I have been working on finding some common ground between MMT & other bank reform proposals, esp. positivemoney and related plans. Curious what you would reply to one of the comments about your Huffpo version:
“Warren Mosler concludes from his brief review of monetary history “The hard lesson of banking history is that the liability side of banking is not the place for market discipline.” This is precisely the point of focus for Positive Money. Our proposals remove the “mission critical” aspect of the monetary system – people’s money – from the liability side of banking and the vagaries of the market, isolating the payments system from the questionable liquidity and ultimate solvency of banking institutions. And that is all we seek to do. We do not propose any changes to the management of banks’ assets, which is where Warren directs his proposals, because we feel that is the wrong place to start. Getting the liabilities side right will eliminate the systemic significance of current concerns – securitisation and inter-bank lending are at present primarily liquidity management practices. Only once the balance between financial stability and profitability has been realigned by this will it be apparent whether and how asset management practices should be regulated.”
WOW, Really a great document. in particular i love the “ex-nay” on libor in u.s. and “ex-nay” on subsidiary off balance sheet stuff. If they aren’t allowed to have credit default insurance, they’ll make sure they write “good” paper!
warren, question:
do you think repealing glass-steagal had a big part in facilitating this mess?
and, any chance elizabeth warren is a fan of yours?
Why is there no public purpose in US banks lending off shore?
Lending in dollars off shore creates international dollar demand (?), which make other countries want dollars and thus willingly export goods and services into the USA in exchange for dollars.
Bad for those countries, good for the US.
Of course that also create enmity towards the US… So maybe it is not worth it.
Regarding not allowing “mark to market” – what about repossessed houses? Don’t banks need to value those?
in the document you wrote that there is no public purpose in allowing banks to lend off shore.
I thought that meant – lending dollars to foreign businesses/individuals. In which case that should create foreign demand for dollars – which in turn should increase foreign willingness to export to US.
But in fact that probably means lending against foreign property? In that case, please disregard what I wrote.
@Captain CraZ,
I wonder how can we get the 50,000+ factories that left the US for China over the last 10 years to take advantage of China’s devalued currency back or replacement factories?
It is not easy to make a new product plus a factory to produce it and the existing products made in China by US companies are protected by patents and the trademarks that we all know and love.
The political and economic interests supporting the current arrangements will have to be given a good alternative to change.
Warren and Finbar from above: Anyone who lives entirely on his interest income may otherwise need employment. Such rentiers have removed themselves from the labor force. To the extent that higher real rates increase the rentier population, potential output is reduced. Furthermore, those left working are, in real terms, supporting those living on interest income
Craz: My grandfather had 11 kids to work his farm, that was cheap slave child labor. As he got older and infeeble, most of those kids served him by bringing him food and medicine and taking him places. Today I cannot find 1 woman to bear even 1 child with me, much less 11 children. I have had to sell my grandfathers farm because I don’t have the cheap child labor he had with 11 kids and I am worried about my future as I age because I don’t have 11 kids to help me as I get old and infeeble. My grandfather lived much wealther than I do or will. 11 slaves to do his every bidding for decades, he was a king, I am a pauper with my 20 million in US green pieces of paper.
Finbar says: If you reduce real rates, you may certainly force the rentier population to go back to work. But you also will encourage the current working population to work less and alter their spending to favor short term consumption goods rather than investments.
CrAz: This mule already sat down a long time ago, I got tired of working and paying taxes to support a system that puts shopping machine princess as the pinnacle of our society. You will not FORCE me to go back to work to support this system, I will die first from starvation or sickness before I will be forced to be a MULE again for a shopping maching princess – pathetic. I am not alone in this regard either, there are million of my brothers who feel the same way – maybe tens of millions – we are tired of the status quo and have sat down and won’t plow that field no more! Already people from Icahn to Cuban to many other CEO’s on wall street say the biggest problem is short term performance, there are no long term thinkers or planners in this country anymore looking out to the future. Beating the street by a penny every quarter is killing this country for the long term. Welch says you have to eat while you plan for the future though, but we are eating all our seedcorn and none is getting planted.
Finbar says: And even if “output†is increased, that’s not necessarily a good thing. Ultimately, output is about producing stuff people want. If people want leisure, why should they be forced to work?
Craz: My last few girlfriends all wanted gucci shopping bags and trips to paris care of my credit cards. They didn’t want to do anything in return for it either, why should they be forced to do anything for me or that I want when this society, loan system, credit corruption will give them whatever gucci handbags they want for NOTHING? Even forcing me to work to get money to buy thier gucci handbags did not get me what I wanted, so I sat down. What good is a society to me that does not produce the things, people, services, or entertainment I want to consume? Pathetic.
Warren lives off his investments no? Also Warren has a small bank in florida, and wants to level the playing field for himself against the big banks – challenge is REAL motives. I am like warren, I live off my investments too, and am moving to the USVI soon to be warrens neighbor and get those 4% tax rates, I may have to open a bank to also be like Warren in that regard, the best way to rob a bank is to own one according to professor black.
Warren says if it is determined seniors need a higher standard of living, social security can be increased, using his Japanese example, I have japaneses senior citizen friends who have determined they do in fact need a higher standard of living, but their social security has in fact not been increased, so what point is Warren trying to make with the japanese example? For Warren to be a BIGthinker, he sure seems to casually dismiss very real concerns, like who does the determining if mr. senior citizen needs more standard of living, and how does it get implemented? He brushes all those “devil in the details” problems away with very broad stroked, poor form! Finbar we just have to keep pointing these things out to Warren and maybe we can convert him. Anyways, the human ponzi scheme that required ever growing population levels to increase the standard of living of those at the top of the pyramid is coming to an end. Humanity will never have the growth spurt of humans it had the past 50 years, the wealth that was generated for some the past 50 years therefore will never be replicated ever again. My grandfather had 11 babies to serve him and his wife, I will not, it’s simple economics.
Derryl Hermanutz Reply: June 23rd, 2012 at 10:41 am
@Captain CraZ,
In 1848, by which time the socioeconomic consequences of the Industrial Revolution were clearly visible to people who objectively observe the macro situation, John Stuart Mill published his “Principles of Political Economy”. Industrialization so vastly increases human labor productivity that it becomes possible to produce abundance for all WITHOUT full employment. The problem becomes not one of production but one of distribution, and Mill advocates that we abandon the by then economically obsolete model of continuous economic “growth” and embrace the model of a “steady state economy” in which issues of distribution would have to be addressed politically. Despite the sound advice of numerous luminaries like Mill, the world has failed to perform this essential task of rational political economy.
Even with offshoring of most of the low value added manufacturing, the US is still producing economic abundance. The problem is that mechanized production does not create employment, it produces economic wealth, and we still believe the only way to justify receiving income that allows you to purchase that wealth is to participate in production. Our industrial era “distribution” problems can be technically solved by putting sufficient purchasing power in the hands of people who want to consume the productive output, but then you run into the “moral” problem where people feel that if you don’t work you shouldn’t be able to eat or otherwise share in consuming the productive output.
Milton Friedman advocated a reverse income tax, which becomes a guaranteed annual income, as a solution, but this went nowhere due to the powerful moral objection. Warren’s solution is an $8/hr government make-work job for anybody who wants one, funded by Treasury creation of money that is distributed to these ‘workers’ as income, but now the moral objection shifts to the cry that this work is not “productive”. The moral objection is not rational: we are trying to increase distribution, not increase production. Nevertheless, people vote their feelings and beliefs no matter how irrational, so this moral problem remains to be solved before the technical solutions can be implemented.
Warren also advocates that Treasury no longer issue debt (i.e. bonds, etc) against its creations of money, which solves the problem of our current zero sum money system where all the money is always owed by the borrower as a repayable debt to the lender or to the bond holder. In order for Warren’s solutions to become politically possible, the voting public is going to have to come to understand that money is “created”, not “produced”, and the US Treasury can create the money that it will use to fund the $8/hr jobs and increases in social security payments.
Treasury doesn’t need to tax Peter to pay Paul, and Warren advocates a reduction of taxes on earned incomes to leave earners with more purchasing power. Treasury can create its own money to pay Paul. If this creation and distribution of new money dilutes the value of the money that is distributed as (earned) incomes in the process of producing goods and services for sale, and this dilution expresses itself as “price inflation”, then the price inflation becomes the “tax” that pays for the redistribution of purchasing power. Inflation is a direct tax on the value of money, which is by far the most “fair” and “progressive”, and not escapable by tens of thousands of pages of tax code loopholes, kind of tax that can be levied in order to serve the public purpose of redistributing purchasing power within your national economy.
We already suffer price inflation that is caused by bank lending for speculative purchases of bubble-priced assets like real estate. Warren’s plan would merely “rationalize” inflation that is going to happen anyway, in ways that serve public purposes rather than serve private interests that are contrary to the public interest.
The political problem is that powerful interests, commonly referred to as “plutocrats”, seem to want to become a new aristocracy ruling over a new feudal peasantry, so these interests oppose monetary understanding and fiscal/monetary policies that would serve the democratic public purpose and instead promote an obsolete belief in the pre-industrial model of economic “scarcity” (when in fact we have a problem of superabundant production shackled by maldistribution), and an equally obsolete belief in zero sum money where one person can only get money by taking it from somebody who already has it and has “earned” it. In fact fiat money is created as numbers on banking system balance sheets (a “balance sheet” is a zero sum equation in which all the loaned money is owed as repayable debt so “net” money = 0), or it is created directly by the Treasury as non-debt money that makes the money system positive sum and allows the economy to have net monetary “profits” and net “savings” of money. Warren advocates this latter source of money as a necessary addition to the zero sum banking system creation of temporary “bank deposit money”.
So CaptainCraZ, the problems you identify are economic distribution problems that are caused by clinging to obsolete understandings of economics and money that applied to a pre-industrial era of real economic scarcity, but which do not apply to our modern situation. Money “distributes” claims on the ongoing production and the accumulated wealth, so the kind of solutions that will solve our maldistribution problems will be monetary and fiscal solutions.
Warren is trying to bring our monetary understanding into the modern era, but the monetary mentality of the public and the policy making classes is stuck in the 14th century and refuses to participate in the Enlightenment that transformed ignorance and superstition into knowledge and science in pretty much all the other fields of inquiry. Nowadays economics and finance remain the only “faith-based” disciplines that refuse to acknowledge rational reality, and the reasons for the failure to modernize this area of our thinking can be directly traced to the anti democratic interests of people who want to concentrate wealth and power in their own hands.
Monetary policy could lend sufficient quantities of variable rate money to the private sector to allow changes in short-term interest rates to actually alter aggregate demand. To get a $100 billion variation in aggregate demand through a variation in short-term interest rates of 5% would require Fed lending of $2 trillion dollars. Pretty close to what they are doing.
In other words, the Fed’s other choice is to fix the transmission mechanism. Partly seems what they’ve done, perhaps by accident, though more likely someone there knows what they are doing.
I would make the current zero interest rate policy permanent.
Wouldn’t that bee a wee bit inflationary? What measure would you advise the Fed to watch for inflation? And wouldn’t an inflation target make more sense than an interest rate target?
It also minimizes rentier incomes, thereby encouraging higher labor force participation and increased real output.
By rentiers I believe you mean senior citizens and retirees. Should they be encouraged to go back into the labor force? It seems like you are instituting a seinorage tax on savings, and using it to fund lending. As someone who would like to retire someday, I’m not a fan of this part of your proposal.
Devin Finbarr Reply: September 17th, 2009 at 2:16 am
Scott-
I’ve been in the process of reading them and am most of the way through. But I’ve still got a lot of questions/skepticism.
In the paper above, Mosler writes: The fed should lend unsecured to member banks, and in unlimited quantities at its target fed funds rate, by simply trading in the fed funds market.
He then says in the comments that this rate should be zero.
So imagine the day this policy is announced. Banks drop their 30-year mortgage rates down to 3%. They borrow from the Fed at 0%, loan out to home buyers, and make money off the spread. These cheaper mortgages increase demand for housing and drive up prices. Banks compete over issuing new loans at lower and lower interest rates. Since each new loan creates the money needed to pay it back, there is never any risk of default on any of these loans. So the banks can keep creating new loans ad infinitum until 30 year mortgages are .1% interest rates, and the dollar is in a hyper-inflationary spiral.
If Mosler addresses this issue already, I’d welcome a pointer. But I’ve been through most of his papers and have not seen this point addressed.
If government spending is treated as fixed, then the problem is solved. The money created by the banks will drive up aggregate income, and drive up tax receipts. If government spending remains fixed, the resulting surplus will drain funds from the economy and prevent the hyperinflation.
But, of course, the probability of government spending remaining fixed in response to rising tax receipts is approximately zero. Government spending expands to a politically palatable level of deficits.
The other point I disagree with Mosler on is employment and rentiers. For instance, here is a line from the “Full Employment and Price Stability” paper:
Anyone who lives entirely on his interest income may otherwise need employment. Such rentiers have removed themselves from the labor force. To the extent that higher real rates increase the rentier population, potential output is reduced. Furthermore, those left working are, in real terms, supporting those living on interest income
If you reduce real rates, you may certainly force the rentier population to go back to work. But you also will encourage the current working population to work less and alter their spending to favor short term consumption goods rather than investments. For instance, I currently consume about one third of my income. If I knew for certain that my savings would be inflated away, I would quit my job and spend my savings now. So senior citizens/rentiers would be forced back to work, and I would go from working to traveling the world. Output overall wouldn’t change, Mosler’s policies would just distort the time structure of people’s spending choices.
And even if “output” is increased, that’s not necessarily a good thing. Ultimately, output is about producing stuff people want. If people want leisure, why should they be forced to work?
Warren Mosler Reply: September 17th, 2009 at 6:51 am
Seems to me the better argument has been that 0 rates are deflationary, to the point where taxes need to be lower than if rates are set higher. For more detail see ‘0 is the natural rate of interest’ thanks.
Right, rentiers are people living off investments in general.
If it’s determined that seniors need a higher standard of living social security can be increased.
Japan’s had 3% mtgs and banks have had a 0% cost of funds for a long time what you fear has not happened. Nor does it mean no defaults. Borrowers still need to make their payments, and banking regulations prohibit lending to borrowers with insufficient income, which in any case is what ultimately limits loan growth.
Also, apart from not agreeing about what causes inflation, there is no evidence that people quit their jobs and spend their savings when faced with inflation. In fact, the evidence points to the opposite. And what would you do when your savings was gone?
Agreed about output. No one is forced to work if he doesn’t want a share of the output.
The point is that there is really no evidence that the much vaunted Fed manipulations of interest rates have anything like the effect they claim to have, and some evidence that they in fact have effects opposite of what is claimed. So why not leave the risk-free rate at 0% (why should anyone get any return for taking no risk?) and let the market determine the rates for actual risky assets?
And as for “tightening” and “loosening”: ideally, tax and spending policies should be set so that fiscal policy is as automatic as possible. With progressive tax rates and fixed transfer payments (as well as, ideally, a federal ELR program), the budget will naturally go into surplus as the economy overheats and deficit as it contracts (this is actually what does the heavy lifting, behind the scenes, while the FOMC takes the credit with its interest rate mumbo jumbo, like witch doctors taking credit for the rain…)
anon Reply: September 17th, 2009 at 9:41 am
So if the funds rate is permanently zero, and if the deficit is left as excess reserves, and if the market determines risky rates, is there any reason for central bank open market operations apart from that? The central bank just becomes a utility function, right?
Jim Baird Reply: September 17th, 2009 at 12:40 pm
Yep. One of the few things I agree with the Austrians about is on removing the policy-setting role of the Fed. (Of course, I’d still keep the pure central banking aspects, but I’d make it a part of the Treasury – and maybe merge it’s regulatory powers with the FDIC, for good measure…)
warren mosler Reply: September 17th, 2009 at 12:40 pm
right. the can concentrate on regulation.
anon Reply: September 17th, 2009 at 2:35 pm
So fiscal and monetary policy really become fused. Interest rates are taken out of the picture, and if and when the real economy runs up against inflation constraints due to resource utilization, expenditure and tax tightening are the policy response?
Devin Finbarr Reply: September 17th, 2009 at 10:47 pm
Seems to me the better argument has been that 0 rates are deflationary, to the point where taxes need to be lower than if rates are set higher. For more detail see ‘0 is the natural rate of interest’ thanks.
Say this policy is announced. Interest rates fall to 0%. Banks borrow from the Fed at 0%, then lend to borrowers at 4%. This pushes up asset prices some. At some point the supply of borrowers that meet the income requirements of the models begins to dwindle. Banks drop their rates down to 2% to compete for borrowers. Borrowers notice the lower rates, take out the loans and buy real estate. This bids up the price of real estate even further. The bidding up of the real estate prices, and the capital gains of the sellers, creates a well effect. People spend more, and incomes rise. More people fit the model, and the banks can make more loans. Thus the inflationary spiral.
Whether this spiral happens or not, depends on the details of the system. The exact regulatory requirements matter, inflationary exepectations matter, and the feedback loop between asset prices and aggregate income matters. I don’t know the details of the Japanese banking system, but for whatever reason, the feedback loop did not happen. But the possibility exists. From a systems engineering perspective, if a logical flaw in your design is pointed out, you have to give specific reasons why it won’t happen, or give specific policies to prevent it. Saying, “well, it didn’t happen to Japan” is not good enough. Furthermore, something like the above inflationary spiral came close to happening from 2003- 2007. So it’s not just a theoretical concern.
One detail that matters is if the regualtory models have very strict income requirements, or if they just require profitability after default and liquidation. If the latter, the bank can still make money, and make very low risk loans, even to low income people, because inflation will continue to push up housing prices. As long as no one breaks the models, more loans can be created, pushing up housing prices further, thus making the models true.
If government spending is held as constant, the inflationary spiral does break, as inflation results in surplus which then absorb the excess money. But politically holding government spending constant is impossible.
If it’s determined that seniors need a higher standard of living social security can be increased.
Taxing away seniors savings, and then maybe deigning to give it back to them, is far too Soviet for my tastes. Not that our financial system isn’t already far too Soviet. But I don’t have to like it.
Also, apart from not agreeing about what causes inflation, there is no evidence that people quit their jobs and spend their savings when faced with inflation. In fact, the evidence points to the opposite. And what would you do when your savings was gone?
I would go back to work. The inflation would shift the structure of my work. Instead of working for thirty years, then retiring, I would work for three years, do a sabatical year, work another four years, etc. ongoing for forty or fifty years.
In practice you are probably right though. From an career perspective, it’s much more difficult to work three years on, one year off, than to do thirty years on, ten years off. So an inflationary policy would most likely result in me working the same amount, and consuming more.
But my overall point stands. Taxing savings to encourage people to work more is normative policy. I disagree with those norms.
warren mosler Reply: September 22nd, 2009 at 8:23 am
wouldn’t the ‘inflationary spiral’ dynamics as you describe them be the same with any starting point for interest rates, and therefore starting at 0% wouldn’t be a lot different from starting at 5%, for example?
So the point is, which you also make, that excessive deficit spending can be inflationary (I agree) and regulation of bank lending matters (I also more than agree and have described why the ‘collateral demanded’ is critical for govt lending, including banks, which are functionally government agents).
Also, i do not favor specifically taxing savings. that’s different than a 0 interest rate policy.
Derryl Hermanutz Reply: June 23rd, 2012 at 9:16 am
@Devin Finbarr, Devin asks what mechanism will halt a hyperinflationary asset price spiral in a zero interest rate environment.
The inflationary asset price spiral Devin describes here can only happen in what Minsky calls the “Ponzi” phase of a credit runup cycle. Banks lend money into the spiral to borrowers who cannot justify the purchase of the asset at that inflated price based on either their ability to service the loan from their income or on the ability of the asset to generate sufficient income to service the loan. The only justification for buyers to buy and lenders to lend at those prices is the expectation that asset price inflation will continue and they can soon sell for a capital gain. Selling to “a greater fool” at ever higher prices gets both the borrower and lender out of their otherwise unsupportable ‘investment’ in bubble-priced real estate. Bank lending to people who want to buy an asset at a price that cannot be justified by the financial returns that asset can realistically generate, but only because they think you can sell it for even more in the near future, is called “speculation”, which is something that Warren’s banking regulation would forbid because this kind of bank-fueled speculation is contrary to the public purpose.
It is technically easy enough to stop bankers and speculators from blowing bubbles, simply by enforcing existing bank regulation that requires sound underwriting of lending, which means the borrower must demonstrate ability to repay the loan out of his existing income or out of projected income from the investment. Paying $600k for a house that rents out for $1500/mo is NOT going to qualify as a profitable investment capable of paying for itself, and Warren advocates an end to securitization so that the lending bank has to keep this dog on its own books, so soon the inflow of payments on these inflated loans will be insufficient to cover the bank’s outflow of costs, and the bank will be subject to takedown by banking regulators. In the good old days bankers who went bust were personally “ruined”, and the prospect of personal humiliation and poverty was a virtuous incetive to sound banking practices.
What Devin fears is the same kind of Ponzi spiral that popped in 2007-08, enabled by securitization, and inflamed by “deregulation” that made insider bank robbery effectively legal. Rather than a system of virtuous incentives that motivate banking to serve public purposes, we created a system of perverse incentives that pretty much “causes” systematic insider bank robbery. If powerful kleptocrats have captured your legislative and regulatory processes then you have a political problem that cannot be solved with technical solutions, because technical solutions can only work if honest regulators have the power to enforce the rules on the players. If the whole financial and political system has become culturally corrupt so that every source of power is in on the kleptocratic strip mining of the system, then there can be no workable solution while the thieves are making their own rules and nobody has power to stop them.
the 2007 ‘ponzi spiral’ was supported by income until the financial implosion ‘pulled the credit cards’, and sales collapsed causing maybe 8 million people to lose their jobs and their incomes all at once. lost sales and jobs meant insufficient income to support debt, etc.
a fica suspension in mid 2008 would have sustained incomes and sales and abilities to service mtg debt as prices leveled off rather than plummeted
“Yet between 1996 and 2007 the profits of finance companies in the S&P500 dramatically jumped from $65 billion to $232 billion, or from 19.5% to 27% of the total. ”
“Increased concentration is vexing for regulators. Because systemically important firms can borrow more cheaply thanks to implicit state backing, small and medium-sized banks struggle to compete. A recent Fed study put big banks’ funding advantage at more than 30 basis points. ”
“Do you think 30 investors (shares) with say $500k each ($15 mil total) could do a small bank in that environment or do you think more or less would be required?”
From what I understand this is close to the current requirement (which seems extreme -perhaps I just don’t know that many people with $500k).
I’d settle for better access to loans (require the Fed to accept a list of collateral from any citizen) rather than better access to FDIC insured deposits (most citizens would rather avoid the paperwork).
From previous posts, it appears small banks play on the same field as a large bank, but with with different rules/access which puts them at a disadvantage.
“Why go to the expense and risk of creating new public/private partnerships when there are already approximately 8,000 member banks already set up for that purpose? ”
The investment required to become one of those 8,000 members becomes a distributional issue.
Public purpose is served by increasing competition and access. Anyone that can provide the Fed with collateral should be granted access. Arbitrary limits based on wealth defeat public purpose.
Matt Franko Reply: September 16th, 2009 at 12:47 pm
Winslow,
Do you think 30 investors (shares) with say $500k each ($15 mil total) could do a small bank in that environment or do you think more or less would be required?
warren mosler Reply: September 16th, 2009 at 2:51 pm
What I was proposing is that the fed simply use its 8,000 banks to do its bidding rather than creating new entities.
For example, if it wants AAA cmbs spreads to be tigher, instead of trying to form new pub priv entites to buy those secs with govt guaranteed funding, why not simply facilitate the buying of those secs at its member banks, who have the same funding?
And if you want to invest in those banks it’s fairly easy to buy stock in most of them.
and the larger point is, the govt doesn’t need private capital
for anything. the only purpose private cap serves in this context is to price risk independently of govt to a large extent.
“And if you want to invest in those banks it’s fairly easy to buy stock in most of them.”
Invest? I thought the point of being a banker was to rob the bank from the inside through bonuses. Buying stock just allows the bank to rob you (see various stock dilutions and penalties paid by BofA)
Matt Franko Reply: September 20th, 2009 at 8:28 pm
Winslow,
I’m starting to believe you (or you and a small group) are going to have to own/run a bank (held CLOSELY for control) to able to make anything in terms of a decent yield.
Unless corporate governance in USA is radically changed (there was a recent exchange here at Warrens blog about this, many good points raised) they will dilute you/not pay dividends/rob huge bonuses etc… and leave a passive investor with next to nil.
beowulf Reply: September 1st, 2010 at 6:28 pm
Hey Matt, do you have a link to the corporate governance thread? I did see that NJ Sen. Bob Menendez rolled a grenade into the CEOs’ tent with the executive pay provision he slipped into the bank reform bill.
Of course that’s looking at the pay inequality angle. Presumably the “typical employee” would be making about the same however much the CEO pays himself; at that point he’s really spending the shareholders’ money.
Congress could tell corporations that from now on, they will be taxed like a REIT (or a SBC), there are no federal corporate taxes if at least 90% of earnings are paid out as dividends.
But there’s one catch: No employee can be paid more than the President of the United States (current salary $400,000). Exceptional employees can be rewarded with what Brad Delong termed, a “Silicon Valley Compensation Scheme”:
Some of the engineers of Silicon Valley make fortunes: they are compensated with relatively low salaries and large restricted equity stakes… they do very well indeed–in the long run, in the five to ten years it takes to assess whether the business is in fact going to be a viable and profitable going concern. http://seekingalpha.com/article/127102-silicon-valley-compensation-schemes-needed-for-aig-and-tarp
If that’s too great a burden for a company (though I can’t see why shareholders would mind), the board of directors can always keep paying whatever salaries they’d like, and keep paying corporate income taxes. The board can look foward to explaining to shareholders why they chose to voluntarily pay corporate taxes with money that should be going out as dividends.
beowulf Reply: September 1st, 2010 at 6:48 pm
To clarify, REITs and BDCs (messed up the acronym above) currently pay no corporate income taxes if they pay out 90% of revenue as dividends, but they do not have any salary caps under current law.
Beo,
I dont think the thread was directly about corporate governance but it “veered off” on that direction in the comments (It’s been known to happen here!). I recall I was criticizing Mutual Funds for doing nothing for their mgmt fees in the way of forcing better, more shareholder friendly managements..
But I think the comments were congruent with what you propose here ie there has to be a way to get more return for the true owners of companies, the shareholders. I like your idea that parallels the REITs with the 90% payouts, etc..
If the ‘natural rate of interest is zero’ then I sometimes worry (as someone who would like to retire someday), how retirees are going to make a decent return for themselves if govt bonds start to permanently yield near zero (I think this is a good possibility from here)….what gives me hope is the non-financial corporate sector, many of these business do make good profits (like they are currently) and maybe low govt bond yields will activate investors/shareholders to force the corporations to pay higher dividends out of earnings to get them some better retirement income via these dividends.
But like you point out there is the double tax issue as dividends are payed out after taxes. This is often imo used by mgmnts to retain earnings as they are quick to point out the tax disadvantage and genrally they get the industry to sell the idea that “they know better what to do with the retained earnings than the sharholders” would if we paid them a dividend (thats BS imo), this just gives them cover to retain earnings and pay out more to insiders, rob, dilute, etc..imo…
Resp,
PS I’m ready to vote for the Zanon/Beowulf ticket in 2012, or maybe check that the Beowulf/Zanon ticket to get control of “The Fuzz”… (picked that term up watching ‘Adam 12’ re-runs in the 70s ;)
winterspeak Reply: September 16th, 2009 at 2:18 pm
Removing the cap on FDIC would also, I think eliminate the money market fund and much of the commercial paper market. Both of those would be great improvements to the financial system, as it’s what enabled Bernanke and Paulson to get Congress over a barrel last year (not that the Fed and Treasury could not have cooked up some other not-so-innocent fraud)
How do you stop Banks from raising their deposit rates when they start to fail and cannot borrow in the wholesale market? If the guarantee by the FDIC covers all borrowings then large depositors can move to the highest rate without risk and Banks can never have a liquidity crisis (which is why they typically fail).
“I would cease all issuance of Treasury securities. Instead any deficit spending would accumulate as excess reserve balances at the Fed.â€
I can see how this accomplishes certain streamlining effects with regard to the term structure of interest rates, etc.
But it forces non government net financial asset accumulation to occur entirely through the banking system. The non government, non-bank sector accumulates its position entirely in the form of claims on banks, with no apparent option to accumulate claims directly on the government, other than currency.
Is this a good thing? It seems to be an enormous restriction on non bank investment portfolio flexibility and risk management.
Or does this assume that bank credit risk is essentially eliminated under your proposal, and that the entire banking system is an extension of the government? You are putting a lot of restrictions on banks, but I don’t think you’re going quite that far.
I have been working on finding some common ground between MMT & other bank reform proposals, esp. positivemoney and related plans. Curious what you would reply to one of the comments about your Huffpo version:
“Warren Mosler concludes from his brief review of monetary history “The hard lesson of banking history is that the liability side of banking is not the place for market discipline.” This is precisely the point of focus for Positive Money. Our proposals remove the “mission critical” aspect of the monetary system – people’s money – from the liability side of banking and the vagaries of the market, isolating the payments system from the questionable liquidity and ultimate solvency of banking institutions. And that is all we seek to do. We do not propose any changes to the management of banks’ assets, which is where Warren directs his proposals, because we feel that is the wrong place to start. Getting the liabilities side right will eliminate the systemic significance of current concerns – securitisation and inter-bank lending are at present primarily liquidity management practices. Only once the balance between financial stability and profitability has been realigned by this will it be apparent whether and how asset management practices should be regulated.”
http://clintballinger.edublogs.org/2012/12/25/can-full-reserve-banking-actually-even-stop-credit-money-creation-the-chicago-plan-v-positive-money/#comment-158
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WOW, Really a great document. in particular i love the “ex-nay” on libor in u.s. and “ex-nay” on subsidiary off balance sheet stuff. If they aren’t allowed to have credit default insurance, they’ll make sure they write “good” paper!
warren, question:
do you think repealing glass-steagal had a big part in facilitating this mess?
and, any chance elizabeth warren is a fan of yours?
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Why is there no public purpose in US banks lending off shore?
Lending in dollars off shore creates international dollar demand (?), which make other countries want dollars and thus willingly export goods and services into the USA in exchange for dollars.
Bad for those countries, good for the US.
Of course that also create enmity towards the US… So maybe it is not worth it.
Regarding not allowing “mark to market” – what about repossessed houses? Don’t banks need to value those?
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WARREN MOSLER Reply:
April 5th, 2012 at 9:16 pm
i don’t follow that first part either, sorry.
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Gary Reply:
April 6th, 2012 at 11:32 am
@WARREN MOSLER,
in the document you wrote that there is no public purpose in allowing banks to lend off shore.
I thought that meant – lending dollars to foreign businesses/individuals. In which case that should create foreign demand for dollars – which in turn should increase foreign willingness to export to US.
But in fact that probably means lending against foreign property? In that case, please disregard what I wrote.
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WARREN MOSLER Reply:
April 9th, 2012 at 10:41 pm
ok, i don’t think foreigners need loans from US banks to export to the us?
it’s more about US buyers needing loans to import?
2…. as it tried to assist millions of US homeowners and
other borrowers who had contacted with US banks to pay interest based on LIBOR settings.
borrowers who had contacted
Should be:
borrowers who had contracted
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@Captain CraZ,
I wonder how can we get the 50,000+ factories that left the US for China over the last 10 years to take advantage of China’s devalued currency back or replacement factories?
It is not easy to make a new product plus a factory to produce it and the existing products made in China by US companies are protected by patents and the trademarks that we all know and love.
The political and economic interests supporting the current arrangements will have to be given a good alternative to change.
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Warren and Finbar from above: Anyone who lives entirely on his interest income may otherwise need employment. Such rentiers have removed themselves from the labor force. To the extent that higher real rates increase the rentier population, potential output is reduced. Furthermore, those left working are, in real terms, supporting those living on interest income
Craz: My grandfather had 11 kids to work his farm, that was cheap slave child labor. As he got older and infeeble, most of those kids served him by bringing him food and medicine and taking him places. Today I cannot find 1 woman to bear even 1 child with me, much less 11 children. I have had to sell my grandfathers farm because I don’t have the cheap child labor he had with 11 kids and I am worried about my future as I age because I don’t have 11 kids to help me as I get old and infeeble. My grandfather lived much wealther than I do or will. 11 slaves to do his every bidding for decades, he was a king, I am a pauper with my 20 million in US green pieces of paper.
Finbar says: If you reduce real rates, you may certainly force the rentier population to go back to work. But you also will encourage the current working population to work less and alter their spending to favor short term consumption goods rather than investments.
CrAz: This mule already sat down a long time ago, I got tired of working and paying taxes to support a system that puts shopping machine princess as the pinnacle of our society. You will not FORCE me to go back to work to support this system, I will die first from starvation or sickness before I will be forced to be a MULE again for a shopping maching princess – pathetic. I am not alone in this regard either, there are million of my brothers who feel the same way – maybe tens of millions – we are tired of the status quo and have sat down and won’t plow that field no more! Already people from Icahn to Cuban to many other CEO’s on wall street say the biggest problem is short term performance, there are no long term thinkers or planners in this country anymore looking out to the future. Beating the street by a penny every quarter is killing this country for the long term. Welch says you have to eat while you plan for the future though, but we are eating all our seedcorn and none is getting planted.
Finbar says: And even if “output†is increased, that’s not necessarily a good thing. Ultimately, output is about producing stuff people want. If people want leisure, why should they be forced to work?
Craz: My last few girlfriends all wanted gucci shopping bags and trips to paris care of my credit cards. They didn’t want to do anything in return for it either, why should they be forced to do anything for me or that I want when this society, loan system, credit corruption will give them whatever gucci handbags they want for NOTHING? Even forcing me to work to get money to buy thier gucci handbags did not get me what I wanted, so I sat down. What good is a society to me that does not produce the things, people, services, or entertainment I want to consume? Pathetic.
Warren lives off his investments no? Also Warren has a small bank in florida, and wants to level the playing field for himself against the big banks – challenge is REAL motives. I am like warren, I live off my investments too, and am moving to the USVI soon to be warrens neighbor and get those 4% tax rates, I may have to open a bank to also be like Warren in that regard, the best way to rob a bank is to own one according to professor black.
Warren says if it is determined seniors need a higher standard of living, social security can be increased, using his Japanese example, I have japaneses senior citizen friends who have determined they do in fact need a higher standard of living, but their social security has in fact not been increased, so what point is Warren trying to make with the japanese example? For Warren to be a BIGthinker, he sure seems to casually dismiss very real concerns, like who does the determining if mr. senior citizen needs more standard of living, and how does it get implemented? He brushes all those “devil in the details” problems away with very broad stroked, poor form! Finbar we just have to keep pointing these things out to Warren and maybe we can convert him. Anyways, the human ponzi scheme that required ever growing population levels to increase the standard of living of those at the top of the pyramid is coming to an end. Humanity will never have the growth spurt of humans it had the past 50 years, the wealth that was generated for some the past 50 years therefore will never be replicated ever again. My grandfather had 11 babies to serve him and his wife, I will not, it’s simple economics.
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Derryl Hermanutz Reply:
June 23rd, 2012 at 10:41 am
@Captain CraZ,
In 1848, by which time the socioeconomic consequences of the Industrial Revolution were clearly visible to people who objectively observe the macro situation, John Stuart Mill published his “Principles of Political Economy”. Industrialization so vastly increases human labor productivity that it becomes possible to produce abundance for all WITHOUT full employment. The problem becomes not one of production but one of distribution, and Mill advocates that we abandon the by then economically obsolete model of continuous economic “growth” and embrace the model of a “steady state economy” in which issues of distribution would have to be addressed politically. Despite the sound advice of numerous luminaries like Mill, the world has failed to perform this essential task of rational political economy.
Even with offshoring of most of the low value added manufacturing, the US is still producing economic abundance. The problem is that mechanized production does not create employment, it produces economic wealth, and we still believe the only way to justify receiving income that allows you to purchase that wealth is to participate in production. Our industrial era “distribution” problems can be technically solved by putting sufficient purchasing power in the hands of people who want to consume the productive output, but then you run into the “moral” problem where people feel that if you don’t work you shouldn’t be able to eat or otherwise share in consuming the productive output.
Milton Friedman advocated a reverse income tax, which becomes a guaranteed annual income, as a solution, but this went nowhere due to the powerful moral objection. Warren’s solution is an $8/hr government make-work job for anybody who wants one, funded by Treasury creation of money that is distributed to these ‘workers’ as income, but now the moral objection shifts to the cry that this work is not “productive”. The moral objection is not rational: we are trying to increase distribution, not increase production. Nevertheless, people vote their feelings and beliefs no matter how irrational, so this moral problem remains to be solved before the technical solutions can be implemented.
Warren also advocates that Treasury no longer issue debt (i.e. bonds, etc) against its creations of money, which solves the problem of our current zero sum money system where all the money is always owed by the borrower as a repayable debt to the lender or to the bond holder. In order for Warren’s solutions to become politically possible, the voting public is going to have to come to understand that money is “created”, not “produced”, and the US Treasury can create the money that it will use to fund the $8/hr jobs and increases in social security payments.
Treasury doesn’t need to tax Peter to pay Paul, and Warren advocates a reduction of taxes on earned incomes to leave earners with more purchasing power. Treasury can create its own money to pay Paul. If this creation and distribution of new money dilutes the value of the money that is distributed as (earned) incomes in the process of producing goods and services for sale, and this dilution expresses itself as “price inflation”, then the price inflation becomes the “tax” that pays for the redistribution of purchasing power. Inflation is a direct tax on the value of money, which is by far the most “fair” and “progressive”, and not escapable by tens of thousands of pages of tax code loopholes, kind of tax that can be levied in order to serve the public purpose of redistributing purchasing power within your national economy.
We already suffer price inflation that is caused by bank lending for speculative purchases of bubble-priced assets like real estate. Warren’s plan would merely “rationalize” inflation that is going to happen anyway, in ways that serve public purposes rather than serve private interests that are contrary to the public interest.
The political problem is that powerful interests, commonly referred to as “plutocrats”, seem to want to become a new aristocracy ruling over a new feudal peasantry, so these interests oppose monetary understanding and fiscal/monetary policies that would serve the democratic public purpose and instead promote an obsolete belief in the pre-industrial model of economic “scarcity” (when in fact we have a problem of superabundant production shackled by maldistribution), and an equally obsolete belief in zero sum money where one person can only get money by taking it from somebody who already has it and has “earned” it. In fact fiat money is created as numbers on banking system balance sheets (a “balance sheet” is a zero sum equation in which all the loaned money is owed as repayable debt so “net” money = 0), or it is created directly by the Treasury as non-debt money that makes the money system positive sum and allows the economy to have net monetary “profits” and net “savings” of money. Warren advocates this latter source of money as a necessary addition to the zero sum banking system creation of temporary “bank deposit money”.
So CaptainCraZ, the problems you identify are economic distribution problems that are caused by clinging to obsolete understandings of economics and money that applied to a pre-industrial era of real economic scarcity, but which do not apply to our modern situation. Money “distributes” claims on the ongoing production and the accumulated wealth, so the kind of solutions that will solve our maldistribution problems will be monetary and fiscal solutions.
Warren is trying to bring our monetary understanding into the modern era, but the monetary mentality of the public and the policy making classes is stuck in the 14th century and refuses to participate in the Enlightenment that transformed ignorance and superstition into knowledge and science in pretty much all the other fields of inquiry. Nowadays economics and finance remain the only “faith-based” disciplines that refuse to acknowledge rational reality, and the reasons for the failure to modernize this area of our thinking can be directly traced to the anti democratic interests of people who want to concentrate wealth and power in their own hands.
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I have to add my alternative vision :)
Monetary policy could lend sufficient quantities of variable rate money to the private sector to allow changes in short-term interest rates to actually alter aggregate demand. To get a $100 billion variation in aggregate demand through a variation in short-term interest rates of 5% would require Fed lending of $2 trillion dollars. Pretty close to what they are doing.
In other words, the Fed’s other choice is to fix the transmission mechanism. Partly seems what they’ve done, perhaps by accident, though more likely someone there knows what they are doing.
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I would make the current zero interest rate policy permanent.
Wouldn’t that bee a wee bit inflationary? What measure would you advise the Fed to watch for inflation? And wouldn’t an inflation target make more sense than an interest rate target?
It also minimizes rentier incomes, thereby encouraging higher labor force participation and increased real output.
By rentiers I believe you mean senior citizens and retirees. Should they be encouraged to go back into the labor force? It seems like you are instituting a seinorage tax on savings, and using it to fund lending. As someone who would like to retire someday, I’m not a fan of this part of your proposal.
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Scott Fullwiler Reply:
September 16th, 2009 at 11:58 pm
Welcome. You might want to see the mandatory readings . . . this is all rather compulsory.
Best,
Scott
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Devin Finbarr Reply:
September 17th, 2009 at 2:16 am
Scott-
I’ve been in the process of reading them and am most of the way through. But I’ve still got a lot of questions/skepticism.
In the paper above, Mosler writes: The fed should lend unsecured to member banks, and in unlimited quantities at its target fed funds rate, by simply trading in the fed funds market.
He then says in the comments that this rate should be zero.
So imagine the day this policy is announced. Banks drop their 30-year mortgage rates down to 3%. They borrow from the Fed at 0%, loan out to home buyers, and make money off the spread. These cheaper mortgages increase demand for housing and drive up prices. Banks compete over issuing new loans at lower and lower interest rates. Since each new loan creates the money needed to pay it back, there is never any risk of default on any of these loans. So the banks can keep creating new loans ad infinitum until 30 year mortgages are .1% interest rates, and the dollar is in a hyper-inflationary spiral.
If Mosler addresses this issue already, I’d welcome a pointer. But I’ve been through most of his papers and have not seen this point addressed.
If government spending is treated as fixed, then the problem is solved. The money created by the banks will drive up aggregate income, and drive up tax receipts. If government spending remains fixed, the resulting surplus will drain funds from the economy and prevent the hyperinflation.
But, of course, the probability of government spending remaining fixed in response to rising tax receipts is approximately zero. Government spending expands to a politically palatable level of deficits.
The other point I disagree with Mosler on is employment and rentiers. For instance, here is a line from the “Full Employment and Price Stability” paper:
Anyone who lives entirely on his interest income may otherwise need employment. Such rentiers have removed themselves from the labor force. To the extent that higher real rates increase the rentier population, potential output is reduced. Furthermore, those left working are, in real terms, supporting those living on interest income
If you reduce real rates, you may certainly force the rentier population to go back to work. But you also will encourage the current working population to work less and alter their spending to favor short term consumption goods rather than investments. For instance, I currently consume about one third of my income. If I knew for certain that my savings would be inflated away, I would quit my job and spend my savings now. So senior citizens/rentiers would be forced back to work, and I would go from working to traveling the world. Output overall wouldn’t change, Mosler’s policies would just distort the time structure of people’s spending choices.
And even if “output” is increased, that’s not necessarily a good thing. Ultimately, output is about producing stuff people want. If people want leisure, why should they be forced to work?
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Warren Mosler Reply:
September 17th, 2009 at 6:51 am
Seems to me the better argument has been that 0 rates are deflationary, to the point where taxes need to be lower than if rates are set higher. For more detail see ‘0 is the natural rate of interest’ thanks.
Right, rentiers are people living off investments in general.
If it’s determined that seniors need a higher standard of living social security can be increased.
Japan’s had 3% mtgs and banks have had a 0% cost of funds for a long time what you fear has not happened. Nor does it mean no defaults. Borrowers still need to make their payments, and banking regulations prohibit lending to borrowers with insufficient income, which in any case is what ultimately limits loan growth.
Also, apart from not agreeing about what causes inflation, there is no evidence that people quit their jobs and spend their savings when faced with inflation. In fact, the evidence points to the opposite. And what would you do when your savings was gone?
Agreed about output. No one is forced to work if he doesn’t want a share of the output.
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anon Reply:
September 17th, 2009 at 9:05 am
So you believe that “tightening” monetary policy by increasing interest rates is actually inflationary?
And if rates should be zero permanently, how do you tighten policy, if ever? By increasing taxes?
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Jim Baird Reply:
September 17th, 2009 at 9:27 am
The point is that there is really no evidence that the much vaunted Fed manipulations of interest rates have anything like the effect they claim to have, and some evidence that they in fact have effects opposite of what is claimed. So why not leave the risk-free rate at 0% (why should anyone get any return for taking no risk?) and let the market determine the rates for actual risky assets?
And as for “tightening” and “loosening”: ideally, tax and spending policies should be set so that fiscal policy is as automatic as possible. With progressive tax rates and fixed transfer payments (as well as, ideally, a federal ELR program), the budget will naturally go into surplus as the economy overheats and deficit as it contracts (this is actually what does the heavy lifting, behind the scenes, while the FOMC takes the credit with its interest rate mumbo jumbo, like witch doctors taking credit for the rain…)
anon Reply:
September 17th, 2009 at 9:41 am
So if the funds rate is permanently zero, and if the deficit is left as excess reserves, and if the market determines risky rates, is there any reason for central bank open market operations apart from that? The central bank just becomes a utility function, right?
Jim Baird Reply:
September 17th, 2009 at 12:40 pm
Yep. One of the few things I agree with the Austrians about is on removing the policy-setting role of the Fed. (Of course, I’d still keep the pure central banking aspects, but I’d make it a part of the Treasury – and maybe merge it’s regulatory powers with the FDIC, for good measure…)
warren mosler Reply:
September 17th, 2009 at 12:40 pm
right. the can concentrate on regulation.
anon Reply:
September 17th, 2009 at 2:35 pm
So fiscal and monetary policy really become fused. Interest rates are taken out of the picture, and if and when the real economy runs up against inflation constraints due to resource utilization, expenditure and tax tightening are the policy response?
Devin Finbarr Reply:
September 17th, 2009 at 10:47 pm
Seems to me the better argument has been that 0 rates are deflationary, to the point where taxes need to be lower than if rates are set higher. For more detail see ‘0 is the natural rate of interest’ thanks.
Say this policy is announced. Interest rates fall to 0%. Banks borrow from the Fed at 0%, then lend to borrowers at 4%. This pushes up asset prices some. At some point the supply of borrowers that meet the income requirements of the models begins to dwindle. Banks drop their rates down to 2% to compete for borrowers. Borrowers notice the lower rates, take out the loans and buy real estate. This bids up the price of real estate even further. The bidding up of the real estate prices, and the capital gains of the sellers, creates a well effect. People spend more, and incomes rise. More people fit the model, and the banks can make more loans. Thus the inflationary spiral.
Whether this spiral happens or not, depends on the details of the system. The exact regulatory requirements matter, inflationary exepectations matter, and the feedback loop between asset prices and aggregate income matters. I don’t know the details of the Japanese banking system, but for whatever reason, the feedback loop did not happen. But the possibility exists. From a systems engineering perspective, if a logical flaw in your design is pointed out, you have to give specific reasons why it won’t happen, or give specific policies to prevent it. Saying, “well, it didn’t happen to Japan” is not good enough. Furthermore, something like the above inflationary spiral came close to happening from 2003- 2007. So it’s not just a theoretical concern.
One detail that matters is if the regualtory models have very strict income requirements, or if they just require profitability after default and liquidation. If the latter, the bank can still make money, and make very low risk loans, even to low income people, because inflation will continue to push up housing prices. As long as no one breaks the models, more loans can be created, pushing up housing prices further, thus making the models true.
If government spending is held as constant, the inflationary spiral does break, as inflation results in surplus which then absorb the excess money. But politically holding government spending constant is impossible.
If it’s determined that seniors need a higher standard of living social security can be increased.
Taxing away seniors savings, and then maybe deigning to give it back to them, is far too Soviet for my tastes. Not that our financial system isn’t already far too Soviet. But I don’t have to like it.
Also, apart from not agreeing about what causes inflation, there is no evidence that people quit their jobs and spend their savings when faced with inflation. In fact, the evidence points to the opposite. And what would you do when your savings was gone?
I would go back to work. The inflation would shift the structure of my work. Instead of working for thirty years, then retiring, I would work for three years, do a sabatical year, work another four years, etc. ongoing for forty or fifty years.
In practice you are probably right though. From an career perspective, it’s much more difficult to work three years on, one year off, than to do thirty years on, ten years off. So an inflationary policy would most likely result in me working the same amount, and consuming more.
But my overall point stands. Taxing savings to encourage people to work more is normative policy. I disagree with those norms.
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warren mosler Reply:
September 22nd, 2009 at 8:23 am
wouldn’t the ‘inflationary spiral’ dynamics as you describe them be the same with any starting point for interest rates, and therefore starting at 0% wouldn’t be a lot different from starting at 5%, for example?
So the point is, which you also make, that excessive deficit spending can be inflationary (I agree) and regulation of bank lending matters (I also more than agree and have described why the ‘collateral demanded’ is critical for govt lending, including banks, which are functionally government agents).
Also, i do not favor specifically taxing savings. that’s different than a 0 interest rate policy.
Derryl Hermanutz Reply:
June 23rd, 2012 at 9:16 am
@Devin Finbarr, Devin asks what mechanism will halt a hyperinflationary asset price spiral in a zero interest rate environment.
The inflationary asset price spiral Devin describes here can only happen in what Minsky calls the “Ponzi” phase of a credit runup cycle. Banks lend money into the spiral to borrowers who cannot justify the purchase of the asset at that inflated price based on either their ability to service the loan from their income or on the ability of the asset to generate sufficient income to service the loan. The only justification for buyers to buy and lenders to lend at those prices is the expectation that asset price inflation will continue and they can soon sell for a capital gain. Selling to “a greater fool” at ever higher prices gets both the borrower and lender out of their otherwise unsupportable ‘investment’ in bubble-priced real estate. Bank lending to people who want to buy an asset at a price that cannot be justified by the financial returns that asset can realistically generate, but only because they think you can sell it for even more in the near future, is called “speculation”, which is something that Warren’s banking regulation would forbid because this kind of bank-fueled speculation is contrary to the public purpose.
It is technically easy enough to stop bankers and speculators from blowing bubbles, simply by enforcing existing bank regulation that requires sound underwriting of lending, which means the borrower must demonstrate ability to repay the loan out of his existing income or out of projected income from the investment. Paying $600k for a house that rents out for $1500/mo is NOT going to qualify as a profitable investment capable of paying for itself, and Warren advocates an end to securitization so that the lending bank has to keep this dog on its own books, so soon the inflow of payments on these inflated loans will be insufficient to cover the bank’s outflow of costs, and the bank will be subject to takedown by banking regulators. In the good old days bankers who went bust were personally “ruined”, and the prospect of personal humiliation and poverty was a virtuous incetive to sound banking practices.
What Devin fears is the same kind of Ponzi spiral that popped in 2007-08, enabled by securitization, and inflamed by “deregulation” that made insider bank robbery effectively legal. Rather than a system of virtuous incentives that motivate banking to serve public purposes, we created a system of perverse incentives that pretty much “causes” systematic insider bank robbery. If powerful kleptocrats have captured your legislative and regulatory processes then you have a political problem that cannot be solved with technical solutions, because technical solutions can only work if honest regulators have the power to enforce the rules on the players. If the whole financial and political system has become culturally corrupt so that every source of power is in on the kleptocratic strip mining of the system, then there can be no workable solution while the thieves are making their own rules and nobody has power to stop them.
WARREN MOSLER Reply:
June 23rd, 2012 at 7:50 pm
the 2007 ‘ponzi spiral’ was supported by income until the financial implosion ‘pulled the credit cards’, and sales collapsed causing maybe 8 million people to lose their jobs and their incomes all at once. lost sales and jobs meant insufficient income to support debt, etc.
a fica suspension in mid 2008 would have sustained incomes and sales and abilities to service mtg debt as prices leveled off rather than plummeted
“did I say i’d get it down to 1%? don’t recall that statement”
No, I don’t recall you ever stating a number. Want to go on record? :)
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by removing the need for the services they provide.
for example, i’d have banks can only originate and hold- no secondary markets, no prop trading, etc.
i’d eliminate the issuance of federal govt and agency securities
did I say i’d get it down to 1%? don’t recall that statement
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“Yet between 1996 and 2007 the profits of finance companies in the S&P500 dramatically jumped from $65 billion to $232 billion, or from 19.5% to 27% of the total. ”
http://www.economist.com/businessfinance/displayStory.cfm?story_id=14419218
How do your proposals cut this to less than 1%?
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Just ran across this….
“Increased concentration is vexing for regulators. Because systemically important firms can borrow more cheaply thanks to implicit state backing, small and medium-sized banks struggle to compete. A recent Fed study put big banks’ funding advantage at more than 30 basis points. ”
http://www.economist.com/displayStory.cfm?story_id=14401276
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warren mosler Reply:
September 16th, 2009 at 2:47 pm
right, which is why i propose the fed trade in fed funds in unlimited quantities with all its banks at its target rate, which i prefer to be 0.
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RSG Reply:
September 16th, 2009 at 3:01 pm
With fed funds target at 0, wouldn’t that reduce aggregate demand per reduced income on savings?
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warren mosler Reply:
September 16th, 2009 at 4:56 pm
yes, which means we can enjoy lower taxes as well
“Do you think 30 investors (shares) with say $500k each ($15 mil total) could do a small bank in that environment or do you think more or less would be required?”
From what I understand this is close to the current requirement (which seems extreme -perhaps I just don’t know that many people with $500k).
I’d settle for better access to loans (require the Fed to accept a list of collateral from any citizen) rather than better access to FDIC insured deposits (most citizens would rather avoid the paperwork).
From previous posts, it appears small banks play on the same field as a large bank, but with with different rules/access which puts them at a disadvantage.
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“Why go to the expense and risk of creating new public/private partnerships when there are already approximately 8,000 member banks already set up for that purpose? ”
The investment required to become one of those 8,000 members becomes a distributional issue.
Public purpose is served by increasing competition and access. Anyone that can provide the Fed with collateral should be granted access. Arbitrary limits based on wealth defeat public purpose.
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Matt Franko Reply:
September 16th, 2009 at 12:47 pm
Winslow,
Do you think 30 investors (shares) with say $500k each ($15 mil total) could do a small bank in that environment or do you think more or less would be required?
I think I see your point here…trying to quantify…
Matt
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warren mosler Reply:
September 16th, 2009 at 2:51 pm
What I was proposing is that the fed simply use its 8,000 banks to do its bidding rather than creating new entities.
For example, if it wants AAA cmbs spreads to be tigher, instead of trying to form new pub priv entites to buy those secs with govt guaranteed funding, why not simply facilitate the buying of those secs at its member banks, who have the same funding?
And if you want to invest in those banks it’s fairly easy to buy stock in most of them.
and the larger point is, the govt doesn’t need private capital
for anything. the only purpose private cap serves in this context is to price risk independently of govt to a large extent.
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Winslow R. Reply:
September 20th, 2009 at 3:24 pm
“And if you want to invest in those banks it’s fairly easy to buy stock in most of them.”
Invest? I thought the point of being a banker was to rob the bank from the inside through bonuses. Buying stock just allows the bank to rob you (see various stock dilutions and penalties paid by BofA)
Not good advice :)
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Matt Franko Reply:
September 20th, 2009 at 8:28 pm
Winslow,
I’m starting to believe you (or you and a small group) are going to have to own/run a bank (held CLOSELY for control) to able to make anything in terms of a decent yield.
Unless corporate governance in USA is radically changed (there was a recent exchange here at Warrens blog about this, many good points raised) they will dilute you/not pay dividends/rob huge bonuses etc… and leave a passive investor with next to nil.
beowulf Reply:
September 1st, 2010 at 6:28 pm
Hey Matt, do you have a link to the corporate governance thread? I did see that NJ Sen. Bob Menendez rolled a grenade into the CEOs’ tent with the executive pay provision he slipped into the bank reform bill.
US companies face a “logistical nightmare” from a new rule forcing them to disclose the ratio between their chief executive’s pay package and that of the typical employee, lawyers have warned.
http://www.ft.com/cms/s/0/977211ac-b461-11df-8208-00144feabdc0.html?ftcamp=rss
Of course that’s looking at the pay inequality angle. Presumably the “typical employee” would be making about the same however much the CEO pays himself; at that point he’s really spending the shareholders’ money.
Congress could tell corporations that from now on, they will be taxed like a REIT (or a SBC), there are no federal corporate taxes if at least 90% of earnings are paid out as dividends.
But there’s one catch: No employee can be paid more than the President of the United States (current salary $400,000). Exceptional employees can be rewarded with what Brad Delong termed, a “Silicon Valley Compensation Scheme”:
Some of the engineers of Silicon Valley make fortunes: they are compensated with relatively low salaries and large restricted equity stakes… they do very well indeed–in the long run, in the five to ten years it takes to assess whether the business is in fact going to be a viable and profitable going concern.
http://seekingalpha.com/article/127102-silicon-valley-compensation-schemes-needed-for-aig-and-tarp
If that’s too great a burden for a company (though I can’t see why shareholders would mind), the board of directors can always keep paying whatever salaries they’d like, and keep paying corporate income taxes. The board can look foward to explaining to shareholders why they chose to voluntarily pay corporate taxes with money that should be going out as dividends.
beowulf Reply:
September 1st, 2010 at 6:48 pm
To clarify, REITs and BDCs (messed up the acronym above) currently pay no corporate income taxes if they pay out 90% of revenue as dividends, but they do not have any salary caps under current law.
If Congress did impose one on corporations (don’t hold your breath), I suppose they could impose it on REITs and BDCs as well.
http://en.wikipedia.org/wiki/Real_estate_investment_trust
http://en.wikipedia.org/wiki/Business_development_company
Tom Hickey Reply:
September 1st, 2010 at 6:54 pm
Beowulf, did you catch this one?
William Black: Theoclassical Law and Economics Makes the Law an Ass
Matt Franko Reply:
September 1st, 2010 at 7:57 pm
Beo,
I dont think the thread was directly about corporate governance but it “veered off” on that direction in the comments (It’s been known to happen here!). I recall I was criticizing Mutual Funds for doing nothing for their mgmt fees in the way of forcing better, more shareholder friendly managements..
But I think the comments were congruent with what you propose here ie there has to be a way to get more return for the true owners of companies, the shareholders. I like your idea that parallels the REITs with the 90% payouts, etc..
If the ‘natural rate of interest is zero’ then I sometimes worry (as someone who would like to retire someday), how retirees are going to make a decent return for themselves if govt bonds start to permanently yield near zero (I think this is a good possibility from here)….what gives me hope is the non-financial corporate sector, many of these business do make good profits (like they are currently) and maybe low govt bond yields will activate investors/shareholders to force the corporations to pay higher dividends out of earnings to get them some better retirement income via these dividends.
But like you point out there is the double tax issue as dividends are payed out after taxes. This is often imo used by mgmnts to retain earnings as they are quick to point out the tax disadvantage and genrally they get the industry to sell the idea that “they know better what to do with the retained earnings than the sharholders” would if we paid them a dividend (thats BS imo), this just gives them cover to retain earnings and pay out more to insiders, rob, dilute, etc..imo…
Resp,
PS I’m ready to vote for the Zanon/Beowulf ticket in 2012, or maybe check that the Beowulf/Zanon ticket to get control of “The Fuzz”… (picked that term up watching ‘Adam 12’ re-runs in the 70s ;)
right, I left out a key proposal that needs to go in right away- eliminate the cap on fdic insurance.
thanks for the reminder!!!
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winterspeak Reply:
September 16th, 2009 at 2:18 pm
Removing the cap on FDIC would also, I think eliminate the money market fund and much of the commercial paper market. Both of those would be great improvements to the financial system, as it’s what enabled Bernanke and Paulson to get Congress over a barrel last year (not that the Fed and Treasury could not have cooked up some other not-so-innocent fraud)
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Martin Reply:
November 9th, 2010 at 1:29 pm
How do you stop Banks from raising their deposit rates when they start to fail and cannot borrow in the wholesale market? If the guarantee by the FDIC covers all borrowings then large depositors can move to the highest rate without risk and Banks can never have a liquidity crisis (which is why they typically fail).
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“I would cease all issuance of Treasury securities. Instead any deficit spending would accumulate as excess reserve balances at the Fed.â€
I can see how this accomplishes certain streamlining effects with regard to the term structure of interest rates, etc.
But it forces non government net financial asset accumulation to occur entirely through the banking system. The non government, non-bank sector accumulates its position entirely in the form of claims on banks, with no apparent option to accumulate claims directly on the government, other than currency.
Is this a good thing? It seems to be an enormous restriction on non bank investment portfolio flexibility and risk management.
Or does this assume that bank credit risk is essentially eliminated under your proposal, and that the entire banking system is an extension of the government? You are putting a lot of restrictions on banks, but I don’t think you’re going quite that far.
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