‘Chasing Goldman Sachs’ by Suzanne McGee – A Review

A Review of ‘Chasing Goldman Sachs: How the Masters of the Universe Melted Wall Street Down…and Why They’ll Take Us to the Brink Again’  by Suzanne McGee (2010, Crown Business)

'Chasing Goldman Sachs'  by Suzanne McGee
‘Chasing Goldman Sachs’ by Suzanne McGee

This book is an excellent complement to the academic stuff I’ve read on the causes of the financial crisis. These latter accounts are very detailed in terms of ‘what’ happened but tend to be light on the ‘why’. ‘Chasing Goldman Sachs’ goes a long way to filling that gap.

The academic consensus view seems to be that driven by an increase in demand for safe places to save there was a huge increase in deposits held by financial institutions and collateralised by Asset-Backed Commercial Paper (ABCP). A significant proportion of this paper was comprised of securitised mortgages – many packaged in such a way that their quality was opaque. The toxicity of these was enhanced by dodgy ratings and shuffling to off-balance-sheet vehicles. When problems with some of these mortgages arose it took a while for holders of these ‘shadow-banking’ deposits to sort out whether or not their deposits were collateralised by bad assets or good ones. There was a panic and large-scale dumping of these deposits which led to loss of liquidity in the market for short-term interbank loans. Without these loans banks find it very difficult to balance their books at the end of each day as they are obliged to. (A good guide to all this from the academic point of view and to further more technical reading is at http://www.nber.org/papers/w17778.)

So the ‘why’ questions become:

  1.     Why was there so much additional demand for large chunks of saving that required collateralisation?
  2.      Why were poor-quality mortgage assets allowed to find their way into supposedly high-quality collateral?
  3.    Why was the nature of these poor-quality assets hidden by the approach of the financial institutions and the rating agencies?

Englebert Stockhammer of Kingston University, UK, has argued that the answer to Q1 can be found in a combination of rising inequality and international financial deregulation. McGee’s book does a good job in answering Qs 2 and 3. There were opportunity and motive to make enormous short-term gains from the huge wave of money flowing around looking for a home – much more than could be recycled into productive investment. The potential gains going to individuals were so large that the long-term fate of their institutions, let alone the financial system as a whole, was of no consequence even if they ever thought about these.

Deregulation of banks allowed them increasingly to use assets on their own balance sheets to leverage large, risky and profitable transactions. Their operations were increasingly about maximising the returns on transactions in which their own capital was at risk, rather than fees earned for safely managing the capital of others. Thus it is hardly surprising that their diligence in looking after the interests of their clients/counterparties dramatically decreased. ‘Chasing Goldman Sachs’ documents well the pressures brought to bear on any individuals who were less happy about these developments!

My own main research interest is in the real (rather than the theoretical) working of the monetary system and its relationship to economic processes that involve real people, goods and services. According to my reading of the way bank lending works, the existence of large quantities of savings looking for a profitable home is actually the result of a dysfunctional economy; one in which banks are creating money in excess of genuine consumption or investment needs. Why should banks do this – since a failed loan results (eventually) in a hit to their equity capital via the profit and loss account? One semi-rational reason is that loans are riding on the back of speculative bubbles, and every lender is hoping they will be repaid before the bubble bursts. Less rational (from the institutional point of view) is reckless fee and bonus-generation activity by managers and employees. Third I guess is just stupidity. All of these appear in Suzanne McGee’s account!

One might predict (hope, anyway) that the stupidity would have been flushed out of the system by the financial crisis, but there is of course no reason to suppose that the incentives driving the first two reasons for excess loans and money creation have changed much.

As this book rightly and repeatedly emphasises, the financial system is a utility primarily for allocating purchasing power where it generates most welfare. Bank loans create that purchasing power for the purpose of allowing production, consumption time-shifting (especially of housing services) and asset re-allocation. That purchasing power actually disappears when the loan is repaid, which allows the quantity of money in the economy to fluctuate in line with the quantity of goods and services being produced and additional value being created. Inevitably, because mistakes are made and because individuals want to save despite the paradox of thrift in the aggregate, not all money created finds its way back to the banks as anticipated. In which case institutions can ‘intermediate’ between these savers and firms needing money to repay loans (or, in practice, other immediate purposes) and reduce the inefficiency resulting from the lending mistakes and saving desire. Because money mainly exists as bank deposits the mechanisms of payment between individuals, firms and the government also take place through the banking system. Any other activities banks get involved in are essentially secondary to these primary purposes.

Thus it is essential and appropriate that banks are prevented from doing anything that puts these primary roles at risk. But how to do so without limiting their ability to provide purchasing power where and when needed, or their ability to intermediate efficiently? McGee describes the regulations aimed at doing this as well as several instances of individuals trying to run their (small) institutions in this way. I think she is quite correct in her views of the limitations of all this.

My view is that the best way to tackle this is to internalise the externalities, by changing the governance of banks to a much more social model by ensuring employee, customer and community representation in their governance. In some ways this model recalls George Bailey’s institution in ‘A Wonderful Life’ but modern versions actually exist in Europe and no doubt elsewhere. The German Sparkasse system was remarkably resilient during and after the financial crisis – maintaining its loan issuance much better than the big German banks. On the other hand similar institutions in Spain apparently made quite a lot of local property and construction loans that went bad – governance has to be competent whoever is doing it.

Understanding Money

Understanding Money – a non-technical account of the essential role money and its creation plays in a modern economy. This article was previously available as a pdf, but I have now posted it as a blog in its own right. Since it was originally written in 2010, I have made a few revisions and additions.

 

Introduction

The genius of Lehman
The genius of Lehman

Most of us have little idea of what money is and where it comes from. When we think of money, we think of bank-notes and coins. We know that most money is held in bank accounts, but even then we have an image (although most of us are probably aware that it isn’t quite an accurate image) of these notes and coins being held for us by the bank or lent out by the bank to make money for them (and hopefully us, if the money is held in an interest-bearing account). In fact the reality is about as far away from this as it is possible to imagine.

Of the total amount of money (adding together bank-notes and coin held by the general public and the value of all bank accounts in the UK), the bank-notes and coin make up only around 3% ! The reality is that the vast majority of all money exists only as a record held in someone’s name by some bank or other. How can this be? Where does this money come from? Where does it go? In this article I will attempt to answer these questions, and in doing so explain the benefits and the potential downside to our monetary system. Continue reading

Money and the Neo-classics… Again

‘Aggregate Demand, Idle Time, and Unemployment’ – A Critique of Michaillat and Saez

Introduction
Like all neoclassical models, that of Michaillat and Saez (2014) referred to in Simon Wren-Lewis’s Mainly Macro blog on 16th August fails to model money realistically. This renders their model incoherent and in any case incapable of encompassing one of the most important causes of unemployment: inadequate aggregate demand due to monetary factors.

The chief feature of their model is a product market in which matching is the mode of exchange. This produces costly frictions that lead output to apparently run ahead of consumption. To make sense of demand that does not automatically follow from income Michaillat and Saez introduce a ‘non-produced good’ which is endowed to every household. When households meet to exchange goods there is mutual trade of this non-produced good and households’ individually produced goods so as to optimise each household’s joint holding in utility terms. Michaillat and Saez ascribe a relative price p to the production good, which apparently becomes the absolute price when they determine the price of the non-produced good as 1. Since it is determined in equilibrium it is important that p is an absolute price, otherwise quantities of exchanges, production and labour demanded would be indeterminate in the model as they would also depend on the rate of exchange between the produced and non-produced goods. In fact it turns out that claiming p to be an absolute price is untenable. Continue reading

Independence is Nominal

Independence is Nominal – long-gestated thoughts given birth to in response to Brian Barder’s blog post on the lack of post Scottish referendum preparedness and the need for the UK coalition government to resign if there is a ‘Yes’ vote.

The view from Scotland
The view from Scotland ©DWP

Here I am, up in Scotland and strangely detached from the debate. (For comparison I was very active for the Yes side in the devolution campaign.) This detachment is partly due to personal events over the last 18 months, but also to a difficulty in getting a handle on what it all means. Continue reading

Modern Thinking: Atomism and Communication

‘Modern Thinking: Atomism and Communication’ – Although written four years ago for an essay competition, I still think this piece encapsulates as well as anything my approach to economics, politics and social institutions.

Atomised and helpless
Atomised and helpless
Bertrand Russell, the great British mathematician and philosopher, believed that to be ‘modern-minded’ was to make the error of thinking with the fashion rather than ahead of it. When he wrote about this in 1937 he believed that with God’s role as arbiter of truth and beauty having been usurped, ‘detachment and objectivity, both in thought and feeling’ had also been thrown overboard. Russell, as a rationalist and a non-believer, believed it was ‘possible and important’ to preserve them without recourse to a Creator. To do so, he believed, required ‘solitude’ and ‘a certain degree of isolation both in space and time’. While he may have been right when it comes to studying the physical world and creating great art, his advice is less helpful when it comes to human nature and society. Even if we wanted to, as human beings ourselves, we cannot stand apart from other humans and society as a whole. Unfortunately when this recognition came it was in part responsible for a critical wrong turning in our approach to social phenomena. This wrong turning came about because modern thinking, having dispensed with God guiding from above, had already turned to look for causes and drivers of events at the level below that at which they are observed. The properties of substances had to be derived from the properties of their molecules; the properties of the forces that change the world about us from day to day are derived from the waves and particles into which they can be decomposed. Continue reading

Unemployment – Morality, Money and Increasing Returns

Returns to Scale in Frankfurt's business district
Returns to Scale in Frankfurt’s business district ©DWP

The causes of unemployment make it a moral issue. Radical solutions are required.

In an earlier post I noted some features of unemployment from a UK perspective. The main thrust was that a fairly constant proportion of the population in employment (around 72% of those of working-age) hides a serious decline in the availability of adequate work, due mainly to the increase in women in the workforce and the fall in the ratio of full-time to part-time work. In a paper I wrote and referenced here on welfare I hinted at a moral dimension to the issue of unemployment in a capitalist economy (by which I simply mean an economy where physical means of production tend to belong in more or less concentrated hands).

I have now written a rather more formal paper (pdf 198kb) which I presented to the Post-Keynesian Study Group annual workshop in May this year in which I expanded on why we have a persistent problem with unemployment, and why this has a significant moral implications in our attitude to the unemployed. In this light of this I review the inadequacy of current policy and look at some of the more radical solutions proffered. The following is a non-technical summary of the paper. Continue reading

The Callousness of a Conservative

Charles Moore is the official biographer of Margaret Thatcher, former editor of the Daily Telegraph and an Old Etonian. He has nicely epitomised the indifference, evident intentional ignorance and convenient innumeracy of a particular type of Conservative. Writing in his column in ‘The Spectator’ magazine (May 4th) he devotes a mere 262 words to writing-off the problems of those on low incomes in Britain.

[T]he people who best understand how welfare works are either its recipients or those who work on low wages and are scarcely better off for doing so

he writes. So far so reasonable. He goes on:

These people recognise that being on welfare is — in effect, though not morally — like having a job. There is a wage for it, plus various equivalents of overtime and fringe benefits, and the task is to get as much of these as you can.

There’s a half-truth in there. If work seems like an impossibility, or hardly worth the candle given its poor rewards and insecurity, self-interest would suggest that you look for all the benefits you might be entitled to – although many don’t. But he continues:

 One effect of this has been to destroy the working class. Its more enterprising members have become middle class and the rest have discovered that they can live by not working.

At a stroke of his expensively-educated pen, Moore dismisses the existence of all those struggling to make ends meet in low-paid jobs. Four million Britons over 18 are in jobs that pay £7 per hour or less; seven million in ones paying no more than £8 per hour. (The minimum wage is set at just over £6.) They cannot reasonably be said to have joined the middle class, and if they could ‘live by not working’ they certainly choose not to. Continue reading

The Real Wealth of Fizz

Coca Cola bottle and CashAmol Rajan, whom I have had cause to praise previously, wrote last week about Coca-Cola’s self-serving ‘anti-obesity campaign’. While much of what he writes is refreshingly scathing, I would take issue with the following statement:

[Coke] is a massive corporation that exists to make huge profits. This is fine by me, because I like big corporations: they create wealth, tax revenues and jobs.

Clearly the first part is mostly true. Mostly in the sense that a company also exists to expand the empires, wealth and reputations of its executives – which is generally also tied up with making ‘huge profits’. The problem I have is with the idea that big corporations necessarily ‘create wealth, tax revenues and jobs.’ Whether they create real wealth is often doubtful.

In the case of Coca-Cola what it mostly creates is sweet fizzy drinks and the additional pleasure that comes from drinking their drinks rather than those of any competing suppliers. If we wanted to monetise that real ‘wealth’ it would be in terms of the additional price we are willing to pay for Coca-Cola products over other similar drinks. Note that we have to pay that surplus freely – if we are forced to pay it because of local monopolies or persuaded by misleading advertising than it represents not a social gain but a loss. Continue reading

The (Press) Barons Bite Back

We knew the press barons (and they are literally barons, in some cases – as we shall see) didn’t like the proposed arrangements for organising press regulation agreed last month between the three main political parties. This arrangement was in the form of a Royal Charter (an arcane form of legislation introduced not by the elected representatives of the people, but by the monarch’s Privy Council) which set up a ‘Recognition Body’ which was to certify a new press regulator as conforming to the requirements based on the recommendations in last year’s Leveson Report. These requirements were in particular that the regulator itself should be truly independent of both the press and political influence, that it should have strong powers to enforce sanctions – both financial and in terms of apologies and corrections, that the regulator should set up a low-cost arbitration arrangement to deal with complaints and that complainants need not necessarily be individuals or organisations directly affected. Continue reading

Thatcher and Labour: The Real Lesson

As Kawan Patel suggested on LabourList a few days ago, New Labour was founded on the idea that while Margaret Thatcher might not have ‘saved the nation’ as her Conservative supporters claim, there were things she ‘got right’. I believe that this focus on the specifics of the Thatcherite legacy, such as privatisation and reductions in union power, is wrong. It is what was entirely responsible for New Labour’s failure to reverse inequality and for allowing a massive financial bubble to replace a sustainable industrial infrastructure in Britain. We must learn this lesson.

For a start, the image of 1970s Labour government in hapless thrall to left-wing union leaders leading their unwilling rank-and-file members to destroy the British economy is almost entirely a creation of the press and Conservative myth-makers. The root cause of the industrial unrest of the 1970s that culminated in the ‘Winter of Discontent’ of 1978-79 was consistent annual inflation in double digits. This was mainly as a consequence of massive hikes in the price of oil. Firms showed no restraint in allowing their prices to rise to maintain their profits; for workers to maintain their standards of living required credible threats to withdraw labour. In doing this they were, on average, successful – but no more than that. In relation to labour productivity, hourly wages were at exactly the same point in 1979 as they had been in 1972. Continue reading

People, Money and Power