July 20, 2009 | No Comments
America’s banks have, over the last decade, entered into a dangerous fictional world of projected automatic wealth in which they expect that all payments they might receive will without fail materialize, regardless of circumstance. They treat the human beings with whom they have major financial relationships as if they were nothing more than endless fonts of easy money. This is the crisis of reasoning and cash flow we are, as a people, as a global society, trying to solve.
The idea of the ‘automatic’ in human affairs is an extremely dangerous fallacy —l’automaticité as a functional problem in French ethical and/or political philosophy. It presumes to be able to rule out nearly all human elements of any relationship: free choice, and by extension human error, the interrelationship of people in a community, or across a market. It dehumanizes for the sake of intellectual convenience, or in the case of banks, for the convenience of using accounting methods that ignore risk.
Though the ‘marketplace’ is the most efficient way of turning a sum of money into more than it started out being, and the marketplace is made up of human beings with human relationships, subject to the whims of timing, collective direction, the emotional cascades that dominate trends in trading and the rules set forth by major institutions (like the banks), the banks have sought to siphon as much wealth as possible out of the marketplace, while totally disregarding the humanity of the millions of players whose lives become the source of their profits.
So what’s the solution? Isn’t the automaticity of repayment part of what motivates banks to lend freely, as they have over the last decade? And aren’t the banks reminding us, day after day, by way of indirect protests against legislative action, complaints about the stifling effects of regulation, and over the last year their relentless devotion to the rigors of the not-lending marketplace, that they need such added motivation to do what it is that most behooves banks, which is to lend and hold debt as future income? (Why deprive ourselves of future income by falsely claiming it as past income?)
What can be done to make an institution founded on lending break its apparent addiction to not lending? The answer just might be in treating people like people, building human relationships that are not authoritarian in their zeal or fictional in their assumptions. The legislation passed by Congress and signed into law by Pres. Obama, in May, known as the Credit Card-holders’ Bill of Rights or the Credit Card Accountability, Responsibility and Disclosure Act of 2009, sought to make those ‘adjustments’ that would require more human relations between banks and borrowers, but it is just a start.
It should be noted, the entire nation has colluded in the grand delusion, letting the banks pretend that by making a loan and selling the loan, somehow the same profits it acquired would also be acquired by the buyers of the loan, and the borrowers would also locate the needed additional wealth to compensate everyone, in the time allotted. That conceptualization of lending and wealth-generation allowed for the delusion that new money could be made almost out of thin air, just by willing it.
A loan became a “product”, and the product could then be sold, over the counter, and morph from wealth projected to product sold to new wealth generated, eventually becoming an “engine” of economic growth. But with such a high percentage of all loans falling into this category of renamed, rehashed, and re-imagined value bases, the “engine” effect was getting too much like an effect and less and less like a genuine engine producing substantive thrust.
The idea of wealth replaced actual wealth. There was a bubble. There was a correction. We are living in the aftermath of the correction. But it is necessary to understand how widespread this financial market bubble was and what philosophy about the creation of wealth allowed for it to get so far beyond sustainable, or substantiable, expansion. The idea that by way of repackaging debt, new wealth would automatically emerge, underpinned an entire philosophy about how banking could be something new, something different, a break from the past.
But it was not the past from which these innovative finances were breaking; it was reality, the measure of the concrete, the measurable, the comprehensible. Money is abstract enough as it is: paper or coin that represents value, formerly backed by silver or gold, now just a currency with value against other currencies. So to craft whole new terrains of complex abstraction, within which money appears to do amazing new things, perform new functions, is to stretch the bounds of lived reality.
Here’s another way to look at it. Banks are required, at least in the US, to keep a certain amount of capital in reserve, to guard against losses and cover obligations to pay out withdrawals to account-holders. In the process of assessing the fallout of the 2008 credit freeze, banks that were taking money from the federal government were found to have inadequate capital in reserve: they had been using investments, bundled assets and projected earnings as “capital in reserve”, which they were not.
This fictionalization of the banking business has many causes, over many years, and cannot be attributed to a single individual, a single idea, or any one point of departure. But at some point, innovative thinking and the generation of valuable financial derivatives morphed into a fictionalization of value, in which there simply was not and could not be enough value generated, in a short enough period of time, to sustain the claims of value being made by those institutions generating and selling off the bundled assets, derivatives and exotics.
So, we can say, the fiction of automatic wealth is bankrupting the US. Yes, even today, even as we are in recovery. Because fictionalized finances found their way into the long-term investment strategies of major institutions, including state governments. California is now broke. Banks have refused to continue accepting IOUs from the state, and the state government now has to shut down one day a week. California, the world’s 5th largest economy, lost billions when the markets seized up and hemorrhaged wealth last year.
It is the second time in a decade that California fell head over heels into a massive swindle. The Enron debacle nearly bankrupted the state, because the power-trading giant had allegedly colluded with other power companies in California to fix prices, forcing the governor to sign an agreement to buy power at many times market rates for up to ten years. Arnold Schwarzenegger came to power in the wake of that collapse, and now the end of his second term is seeing another collapse, brought on by huge losses caused by a financial system whose claims of real value were simply not real.
The entangling of state pensions plans and other long-term investments with the esoteric workings of the financial system is a natural consequence of a mindset in which every player has a right to earn, and to profit, via financial investment. The problem is, someone generally has to lose wealth in order for someone else to gain substantially, so the more players involved, the more risk —one might think— that more players will wind up losing. Creative strategies have to be adopted to prevent this, or at least to make it look like it will not occur.
The math might change altogether. A 30-year mortgage, which may or may not ever be repaid at its highest projected value, is counted as an asset. The lender claims to in fact hold that wealth now. $500,000 was just paid out, but in fact, the bank will claim to hold the $500,000, plus all the accumulated future interest. It does not, in fact, have the money, but it says it does. And it makes this questionable logic look viable by selling the debt.
With most commodities, this works, because the risk of lower value is taken on by the buyer, and such is the speculation that comes with buying and selling commodities. At some point, there will be a buyer who has to know the risk is mounting and he may never see a higher price than he paid. But with debt, the value of the loan is fixed: the borrower will not in fact pay more than the highest amount allowable under the loan agreement.
So once the bank sells the debt at the highest price it can, the buyer is very likely never to see a higher price or a return on investment. To get around this, debt holdings were “bundled”. Or rather, they were fragmented, then recombined. So the $500,000 plus interest becomes 5,000 $100 values, each with potential accumulated interest, and each with a speculative price that might actually go up. The money multiplies, and the buyer has some confidence that this speculative commodity will in fact yield a higher price than what he pays for it.
But the problem remains the same: the underlying loan will never be worth more than the monetary value assigned to it in the initial loan agreement. At some point, someone somewhere will be holding debt, which they “bought” at a very high price, which will either be repaid at the initial agreed (lower) value, or not be repaid at all, because in fact the wealth necessary for the borrower to successfully repay the loan never materialized at all.
Imagine this happening hundreds of thousands of times across the financial system, then millions, over several years. Imagine people with fixed-rate mortgages, able to repay, refinancing their homes in order to get access to more wealth, buying into new loans that work in this way, so that a majority of all loans were in fact of this kind. Banks were long past the critical mass on unsustainable debt when the house of cards started to wobble last summer.
What happened between the spring and the fall of 2008 was that a scenario some economists had predicted for years actually became apparent and apparently inevitable: there simply was not enough real wealth in the world to sustain the claims of value being made by the financial sector as a whole: too many outstanding mortgages were in fact unpayable as it was, let alone in a world where repayment depends on a financial system with exorbitant growth levels and where wages are expanding too slowly —actually declining by $2,000 per household from 2000 to 2008— and cost of living skyrocketing — namely food, fuel, healthcare and credit.
We are still working our way out of the labyrinth of that fictionalized financial world. But it’s important to recognize the underlying big picture conceptualizations of wealth that led to the mess we are in. The idea that wealth can automatically materialize from cunning manipulations, or even from what might be essentially nothing more than a shift in vocabulary, is dangerous and must be guarded against.
Automaticity is a tempting idea: it periodically takes hold of and distorts entire political systems. It is the logic behind building ever more destructive weapons —logic that the use of brute force will automatically compel our enemies to respond as we wish— and of prejudice of all kinds —if a stereotype can be applied to an entire group, then why not pin the blame for all our ills on that group—, and so the logic of automaticity is at the root of some of the most massive and widespread suffering in human history.
In banking, it has led to millions of bankruptcies and home foreclosures, millions of layoffs, a frozen credit industry. A lack of government response may have allowed the nation to slide into a long economic depression, by many economists’ forecasts. So the lesson has to be: wealth is not generated automatically by any flip of the wrist, by any sleight of hand, by any cunning financial innovation; it emerges, over time, from real evolutions within the economy as a whole, and has to correspond to measurable real-world value.
Banks are no more entitled to an automatic unending expansion of the wealth they hold or claim to hold than is any one individual. Banks are no more virtuous than any borrower, when they make claims about future wealth projections. The virtue is in the human element, which is expressed by the measurable wealth construct, the figures that are not purely figurative but actually correspond to lived reality.
We must remember that banks are made up of human beings, just as the market landscape of borrowers and investors is made up of human beings. Ideas are tools we use to serve our purposes, but they cannot be bought and sold independent of the human world in which they function; innovative financial instruments must operate on the human scale, so that investors know they are not handing over real wealth in exchange for unsustainable wealth claims.