding in the system.
Rod said: Listening to Ferguson’s stories impressed upon me how very much the stability of states depends on finance.
Yes – and that is why we should keep this in mind when we discuss how best to protect the US – no state – no matter how impressive their military – has ever lasted for long if their economic system was not sound. A sick economy represents a lot more threat to the US than any number of terrorists etc. I am inclined to think the more some carry on about other threats – the more we should pay attention to what they aren’t talking about. Focus our attention of the threat of (for example) Islamic radicalism so we don’t notice the more significant threat – like their hands in our pockets.
John E said: I’ve been reading that China is tightening up on new loans. That’s worth noting
Suspect a lot of what China is up to is worth noting. Given the buying spree the Chinese have gone on they probably don’t have much to loan – they have been buying up all sorts of oil related companies of late including storage space and striking deals for pipelines. They obviously are safeguarding their access to oil.
Given how important economics are I have always thought it should be part of the high school curriculum – if nothing else a basic literacy in finance concerning how banks work and facts about loans etc should be taught. I started Ferguson’s book and put it aside for something else – you’ve motivated me to get back to it.
Someone I have been impressed with is Elizabeth Warren – the head of the group with oversight over the TARP funds. She has been speaking out a lot about consumer protection and what we really need to do to protect the average person. Doesn’t grab headlines of course.
posted January 23, 2010 at 4:45 am
Lead me not into temptation, Mr. Dreher…..I ‘m perfectly capable of finding it myself.
Mr. Dreher, @ 9:25 PM, writes:
“It’s all about morality, in particular, accountability for incompetence and greed, the people’s righteous disgust that the class most responsible for our current misery are refusing to take meaningful responsibility for what they did, and our government being unwilling to meaningfully hold them accountable. Faith in the system must be restored, and I don’t see how it can be restored without some sort of reckoning — which the political class seems determined to prevent. This could get real interesting, real fast. Which, if you’ve read Ferguson’s book, is not something to look forward to.”
In terms of the financial “industry”—and loosely do I use that term, as much of it seems to be simply Monte Carlo writ large with a serious cover charge, which produces nothing—we have a situation in which the larger banks are being bailed out by central governments. This is different, far, far different, from past centuries. I recall reading how the great banking houses of the early-Modern period were borrowed from heavily by kings and high nobles (often for the purpose of making war), and sometimes went broke when said kings and high nobles decided not to pay them back.
At least one fairly reliable source (Gary North, at LewRockwell.com) links the change in modern times to the abandonment of the gold standard since the 19th century. Without the discipline of hard money and market standards, it becomes easier for banks and other financial institutions to over-leverage (to make too many loans relative to deposits, for those of you in Our Studio Audience). When times are good—when those loans go towards things that produce a return, like producing, profit-making companies—banks make money, because everyone else makes money. Life is good.
When times go bad, the over-loaned bank goes bust very easily. I seem to recall a Time magazine article from early last year that refers to some of the larger banks being leveraged 30:1. For Our Studio Audience, that means that said banks had made 30 times the amount in loans that they had on hand in deposits. The problem was that having that many loans means that there is a far greater chance that some of them are going to go bad. The bank in question, like all banks, is required by law to have a certain “capital ratio”, a certain level of deposits to loans. The bank still has to cover its deposits. In the 30:1 example, that means that if three-point-something of those loans go bad, the bank cannot pay out its deposits, and gets “wiped out”. This is the problem with the so-called “toxic assets” that was the nominal reason behind the TARP program that Messrs. Obama, Bernanke and Bush came up with in late 2008. Assets that could not be readily valued—the so-called “mark to market” issue—had to be treated as worth nothing. Lots of banks found that, all of a sudden, many of the items they had in their portfolios could not be valued, and were worthless.
How many bad loans do you suppose the larger banks made before the Lehman Bros. Crash ? And worse still—how many of those non-performing loans are still out there on banks’ balance sheets ? I suspect that the actual balance sheets of the larger banks are in much worse shape than most commoners think, even today.
Now let’s get governments in on the act. Modern central governments are at least nominally democratic; they stay in power by virtue of their ability to secure “the consent of the governed”. Let’s also remember that the franchise is effectively unlimited; virtually everyone over the nominal age of majority is entitled to vote. These men and women who wield the Power of the Rods and the Axe are supposed to use their power to further “the public good”. In actual practice, people use that vote to advance their own immediate self-interest, through the redistribution of wealth. They vote for politicians who will introduce new benefits, or expand existing ones.
Since time moves forward, not backward, people will tend to support expanding those programs that they are likely to benefit from in the future, not the past. (The stereotype that springs to mind is that of the old, retired man who won’t support public schools because all his children are grown.) This is why 60 % of central-government spending–and rising !—goes towards elderly-supporting entitlements: Social Security, Medicare/Medicaid and public-service pensions.
As it stands now, the US government and its provincial subsidiaries face unfunded liabilities amounting to roughly $ 85 TRILLION, and growing at a 5-7 % clip per year. Growth in the productive economy in the US is usually in the 2-3 % range. When government liabilities grow faster than the productive economy, there is a sustainability problem.
The people who are in charge, who are actually in public office, wish to stay in office. It’s not a bad gig, after all: good pay, nice benefits, and people call you “Mayor” or “Congressman” or “Your Honor”and invite you to lunch in fancy restaurants. They pay attention to what you say, too; you can even get on TV sometimes ! What’s not to like ?
All Mr. Mayor or Senator So-And-So or Congressman This-And-That have to do is keep the voters happy. That means handing out Lots of Free Stuff to The Dear Peepul, while sending the bill to Those Mean Old Nasty Rich White Guys Who Live Somewhere Else and their Evil Allies, the Bad Corporations Who Make (gasp !) PROFITS. As I wrote earlier, we live in a (nominal) democracy: numbers count. Which group has more people in it ?
There’s your target for “the people’s righteous disgust”, Mr. Dreher: The Man In The Mirror. Thee and Me and The Man Behind the Tree. When you refer to “the political class”, that’s who you’re referring to. We vote, and voters, after all, are public officials.
You write: “Faith in the system must be restored, and I don’t see how it can be restored without some sort of reckoning — which the political class seems determined to prevent.”
This will require a serious overhaul of the political/economic system as a whole. The last 70 years or so has seen imbalances of all sorts spring up: an imbalance of debt to earnings, an imbalance of central-government promises to the ability to keep them, and most importantly, an imbalance of political power between those who produce and those who consume.
Our economic debts are going to have to get paid off. We’re seeing this already, at least on a personal/family level: households are spending less and saving more. Many people are going to have to go bankrupt; some of their creditors are going to have to take nasty hits. The next 5-7 years are going to be, economically speaking, no fun.
Our “promise debts” are going to be largely repudiated, either through inflation, which reduces the nominal value of the benefits promised, or through actual reductions in benefits valued in stable dollars. My guess is both, with the politicians favoring the former. Generation Xers and Millennials, here’s some investment advice: anyone assuming that SocSec and Medicare will be around in anything like their current form in 2025 is taking the short end of a bet.
This leaves the political imbalance. That is the heart of the problem, and I don’t see it changing voluntarily absent a change of mindset on the part of the population as a whole. “Democratic” government—government based on the notion of absolute “equality”—is going to have to go. In order to keep State spending under control, we are going to have to restore the feedback mechanisms we dismantled in building the welfare state. The right to “vote”is going to have to be limited to property-owners and those who contribute to the economic system, i.e. taxpayers and the productive. Something like the setup that existed under the pre-1828 Constitution, perhaps. Otherwise, the parasites and their politician-handlers will get right back in control.
THAT is going to take inflation, economic collapse, and revolution.
Have a nice day.
Your servant,
Lord Karth
posted January 23, 2010 at 6:11 am
Well, while I don’t endorse restricting the franchise to property owners (to put it mildly), I do appreciate the corrective/clarification you made to my remarks. Yes, in a democracy, the people generally get what they deserve from their government. One reason why I found the recent Massachusetts election results so demoralizing is not because the machine politician lost (a result I would normally find pleasing), but because the “outsider” politician who won seems to me to have no more realistic idea of how to get out of this economic mess than his opponent. I do not blame the People for being angry and frustrated at how financial interests dominate our government, but I do find it maddening how easily the people are persuaded to believe that one side’s snake oil is better for us than the other’s.
posted January 23, 2010 at 9:40 am
Interesting post and comments. I don’t pretend to any expertise about finance, so some of the discussion is over my head. But, I was really heartened to hear that Obama announce the proposed reforms of our banking system the other day. Finally. It was predictable that the Stock Market would drop.
I’m sure it is deflating to Wall Street folk to be asked to do what is healthy for our economy in the long run when they are beginning to feel that “irrational exhuberence” again, and the idea that rules that might prevent another financial collapse are a bad thing is adolescent and absurd.
One financial advisor, interviewed on the Today Show, said that these new rules would be a wet blanket on the economy. “Your 401(k) might drop!” I’m sure most of us wouldn’t mind a temporary drop in our retirement savings if it were followed by slow and steady growth without the danger of imminent global economic collapse as the newest bubble bursts.
The assumption the Wall Street folk appear to make is that there will be no day of reckoning when the taxpayer can no longer afford to bail them out, and comes to Wall Street with torchs and pitchforks to “burn the suckers down.”
But, God forbid that President Obama should expect Wall Street to accept rational regulations in the present. It might reduce someone’s unearned bonuses.
posted January 23, 2010 at 10:18 am
I’ve got The Ascent of Money on my digital recorder; not overly impressed (he’s pretty biased imo), but some of the history is educational for me.
Rod, It’s all about morality, in particular, accountability for incompetence and greed, the people’s righteous disgust that the class most responsible for our current misery are refusing to take meaningful responsibility for what they did, and our government being unwilling to meaningfully hold them accountable. Faith in the system must be restored
AAAAACH! This is so, so wrong!
The problem is the people. WE are the “class” that is to blame. We, the public:
- refuses to cut spending and live within our means.
- have our families in a wreck.
- borrow money to spend on luxuries
- refuse to save a dime
- borrow from China (on starvation wages) who yet saves 25% to loan to us, the richest people in world history!
We deserve whatever happens to us – and it’s gonna have to be really, really bad to reach our hard hearts.
Yet you blame “banksters” and “pols”?? They are giving us exactly what we want! So we blame others whilst demanding “stimulus”, more debt to avoid the pain we’ve earned, and the public supports this blatant robbery of our children.
The economic crisis is caused by “debt deflation” – that is, government and private debt absorbing such a large percentage of our GDP that our debt will simply never be paid off, so we are collapsing. But we can’t abide by that, so we are printing money to make up the difference. It’s really that simple. But hey, it’s so, so much easier to blame others.
posted January 23, 2010 at 10:49 am
Karth, There’s your target for “the people’s righteous disgust”, Mr. Dreher: The Man In The Mirror.
Thank you.
At least one fairly reliable source (Gary North, at LewRockwell.com)
Keep in mind that North is a strict inflationist who missed the deflation of 2008. Guys like North missed out on 2008 while many others made 50% or more – it was a very sweet time to make money my friend! And there is more on the way that North will again miss out on (google Mish and North for a good discussion of deflation versus inflation).
Sure, North is right that inflation is where we end up – the dollar will go to exactly zero eventually due to the uneducated, immoral, outrageous public – but anyone (like North) who believes deflation will not happen first should be read at with caution methinks.
posted January 23, 2010 at 12:14 pm
Re: He pumped up a massive bubble based on investment in France’s Louisiana colonies, and when it burst, the effect was catastrophic on the French economy, leading to the bankruptcy of the royal house, and to the French Revolution
The Mississippi Bubble was in 1721 and the Revolution got under way in 1789 so this is a little like blaming our current troubles on the Roaring 20s. All the great powers of Europe were in serious financial trouble in the 18th century (except the Netherlands which was basically a banking chain with a country attached). I’ve seen arguments that Britain and Prussia were in worse shape than France. The real problem was that France lacked a comptenet government by the late 1700s. The king was a doofus, the queen a bimbo, and surrounding them were a gang of greedheads and reactionaries utterly unwilling to accept any change to their priveleges. Louis XVI had a decent and capabale finance mninister in Jacques Necker but he was hamstrung constantly whenever he tried to make any serious reforms. (The guy was a rare example of a virtuous banker: to tide Frnace over on the eve of Revolution when famin was threatening he out up a large part of his personal fortune as collateral for loans to purchase enough grain to keep the people fed. He lost the money when the revolutionaries defaulted on France’s debt.)
posted January 23, 2010 at 12:28 pm
Crystal Knight, Could you please explain in simple terms how an unfunded liability is meaningful?
It’s meaningful because the US Government:
a) has the power to rack up debt unlike any other business (because of it’s sheer size and power)
b) has the power of taxation after this fails
c) has the power of the printing press…that is, “stimulus” when we run out of a) and b)
d) answers to a bunch of lunatics (citizens) who care nothing but for themselves and their own greed (they even bankrupt their own offspring…when they ain’t aborting them!)
So these unfunded liabilities (which the public now believes is their birthright) will simply be “paid” via borrowing first, then by taxing every last drop of income or asset (bringing deflation as money is robbed from productive business to government) and finally by printing money to erode the massive debts, leading to inflationary collapse.
It’s going to be like a fire in a crowded theater. So get outside the building and grab the popcorn. But don’t forget to buckle your seat belt (that is, sell your stocks and prepare, because it’s easy to make money during these time for those prepared). Then enjoy the show! Because it’s going to be a blast to watch the “hey, debt and liabilities don’t matter because they can’t be paid!” crowd suddenly get religion when the system melts. Justice will be served wholesale.
posted January 23, 2010 at 2:41 pm
All well and good to blame the voters. Just a few posts ago someone quoted studies that indicate that “natural leaders” are the best liars.
I suppose we can blame voters over 30 for falling for it, but the fact is many people consistently believe candidates. I, for one, am sick of how namby-pamby the Dems have become over health care reform. Shoot the current system – put it out of our misery and start over with something rational. But no, they are kow-towing to every corporate interests and letting the wackiest Republicans have the spotlight (I hail from Bachman country).
I didn’t believe they’d fix everything, but I had hoped we would emerge from “health care reform” with something better than we have now. The way it looks, it will be another boondoggle for insurance and pharmaceutical companies. This is W’s third term in every sense. We’re going to end up with a worse system, in all likelihood, that fixes none of the real problems.
I voted for the people who indicated they understood the problem. So, I fell for liars again. I’m 55, so blame me, yeah. But damn, they were convincing.
posted January 23, 2010 at 4:16 pm
Crystal Knight @ 11:13 AM writes:
“Could you please explain in simple terms how an unfunded liability is meaningful? As I understand it, the unfunded liability for say, a life insurance company would be the amount due ALL policyholders if ALL policyholders dropped dead tomorrow, minus assets on hand. A handy actuarial tool I suppose, but in general discussions little more than a scare quote?”
mdavid was pointing the way, Crystal.
An unfunded liability occurs when the central government (or one of its subsidiaries) establishes a program—a medical-care fund, let’s say—and then does not set aside moneys in a trust or some other sequestered instrument to pay for it. In that sense, it is a great deal like an insurance company trust, except that its promises to pay have nothing behind it.
Unlike an insurance company, however, the government can raise funds through coercion. The Equitable Life Insurance Company of West SouthNoplace cannot demand payment at the point of a gun. It is therefore FAR less likely to go out of business, and far MORE likely to keep shelling out. All it’s doing is deferring the day when that “funding mechanism” known as the IRS will be directed to go and collect its “dues” at gunpoint.
That day, however, is still coming. The government will still have promised the money—and is going to be more than willing to go and collect. That’s the problem.
All the current gaggle of elected officials is doing is trying to kick that particular can down the road. Sooner or later, however, the music will stop. The guns WILL come out, and the fit WILL hit the shan.
At which point a ROCKIN’ good time WILL, repeat WILL, be had by all.
Even if they don’t want to.
Your servant,
Lord Karth
posted January 23, 2010 at 6:12 pm
re: The Equitable Life Insurance Company of West SouthNoplace cannot demand payment at the point of a gun.
You know, the gun part is annoyingly melodramatic, but any business that has a contact with individuals to pay them X for Y can indeed call on the state to enforce that contract with all the govermmental powers (guns or not) it has to enforce its own levies.
In terms of unfunded liabilities, all the world is one: while you sock money in the bank and pretend you are saving for the future, in reality the future can only be paid for by the future (the bank will simply be lending out your money today for things people are spending money on now). The unfunded liabilities argument is simply a way to scare the unwary. But total up your expected expenditures for life’s necessities over the number of years you expect to be piddling around this mortal coil: it’s rather nasty isn’t it? And unless you are Mr Gates or Mr Buffet you are unlikely to have the money saved to fund those numbers. But in reality unfunded liabilities should be considered not against savings but against expected future income. Same for the govermment and businesses. If you also total up your expected lifetime earnings your personal future liabilities donlt look so monumental any more.