One of the remarkable features of the Crisis of Usury is how thoroughly it has exposed the flaws of our reigning public orthodoxies; and yet how invincible they remain in many particulars touching on those flaws.
To me this peculiar quality of the times is most prominent when it comes to the orthodoxy of globalization. For our purposes globalization may be defined as simply the integration of world capital markets. Globalization allows an investor in Asia or Europe, working through credit intermediaries — banks, funds, shadow banks — to deploy his capital in, say, the US housing sector by a few strokes of a keyboard. For decades this development was praised by almost everyone, Right or Left, as a manifest advance for human prosperity; more importantly, it was commended particularly for the stability it would secure for all of us.
The Great Recession has blown that theory to pieces. In the event, what globalization achieved was a condition of appalling fragility — and what’s worse, an exploitable fragility. The integration of capital markets across borders and cultures meant that, as a finance firm, all that was necessary for “too big to fail” status was a position sufficiently integral to the infrastructure of finance that the consequences of bankruptcy would destructively ramify to all corners of the globe. The key attribute need not even be sheer size. AIG included a sizeable shadow banking operation, to be sure, but what was far more important than its size was its crucial role in guaranteeing for other banks vast swaths of the mortgage-backed securities market. These guarantees were extended around the world; after Goldman, the next biggest institution to receive billions in US taxpayer cash after the chaotic September 2008 rescue of AIG was a French bank. AIG found an integral niche in global finance, and exploited it to the hilt.
More than systemic fragility, as can be readily observed, globalization presented the financiers with irresistible opportunities for high-tech blackmail. Corner a certain market in systemically important securities — commercial paper, say, or overnight repurchase agreements, or any number of a vast array of credit derivatives — and the unscrupulous financier could count on winning any stare-down with regulators in the event of panic and crisis.
Liberal economists like Yves Smith and Simon Johnson can perceive all this, and certainly elucidate the intricate details far better than I can; but what they cannot do, what they appear almost congenitally incapable of doing, is undertaking a reexamination of the assumptions behind globalization as such. Mr. Johnson, for instance, indulges in some extraordinary wishful thinking when he writes of a possible “cross-border resolution authority” encompassing the US, UK and Eurozone finance sectors, and empowered to “manage the failure of a financial institution with large cross-border assets and liabilities.” The EU is only barely able manage the financial troubles of one of its small peripheral members like Greece; what folly it is to imagine that any authority on earth could manage the failure of a British bank from Washington or the failure of a US bank from Geneva!
So even among the very best critics of the Usury Crisis, the assumptions undergirding globalization remain, for the most part, unassailable.
My second point under this head I can only offer in the form of the barest sketch. Frustrated by the high finance blackmail, Ms. Smith imagines a bracing lecture read by a US regulator to the heads of our finance firms. These firms launch their swarms of lobbyists to warn of a terrible “destabilization” of markets because of X, Y, or Z regulation, and the reader sympathizes with Smith’s imagined regulator who tells them to go pound sand. She ruefully gestures toward more robust regulatory authority “back in the days of Johnson or Nixon” — authority that would not, it is supposed, have taken these blackmails lying down. Well, maybe not.
But according to my reading of the design and history of the American republican system, the institution with the proper authority to undertake this sort of rebuke to private actors exploiting the bewilderment and inattentiveness of the public is the Legislature. Put otherwise, the congressional power of inquiry, in the American political tradition, is very robust. From the financial intrigues of James Wilkinson and Aaron Burr to the Jay Cooke bankruptcy after the Panic of 1873; from the Teapot Dome oil contracts scandal to the Pecora banking investigations of the Great Depression, Congress usually took the lead role of inquiring into the financial woes of the nation. The power of inquiry, in the republican form of government, is at the very heart of the legislative authority; indeed, sound legislation presupposes a body capable of inquiring into the causes of distress or alarm that may require legislative remedy.
Well, beginning in the middle of the 20th century, liberals, disturbed that Congress was being mean to Communists, mounted a sustained assault on the investigating power of the Legislature. They began by insisting that the Fifth Amendment protection against self-incrimination be extended to congressional committees of inquiry (previously contumacious witnesses had been literally jailed by Congress for failing to answer questions), and broadened the critique include a call for committee hearings to be subsumed under the robust regime of rights for the accused, as in court proceedings — a right to counsel, to cross-examine, to call rebuttal witnesses, and so forth. They developed a new theory of limitation of congressional inquiry to matters of an exclusively public nature. They pushed for stricter Judicial branch oversight of committee proceedings. And, more generally, they steered more and more of the matters formerly compassed by Legislative inquiries toward the sphere of the Executive branch and the enormous bureaucracy which has been built up around it.
Now, as a fact, in the vast majority of these cases, Congress as it were voluntarily relinquished its former investigatory powers. (The relevant Court precedents upholding that older prerogative of Congress remain by and large unchanged.) The power of inquiry lies quiescent.
As with so much else over the past few decades, Congress, under pressure from enlightened opinion, has been happy to surrender its oftentimes nettlesome responsibilities to other political actors — above all the courts and the Executive bureaucracy — and content itself with appropriations of public money and posturing on the Sunday television shows. The retreat of the authority of the Legislature has coincided with the retreat of republican self-government. It would not have surprised Madison.
The point here is that enlightened opinion, once it hardens into public orthodoxy, is remarkably immune to critique even after its flaws are dramatically exposed. For years we have heard an enthusiastic song and dance concerning the immense benefits of globalization, including a “great moderation” of economic uncertainty which was to issue in stability the like of which the world had never seen. A previous generation heard a series of lectures, not all that dissimilar in terms of its enthusiasm for newness and modern reform, about the backwardness of the Congress’s investigating committees; and how modern democratic nations should put their trust in competent Executives, with their armies of professional bureaucrats and experts, to govern society. Yet despite the evidence that continues to pile up suggesting that maybe these orthodoxies leave something to be desired, they remain more or less invulnerable to critique. Even those liberals who realize that globalization has strengthened the hand of the financiers cannot bring themselves to question its assumptions. Even those liberals who realize that the operations of the financiers cry out for thorough investigation and exposure have yet to even consider that the American political tradition actually does provide for this; it was their forebears on the Left who worked to dismantle it.
Comments (18)
To be fair to Johnson, while he is not questioning the viability of globalization as an economic architecture, he is questioning the viability of any global regulatory regime, inasmuch as each nation will rush to secure a temporary and destabilizing comparative advantage by luring predatory banksters to its environs. In the end, he concludes, perhaps wearily, that there is nothing to be done but to clamp down on speculative excesses at the national level, in effect telling the banksters to pound sand. It is probably true that the only secure route to that end would be a robust Congressional investigative power; but this would require not only the overturning of the liberal precedents you speak of, but of the structural reforms, applied to committees and the like, in the wake of Nixon's abuses, and the utter overthrow of our system of campaign finance, which is both corrupt and the condition of the possibility of much corruption.
Posted by Maximos | March 2, 2010 4:30 PM
He does seem to hold out some hope for a global regulatory authority under the auspices of the G20, though I think you are that his realism takes over by the end of the post.
Posted by Paul J Cella | March 2, 2010 4:37 PM
Paul, this might seem silly & trivial, but something that really puzzles me about your many discussions of these issues is your constant use of the antique term "usury."
I gather that, once upon a time, "usury" meant *any* charging of interest on loaned money. Later, it came to mean the charging of *excessive* interest on loaned money - especially from the point of view of stupid Christian wastrels indebted to non-stupid jewish money-lenders.
I suppose that *The Merchant of Venice* would be the *locus classicus* of the stereotype, here.
But what does all the recent unpleasantness have to do with the charging of excessive interest?
Posted by steve burton | March 2, 2010 9:23 PM
Some of Zippy's old posts examined usury from a Thomist perspective, in which it is the defined as the crime of "selling something that doesn't exist."
I'm using it a word to describe the various practices of profiting on the unearned increment. Especially in debt markets, so much of the work of financiers amounts to piling up enormous sums of capital behind infinitesimal variations in bond yields. Essentially we're talking about billions upon billions tied up in side bets on the directional moves of various securities. Below is a passage from Roger Lowenstein's book When Genius Failed which describes the "convergence" arbitrage trade on 30-year Treasury bonds. It gives you a taste of character of these trades on infinitesimal variation.
So a $15.80 profit on a $1000 bond becomes, on a $1 billion bond, a profit of $15,800,000, minus the borrowing costs. The whole trade is accomplished on leverage, on borrowing. The big profit was only possible because a half dozen banks lent the fund capital to "lever up" its trade.
Now this particular trade is ancient by Wall Street standards. Lowenstein's book is ten years old, and John Meriwether had been running this sort of arbitrage trade at Salomon Brothers ten years before that. These days, Wall Street uses supercomputers to identify market irrationalities and trade on them in fractions of a second. Oftentimes there is little or no human input at all. Again, the profit in these trades is almost completely dependent on being able to borrow huge sums to lever these tiny variations into enormous gains.
And yes, sometimes the trades go wrong. Then the leverage hurts you as much as it helped on the way up. Long-Term Capital collapsed and was (privately, but by Federal Reserve facilitation) bailed out in 1998.
I hope that helps, Steve.
Posted by Paul J Cella | March 2, 2010 10:05 PM
Well, not really, Paul.
I remain as befogged as before.
But thanks for trying.
Posted by steve burton | March 2, 2010 11:11 PM
Mr Cella,
In the arbitrage example above, where is the usury?. The arbitrage did exist.
Or is the objection that it was leveraged?.
Posted by Gian | March 2, 2010 11:32 PM
Hmmmm, Steve. I'll take to come up with another way of explaining it.
Gian -- I don't know that I would call that particular trade usurious. Certainly if bond arbitrage were no more complicated than that, there wouldn't be much to worry about. But as I pointed out, the 30-year Treasury convergence trade is now antique. For one thing, it dealt with actual Treasury bonds; most of the exotic trades today are operating in the netherworld of derivatives, structured products, and the like. Imagine the same arbitrage strategies applied to some bond, but all undertaken in off-balance-sheet derivative trading. So instead of buying the older bond and shorting the new one, a firm might buy-and-short a "interest-only strip" derivative, which provides exposure to the fluctuations in interest rate only, not the underlying bond; or maybe the firm would operate in the infamous credit-default swap market. These derivative products can be easily tailored to the desires of the client.
The leverage is a significant factor for sure. Without it, most of these trades would not be worth the effort. It is the leverage that magnifies a tiny profit into an enormous one.
Further, to me the usury is only visible from a broader perspective that gives us a picture of the relationship of this business to the political economy as a whole. Where these exotic trading strategies a mere backwater for quants to dabble, there would be little to complain about. Instead, we face a situation where, over the decade at least, and probably over the past three decades, high finance engineering has dominated American capitalism. In 1950, finance accounted for 10% of US business profits; by 2005 that had quadrupled. After the dotcom crash in 2000-01, virtually all of the subsequent economic growth in the US came on the back of financial engineering.
Posted by Paul J Cella | March 3, 2010 8:46 AM
Gian,
A complimentary perspective to Mr. Cella's would be to say that the a government fiat currency and central banking regime, such as we have in the US, allows for the counterfeiting of genuine capital on a massive scale. What this means is that the banking system has an amount of capital to lend out that is 10 or 20 or 30 times greater than the true amount of savings that actually exists in the economy, savings being the only way to generate real capital accumulation. Thus connected players such as Long Term Capital Management have access -- access that few other economic actors have -- to a huge pool of capital which is largely phony with which to play their games.
If everyone in the economy received a pro-rata share of this newly created capital (money) at the same time, everyone's relative position in the economy would remain unchanged. However, this money spigot injects new capital into the economy at a source and it's the banks who operate the spigot and those close to or connected with the banks who get to play with the new money first and gain a huge advantage over everyone else. I would qualify this as usurious.
Posted by Andrew E. | March 3, 2010 11:14 AM
Paul,
I would amend your title to say "being a classical liberal means never having to say you're sorry", as I don't want to get lumped in with President Obama, Nancy Pelosi and the gang in charge of Congress. But to the point of this post, it is not clear to me at all how globalization and the "Great Usury Crisis" are related. To begin, I'd like you to point me to a globalization cheerleader who makes the claim that globalization = stability. If they do make such a bizarre claim, they are wrong -- just like capitalism, globalization will lead to more prosperity for all, but the road to get there can and will be bumpy (i.e. far from stable). Secondly, as you say yourself, it is not clear that size by itself was key to the problems related to the "Crisis", rather as the example of AIG demonstrated:
So if there is no "vast swath" of "mortgage-backed securities market" there is no "Crisis". And as you and I have discussed previously, this market was an unholy creation of Wall Street and Congress (through Fannie and Freddie). So there is plenty of blame to go around, but I fail to see how globalization fits into the picture AT ALL. In fact, as Mark Perry notes in this excellent short article:
http://www.american.com/archive/2010/february/due-north-canadas-marvelous-mortgage-and-banking-system
Canada has been a global economic player for years and yet they hardly suffered during the "Crisis" because they had very different domestic policies in play with respect to their banking system.
I will continue to cheer the benefits of globalization and free trade until someone actually presents compelling evidence to me that the dislocations for some (which I can hardly deny) outweigh the benefits free capital and trade confer on the many.
Posted by Jeff SInger | March 3, 2010 3:54 PM
Jeff, if you really think globalization has nothing to do with this crisis, you haven't been paying attention. As it happens, Bill Gross of PIMCO just put out his March commentary and guess what he points to as the first aspect of "the fundamantal economic problem of our age"?
"Twenty years of accelerated globalization incrementally undermined the real incomes of most developed countries’ workers/citizens, forcing governments to promote leverage and asset price appreciation in order to fill in what is known as an 'aggregate demand' gap – making sure that consumers keep buying things."
Globalization was, furthermore, the conduit for the enormous sums of capital to pour into US securities markets, especially those related to housing, and wildly inflate those securities; that why losses in the US bankrupted Iceland, Australian and Norwegian towns, and so forth.
I read that piece on Canadian banking a few days ago. Very interesting. Of course, the mortgage-related reforms necessary to emulate that model here would right smack into the brick wall of US consumers.
Posted by Paul J Cella | March 3, 2010 9:43 PM
So usury is fundamentally related to Fiat Currency. The False Capital was generated by US Govt and is not linked with Globalization. However, the globalization leads to other countries being affected by the inflows of this False Capital.
The point of Mr Cella about globalization being conduit for the capital to pour into US securities market, I think, it was just the backflow of the False Capital to its source.
Posted by Gian | March 4, 2010 2:09 AM
Mr Cella, your 9:43
para #2, please show me where global trade intrinsically diminishes income. That is, trade qua trade.
para #3 "especially those related to housing", imagine!
para #4, whew! perhaps Canada escaped much of the damage because their government did not falsely pump up a market to the tune of, take your pick, four to six $trillion dollars. Perhaps brick walls will have to be "smacked" into.
The false inflation of a huge market in the world's leading economy may have had something to do with it, and yet barely rates a mention while we plunge on. Mr B. Frank desires greater, not less, participation, and subsidies in the billions remain available to our federal "pump priming" agencies.
Meanwhile, along with Greece and a few others, Great Britain appears prepared to take a fall, and all seem to have done it absent the bugaboo "globalization". Trade is not bringing this reckoning about, purely domestic, internal,political & electoral policies are.
I don't mean to exculpate the biggies of world or national finance, but a reminder of who are senior partners in this overall mess may be salutary.
Posted by johnt | March 4, 2010 10:50 AM
Paul,
I read about two paragraphs of that guy from PIMCO and couldn't take it any more. I mean, I'm sure he makes 10 times my income and knows a thing or two about investing money, but his "explanations" are silly. As "johnt" points out, there is no story behind his pronouncements -- he just pontificates as if it is self-evident to everyone that whart happened over the past couple of years is the following:
"In order to get us out of the sinkhole and avoid another Great Depression, the visible fist of government stepped in to replace the invisible hand of Adam Smith."
This is something I might read over at the DailyKos website but doesn't describe the real world in 2007 or 2010. Again, if globalization is the problem, then why aren't all global players equally hurting (e.g. Canada)? And without a proper accounting for the BENEFITS as well as the costs (which I won't deny exist), I don't think a proper analysis of globalization can be done.
Also, it would be interesting to have you tease out the implication of your statement that loses in the U.S. led to the massive problems in Iceland and Ireland. Couldn't one say just as easily that their foolish leverage and unrealistic hopes for high returns as far as the eye could see led to their massive problems? Again, as "johnt" suggests, I wonder if you confuse globalization and international finance with bad domestic policies?
Posted by Jeff Singer | March 4, 2010 11:57 AM
I can scarcely fathom the resistance to the inclusion of globalization in the indictment, inasmuch as econobloggers have written, literally, thousands of posts on the role global imbalances played in the genesis of the crisis. "Global imbalances" is shorthand for the balance of trade problem that developed in the decades following the collapse of the Bretton Woods currency regime, where the United States, in consequence of both a determination to retain the reserve currency role - which necessitates that the US facilitate the accumulation of dollars by trading partners, for use in international payments - and the turn towards neoliberalism, with all of its accoutrements, such as outsourcing, ended up running massive structural deficits. The obverse of those massive deficits was the accumulation of foreign reserves in numerous foreign locations. For a sizable percentage of the holders of those reserves, the meager returns available on US sovereign debt were insufficient, and thus the relentless pursuit of yield accelerated; this is the reason, often mentioned in recent economic literature, for the increased quantity of lending, including subprimes, NINJA, and so forth, in the United States: there was an insufficient supply of prime securities, and so various expedients were developed whereby worthless securities could be transmogrified into investment-grade paper, all to satisfy this growing demand for investment instruments.... which itself was conditioned by globalization-driven imbalances.
The reason Canada largely escaped the financial crisis, at least insofar as globalization and international capital flows were concerned, is buried in that article linked above: Canada is a bit player, if at all, in the securitization market, which is to say that Canada wasn't interested in satisfying the burgeoning global demand for usurious investment instruments. Neither their banks nor their regulators altered mortgage standards in order to facilitate this financialization, and their stolid good sense served them well.
As for the argument over usury, and the applicability of the concept to the present distress, suffice it to state that the simple arbitrage play Paul mentioned is socially useless and utterly infecund. It generates no new wealth, no new productivity, but merely exploits a differential which may or may not be rational (It is worth mentioning that, if the differential is irrational, than the EMH, on which so much haute finance depends for theoretical legitimation, is false, inasmuch as irrational valuations cannot reflect the "rational analysis of all relevant information".). It does not facilitate price discovery, because it is predicated on prices, and neither does it, assuming that it works, actually discover any prices, for it assumes that the prices should converge, and, with the aid of leverage, undertakes to cause them to converge - which is quite a different thing. It is a pure paper trade, money chasing money in the pursuit of profit. We should not dignify this sort of practice as though it were fundamentally identical to investing in a factory that makes better widgets.
Posted by Maximos | March 4, 2010 1:24 PM
Maximos, Paul,
I don't know if either of you read VDH, but his latest article is very much in the spirit of the general discussion about the direction our economy has taken. I think his points about how we have the ability to produce so much actual wealth, but don't have the culture or will to do it instead of playing financial games and consuming the accomplishments of our ancestors dovetail quite nicely.
Posted by Mike T | March 4, 2010 1:56 PM
I suspect the difficulty in understanding economic sins like usury stems from the immoral abstraction of the human relation out of economic transactions, displacing the reality of mutual obligation on the part of the buyer and seller with a reductive and legalistic "if both consent, all is well" contractual view which considers only price and quality as meaningful criteria for economic transactions once consent is acquired. Makes things much easier for the gifted technocrat.
On such a contractual view, I have no obligation to refrain from exploiting asymmetric information, intellect and power. "If I can sell a common apple to a weaker, dumber person than myself for an agreed upon price of $50, so much the better for me," says Mr. Contract. "After all, one can't articulate a complete and exactly formulaic account of what things should cost and when, so maybe I am justified in selling this man an apple for $50." When such transactions take place on a personal scale, face to face, it is much harder to commit such an injustice and much easier to refuse to abstract the human relation from the transaction by discussing the context that would determine the price--even if the seller sells at a lower price than he could have gotten had he not cared for the buyer, that is, for his neighbor. Wisdom in love would be used.
The point is not that only face to face economic transactions are legitimate. The point is that to the extent that the involved parties in economics--investors, producers, buyers, sellers, etc.--are separated by greater distance of space and time, the more wisdom with regard to the human relation inherent in the economic transaction is required to do justice to the human person. But we have gone in the opposite direction. Having denied the place of the human relation in the economic transaction in our theory and practice (or more accurately, having reduced it to mere consent, which frees the powerful to manipulate and dominate), we have reduced economics to a system of technical process that legitimates all outcomes on the basis of its procedural perfection rather than on the basis of relatively messy wisdom, messy because it engages the fullness of the human person rather than denying full humanity by accepting a human defined in terms of mere will (and therefore and transactions legitimated by consent).
So we have, across great distances, billions of dollars worth of economic decisions designed to exploit the irrationality, ignorance, and weakness of human persons and peoples we never even know and so never even think to care about (though we believe we may, despite our complete lack of care, nonetheless trade with them). Indeed, I am well aware that many people reading these paragraphs will dismiss these words with the technocratic arrogance of the Progressive Uebermensch. But they are nonetheless true.
So is globalization intrinsically evil? I don't believe so, and neither should anyone who believes in a universal Church. It is a catalyst of the underlying anthropological assumptions built into our economic institutions. But it is not merely a "neutral" catalyst either since it makes ever more distant the relations we enter into as finite human beings, which must strain our capacities for wisdom even in a perfect world. In a world where the only kind of "wisdom" in economics and finance consists in a technocratic competence for exploitation, globalization is gas poured on a campfire next to tents where people sleep.
Posted by Albert | March 4, 2010 2:47 PM
Another way to understand globalization, from a historical perspective (as Maximos indicates), is by way of the post-Second World War settlement by which the losers in that conflict were revived to prosperity and peace. Economically, the way this worked was that the US allowed and encouraged a series of nations to grow by means of structural mercantilism. First Japan and Germany, then South Korea, Vietnam, China, and some smaller Asian and Persian Gulf nations, imported US demand in huge quantities, which demand their merchants and manufacturers answered with productive supply. The US provided an enormous market for their products, and globalization facilitated it. Now Maximos might disagree with my view that this settlement reflected basic American generosity, but I think even he must concede that it was a very peculiar imperial system indeed.
Just when it seemed, after oil crisis and several rough recessions, that US demand had reached its natural limit, with the consequence that these now robust economies were poised to displace America, Wall Street began to develop whole new fields of speculative debt. US demand continued to expand -- by credit. That is not the whole story, of course: you will surely know that some very real innovation and new wealth was generated in technology. But as a friend and small businessman in the technology field constantly reminds me, American innovation has not yet recovered from the dotcom crash. Again, the natural limit of US growth was extended by debt mechanisms, increasingly opaque, usurious, and sometimes actually destructive of real wealth. A market like credit-default swaps is, truly, a zero-sum market. Everyone's gain is someone else's loss. And it turns out that there is more profit (as Goldman's hyena-like dismemberment of AIG showed us) on the downside. On the upside, these derivative products seem great for everyone: they lower borrowing costs for all actors involved. AIG selling "protection" on MBS enabled more and more borrowers (many with dubious creditworthiness) to borrow cheaply. It facilitated the brokers selling mortgages to Wall Street firms. And it facilitated the Wall Streeters packaging them into massive collateralized securities. It was great for everyone on the upside, but when these securities started collapsing from their inflated heights, only a few really sharp actors (like Goldman) were out in front of this movement well enough to profit by it.
(And profit they did. Have a look at the graphic attached to this story: http://www.nytimes.com/2010/02/07/business/07goldman.html --Keep in mind that by the end, much of that capital transferred to Goldman was taxpayer capital.)
The point is that the impetus for this transformation of the American political economy from one where 10% of business profits came from finance (1950) to one where over 40% of business profits did (2005) -- the impetus for this was the structure of the world economy.
Posted by Paul J Cella | March 4, 2010 7:15 PM
Gian,
If you have the time and the determination I suggest this lengthy article by the economist George Reisman which I found extremely helpful in explaining the fragile nature of our financial system. It was written a little less than two years ago right after Bear Stearns went under, it covers topics such as leverage, bank capital and credit expansion.
http://mises.org/story/2926
Posted by Andrew E. | March 4, 2010 9:32 PM