Thursday, April 5, 2012
John Carney — What Really Constrains Bank Lending
Must read. John lays out very clearly the kinds of cost banks need to figure in making loans.
As John observes, although banks can make loans that create deposits without having to have reserves or deposits to do so, it cannot just hand out money willy-nilly and stay in business — unless it is TBTF, that is.
Read it at CNBC NetNet
What Really Constrains Bank Lending
by John Carney | Senior Editor
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24 comments:
Banking lawyer - terrific combination.
If you see at legal documents on banks, central banks etc - they are always right technically and they also seem to be aware of all scenarios that may arise.
More general IMO, the greatest thing about money is its legal nature.
So wonder John Carney gets it so fast.
I mean no wonder ..
"More general IMO, the greatest thing about money is its legal nature. "
As beowulf often demonstrates.
Sure, these are a bank's costs under the "traditional" model when banks actually retained the loans they made. You know, back when bankers were sound risk manager.
But things get interesting real fast when banks are allowed to dump interest rate risk and default risk into secondary markets with AAA credit rating stamped on them.
What could possibly go wrong there?
"legal nature"
The ancient Greeks called theirs nomisma.
http://mikenormaneconomics.blogspot.com/2011/12/nomisma-and-argurion.html
Looks like a derivative of their words for types of 'law', nomos or nomia...
http://en.wikipedia.org/wiki/Nomos_(sociology)
"In sociology, nomos is a socially constructed ordering of experience. The term derives from the Greek νόμος, and it refers, not only to explicit laws, but to all of the normal rules and forms people take for granted in their day to day activities. In this sense it is closer to the use of the term in Plato,[citation needed] than in the more specific sense of the word "law" as a codified set of external rules."
What we may mistakenly and in a moron way refer today to as "money" (this term is garbage), our ancestors (who were NOT morons), called 'nomisma' and it specifically referred to tokens of state currency that were used to provision govt to provide order (thru law) in society.
As opposed to this lawlessness that our morons in TPTB our delivering to us today.
Resp,
Well currency tokens can be created by non-state actors too.
Ramanan,
You're right that it was my experience as a banking lawyer that attracted me to MMT. It was very clear that the traditional loanable funds and lending out deposits model did not describe the lending market my clients operated in.
Anon,
but that type of system would ultimately not be successful if it was not specifically authorized and regulated by the government...
Resp,
The state normally plays a negative role as far as privately-created currencies are concerned, i.e. it outlaws them or shuts them down if they get too popular. I've often wondered if this isn't basically unjust, and whether MMT might be able to accomodate the existence of domestic competing/complementary currencies.
John Carney needs to send this article to Krugman, help him fill some gaps in his understanding.
One thing Carney doesn't mention is the way in which banks were able to circumvent the costs of credit risk by repackaging subprime and liar loans into mortage backed securities and by purchasing credit default swaps. I.e pre-2008 fraud and complexity, in combination with buying off the rating agencies, was a major way in which banks were able to minimise short term costs and maximise short term profits.
The game was then to jump ship with as many bags of loot as possible just before the whole thing went down.
anon,
To me, "privately-created currency" is an oxymoron. "currency" and "state currency" being synonymous.
Mike in his recent Bloomberg interview used the phrase "unit of exchange" IIRC something like that... which is what I would interpret you are talking about with your "privately-created currency"... that would be some sort of non-govt operated "unit of exchange".
Which perhaps to your point I believe that type of system could function along side a system of state currency, as long as the govt would recognize that was a separate system and that the govt accordingly COULD NOT TAX any transactions that settled in that separate 'unit of exchange'.
From my POV of the Greek Scriptures, this is how the system (a "dual" system) was working in the Roman empire during the time of Jesus' earthly presence.... and it looks like it worked pretty well for them for quite a while.
Resp,
"The state normally plays a negative role as far as privately-created currencies are concerned, i.e. it outlaws them or shuts them down if they get too popular. I've often wondered if this isn't basically unjust, and whether MMT might be able to accomodate the existence of domestic competing/complementary currencies."
As I've come to see, the major kerfuffle arises over attempted tax-avoidance. Any lack of transparency or more than sporadic attempts by alternative currency users to avoid the sharp eyes of the eagle soon feel the sharp talons.
Yeah but Tom, this comes back to their moron belief in the false 'Taxpayer on the Hook/Government as Household' dogma imo.
They think they "need the money" so they want to tax these types of transactions that dont even settle utilizing the state currency system.
Talking about "barter" transactions or "gifting", etc.. those types of transactions that many people seem more comfortable with.
IMO, the govt does not have authority to tax these types of transactions; but they try to force these taxes upon agents operating outside of the system anyway; meanwhile they do not provide the add'l balances of state currency necessary to pay these taxes and chaos ensues....
Resp,
On the alternative currencies topic (one of my favourites), I find "puzzling" (not really, but speaks volumes on who serves who) why sometimes states try to kill lower administration alternatives to inject liquidity and create alternate payment systems when they try to accept and promote these currencies being able to liquidate local taxes in these currencies.
The most "known" case, the case of Wörlg during GD in Austria, when Austrian CB rapidly seized it and annihilated the growing public sanctioned currency.
In Spain, recently, there has been a similar measure and at least until now neither central bank or other government institutions have tried to do anything about it fortunately, probably because is a bit convoluted and it's no an 'exchange unit'.
A municipal government has issued some sort of 'subsidy claim' notes that can be redeemed at any point in the future for euros at the local government as a medium of exchange in local business. It was rapidly accepted and has been running for months without problem. One way to help with any liquidity issues at the location business could have and 'leverage' by the local government euros as 'tax credits', helping local commerce and exchange of goods.
The same location had its own currency during the civil war BTW, and it helped a lot local business.
Matt, if the government would not have the ability to tax all transactions within its jurisdiction it sovereignty would be threatened. No state will permit a challenge to its sovereignty within its borders.
Another excellent column by Carney. Beautifully stated...
What about a simple property tax or poll tax Tom?
Resp,
Matt, once the government permits large-scale tax avoidance, then its legitimacy is questioned.
This is actually a growing issue now. As more people see wealthy people avoiding taxes even legally, it induces others to skirt the law or even break it by not reporting truthfully and dealing as much as they can in cash, bater, money laundering, and alternative currencies. Actually, inside and outside the US the preferred medium of exchange in black markets is the US100.
Unless fax policy is administered fairly and evenly, it's a problem.
Then you have people like Roche blaming the hoodwinked victims ("AMERICA’S CRISIS IN ACCOUNTABILITY") as though this were the revealed wisdom of a revolutionary thinker and not the favorite excuse of Wall Street cockroaches for years going. The securitized mortgage market was built and constructed by wolves for the sole purpose of fleecing sheep. To fault the sheep for not being held accountable is simply vile.
Not everyone is a financial professional. For the country to have any widescale housing market, it needs to be possible for the average citizen to get a mortgage without being taken to the cleaners by predatory professionals.
Anyone know where I can read more about the MMT approach to taxation and how it could be properly conducted (as a means to control inflation rather than as a means to raise revenue)? I mean specifics, i.e. about how the system could work along MMT lines.
Seems to me taxation also allows the government to spend more enabling the recirculation of funds into the hands that will spend it. The less the government taxes the less it is able to do this.
I know this idea is not a part of any theory but in reality the economy is not a perpetual-motion machine. It must be continuously "wound up" or reset to keep it in motion, otherise it will come to rest (it's natural equilibrium).
@ JJ
There is macro theory, and policy, strategy and tactics based on it. MMT macro is based on the sectoral balance approach in which government uses fiscal means to offset non-government saving leakage by adjusting the size of the fiscal balance. This is ideally done through tax policy and automatic stabilization. Fiscal policy is affected through Abba Lerner's functional finance, which sees the role of government disbursement as injecting net financial assets into non-government and taxation as withdrawing net financial assets. Fiscal policy would therefore involve a combination of injection and withdrawal to make the targeted adjustment.
Strategy recognizes that the changes in non-government propensity to save are beyond the control of government. The size of the deficit is also largely non-discretionary, varying cyclically, with automatic stabilization and a variable tax rule operating. So the basis of strategy is design of a procyclical policy in which taxation withdraws net financial assets to curtail effective demand as the economy fails to expand quickly to meet it, while automatic stabilization decreases, reducing injections. The reverse happens countercyclically, where automatic stabilization increases injections and tax revenue decreases due to contraction.
Tactically, approach to policy and strategy would have to be implemented though specific policy proposals. For example, Warren Mosler put forward some proposal at moslereconomics.com under Proposals in the menu bar.
@ Paul,
This is why taxation is progressive. Capitalism is loaded in favor of capital, in order to promote investment, which is necessary for growth commensurate with population growth and innovation that increases productivity, which raises the standard of living.
If owner's would consume or invest their entire share, then there wouldn't be a problem, but if they save, which they do since they make so much, this creates a drag on effective demand. So government steps in with tax policy to "recycle" some of what would be saved. This actually spurs capitalists to invest more rather than acting as a deterrent, as many claim. The government then offsets the rest with injection.
As Michael Hudson observes, progressive tax policy is ideally target at economic rent — land rent, monopoly rent, and financial rent — while not taxing productive contribution including work. This discourages non-productive endeavor and encourages production, innovation, and work, which result in the non-financial economic growth that is the basis of real prosperity for a nation.
Banks also must price in the “credit risk” of making a loan—the risk that the borrowers may default, either because the collateral for the loan becomes so undervalued that the borrower “walks away” or because cash flow fall short of what is needed to make the loan.
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