What’s Wrong with the World

Are ideas considered property in this case?

What about intellectual property law/rights?

It is helpful I think to cast it in terms of "fraudulent property" as you have here. In the previous discussions a commenter, Kristor perhaps, suggested that usury might be a species of fraud. But the problem with the term "fraud" is that we tend to use it to characterize deliberate, calculated intentions: lying about material (in the business sense of the term 'material') facts, if you will. Snake oil, on the other hand, is fraudulent property even when the snake oil salesman sincerely believes his own sales pitch. What is at issue is which of the things flitting back and forth in our economy are real, and which have only illusory existence. The fact that modern people sincerely believe a great many things about money, contracts, etc (indeed are well motivated to sincerely believe them for the sake of personal gain) doesn't make those things ontologically true.

So a person charging interest on an unproductive loan, or issuing a credit default swap subject to the sort of circularity involved in this crisis (where X insures Y's bonds, Y insures Z's bonds, and Z insures X's bonds), or (in a nod to Lydia) issuing fiat currency, or doing whatever things we end up determining to be usurious or of the same genus as usury, may not even believe or know that he is selling something which does not exist. But objectively what he is selling actually is something which does not exist.

There is still something bugging me about the characterization of financial reality in probabilistic terms, which is to say materialist terms. Contracts and such represent anticipated events and obligations; while anticipated events may have a probabilistic element, obligations are not material. So I'm left with this buzzing in my head that I can't quite pin down yet; but something doesn't seem quite right with our (or my) 'metaphysics of money', if you will.

It seems to me that sometimes government and also analysis has to play catch-up, because people think up new things that no one ever thought of before. It might have been somewhat difficult for an armchair philosopher to think of a Ponzi scheme in order to condemn it and analyze what is wrong with it before anyone had ever carried out a Ponzi scheme. It might be helpful if one could say, "Such-and-such is fraud in property, because it pretends that ______ when ________ is not the case." For example, a Ponzi scheme is fraudulent, because it involves pretending that the money is being invested in a profitable enterprise, when this is not the case. One might argue that fiat money is fraudulent, because it involves pretending that wealth can be created out of nothing, when this is not the case. I'm sure someone else can do a better job than I can at making such a sentence for these abstract derivatives.

At best what the exotic finance engineering of Wall Street did was trade in property in something that did not yet exist.

They were Being speculators?

Insofar as this proposal attacks treating securitized risk as an alienable property interest, I support it entirely. However, I'm curious as to where we would draw the line of "existence." The law has long regarded as concrete and substantial many interests that cannot be given any tangible expression beyond the creating instrument. Take the remainder, or the trust, or the various forms of corporate entities (which one finds even in Canon Law, under the heading "juridic persons"). I could describe with great specificity the rights that inhere in each such type of property, but this is due in large part simply to their antiquity. Is it simply that the remainder reflects an interest in actual property, while the commercial paper reflects an interest in nothing but a contingent payout?

As for fiat money, I think it's unsound fiscal policy but I don't know I would label it fraudulent. That seems to assume that money is itself a good (as in a product, not a virtue), as opposed to simply a currency. No form of currency is inherently valuable, instead being useful only as an article of exchange. If I am marooned on a desert island with 100 chests of gold doubloons, I am not a rich man. I think this was one of the primary economic arguments of the Late Scholastics, but their work is devilishly hard to track down in English so I don't know for sure.

I wouldn't mind fiat money if nobody ever made any more, except (in the case of actual physical bills) to replace some that became old and were destroyed--that is, if it remained a fixed quantity. Then it could just be regarded as a means of exchange, as you say, Paul.

Yes, where we draw the line is obviously a huge question. It's where the rubber hits the road.

If we take one of our principles to be closing the gap of abstraction between capital (productive property) and the paper or digital instruments that represent it in daily trading, then usury may prove useful in illustrating where this gap of abstraction has exceeded the boundaries imposed reason and experience. In the old days capital meant either land or the means of production. The latter is a pretty broad category in an economy like ours, because it may legitimately embrace a good variety of abstract instruments. No one here is proposing to prohibit basic equity and debt securities, for instance; we all agree that they constitute an indispensable aspect of the means of production in the modern economy. I expect that few of us would want to throw out futures contracts or "plain vanilla" interest rate swaps.

The tough question is how to determine the line beyond which we are obliged to say that reasonable limits have been crossed. When does abstraction become excessive and dangerous? Where do we cross the line from "legitimate abstraction of property for productive purposes" to "selling property in nothing"?

As several people have raised, though, "capital" should be able to include things like ideas, intellectual property rights, and even name recognition value. Obviously when a company is sold the good will it has built up under its name will be part of what determines the price one can get for it.

Also, our account of modern usury ought to take cognizance of the implicit blackmail inherent in this mess. If all the big banks are trading in the same fraudulent property, the same exotic, engineered bonds, and spinning off new abstractions to capture microscopic yields on huge collections of securities, then at back of this whole system is the stability introduced by the presence of the one actor who can absorb all the risk that the banks abstracted away: I mean, of course, the taxpayer.

The banks and investors can trade in what does not exist, because they know that, off at the end, the US government will step in to make their pretended property real.

Quite true, Lydia -- which is why this is such a tricky question.

It seems to me that reading Aquinas on banking and finance is like reading David Ricardo on the Trinity. I'd no sooner filter these financial issues through the grid of scholasticism than I'd filter the truth claims of the Catholic church through the filter of mercantilism. We need to select better tools of analysis.

Put differently, the medieval synthesis unraveled because it was inexpertly cobbled together by folks who, for various historical, philosophical, and theological reasons, did not understand many things about which they wrote. Under the weight of reality, that synthesis had to unravel, and it did -- just like all its truncated and deformed successors. None in the long, historical train of competing "isms" can or shall succeed in properly sorting out the complexities of life in a fallen world, Thomism included.

We do ourselves no favor, therefore, by jamming this and related issues through the grid of "being" or "existence." The apostles, the prophets, and Christ Himself sorted out financial, political and moral issues in very different terms and in very different ways -- not one of which approximates the Summa. For my money, literally, their ways are better because they are the revelational terms of righteousness and obligation. They have nothing to do with Aristotle or his medieval devotees.

Aristotle doesn't unravel the knots in revelation. Revelation helps you better to unravel the knots in Aristotle. It is a step down from the mind and methods of Christ to those of Aristotle, not up. We see best in light of the Former, not the latter. Invoke Him, not Thomas. Fundamentally, we are, or ought to be, Christians not Thomists. (Though one can be a Christian and a Thomist, of course.) I notice that nobody here has posted a thread on Christ and usury, or on the prophets and profit. To me, that's a telling point.

The myopia of scholasticism has been displaced with other forms of distortion. We wont'fix any of them by going back to the middle ages.

Go back further.

The banks and investors can trade in what does not exist, because they know that, off at the end, the US government will step in to make their pretended property real.

They shouldn't be doing that, though. And is it even possible to "make pretended money real"? There has _got_ to be a confusion somewhere if we really believe that. There just is no such thing as magic. You can't make pretended things real by saying "abracadabra."

Mr. Bauman, I think your comment qualifies as a threadjack, but to respond briefly, I think you have mistaken a quotation from Aquinas which comported well with our prior discussions, for an attempt at "jamming" this discussion through the Thomist "grid."

Lydia, that's just infelicitous phrasing on may part. Basically what the government has done is sell sovereign debt (which is in high demand right now: consider how many millions have shifted their 401k to bond funds recently -- they are the new holders of US debt) and given the capital raised to banks. The toxic securities (my "pretended property") are still sitting there, dragging down the banks and everyone else.

Not so, Paul. It's not a thread-jack at all. The history of the discussion you say you want to "stick with" here from earlier threads is precisely the Thomist-analysis-applied-to-finance and that I am speaking against and which was invoked here again under a particular theory of existence.

In my view, the discussion will not progress well unless we bring that out into the open and reject it.

Then is it not so, Mr. Bauman, that you have placed yourself outside the discussion by rejecting it tout court?

If you and I began a conversation on the nuances of solo scriptura, we might justifiably grow annoyed if other people jumped in now and then with lectures about the folly of solo scriptura and how we should abandon the conversation altogether.

On the other hand, if you have some thoughts on usury, biblical, philosophical, etc, please feel free to contribute them.

Michael:

We do ourselves no favor, therefore, by jamming this and related issues through the grid of "being" or "existence."

In that case, I've got quite the castle in the sky I'm happy to sell you. Send me all your money, and I'll hand over title to the castle.

Lydia:

"Such-and-such is fraud in property, because it pretends that ______ when ________ is not the case."

Great formulation. Much of the selling of credit default swaps is fraud in property, because it pretends that it reduces risk of loss from default on a bond when in fact what it does is, in circular fashion, result in A using its 'insured' bonds as the reserve which insures the bonds of B, while B uses its insured bonds as the reserve which insures the bonds of A. Typically the chain of risk is more roundabout than this; but in the end it is a kind of 'horizontal' ponzi scheme.

While I'm pretty convinced at this point that 'insuring' bonds via credit defaults swaps is often usurious/fraudulent (previous comment), the purchase and sale of CDS's (remember that a CDS is an insurance policy which pays out when a bond defaults) by folks who don't own the bonds at all is kind of a different matter, and more difficult to untangle. It can be thought of as 'indirect' insurance for a portfolio, for example: if you know the implications of the collapse of Lehman it might make sense to insure against it, even though you don't own any of their bonds.

Still though there are more conventional ways to do that: buy puts against the securities you actually do own, for example.[*]

So my inclination is that when it comes to swaps, most of what takes place is gambling: there is no connection to underlying production or preservation of value, it is just a zero-sum game of betting on events which are completely disconnected from the bet itself.

Maybe we could say that gambling is (zero-sum property games are) fraud in property too, though I'm having a more difficult time fitting it into Lydia's formulation.

OK, let me try this: Gambling set up to look like a form of investment is fraud in property, because it pretends to be a productive activity, that is, an investment, when that is not in fact the case.

There. Now we have CDS's synthesized into bonds covered, as well as stand alone CDS's.

Note that this won't be true of CDS's in general, as an inherent matter. An institution which has no dependency whatsoever on CDS-covered bonds might itself licitly issue CDS's, for example. Its reserves covering the risk are not themselves ultimately subject to the very risk which the swap pretends to cover.

And hey, that gives me another way to say it: Most mortgage backed securities are fraud in property, because they pretend that the risks posed by defaults are reduced by the securitization structure, when in fact those risks are merely transferred, and then reintroduced into that very same security through the Great Circular Chain of Banking Being. (There. I even invoked Being for Michael's sake).

Sorry for the rambling comment.

[*] It occurred to me - I know, what a horrible ramble - that one reason an investor might prefer swaps on bonds he doesn't own (in the pre-collapse world) to buying puts covering securities he does own is that swaps were a lot cheaper. In retrospect there is a reason for this of course. In addition, an investor would have to be practically omniscient for this strategy to make sense, and if he is omniscient there are probably better ways to make even more money.

Paul, Zippy:
It's OK to read the words I actually wrote and respond to them rather than falsely to intuit something I did not write and respond to your own invention.

To say, as I did, that the current terms of discussion and methods of analysis are misleading and need to be revised does not put me outside the discussion. Nor does determining if something is financial snake or not require us to employ Thomistic categories of existence.

Michael, couldn't you just interpret it without anything uniquely Thomistic? Zippy's entire interesting comment about CDS's and "horizontal Ponzi schemes" and so forth doesn't seem to require one to buy into Thomism per se.

Michael:

It's OK to read the words I actually wrote and respond to them rather than falsely to intuit something I did not write and respond to your own invention.

Physician, heal thyself.

If we did want to ram this through the grid of Thomas's understanding, perhaps it would go something like this. As before, I'm attempting to explain rather than advocate.

It is morally acceptable to engage in productive business transactions: business endeavors which propose to result in a profit from producing something of value, and end up with investors of various kinds at various levels of risk sharing in those profits to various degrees, and receiving return of capital at varying seniorities in a 'downside' result. (If there is a profit, everyone gets their initial capital back).

However, there are other kinds of business transactions which result in nothing but a transfer of capital. (Initially I was going to add "based on chance-dominated outcomes", but sometimes it may be a contest of skill or whatever: the key element here is that nothing new of value is produced). This is what we generally mean by "gambling". Gambling, on my interpretation of the Thomist view, would be immoral because it doesn't involve sharing the profits of a productive enterprise. Rather, it simply transfers wealth from one person to another based on the results of non-productive processes and events.

Other situations no doubt involve a mix of these things.

So Thomistically (well, under my interpretation of it, for what it is worth) any wealth transfer, any ownership transfer of existing capital as opposed to distribution of profits, has to be gratuitous. It mustn't be the result of an agreement or business contract, or else that contract is usurious. If this is a correct interpretation then the commenters who thought it might lead to the illicitness of insurance as we presently practice it are probably right. There might be a way to create a pool of shared capital to deal with individually devastating risk - an insurance co-op of sorts. But I'd have to think on it some more, and it probably would be different in important ways from present practice. (Interestingly this may mean that property taxes are immoral in this 'grid', though income taxes - as a share in profits - might not be. And that does rather strongly correspond to my own intuitions, since I see property tax as a kind of theft by the sovereign whereas income taxes are just the sovereign's share in production).

End of exposition.

Note though that one need not buy any of that to come to the conclusion that our derivative problem is the result of a 'horizontal' ponzi scheme, charging for the transfer of risk out the front door and, simultaneously, whether deliberately or unwittingly, sneaking it right back in through the back door. One need not buy into the Thomist understanding (whether my interpretation or some other) in order to think the notion of selling what does not exist very helpful in teasing apart what is and is not morally just in financial activities.

What Zippy said. I'll doubly emphasize my similar intuition against property taxes, and thank Zippy for adding a measure of clear reason to that intuition.

His may only be a Thomist interpretation (or as the Straussians would say, thus Zippy's Thomas on usury), but I'll sooner trust a Thomist than a modern.

For Mr. Bauman's sake I did a brief search of usury on a Bible site. Alas, there was no cross-reference for "credit default swap."

Lydia's formulation ("Such-and-such is fraud in property, because it pretends that ______ when ________ is not the case.") sounds awfully close to my suggestion in the Aquinas on Usury thread, that usury consists ultimately in fraud - in the intentional sale of something that one knows does not exist (that knowledge being captured in her formula by the word "pretends"). The probabilistic element inherent in any projection of the fulfillment of a given contract can be handled by the formula thusly: "Such-and-such is fraud in property, because it pretends that its fulfillment is x% probable, and is thus worth $A, when such is not the case."

At one extreme, two parties who are both innocently wrong about the value of the good they have exchanged - as with Zippy's example of the snake oil salesman who believes in his product - are not usurers. Neither is defrauding the other. They are simply mistaken, at worst imprudent. With Lydia's formulation, innocent error or incapacity in the fulfillment of a contract does not qualify as usury, because no pretense is involved.

Zippy's suggestion that the sale of snake oil is ipso facto fraudulent because snake oil is inherently fraudulent does not work out. It can't be the case that we are defrauding someone every time we innocently err in transacting business. However appropriate it may be to exact compensation for such innocent errors (as, e.g., under the law of torts), we cannot criminalize it (as we would if we deemed it fraudulent) without all of us ending up in jail.

At the other end of the spectrum lies Zippy's counterexample from the other thread, of the loan shark who sells the use of his money at an extremely high interest rate (10%/week plus you get your legs broken if you don't perform). The loan shark and his customer are engaging in a transaction where no one is deceived about the terms, and no one is pretending. It would not therefore technically qualify as usury either. Where both parties are equally clear on the terms of the contract and they enter it willingly, neither has harmed the other merely by virtue of the exchange. It could even be argued that, in breaking his customer's legs, the loan shark is only fulfilling his part of the contract (implicit in the business relationship ab initio) that specifies his options in the case that his *customer* fails to perform.

But if the seller knows that the good he has sold is less valuable than his representations thereof to the buyer, usury has occurred: the seller has sold economic goods, that the buyer thought were properties attaching to the object of the exchange, but which did not really exist.

Some inflated fiat currency is usury. But not all. The Social Security scheme is probably usury. But even in these cases it is extremely difficult to tell, because so much of the backing for both sorts of contracts is made up of the current productive capacity - and thus, the likely future production, and thus the tax revenues - of the country, and an accurate determination of that productive capacity is not really possible.

And this is where moral hazard comes in. For any prospective deal, the probability of successful performance by both parties depends crucially, not only on sheer happenstance, but upon the moral character of the parties. Where the moral character of a bank or insurer or broker is represented as rock-solid, and that representation is credible to the careless buyer because of an expectation - implicit in the entire financial economy of our nation - that the Fed and the Treasury will in the last resort step in to rescue both parties to the deal, usury has probably occurred. Whether or not it has depends ultimately on the moral character of the citizenry, and thus on their future capacity to produce the goods that will sink the debts of their government. Such an implicit Federal guarantee makes it far easier, and less costly (in terms, e.g., of search costs imposed by due diligence), for both parties to pretend that the deal is worth more than it really is, because it is less risky than it really is.

I think Zippy has nailed it when he says that, "What is at issue is which of the things flitting back and forth in our economy are real, and which have only illusory existence." Yes. The question, in any mediate exchange - any exchange, that is, where a verbal instrument mediates the future delivery of economic goods (the Word being the connection in language and myth between markets and their god, Mercury) - is whether the instrument is any good, or rather, just how good it is. The measure of a deal's goodness - of its accuracy, adequacy, and faithfulness to the really present state of things - is the discount factor both parties use in calculating the present value of the future good, for the purposes of the exchange. And the discount factor is implicit in the price of the deal, as recorded in the effecting instrument. Good traders are skilled at making such determinations; prudent businessmen are skilled in gauging their capacity to undertake the risks involved, given their other commitments.

Whenever we make a decision, we confront the necessity of determining the true state of affairs, including the true present likelihood of various potential futurities. Since it is possible for creatures to err in this sort of determination even when they are morally perfect, it cannot be that such innocent errors in and of themselves are sinful, however much harm they may do. We are not blameworthy because we are not omniscient, but because, given even our meager store of knowledge and understanding, we do other than we know we ought.

@Zippy's last: if transactions that are intended to be profitable are OK, then most business transactions - even fraudulent ones - don't involve usury, for both parties can profit even from a fraudulent transaction. Insurance would be OK by this standard. Insurance is aimed at increasing the profitability of an enterprise by reducing the financial impact upon it of catastrophes that cannot otherwise be controlled. In buying the insurance, the buyer has (if he's calculated things properly) increased his risk-adjusted return, based indeed solely upon his own idiosyncratic preferences, but based nonetheless upon real factors of his experience. Otherwise, he wouldn't buy. The fact of the insurance contract can in turn induce investors in its buyer's enterprise to adjust the price of its stock upward; their risk-adjusted return on the deal has gone up, thanks to the insurance. Thus the assembly of the capital necessary to the enterprise can be made possible by the insurance. How that would per se be a bad thing is hard for me to see. The insurer effectually shares in the profits of a productive enterprise by means of the premium, just as a creditor would share therein by means of its own form of premium, the interest rate on the loan. All this is true even if the enterprise in question is no more than a family, or a personal portfolio.

It sounds to me as though Zippy's objection to gambling boils down to an objection to waste. Thomas objects to interest for the same reason: because he views interest as a consumption of money. I don't disagree that waste is bad. But I don't think it is usury. I don't disagree that gambling is bad. But I don't think it's usury.

And I certainly don't disagree that property taxes are bad. But if income tax can be construed as the sovereign's share of business profits, property tax can be construed as the sovereign's rental income on property of which he, as the sole legitimate coercive power, is ultimately the owner.

I haven't had time to read all of Kristor's comments, but the question of intent is a very interesting one. Is it possible for us to say that some financial instrument "pretends" something when the person involved doesn't intend to commit fraud? Can we imagine some strange situation where a person runs a Ponzi scheme but doesn't know that the people involved would never invest with him if they understood what he was really doing? What about passing counterfeit bills? They are counterfeit even when the people passing them don't know that. Could it be possible for the people involved in what Zippy calls these "horizontal Ponzi schemes" not to _intend_ to deceive but nonetheless to be involved in something that is profitable only because the other people involved are being irrational? Maybe that is what one might mean by saying that a particular financial set-up is fraudulent (or "pretends" something) even if the people involved don't think it through and intend to defraud.

Lydia: yes. A deal, and the paper that mediates it, can be ill-conceived from the get go even if none of the parties thereto are wise to the fact. Like Zippy's snake oil, it is a 'fraudulent good.' It seems a stretch then to condemn the investors as userers.

Their innocence will not however exempt the parties from paying the price of their error (absent Fed rescue). Similarly, Eve was not exempt from the wages of sin, despite the fact that her ignorance of evil made it impossible for her to understand ex ante that she ought not disobey God - that doing so would be bad. It is possible to sin in all innocence.

But I'm pretty sure that a contract can't itself pretend. Pretense is intensional, and a contract is not itself an intensional agent. At most it is an instrument of such agency. If a party to the contract pretends to a falsehood, an exchange of a non-existent good may occur; but it is the pretender, and not the pretense, that pretends.

Kristor:

I agree that knowledge and intent make a moral difference in the culpability of agents. It is just that I don't care.

When the metal meets the meat it doesn't matter, from the perspective of understanding what are and are not objectively good and healthy practices, whether the person is aware of the harm he is causing. If someone (say an Amway 'distributor') innocently engages in a Ponzi scheme it doesn't become any less a Ponzi scheme.

My concern right now is not assigning blame. That is exactly why I think the formulation 'fraudulent goods' is especially useful: because trading in fraudulent goods is objectively destructive independent of intent. Sure, it is morally evil to do so with full knowledge and consent. But it is harmful and destructive with or without full knowledge and consent.

It sounds to me as though Zippy's objection to gambling boils down to an objection to waste.

And at issue isn't that gambling is wasteful (in fact it isn't necessarily wasteful, in the sense of destroying capital, as far as I can tell). At issue is that it involves one person becoming entitled to take capital from another in exchange for nothing.

Zippy:

I see now what you mean, and I guess I agree. One wants to eliminate fraudulent goods to the extent one can. Is this different than saying that one wants society to understand reality as well as possible? Take a painting that for 200 years has been traded in all good faith as a DaVinci, for millions. Then some art historian discovers that it was not done by Leonardo at all, but by his student Luigi. It is a fraudulent good, no? Despite everyone's good intentions. Lives have been mistakenly diverted, resources misallocated, insurance mistakenly bought. A real price has been paid.

So this problem as you have defined it - not in terms of the moral blame to be assigned to a false deed, but in terms of the harm done by a false impression (that may been formed honestly) - begins to look like a problem in epistemology rather than in ethics or economics. But most of my argument has orbited the notions of risk, of uncertainty, and these are epistemological. And this brings me back to the question Thomas was originally trying to get at: is interest morally justified? Is it justified, as the price of really assuming the cost of uncertainty, and that at a fair price? Ought we to prevent it occurring?

I don't think we can. It would work only if we could prevent any betting on anything other than a sure thing. But creaturely interaction entails betting on unsure things. Preventing them would be preventing life. Consider the marriage contract. Does it impose obligations to deliver real goods in the future? Oh yes. Can one enter into it fraudulently? Yes.

Neither will it work to allow betting on unsure things only in the event one maintains a 100% reserve. For, as I showed on the other thread, if one already owns 100% of what one would put at risk in a venture, the motivation of enterprise - of putting anything at risk - vanishes.

There is only one bet on a sure thing, because there is only one sure thing; and it is not made on a creature, or on the work of any creature.

Anyway, I agree that better knowledge and understanding are preferable to worse. But that's not the question Thomas was answering; and it is not clear to me that making interest either licit or illicit will help with the knowledge bit.

Well, again, at this point I'm not concerned with epistemology in the sense of what was known by the people who were actually doing this, or with any of the more subjective issues. Those always come second, despite modernity's tendency for the tail to wag the dog.

I'm concerned with ontology, with what is true; e.g., is it true that many of these securitization structures were horizontal Ponzi schemes, selling insurance against risk out the front door while bringing equivalent risk right back in through the back door. IOW, is it true that these were instances of selling something which doesn't exist.

There is an point to be made that Thomism and the Scholastics did not handle the ethics of money production particularly cogently, but Mr Baumann errs when he avers that going back to biblical precepts would help since those authors too saw "money" as minted coins, way too limited a vantage point for the present conundrum, see Hulsman "The Ethics of Money Production" 2008

"Let us emphasize that this gap concerns most notably the
moral aspects of modern monetary institutions—in particular banks, central banks, and paper money. The Bible provides rather clear-cut moral guidance in regard to the production of money in ancient times, in particular with regard to gold and silver coin making (*) Similarly, the medieval scholastics had developed a very thorough moral doctrine dealing with the old ways of making money. The first scientific treatise on
money, Nicholas Oresme’s Treatise on the Alteration of Money made important breakthroughs and is filled with insights that are still relevant in our day. Prior to his writings, the teaching office of the Catholic Church had addressed these problems,
most notably Pope Innocent III’s Quanto (1199), which denounced debasement of coins made out of precious metals. But then the gap appears as soon as we turn to modern
conditions. The old precepts about coin making do not exhaust the problems we confront in the age of paper money. And perhaps we encounter here the main reason why contemporary popes did not follow up on their medieval predecessors with any statement addressing the monetary institutions of our age. In our book we purport to show how high the price of this gap is...."
___
* see Rousas J. Rushdoony, “Hard Money and Society
in the Bible,” in Hans Sennholz, ed., Gold Is Money (Westport, Conn.:
Greenwood, 1975).

and contrary to the blow-hards vilifying the sub-prime borrowers (former slumlord tenants, now indentured serf of toxic-asset-banks) of prime-time cable TV fame consider the province of justice and who is being hurt in this crisis, endemic moral hazard wounds the body politic (the common good, that perennial of VII Catholic Social Teaching) and impoverishes the needy :

"Money production is therefore a problem of justice in a
double sense. On the one hand, the modern institutions of money production depend on the prevailing legal order and thus fall within one of the innermost provinces of what has
been called social justice. On the other hand, the prevailing legal order is itself the very problem that causes perennial inflation. Legal monopolies, legal-tender laws, and the legalized suspension of payments have

citation: Introduction pages 4, 6 of http://mises.org/books/moneyproduction.pdf

Zippy:

Is it true that these [layers of securitizations] were instances of selling something which doesn't exist? Yeah, in retrospect, it seems that they were. [That being said, a repeal of the mark to market rule might result in a much higher valuation of those assets than is analyticlly possible when it remains in force and there is no market.] But one can't trade retrospectively. One can't price a deal on the basis of information about how the deal will be discovered to have turned out ex post. Until the deal turns out, the information isn't there to be had. That's why there is discounting - one form of which is interest.

You are drilling down to one of the fundamental conundra of economics. The whole discipline is based on the principle that the market will seek the equilibrium price; but ask what the equilibrium price *truly* is, what it *ought* to be, and you'll get a shrug of the shoulders. All we can know is what people *think* the true price is. Is the widget worth a dollar? Dunno; is it worth a dollar to you?

And thus it must be. You can't know what the widget, or the contract to deliver a million widgets next week, is *truly* worth, because to do so you'd have to know what all the potential buyers and sellers would pay or accept for them. And this, even those buyers and sellers can't really know until they are presented with a concrete proposal, because their situation changes constantly, and with it their schedule of preferences. All you can really know about is what has already happened. So, you can know what the widget futures contract was worth to the traders who executed on it a few minutes ago, and you can know whether you feel some disagreement with their price. Nothing more. You can't know ahead of time whether the price you are about to strike on will turn out to be more accurate than not, because that information won't exist until the whole world suffers through the next few minutes.

All trading presupposes that the truth is out there, and that we can reach it (capax mentis rei), because all trading presupposes that the parties to a deal can each be more or less correct about the true value of the good exchanged. If traders believed that you couldn't be more or less correct, they could never reach the conclusion that it was better to trade than not. You can't agree or disagree, can't know more or less, about something that can't be known at all. A disagreement is an implicit assertion that knowledge is possible. OK, so traders agree that it is possible to know more or less about the true state of affairs, so they trade; and their agreements and disagreements move the market toward a better and better understanding of the true value of the instruments thereof, closer and closer to the *true* price.

NB that it is possible for all the traders to be wrong, or to overlook something salient. In such cases, the arrival of new information can teach traders that they have been way off base; then you get a massive "correction" (down or up; same thing, epistemologically). Looking back across a correction, the state of the market beforehand generally looks irrational, the valuations preposterous, even evil, usurious. But almost all of them were simply mistaken.

BTW, when I say that, "All trading presupposes that the truth is out there, and that we can reach it (capax mentis rei), because all trading presupposes that the parties to a deal can each be more or less correct about the true value of the good exchanged," what that really means is that all trading presupposes the existence and omniscience of God, whether or not the traders themselves realize this fact. If the truth about the way all other traders feel about things can't be known by us until after they have revealed their true feelings through their trading behavior - until, that is, it is too late to trade on the information - how can we really say that that truth is accessible to us at all? How can we even say that there is objectively any such thing as the true price, in such a case?

The only way we can is if God is out there and knows the truth about each trader better than any of them know themselves. Only if God's understanding of things is really accessible to us can we believe that it is a real thing, to which our own understanding can approximate.

Kristor:

While as usual you say some interesting things, with many of which I already agree, I think you are overcomplicating the issue. It is not the case that someone engaged in a Ponzi scheme cannot know, is incapable of knowing in principle, that he is engaged in a Ponzi scheme, until after the fact. I am not talking about trading and markets in general, and my discourse isn't subject to dismissal with a shrug over the ineffability of market price. I'm talking specifically about whether certain kinds of swaps and securitization schemes are in fact a kind of 'horizontal' Ponzi scheme. It seems likely to me that some are, and yes, that would have concrete implications: just as the law makes regular Ponzi schemes illegal, if there are other kinds of 'horizontal' Ponzi schemes in our economy the law perhaps ought to make them illegal too.

I assume that you agree that Ponzi schemes should be illegal. If so, and if there are other kinds of transactions and structures in our economy which are inherently fraudulent independent of the knowledge and intention of the acting subject, should they not also be illegal, especially if they were a major contributing cause of the worst financial crisis since the Depression?

Its all materialistic so it has no real value anyway

At issue is that it involves one person becoming entitled to take capital from another in exchange for nothing.

I approach it more from the angle of misinformation. In order to get around the buying restrictions of money market funds and banks, the sellers of the mortgage backed securities committed fraud with the help of the ratings agencies by getting a highly unrealistic amount transformed into AAA rating. It is like buying a car that is designed with a braking system that only functions in a narrow range of temperatures, road conditions, and humidity. The only reliable prediction is that the vehicle will crash at some point in the future and it is impossible to know how severe the crash will be until it happens.

oops sorry about the chopping-block quote!

Re: Lydia's hypothetical "What about passing counterfeit bills?" What assumption about ontology am I missing that makes the bills the treasury creates in open market trades NOT counterfeit? What assumption about the money supply led to the crashes of 1847, 1857 and 1866 in the wake of the collapse of the Bank of England's debt instruments bubble that funded the railroads across the US even with Peel's 100% reserves Bank Charter Act?(*) The same fallacy y'all are seemingly blind to - that the money supply is more than total coins minted or dollars deposited from savings, it includes monetized instruments such as debt certificates, commercial papers, checks & bills (and hedged derivatives of all the above) for which most banks have no reserve requirement. Add FIAT powers to your Treasury's political authorities and there's nothing "free will" or "intentional" for philosophers to salvage for their citizenry, we're all serfs to the financial titans... see p 37 of Jesus Huerta de Soto's "Money, Bank Credit and Business Cycles" at http://mises.org/books/desoto.pdf

"...bankers have throughout history violated traditional legal principles in the irregular deposit, and we will consider the reasons behind the failure of society’s regulatory mechanisms to put a stop to these abuses. We will also contemplate the role of governments in this process. Far from endeavoring to scrupulously defend property rights, they supported bankers’ improper activity almost from the beginning and granted exemptions and privileges in order to take advantage of this activity for their own uses. Thus the intimate complicity and solidarity traditionally present (and still existent) in relations between state and bank institutions. To understand why the different attempts to legally justify abuses have failed, we must first properly understand the legally corrupt origin of fractional reserves in monetary bank deposits"

___
* see page 484, ibid

I wouldn't mind fiat money if nobody ever made any more, except (in the case of actual physical bills) to replace some that became old and were destroyed--that is, if it remained a fixed quantity. Then it could just be regarded as a means of exchange, as you say, Paul.

Lydia, what about the new wealth that is constantly being created. I agree that in a fixed-wealth, zero-sum environment, printing more fiat bills over time is a problem. But given that people produce wealth anew, there is an obvious concern with not printing more bills. If you leave the amount of money in circulation constant, the increase in wealth overall will mean that each bill begins to represent a larger amount of wealth than it did before (i.e the same proportionate share of a growing pie). If I owe John $100 to be paid as $10 per year for 10 years, then my last $10 payment is going to be worth more than my first $10 payment, and in fact my total repayments will represent more wealth than I originally borrowed.

When there is fiat money, it seems to me that in principle the money supply should grow at the same rate as the overall wealth. The problem, of course, is figuring out a measure of the actual growth of wealth, in particular, a measure that can stand up to faulty individual judgments about the value of this house, that car, and those circus tickets.

But presumably John can take probable deflation (and consequent increase in the value of the dollar) into account when you make your arrangement for repayment. My _guess_ (and I could be wrong, here) is that the constant inflation and twiddling we see with the money supply in our current system leads to far more incorrect decisions based on faulty predictions and misleading information than a situation in which the money supply remains constant and underlying wealth genuinely grows.

That may be so, Lydia. The conjecture is one that economists have long puzzled over. But that ship has sailed. We're on fiat money and ain't about to give it up.

Other conjectures can be presented as well. For instance, it seems reasonable to expect that in an environment where "the money supply remains constant and underlying wealth genuinely grows," currency would become very dear indeed, producing excessively high savings rates. Just by hiding money in your mattresses, you'd be, as it were, appropriating a small fraction of the new wealth created. Or maybe, to counteract this effect (hyper-paradox of thrift), you'd observe a proliferation of new securities bearing negative interest rates, which operate as hedges against deflation.

I wonder also how a money supply could be keep constant absent an institution very much like the Federal Reserve chartered precisely to, well, twiddle. So much of our economy is digital. Who's going to keep track of bank reserves? Who's going to assess how losses or gains in securitized investments affect those reserves?

Speaking just from a sort of deliberately naive perspective, it does seem on the face of it that there's a big difference between keeping track and _changing_ the money supply, which is what I meant by "twiddling."

There's a whole school - I don't know much about it - that argues that the best way to keep the money supply in synch with the real wealth of society is to revert to "free" or "natural" banking. It's what we used to have in the early 19th century, with banks issuing their own banknotes. I read about this stuff many years ago. In theory, if a bank issues more notes than it can back with real economic assets, then, provided there is good public information about its financial condition, its notes become worth less than those of more creditworthy institutions. This is another way of saying that its cost of capital goes up - i.e., it must pay depositors more. And that makes it harder for a bad bank to earn the spread between the interest paid to depositors and ROI. It's profits will begin to vanish. It will then have to get its act together quickly, or it will be purchased by a rival, and the management will lose their jobs.

If you have lots and lots of banks competing with each other this way, the system as a whole will respond quite quickly to keep the money supply in line with the real wealth of society.

The problem of course is you get occasional bank runs and ruined investors. Unlike today. Ahem. But the system as a whole would be more stable than what we now have, where everything depends on the perspicacity of a couple thousand people. If all buyers and sellers were constantly forced to scrutinize banks for any sign of weakness the financial system would be dependent on the netted perspicacity of millions.

More seriously, perhaps, distributed scrutiny would force everyone to think about whether they were going to accept notes or checks tendered by a counterparty written on Bank A or Bank B. This would impose some additional transaction costs on us all. But we face this problem with every other thing we buy or sell. That's why there are such things as brands, trademarks, rating agencies, underwriters labs, and so forth. We don't have to bother with all that in respect to Federal Reserve Notes right now. But the intermediation of the Fed does not, of course, mean that the transaction costs of natural banking, and the risks they are expended in ascertaining, just go away. Its just that the Fed takes over those costs, and risks. We pay via inflation, rather than by our own increased seach costs.

So here's the interesting thing about free banking that I just realized. The credit default swaps sold by AIG were in some ways equivalent to bank notes. The market for those swaps was totally tweaked by the fact that the Fed and the Treasury stood ready to keep the whole system afloat come hell or high water, and everyone knew it. Hell, it was the Fed and FDIC that forced commercial bankers to start writing NINJA loans in the first place, and it was Fannie and Freddie that were the market makers on that paper. So naturally, none of the traders at AIG thought they might face personal ruin if the "bank" failed. And they were right! So they had no reason not to write as many swaps as they possibly could; no reason not to securitize the premium income on the swaps, which should have been banked to cover those "notes," and sell it, too. And they had an urgent and pressing reason to write as much junk as they could. Why? Because their incomes were a function of their trading profits.

The traders at AIG were in the same position the commercial banks would be in if they were able to issue their own bank notes, and yet the Fed, the Treasury, and FDIC were standing ready to bail them out if they should get in trouble. In such a system, bankers would have every incentive to sell as many bank notes as they possibly could, and distribute the profits to their shareholders and executives as earned, so that they could not easily be pulled back later for the benefit of investors. This is why, once the Federal guarantee on bank deposits came in, the Fed had to have a monopoly on bank notes.

If bankers and traders could not engage in their business unless they had their own skin in the game, these things - such as the massive blowout of the 300 opitimists at AIG in London, Zippy's horizontal Ponzi scheme - just would not happen. So I think if there were going to be a reform along the line of moving back to natural banking, it would mean the end of the limited liability corporation. I think that might be a good thing. It would not mean the end of the stock market, or of capitalism; would not make impossible the massive public capitalization of enterprise. All it would mean is that the liability of passive investors would be limited, just as it is for limited partners; whereas that of the active investors (i.e., those who worked for the firm in question) would be general, just as it is for general partners. All you'd need would be two classes of stock, and that's already done all the time.

And this brings me back to a thought I had a couple days ago, about Lloyd's of London. If you want to invest money in the insurance contracts written by Lloyd's, you can. But to do so, to become an underwriter, or as they are called, a Name (as in, the Name written under the contract of insurance, as sharing in the risk thereof), you must pledge all of your assets to the fulfillment of the contract. All of them. So Names tend to be very careful about the contracts they underwrite. They don't want to get overextended. If traders and bankers all likewise had to have all of their assets at risk in order to work as an executive, they would be far more cautious.

It could be argued that this would make our economy less dynamic, more risk-averse. But that would be a small price to pay, if it made us all more concerned with truth, more prudential; for that would increase the accuracy of our economy (reducing the sort of usury I have been getting at in these threads) and constrain speculation more tightly to the reality of the values we have already achieved, and can reasonably be expected to achieve (reducing the sort of usury Zippy has been gettting at). Both sorts of changes would tend to decrease the ratio of noise to signal in the economy, meaning that our real wealth would increase more quickly.

Zippy: to answer your question of a few days ago --

I [Zippy] assume that you [Kristor] agree that Ponzi schemes should be illegal. If so, and if there are other kinds of transactions and structures in our economy which are inherently fraudulent independent of the knowledge and intention of the acting subject, should they not also be illegal, especially if they were a major contributing cause of the worst financial crisis since the Depression?

Yeah, I do think Ponzi schemes should be illegal. But they are a form of fraud, which is what I have been arguing has to take place, and that knowingly, in a transaction that we can fairly call usury, in Thomas's sense, of selling what does not exist. Usury in that sense - of selling a pig in a poke - ought to be illegal. But usury in the sense you have been getting at, which boils down really to wild imprudence, to financial negligence, probably should be only tortious. But, however, I do think that some reform of the sort I have just discussed in my last comment would correct the problem, while avoiding the necessity of forcing the SEC to make this that and the other new derivative illegal. It's one thing for a derivatives trader to think, "If this deal doesn't work out for the bank I could lose everything I own," and quite another to think, "If this doesn't work out, I might lose my bonus, or at worst my job."

Kristor:

But usury in the sense you have been getting at, which boils down really to wild imprudence...

I think you've made many interesting and valuable comments in these threads, but you seem to have something of a fixation on the subjective aspect. I've already said multiple times that I don't care about intentions or the subjective aspect: that isn't the focus of my attention in these threads. Yes, first degree murder should be punished differently from involuntary manslaughter, and yes, the difference between them has to do with subjective intentions. But I don't care about that kind of difference here. What I care about here is whether, as an objective structural matter, many of these transactions were a horizontal Ponzi scheme in the sense that they involved selling what does not, objectively, exist.

You seem to be insisting, though I could be wrong, that nothing should be illegal except having a bad subjective intention: that objective actions ought not be prohibited by law. I could not possibly disagree more. I completely, utterly, unequivocally reject that approach, and I think everyone should unequivocally reject that approach. Subjective intentions do pertain to the degree of culpability of the agent, and justice ought to take that into consideration when determining penalties, etc. But Ponzi schemes should be forbidden by law, period, as such, radically subjectivist escape-hatches be damned. If someone is naive or unknowing then they ought to be shown mercy, of course; but what the law ought to prohibit is certain kinds of actions, not subjective mental states.

Zippy:

Sorry, I don't mean to be irritating. You are indeed mistaking me, probably because I am being unclear, in thinking that I want to make nothing but subjective intentions illegal. What I think should be illegal is the concrete act of misrepresentation.

The thing I've been trying to get at in these threads is that all transactions mediated by financial instruments involve selling something that objectively doesn't exist, because they all involve promises to perform in the inherently uncertain, and as yet only potential future. When I take out a mortgage to buy a house, I am selling the bank the stream of my future payments, which I may or may not be able to make. The payments don't actually exist until I actually make them. So when the bank buys them by funding the loan, it is buying, and I am selling, something that doesn't yet actually exist. At the time of sale it only potentially exists. The only thing that is _actually_ sold in such a transaction is a representation of the current state of relevant affairs, which is an indication, and nothing more, of the likelihood that both parties will perform. I doubt you would characterize such transactions as Ponzi schemes. If you would, then by the same token you'd have to do the same with essentially all financial instruments.

The bank and I do all sorts of things to reduce the risk of my non-performance; insurance, collateral, and so forth. At some point, these measures, together with the bona fides of my employment, other assets, moral character and so forth, and with the interest the bank will charge on the loan, suffice to make the mortgage prudent for both parties. So we enter into the contract. If in our negotiations I have misrepresented myself to the bank with respect to any of the pertinent aspects of my situation, I am guilty of usury, because I have sold the bank a story about the present, _actual_ state of affairs that is not objectively true, have sold something - a set of present, _actual_ values - that is not really mine to sell, because it doesn't _actually_ exist. This is just fraud. It is already illegal.

Now if I have been completely accurate and honest with the bank about my situation, and nevertheless it should happen to turn out that for unforeseen reasons I fail to perform on the mortgage, I am not ipso facto guilty of usury. It was that latter sort of eventuality that the risk reduction measures both parties undertook, such as insurance, were intended to control. But if there is a fact about me which no such measure could ameliorate, which I knew and failed to mention to the bank, then I have effectually stolen from the bank. And vice versa.

The traders at AIG were making all sorts of wild bets. If those bets had all panned out, everyone would have been golden. But there were so many unlikely bets strung together, that the overall likelihood of success was low. Assuming the AIG traders were not advertently lying about the overall likelihood of success - in which case they would be guilty of usury, of fraud - they were at least being wildly imprudent. Now this is not to say that in being so imprudent they were not doing something very wicked indeed. They were. And such wickedness ought to be prevented - we should set up the system so that it is difficult or costly to be wicked. The question is how: make such wickedness illegal by outlawing the instruments the traders were using, or make the traders pay the price of a losing bet with their personal assets.

If you outlaw the instruments, you hamstring the financial system, just as you would by making the residential mortgage illegal. An instrument is just a tool. Shall we outlaw chain saws because some people use them imprudently? In any case, the SEC is always playing catch up with the market; always fighting the last war. Human invention is squirrelly, anfractuous, protean - contain it here, and it will sneak out of control there. So there will always be new instruments, new modalities for the implementation either of good or evil. You can't prevent suicide by making it impossible to jump off the Golden Gate Bridge.

As it happens, imprudence is _already_ illegal for full fiduciaries, such as trustees and investment advisors. What I would propose instead of outlawing particular instruments is that executives be made full fiduciaries of their employers, and therefore by extension of the customers thereof, to the full extent of their personal assets. This would at one fell swoop cover the risk to the financial system posed by all instruments, from the most ancient and widely understood to the most novel and obscure. Furthermore, its enforcement would be distributed and automatic (in the original sense of that word), because millions of executives would have their own skin - _all_ of their own skin - in the game. They would impose the discipline of prudence upon themselves, without any need for a few outmanned and underpaid regulators to chance upon their infractions.

The same sort of measure could replace the mare's nest of Sarbanes-Oxley compliance. Ditto for most SEC compliance, which I can tell you from personal experience has virtually nothing to do with the real risks to investors.

Let wickedness earn its economic wages, first, and at least, by removing the systems of social insurance that inure us to the risks and costs thereof. Only then will we discover the sorts of wickedness that the market so far fails to control, because we its agents are nominally blind to them. At that point only will we be able to design remedies that will cure such market failures, by imposing upon each of us all the costs we each errantly and really incur.

Kristor:

You are indeed mistaking me, probably because I am being unclear, in thinking that I want to make nothing but subjective intentions illegal. What I think should be illegal is the concrete act of misrepresentation.

The thing I've been trying to get at in these threads is that all transactions mediated by financial instruments involve selling something that objectively doesn't exist, ...

By "doesn't exist" I do not mean (and I'm pretty sure Aquinas doesn't mean) "doesn't exist as a physical object". The profits from a productive enterprise exist, though of course there are always risks involved. Even future anticipated profits exist as a real, genuine, bona fide potentiality. The "profits" from a Ponzi scheme don't exist at all, even as a potentiality, because Ponzi schemes don't produce profits. The profits from a Ponzi scheme are like the children of a rock: they don't exist, either as actuality or potentiality. Notice that "Ponzi schemes do not produce a net profit" is true no matter what the intentions or knowledge of the persons engaged in them happen to be.

Shall we outlaw chain saws because some people use them imprudently?

It remains an open question whether some of the shenanigans in this financial crisis involved 'horizontal' Ponzi schemes of some sort: selling "risk reduction" which in fact did not reduce risk, for example.

But a Ponzi scheme is not wrong because it involves deception or misrepresentation. It would be wrong even if everyone knew what was going on and was merely hoping not to turn out to be the guy left holding the bag. No misrepresentation or deception is necessary in order for a Ponzi scheme to be a Ponzi scheme; therefore no misrepresentation or deception is necessary in order for a Ponzi scheme to be morally impermissible. Appeals to subjectivity, intentions, deceptions, etc are a non-starter: they miss the point of my discourse completely.

Zippy:

Not sure how you got the idea that I think Ponzi schemes are OK. We haven't been talking about that. The questions rather have been, "what's usury?" and "do the recent financial shenanigans fall under the category of usury?" The former question seems to have been settled: usury is selling what doesn't exist. You say,

By "doesn't exist" I do not mean (and I'm pretty sure Aquinas doesn't mean) "doesn't exist as a physical object".

At the time of sale [a stream of future payments on a loan] only potentially exists. The only thing that is _actually_ sold in such a transaction is a representation of the current state of relevant affairs, which is an indication, and nothing more, of the likelihood that both parties will perform.

The profits from a productive enterprise exist, though of course there are always risks involved. Even future anticipated profits exist as a real, genuine, bona fide potentiality. The "profits" from a Ponzi scheme don't exist at all, even as a potentiality, because Ponzi schemes don't produce profits. The profits from a Ponzi scheme are like the children of a rock: they don't exist, either as actuality or potentiality.

Stipulating then to your insistence that exchange of potentialities that do not really exist in the actual situation is immoral and ought to be prevented, whether or not the [intensional] defect in such an exchange is advertent [a point which I have not disputed], the question then becomes whether the recent financial shenanigans - let's use credit default swaps as a proxy for the whole mess - constitute such an usurious exchange. If they do, and that by definition, not from mere happenstance, then my argument from the analogy of the chain saw is indeed a straw man. But if credit default swaps are not usurious by definition, then it would seem that one could be either prudent, and thus ethical, in their use, or not. In that case, my argument from analogy with chain saws is not a straw man.

And this I think is the nub of our disagreement, and the matter of these threads on usury. Are credit default swaps usurious by definition, the way Ponzi schemes are? Is it simply impossible for them to add value? You strongly suspect that they are, so much so that you keep mushing together credit default swaps and Ponzi schemes, to the point of insisting that Ponzi schemes are always bad, when that is not at issue. Still, you say it's an open question whether credit default swaps are usurious. Agreed! I can't see how we are anywhere near being able to reach a conclusion about that. My hunch, however, is that they are probably not. After all, when Executive Life failed, it wasn't the fault of junk bonds as such, but of the executives who bought too many of them. Still, it's only a hunch.

When Executive failed, there was talk of outlawing junk bonds. My hunch then was that junk bonds would end up serving a useful purpose in the credit markets, especially as traders came to understand them better - understand their risks - or else disappear on their own. Instruments that don't work die out. If credit default swaps can't add value in any situation, traders will figure that out and no one will want to buy them at all.

When I said,

The former question seems to have been settled: usury is selling what doesn't exist.

The former question seems to have been settled: usury is selling what doesn't exist, even potentially.

Kristor:

Not sure how you got the idea that I think Ponzi schemes are OK. We haven't been talking about that.

And this I think is the nub of our disagreement, and the matter of these threads on usury. Are credit default swaps usurious by definition, the way Ponzi schemes are?

I've been thinking more and more about Zippy's statement that these CDS circles--horizontal Ponzi schemes--involve A's ultimately insuring A against credit default. Something is _very_ wrong there. Zippy, do you mean that literally? I deal with an analogous type of thing in epistemology--the attempt to say that a proposition P can lift itself by its bootstraps and that circular reasoning isn't so bad if the circles are really big. :-) I don't buy it there, and it certainly can't work in finance, either. That being said, I'm not sure I quite grasp yet how over-optimism works together with the circular insurance scheme. Just the fact that I don't know much about finance, there. I suppose it's just that A thinks he'll never actually be called upon to lift himself by his bootstraps?

Zippy, do you mean that literally?

Maybe some of the difficulties people have been having is in understanding that I mean it literally though.

I see now for the first time what Zippy has been getting at, in talking of a horizontal Ponzi scheme. It's easy to see what Zippy means if you imagine a 3 person economy: Paul invests in Lydia, who takes the investment and invests in Zippy, who takes the investment and invests in Paul. Nothing has been done. It's the economic version of a perpetual motion machine. And like Lydia's circular reasoning spread over a whole population of propositions, it doesn't get more legitimate just by virtue of an increase in the number of agents in the economy (any more than you get consciousness if you just jumble together enough unconscious neurons).

When the market for overnight paper locked up on the evening of September 17, 2008, it was because everyone suddenly realized that they were being asked to loan to counterparties whose assets consisted of loans to counterparties whose assets consisted of loans to ... All of a sudden, everyone realized that their counterparty risk was immense, because they had no way to perform the due diligence that would tell them where the real assets were that were supporting all those loans, or how good those assets were.

This is an interesting problem. Almost the whole financial economy is almost wholly abstracted from the production of real goods and services - from actually moving things around. It could almost all be characterized as a horizontal Ponzi scheme. Yet it seems overreaching to go so far.

I shall have to think about this.

Kristor:

It's easy to see what Zippy means if you imagine a 3 person economy: Paul invests in Lydia, who takes the investment and invests in Zippy, who takes the investment and invests in Paul. Nothing has been done. It's the economic version of a perpetual motion machine.

And remember that at each "handoff" someone is getting paid - that is, there are fees to set these up in the first place, transaction fees every time they change hands, etc. So as with any real attempt to make a perpetual motion machine, friction actually robs it of 'energy' (that is, destroys value and increases risk) as time proceeds. On a net basis [I propose that it is plausible that] these particular kinds of risk-circulating systems actually destroy value and increase risk.

If true, it is an objective observation about the nature of these kinds of risk circulating systems: an objective truth which is in no way mitigated by anyone's particular knowledge, intentions, or whatever, just as "ingesting a large enough dose of potassium cyanide results in death" is true independent of anyone's knowledge, intentions, etc.

I've been thinking first about exactly why and how I got on the wrong track, in my thinking about just what it was Zippy was talking about, because I figure that my lacuna might be informative. I have come to the conclusion that what I was doing was thinking in terms of a two person economy - i.e., in terms of a single transaction between two parties, and the instrument used to effect it. In a normal, vertical Ponzi scheme, that's how it would work; Paul would invest in Lydia, and Zippy would invest in Lydia, and then sooner or later Lydia would pay Paul some "return" out of the investment she had got from Zippy. It's one dyadic transaction at a time.

Now, clearly, most dyadic transactions in the financial economy are not usurious the way Madoff's transactions were. It makes no sense to characterize them as a Ponzi scheme, because each party to the transaction gains value from the deal (or they would not effect it). It is this fact - the fact that most such transactions are on the up and up - that makes it possible for a Bernie Madoff to camouflage himself as an honest trader like most of his competitors.

But when you expand the thought experiment to include 3 agents, and realize that they are investing in each other, at the same time, and with the same money, it becomes clear that, while each individual transaction may make perfect sense in isolation, the whole nexus has become a thing floating in air, dissociated from material economic fact, thus creating no real value for the system as a whole, and therefore making it vulnerable to massive collapse. The collapse happens when the difference between the real material economy and the financial image thereof becomes apparent to everyone. The emperor is suddenly seen to have no clothes, and the system collapses. This is why it is called a "correction." It is a great recalibration of the financial economy to the real economy.

As Zippy says, the wandering of the financial system away from the concrete economy is not at all a result of bad faith on the part of the people involved. It is precisely _un_-intentional, in fact; an error made in ignorance, an honest mistake. And it doesn't matter what the instrumentality is: tulips or CDS's, it's all the same.

Will think more on this.

Kristor:

As Zippy says, the wandering of the financial system away from the concrete economy is not at all a result of bad faith on the part of the people involved. It is precisely _un_-intentional, in fact; an error made in ignorance, an honest mistake.

I have no doubt whatsoever that there is a mix of moral culpability in the case of these complex risk-circulators: that some knew it was a sham and did it anyway; that some got a queasy feeling about it, suppressed that feeling, and did it anyway; and others strongly thought it was completely legitimate. You don't get into a position to create and structure these deals without having some clue about how things work. I fully expect that "it isn't technically illegal, and we can make a bunch of money doing it, therefore we will do it" describes the attitude of some of the actors involved. I find the notion that every actor was completely honest and innocent, from an intentional moral standpoint, utterly implausible. On the other hand I also have no doubt whatsoever that many folks went along innocently with what they did not understand and thought was legitimate.

In a 'traditional' Ponzi scheme the accounting is more straigtforward: it is more obvious that one investor is being robbed in order to produce faux profits for another. (Even so many people still fall for things like scAmway and other 'multi level marketing' snake oil, which is little more than a slightly modified Ponzi scheme). In these CDS-based risk circulators on the other hand it is significantly less obvious what is going on, though when historians look back on it they may well see them as clearly as we see Ponzi schemes and tulip bubbles now.

But all of that subjective analysis is not the important thing. In the words of the Prophet Jim Barksdale, the main thing is to be sure that the main thing is the main thing. Ponzi schemes and related markets in Nothingness aren't OK no matter what the people doing it happen to think of it. Someone who doesn't understand Ponzi schemes and thinks they are OK is in the wrong, and someone who does understand them and thinks they are OK is in the wrong too. The latter probably deserves stronger punishment than the former, but they are both in the wrong and need to be corrected.

Zippy:

Yes, agreed. I was sloppy in my diction. What I meant to say, and should have said, was,

the wandering of the financial system away from the concrete economy is not even necessarily the result of bad faith on the part of the people involved. It can in fact be precisely _un_-intentional; an error made in ignorance, an honest mistake.

There were certainly cheaters in these derivatives markets - there always are. But I confess I'm even more worried about the ideal case I have outlined, wherein even if all the agents are as honest as the day is long, you still end up with a horizontal Ponzi scheme.

Kristor:

But I confess I'm even more worried about the ideal case I have outlined, wherein even if all the agents are as honest as the day is long, you still end up with a horizontal Ponzi scheme.

Happily I think we've reached full agreement - including agreement on what is more worrisome.

Right. It has taken a lot of effort, but I believe we are through with the ground work. We've defined the problem - a financial system operating at such a level of abstraction that, through it, capitalists are willy nilly investing in themselves, at considerable cost, and without realizing it, so that the system as a whole becomes unhinged. I believe there may also be consensus that usury consists in selling what does not exist even potentially.

But I'm not at all clear on what ought to be done about it, or if anything can be done about it.

As a tangent, I'm unhappy with the outcome of the linguistic history here. "Usury" is a much better, more accurate term than "interest" for what we now call interest. “Usury” derives from "use," so it is directly linked to the use of money. If I lend you money, you have the use of it, so it is only fair that you render to me some compensation for that use, from the returns you are able to generate with it. "Interest," literally "be between," is by contrast something closer to “participation” or “entrepreneurship.” It is suitable term for the return one earns by putting one's money to work as an equity partner - i.e., an at-risk partner - in a joint venture (as in, "I have an interest in that project"). I bet that, thanks to the ban on usury between Christians, interest was the only way Christians could invest. After a while, usury too was called interest – just as, in Muslim banking today, the bankers are engaged in figuring out how to pay usury without calling it usury, by calling it some sort of equity.

Which is interesting, and maybe not so much of a tangent, because it may provide a glimmer of a solution. When I put my money in the bank, it is simply false that my money is safe. If the bank fails, my money really is gone, its value destroyed. It's just that FDIC steps in and pays me back with money it has collected from everyone, including me (another horizontal Ponzi scheme). What the bank and the FDIC have sold me is the false good of security, which is simply not available to sublunary creatures. It does not exist here below. Only in God can we live in safety. When a bank sells safety it is selling a creaturely good that does not exist even potentially.

This means that in reality the _only way_ to give someone the use of your money is to invest as an at-risk participant in the venture, no matter how you may try to cloud the issue with talk of guarantees. The reality is that your total investment is always at risk. So, interest is the more accurate term, aetymologically. Like all sin, then, usury is a defect of being, and either a misprision or a lie about what is really going on. Usury is a defect from the ideal, which is interest in its true sense, of equity participation. When Jews are forbidden to loan each other money at interest, what they are forbidden to do is to put their own tribesmen at arm’s length, as economic adversaries; they are instead abjured, by a process of elimination, either to invest with and in their brothers as partners, or simply give to them (or refuse them, of course).

Not sure where this leads, in terms of policy. Should banks replace mortgages with equity stakes in enterprises, such as business firms or households, or persons? What would that look like? Quarterly shareholder meetings, where your banker – more of a merchant banker than a commercial banker, now – sits down with you and reviews your financials, and you discuss important household decisions? That would be a lot of trouble, but boy would it ever increase the prudence of banks and households! We use insurance, such as FDIC and the Fed (and its notes), both guaranteed by … us, to make commerce easier for everyone by eliminating the necessity of prudence. But just that last sentence on its own ought to be sufficient to indicate the perversity – both moral and economic – of FDIC and the Fed. Why on earth would we really want to reduce prudence?

So the policy solution that suggests itself is the elimination of state guarantees on private contracts, including guarantees of the soundness of Fed notes.