What did you think they would do with all that money?

28/08/2013 § Leave a comment

A friend pointed me via social media to a column/post on The Leveraged Buyout of America:

As Representative Grayson and co-signers observed in their letter to Chairman Bernanke, the banking system is now dominated by “global merchants that seek to extract rent from any commercial or financial business activity within their reach.” They represent a return to a feudal landlord economy of unearned profits from rent-seeking. We need a banking system that focuses not on casino profiteering or feudal rent-seeking but on promoting economic and social well-being; and that is the mandate of the public banking sector globally.

The core argument is that banking should be an auxiliary activity in service of the commercial sector. The current set-up (in both senses of the term) promotes (a) risk-taking and (b) rent-seeking in ways that harm the economy. Responsible public banking should be promoted as an alternative, to achieve better well-being.

The column packs a lot of ideas into a small space, so it might help to tease them out a bit.

Rent-seeking: This is jargon for economists but isn’t being used exactly that way in the column. Economic ‘rent-seeking’ is trying to fix the rules of the game to get an unfair advantage. ‘Rent’ is super-normal profits for not doing anything useful. So, for example, getting the government to change copyright laws to protect a monopoly over a certain cartoon character — that’s rent-seeking.

The letter the author cites focuses on:

businesses [in] such fields as electric power production, oil refining and distribution, owning and operating of public assets such as ports and airports, and even uranium mining.

We’re talking capital-intensive infrastructure businesses, some of them with local monopolies. These sorts of businesses can have a standard return on investment, including a payment for the land they use (‘rent’ in the everyday sense). In addition, they can use their market power to extract economic rents or excess payments. It’s a classic problem with infrastructure — they tend to be ‘natural monopolies’.

What’s not clear is what ‘rent-seeking’ is alleged. The purchases could be innocuous: just people with lots of money buying things that cost lots of money and generate a consistent return over many years, sort of like buying bonds. On the other hand, they could be nefarious: sharp suits buying local monopolies with a plan to extract super-normal profits. But that has to happen over time — it isn’t the buying that’s the problem, it’s what they do with the assets once they own them.

Risk-taking: The deals described are risky, in the sense that they are done with borrowed money and expose banks to Minsky’s debt ratchet (pdf). It isn’t the underlying assets that create the risk, or the fact that someone new has bought them. It could be an insurance company, a pension fund, a sovereign investor or a consortium of private investors who buy the asset hoping to make a profit. The fact that it happens to be financial holding companies linked to banks isn’t all that important. It’s the structure of the finance that creates the risk.

But the deals create a problem I find more interesting: a privately planned economy. Think about it. These finance companies are trying to manage a whole bunch of assets and make as much money as they can — they are trying to manage small economies. This was Schumpeter’s and Galbraith’s insight about modern industrial economies. Especially as they start to manage the supply side through infrastructure investments and the demand side through credit card policies, they are now faced with trying to be Soviet planners. Do they relax credit conditions for their customers to goose spending on their airports and ports, or would they be better off charging monopoly prices for port access but thereby reducing demand and credit card earnings?

Here’s my prediction: they will fail. The problem, though, is that they are going to take down an even bigger portion of the economy than last time. That’s the ‘macro’ or ‘systemic’ risk that is now being created.

Cash is king: In a financial crisis, when a Ponzi bubble bursts (see the above Minsky paper), cash is king. People are trying to reduce debt as quickly as possible, so they sell assets at whatever price they can get. The people with the cash have the power. In this case, the banks have the ‘cash’ — safe, liquid assets. Highly indebted people with large, illiquid assets are looking for buyers. It’s not really a surprise that mines, airports, ports and other big expensive items are being converted into cash. Heck, New Zealand is following the same strategy. There’s not a lot you can do about it once you’ve got a Ponzi situation — it’s a natural consequence of the debt cycle.

But let’s ask ourselves, why are the finance companies cashed up? Well, that’s where any reasonable justification falls over. The same swaggering sultans spending large to buy all these assets crashed the world economy a few years back. They were bailed out by public money. It is like they went to a casino, bet large and lost, and then the house gave them the money back and let them try again.

The real problem isn’t so much what they are doing with the money they have. It’s the fact that they still have any money in the first place.

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