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>the banks started acting differently, and against everyone's best interests, including their own But that's the rub: "a bank" is just some paperwork, it doesn

>the banks started acting differently, and against everyone's best interests, including their own But that's the rub: "a bank" is just some paperwork, it doesn't have interests. The reason a banking executive might want to issue bad loans is, they raise short-term profits, which translate into incentive-based bonuses. When those loans inevitably go into default, the loss isn't on the executive, it's on the corporate account and, by extension, the shareholders. Of course, when it later becomes possible to securitize the loans and foist them off onto institutional investors (who think "mortgages, what could be safer?"), the game becomes about origination.

lend000 9y ago
> "a bank" is just some paperwork No, a bank is typically a corporation with the shareholders you mentioned, who have immense interests in the longevity of the company. > The reason a banking executive might want to issue bad loans is, they raise short-term profits, which translate into incentive-based bonuses. How do they raise short term profits? The bank just gave away X dollars for the loan. The profits are only projected on paper, and they assume a given interest profit on inflation and compared to the nominal interest rate. So don't you see how holding artificially low interest rates would distort this process? And don't you see how government programs to repackage and subsidize parts of this debt would incentivize more of it? What I truly don't understand is how so many people believe that the banking sector all of a sudden got greedier than usual in concert. There is a reason that their actions follow economic incentives, and the negative ones are largely following stimuli introduced by the government in the early 2000's.
- colorint 9y ago
  A corporation is also paperwork, which also does not have interests. Only people have interests. Shareholders have interests, but they're usually not privy to the actual inner workings of a business. I mean, even ultra-libertarian finance recognizes this, under the name "principal-agent problem." Banks don't give away money when lending; the situation is a lot subtler than that. First, consider that, when you deposit money in your bank account, you're loaning the money to the bank. From the bank's perspective, you've given them cash, which is an asset, and they've given you the right to demand the cash back, which is a liability. This being a loan, they pay you a small amount of interest. Second, consider that you can create liabilities on yourself ex nihilo just by writing "I owe you $5" on a piece of paper and signing it, which creates an asset for the person you give the IOU to. Third, consider that, if you're incredibly trustworthy, these assets that you created are marketable---and if you've got the backing of the Federal Reserve and the FDIC, then those assets will trade at par. With all this in mind, it should now be clear that, when a bank creates a loan, it creates the assets for the loan by creating corresponding liabilities on itself, which is, new deposit account balances. That is, the bank creates "bank money" (deposits) ex nihilo when issuing a loan. The borrower creates a corresponding asset/liability pair, in the form of the loan itself (i.e., similarly to a bond), which is an asset of the bank. In this situation, losses only occur if the loan goes into default and gets written off the bank's balance sheet. As long as the loan is in good standing, the created deposits (liability) are in balance with the created debt instrument (asset). On the other hand, the loan being paid off reduces deposits (reduction of liabilities), of which the principal component is used to write down the loan (reduction of assets) while the interest component is profit (increase in capital). There are more layers to this (what if the deposits are cashed out, or transferred to another bank?), and answers to those questions concern the actual role of the Fed, but suffice it to say, those questions don't refute this discussion. So this is why a bank executive would do this. As long as the loan remains in good standing, it generates profits. Once the loan defaults, those profits are wiped out by the write-down of the remaining debt (reduction in assets), and while the bank can foreclose (take over the house, which increases assets), that usually isn't to the bank's favor. But that window, where profits go up and before the losses are realized, is a gold mine for corrupt executives. This game was played before, which was called the Savings and Loan Crisis. The thing that changed was deregulation: the S&L debacle got people sent to prison, while the latest resurgence of liar's loans came in an era of notoriously ineffective banking oversight.
  - lend000 9y ago
    No need to write an essay to explain basic banking. > but suffice it to say, those questions don't refute this discussion. You should address them -- you've completely avoided the point. There is no dispute about the mechanism; I'm interested in the cause / incentive that drove the results. > The thing that changed was deregulation: the S&L debacle got people sent to prison, while the latest resurgence of liar's loans came in an era of notoriously ineffective banking oversight. Perhaps you missed the part about unpredictable Federal Reserve price-setting... from Wikipedia: "In 1979, the Federal Reserve System of the United States raised the Discount Rate that it charged its member banks from 9.5% to 12% in an effort to reduce inflation. The building or savings and loans associations (S&Ls) had issued long-term loans at fixed interest rates that were lower than the interest rate at which they could borrow. In addition, the S&Ls had the liability of the deposits which paid higher interest rates than the rate at which they could borrow. When interest rates at which they could borrow increased, the S&Ls could not attract adequate capital, from deposits to savings accounts of members for instance, they became insolvent. Rather than admit to insolvency, lax regulatory oversight allowed some S&Ls to invest in highly speculative investment strategies." Someone like you would probably blame everything on the last sentence, whereas I am more interested in the root cause.
    - colorint 9y ago
      An essay on banking seemed necessary, since you said that banks "give away money" when lending. It's important to understand that banks create money when they lend, but that's too esoteric to say on its own. As for the questions that were set aside, one role of the Fed is to ensure that enough ("high-powered") money is available to ensure that transactions clear, which is part of monetary policy (including, as you sort of mentioned, the discount window). Asymmetries between banks are resolved through interbank lending. Because all these mechanisms are available to cover their reserve needs, banks will issue loans (creating deposits) based on the creditworthiness of their applicants, not on their own reserve positions. But these are secondary matters, which is why I didn't talk about them earlier. >Someone like you would blame everything on the last sentence, whereas I am more interested in the root cause. On the one hand, interest rate risk is precisely why we allow lenders to charge interest; otherwise it would be money for nothing. On the other, I suspect you just want to blame the federal government, because that's ideologically convenient. For my part, I'm skeptical of the Fed's belief (and general economic orthodoxy) that interest rate increases are the correct response to inflation, but that's even more secondary. More importantly, we have the issue that normal people need to be secure in their bank deposits, and since the government is us, it's perfectly reasonable to make that happen. In particular, once you start insuring deposits, you really need to be ready to regulate. As for S&Ls, deregulation was the response to their interest rate troubles (they went for deregulation rather than closure because of free market orthodoxy), but then that turned out to be a disaster. The "control fraud" I talked about, where executives pillage the bank, was rife in the latter days of the S&L boom. Past that, y'know, it was a situation of making extremely risky loans with capital from insured deposits, because there was nothing holding them back. This is about as far from "won't somebody think of the bankers" as it gets. The FDIC has a fair write-up of it: https://www.fdic.gov/bank/historical/history/167_188.pdf https://www.fdic.gov/bank/historical/history/167_188.pdf Indeed, if you keep a vaguely open mind and know anything about the global financial crisis, you ought to spot one or two similarities, that have nothing whatsoever to do with the federal government strong-arming put-upon banks to make unreasonable loans to poor people---and, if anything, a failure of the federal government to lay down the hammer on private-sector fuckery.

lend000 9y ago

> "a bank" is just some paperwork No, a bank is typically a corporation with the shareholders you mentioned, who have immense interests in the longevity of the company. > The reason a banking executive might want to issue bad loans is, they raise short-term profits, which translate into incentive-based bonuses. How do they raise short term profits? The bank just gave away X dollars for the loan. The profits are only projected on paper, and they assume a given interest profit on inflation and compared to the nominal interest rate. So don't you see how holding artificially low interest rates would distort this process? And don't you see how government programs to repackage and subsidize parts of this debt would incentivize more of it? What I truly don't understand is how so many people believe that the banking sector all of a sudden got greedier than usual in concert. There is a reason that their actions follow economic incentives, and the negative ones are largely following stimuli introduced by the government in the early 2000's.

colorint 9y ago
A corporation is also paperwork, which also does not have interests. Only people have interests. Shareholders have interests, but they're usually not privy to the actual inner workings of a business. I mean, even ultra-libertarian finance recognizes this, under the name "principal-agent problem." Banks don't give away money when lending; the situation is a lot subtler than that. First, consider that, when you deposit money in your bank account, you're loaning the money to the bank. From the bank's perspective, you've given them cash, which is an asset, and they've given you the right to demand the cash back, which is a liability. This being a loan, they pay you a small amount of interest. Second, consider that you can create liabilities on yourself ex nihilo just by writing "I owe you $5" on a piece of paper and signing it, which creates an asset for the person you give the IOU to. Third, consider that, if you're incredibly trustworthy, these assets that you created are marketable---and if you've got the backing of the Federal Reserve and the FDIC, then those assets will trade at par. With all this in mind, it should now be clear that, when a bank creates a loan, it creates the assets for the loan by creating corresponding liabilities on itself, which is, new deposit account balances. That is, the bank creates "bank money" (deposits) ex nihilo when issuing a loan. The borrower creates a corresponding asset/liability pair, in the form of the loan itself (i.e., similarly to a bond), which is an asset of the bank. In this situation, losses only occur if the loan goes into default and gets written off the bank's balance sheet. As long as the loan is in good standing, the created deposits (liability) are in balance with the created debt instrument (asset). On the other hand, the loan being paid off reduces deposits (reduction of liabilities), of which the principal component is used to write down the loan (reduction of assets) while the interest component is profit (increase in capital). There are more layers to this (what if the deposits are cashed out, or transferred to another bank?), and answers to those questions concern the actual role of the Fed, but suffice it to say, those questions don't refute this discussion. So this is why a bank executive would do this. As long as the loan remains in good standing, it generates profits. Once the loan defaults, those profits are wiped out by the write-down of the remaining debt (reduction in assets), and while the bank can foreclose (take over the house, which increases assets), that usually isn't to the bank's favor. But that window, where profits go up and before the losses are realized, is a gold mine for corrupt executives. This game was played before, which was called the Savings and Loan Crisis. The thing that changed was deregulation: the S&L debacle got people sent to prison, while the latest resurgence of liar's loans came in an era of notoriously ineffective banking oversight.
- lend000 9y ago
  No need to write an essay to explain basic banking. > but suffice it to say, those questions don't refute this discussion. You should address them -- you've completely avoided the point. There is no dispute about the mechanism; I'm interested in the cause / incentive that drove the results. > The thing that changed was deregulation: the S&L debacle got people sent to prison, while the latest resurgence of liar's loans came in an era of notoriously ineffective banking oversight. Perhaps you missed the part about unpredictable Federal Reserve price-setting... from Wikipedia: "In 1979, the Federal Reserve System of the United States raised the Discount Rate that it charged its member banks from 9.5% to 12% in an effort to reduce inflation. The building or savings and loans associations (S&Ls) had issued long-term loans at fixed interest rates that were lower than the interest rate at which they could borrow. In addition, the S&Ls had the liability of the deposits which paid higher interest rates than the rate at which they could borrow. When interest rates at which they could borrow increased, the S&Ls could not attract adequate capital, from deposits to savings accounts of members for instance, they became insolvent. Rather than admit to insolvency, lax regulatory oversight allowed some S&Ls to invest in highly speculative investment strategies." Someone like you would probably blame everything on the last sentence, whereas I am more interested in the root cause.
  - colorint 9y ago
    An essay on banking seemed necessary, since you said that banks "give away money" when lending. It's important to understand that banks create money when they lend, but that's too esoteric to say on its own. As for the questions that were set aside, one role of the Fed is to ensure that enough ("high-powered") money is available to ensure that transactions clear, which is part of monetary policy (including, as you sort of mentioned, the discount window). Asymmetries between banks are resolved through interbank lending. Because all these mechanisms are available to cover their reserve needs, banks will issue loans (creating deposits) based on the creditworthiness of their applicants, not on their own reserve positions. But these are secondary matters, which is why I didn't talk about them earlier. >Someone like you would blame everything on the last sentence, whereas I am more interested in the root cause. On the one hand, interest rate risk is precisely why we allow lenders to charge interest; otherwise it would be money for nothing. On the other, I suspect you just want to blame the federal government, because that's ideologically convenient. For my part, I'm skeptical of the Fed's belief (and general economic orthodoxy) that interest rate increases are the correct response to inflation, but that's even more secondary. More importantly, we have the issue that normal people need to be secure in their bank deposits, and since the government is us, it's perfectly reasonable to make that happen. In particular, once you start insuring deposits, you really need to be ready to regulate. As for S&Ls, deregulation was the response to their interest rate troubles (they went for deregulation rather than closure because of free market orthodoxy), but then that turned out to be a disaster. The "control fraud" I talked about, where executives pillage the bank, was rife in the latter days of the S&L boom. Past that, y'know, it was a situation of making extremely risky loans with capital from insured deposits, because there was nothing holding them back. This is about as far from "won't somebody think of the bankers" as it gets. The FDIC has a fair write-up of it: https://www.fdic.gov/bank/historical/history/167_188.pdf https://www.fdic.gov/bank/historical/history/167_188.pdf Indeed, if you keep a vaguely open mind and know anything about the global financial crisis, you ought to spot one or two similarities, that have nothing whatsoever to do with the federal government strong-arming put-upon banks to make unreasonable loans to poor people---and, if anything, a failure of the federal government to lay down the hammer on private-sector fuckery.