patrick.net

CL says

Is the Financial Sector parasitical?

CL says

But in normal capitalism how does it hurt, if the system funds purchases, takes a cut for the investment, then spends the investment on anything? Is it that their share of the profits is just too large? Or is it always a negative?

It's the obscenely large cut, the fraudulent ways in which the financial sector maximizes its cut, the zero-sum games they play, and the incredible inefficiencies they introduce into the economy.

Consider basic banking:
1. Secure deposits of any amount.
2. The ability to query, deposit, withdraw.
3. Electronic payments including debit cards and online payments.
4. Online banking (this makes banking cost less).

Basic banking should be so systematic, so standardized, so well-implemented, and so streamline that its cost is basically a rounding error. That cost should then be socialized and minimized and all basic banking services delivered as non-profit.

Profit is suppose to be a reward for doing something innovative, not for maintaining a revenue stream by preventing an inefficiency in the economy from ever being fixed.

When banks profit by harming their customers rather than by helping their customers, those customers have less money to buy other goods and services. The entire efficiency and total wealth of the world goes down. This is where capitalism in its modern form fails.

If the market is unable to produce honest, ethical banking, then this extremely important task should not be left to the market. So far, the market has failed epically.

CL says

But if the financial sector were working properly, wouldn't it aid in wealth creation by supplying capital from those who had it to those who needed it? Or should there be no financial sector to speak of other than direct from the Government?

We definitely need a financial sector, but it must be non-profit. The entirety of history has shown that any for-profit financial sector will become corrupt, parasitic, counter-productive, and unpolicable.

What we need is a well-picked group of experts in economics, software development, law, and ethics to form a non-profit corporation to standardize and streamline all financial services and contracts. These employees will be paid, not by the profitability of the system, but by how well it works as evaluated by the public.

Whenever a company proposes that some new kind of product or contract template is needed, that company submits a fee that goes to evaluating the product or contract template to determine if it is necessary or helpful and to correct the product or contract template to ensure it is just, transparent, easily understood, and in the best interest of all parties and society at large.

Have you ever rented a car? When you rented a car, did you read the instruction manual for the car? Of course not. You just drove it, and you could do that because all cars are basically the same. This is called the power of familiarity and standardization. You don't have to learn how to drive every make and model of car.

Image if the same thing applied to mortgages, other loans, credit card lines, 401Ks, annuities, and every other financial product. No more fine print. No more deceptive and manipulative practices. You'll know what everything about a mortgage just by a one-page brochure and the power of familiarity.

The power of familiarity and standardization drives everything from electric power sockets to websites to mass transit systems to gas pumps to restaurants. Surely something as important as financial services and contracts should also be based on this principle.

If you compound interests on other people, with money you create (and you don't return that money in the cycle as dividends or salaries), then you can suck dry the rest of the economy within a few decades.

That's a level of parasitism. This is usually justified by the risks they take: if things turn against them, they can easily lose most of that money. That's they earn a percentage on money lent.

However history has proven that they don't take the risk. The taxpayer takes the risks.

So they just extract a percent of the productive economy, using money they are entitled to create, in exchange of nothing. They don't produce anything, and they don't risk anything. They just milk their position.

Most people, who just want to own a house, will pay a major part of their life savings to these people, in exchange of essentially nothing.

Dan8267 says

If the market is unable to produce honest, ethical banking, then this extremely important task should not be left to the market. So far, the market has failed epically.

As far as I can tell, the "regular" banking works just fine. Maybe I'm wrong.

Investment banking, on the other hand...

The Glass-Stegall Act of 1933 separated the two, right? But we thought it was too old-fashioned and repealed it.

Dan8267 says

We definitely need a financial sector, but it must be non-profit. The entirety of history has shown that any for-profit financial sector will become corrupt, parasitic, counter-productive, and unpolicable.

How is it possible to have a non-profit financial sector? A non-profit financial sector almost sounds like an oxymoron.

When people buy stocks/bonds or lend money, they hope to make a profit.

Heraclitusstudent says

So they just extract a percent of the productive economy, using money they are entitled to create, in exchange of nothing. They don't produce anything, and they don't risk anything. They just milk their position.

So, really, our complaint is that the wealthy benefit disproportionately from the system, resulting in a loss of productivity from the other sectors. They are skimming off the top.

In another world, where financial markets were too heavily constrained, we'd be arguing that the Government needs to loosen up its constraints on the sector, then?

It's not inherently parasitical, just today, and only due to the tremendous inequality that exists?Dan8267 says

We definitely need a financial sector, but it must be non-profit.

Like we would have Government make funds available to the non-profit, and the non-profit assumes the role of what--all private banking?

CL says

It's not inherently parasitical, just today, and only due to the tremendous inequality that exists?

It's not inherently parasitical, but today it is.

It is also very badly organized, unstable, prone to bubble and crisis. It assumes that lending and money creation are the same thing. These 2 things should be totally separate. The government alone should create money based on its deficit. Banks should just be there to allocate capital, and do so only by lending money they borrow from other sources, and be responsible for their own risks.

Heraclitusstudent says

The government alone should create money based on its deficit.

Really??? Then there's no reason to limit debt. No need for taxes! Just print money! It's free!

Maybe I misunderstand your argument.

freak80 says

How is it possible to have a non-profit financial sector? A non-profit financial sector almost sounds like an oxymoron.

When people buy stocks/bonds or lend money, they hope to make a profit.

It's quite simple. The transactions are standardized and no economic profit is made off the transactions or on margins. Normal profit is generated from minimal interest off of loans. The rest of the interest of loans goes to the loaner (bank account user), not the bank.

A non-profit financial industry certainly is not an oxymoron. The users still profit, but the industry itself does not. Removing the profit motive from the financial industry would vastly improve both stability and efficiency by eliminating the inherent conflict of interest that causes almost all of the evils in the financial industry.

Of course, a lot of parasites will leave the financial industry, but that's a good thing. There is nothing productive that the brokers and bankers can do that a well-written software system can't do better and in a more transparent fashion. I would even argue that the transparency and non-profit nature would make the financial system far more helpful to the economy at large by providing much more efficient liquidity without the massive amounts of fraud and misallocation of resources.

freak80 says

Heraclitusstudent says

The government alone should create money based on its deficit.

Really??? Then there's no reason to limit debt. No need for taxes! Just print money! It's free!

Maybe I misunderstand your argument.

I'm not defending that they print money, nor am I proposing that the gov finance themselves this way. But if you want price stability in a growing economy (and a bit of inflation), you need to increase the money supply. My point is this should be the privilege of the government only. Maybe controlled by a separate entity like the Feds, but in any case this should be a public function. Private banks should not be allowed to increase the money supply (like they are today), and should have for only role to route the money through the economy. If they were doing that well, a lot of things would be a lot more efficient in this country.

CL says

Like we would have Government make funds available to the non-profit, and the non-profit assumes the role of what--all private banking?

The non-profit corporation would handle the mechanics of banking and financial agreements, standardizing and streamlining everything. For-profit corporations can still act as brokers but would conform to an interface defined by the non-profit and would use standardized documents defined by the non-profit.

Instead of the end user being dictated terms like a user-license agreement that protects the big corporation while screwing the individual, the non-profit would only publish contract templates that were fair to both sides. The price of doing business is conceding to fair rules and contracts. New contract templates can be submitted to the non-profit along with a justification for the template, but the non-profit will decide if the template is acceptable or not. Naturally, lobbying and other forms of bribery would have to be highly criminalized and anyone working in the non-profit must not have any business, financial, or personal relationships to the financial industry.

Heraclitusstudent says

should have for only role to route the money through the economy.

And the reason why I think banks should be private is that someone needs to decide where to lend the money. This capital allocation is critical for economy. The assumption is that private people investing money at their own risk will do a better allocation than government bureaucrats reacting to various political pressures.

Dan8267 says

It's quite simple. The transactions are standardized and no economic profit is made off the transactions or on margins.

I see what you are saying. Eliminate the "middle men", i.e. the brokers and their silly "commissions." It's absurd to pay a fee just to exchange a piece of paper (when today it's all electronic transactions anyway).

Dan8267 says

A non-profit financial industry certainly is not an oxymoron. The users still profit, but the industry itself does not. Removing the profit motive from the financial industry would vastly improve both stability and efficiency by eliminating the inherent conflict of interest that causes almost all of the evils in the financial industry.

I'm not sure what you mean here. I'm assuming "users" means investors? Banks invest for profit; banks are usually considered part of the financial industry.

Heraclitusstudent says

The assumption is that private people investing money at their own risk will do a better allocation than government bureaucrats reacting to various political pressures.

Agree with you there!

I have no problem with private banks, but I do think regulations are needed in order to limit the systemic risk inherent in fractional-reserve banking.

Heraclitusstudent says

And the reason why I think banks should be private is that someone needs to
decide where to lend the money. This capital allocation is critical for economy.
The assumption is that private people investing money at their own risk will do
a better allocation than government bureaucrats reacting to various political
pressures.

Except during the last decade, obviously.

Dramaticly parasitical! The financial sector is 1/12 of GDP, but it keeps all of the following instructive information out of sight!

The Wall Street Journal 1999

The New York Times 2006

http://patrick.net/?p=1223928

freak80 says

I see what you are saying. Eliminate the "middle men",

Even more than that. Eliminate all "men" from the system. The system should be completely automated and the only humans involved are the ones designing, building, testing, and deploying the hardware and software. Eliminate human corruption from the system by eliminating humans from the system.

freak80 says

'm assuming "users" means investors?

A user is anyone who uses the finance and banking system including, but not limited to,
1. Bank account holders
2. Debit and credit card users
3. Owners of low risk investments like money market accounts, CDs, treasuries.
4. Purchasers of risker assets like bonds and stocks.
5. Lenders
6. Borrowers

Dan8267 says

Even more than that. Eliminate all "men" from the system. The system should be completely automated and the only humans involved are the ones designing, building, testing, and deploying the hardware and software. Eliminate human corruption from the system by eliminating humans from the system.

Hmmm...sounds like science fiction.

So when I buy a stock (for example), what happens in your totally automated system? How do I (hopefully) make a profit?

I thought finance was all about humans taking risks in hope of reward. How could a machine do it? I'm not saying it's absolutely impossible, but I must say I'm incredulous. :-)

freak80 says

I thought finance was all about humans taking risks in hope of reward. How could a machine do it? I'm not saying it's absolutely impossible, but I must say I'm incredulous. :-)

There are machines in Vegas that do this all the time. ;)

freak80 says

Hmmm...sounds like science fiction.

All proposed technological advancements are science fiction until they are implemented.

freak80 says

So when I buy a stock (for example), what happens in your totally automated system? How do I (hopefully) make a profit?

Same way you do in the current system except without all the fees. Stock trading actually has already been automated. What isn't automated is the checks that everything is done legally.

“Just imagine that a bond is a slice of cake, and you didn’t bake the cake, but every time you hand somebody a slice of the cake a tiny little bit comes off, like a little crumb, and you can keep that. […] If you pass around enough slices of cake, then pretty soon you have enough crumbs to make a gigantic cake."
Bonfire of the Vanities, Chapter 10, page 229

The quotation reveals the essential meaninglessness to society of Sherman’s job and the jobs of all the traders on Wall Street. They really create nothing of their own and contribute nothing; they just collect the commissions off the bonds they sell, like crumbs that fall off each slice of golden cake.

Like all middleman/salesmen they talk big about how ESSENTIAL they are to the process. You need only look at the growth of the FIRE sector and how much GDP it claims historically, to see there just MIGHT be a problem here.

Finally a thread topic most pat-netters can mostly agree on ;) There are quite a few solutions to this, some very simple, but they will meet the full resistance of the controllers of the fiat money. One is abolishing fractional reserve lending and replacing it with "each dollar of credit that a bank extends it must have on it's books either a dollar of immediately reducable to liquid asset or a dollar of actual capital. Capital is either (1) borrowed from the market and is 100% "at risk" (e.g. through the sale of bonds), it is (2) exchanged for equity (ownership, aka through the sale of stock) or (3) it is retained cash earnings from previous business operation." You can read more here and even if you don't like KD you may agree that this is a decent, simple and workable solution:

http://market-ticker.org/akcs-www?post=207502

That and punishing all fraud, i.e. uphold the rule of law ;)

Vicente says

The quotation reveals the essential meaninglessness to society of Sherman’s job and the jobs of all the traders on Wall Street. They really create nothing of their own and contribute nothing; they just collect the commissions off the bonds they sell, like crumbs that fall off each slice of golden cake.

Agree.

Some companies do sell stock direct to the public, rather than via a broker. Not sure about bonds.

APOCALYPSEFUCK is Comptroller says

No, it should be left to the market. Bank of America, Wamu et al should have been left to fail and their executives dragged from its offices by howling throngs of bankrupted investors and depositors, torn limb from limb and skull fucked and their offices burned and the rubble left as a memorial to criminal banking.

The surviving banks would have learned a lesson.

Agreed.

sbh says

How does your model

My proposal is to automate the mechanics of basic banking and to standardize contracts, not to take over every niche in the financial market or to be the sole marketplace.

There's no reason why basic banking can't be streamlined and made freely available. There's no reason that contracts can't be made simple, fair, and understandable.

sbh says

Does your model of non-profit finance apply to this relationship.

No. The non-profit corporation I propose only handles the mechanics and standardization. I am not proposing to eliminate all profit seeking from buying and selling of stocks. However, my system would eliminate the rent on electronic money that banks charge as well as all the fraudulent fees.

sbh says

Also, with respect to the original question about parasitism: my retirement account has accumulated multiples of my life's earnings through labor, and I will spend or give away every dime of it by my death. Does anyone think that generated wealth is parasitical?

There's a huge difference between investment and speculation. One is symbiotic, and the other is parasitic. My tax proposal from other threads would eliminate speculation, bubbles, and microtrading while encouraging investment.

T = 1 - 0.01M

If we had the above tax rates, the Second Great Depression would have never had happened. Neither would the first one.

sbh says

Apropos of the distinction between investment and speculation, you may want to clarify that.

Owning something for a short time (a few milliseconds or a few days) and then selling it is speculation. Real wealth creation (the creation of products, jobs, infrastructure, and markets), takes time. Investment is a long-term enterprise, not a short-term one. Furthermore, investment is not a zero-sum game, whereas speculation is.

Of course, nature is messy and works with gradations rather than lines. So, my capital gains tax proposal takes this into account:

T = 1 - 0.01M
where T is the Tax Rate, M is the number of months a property (stock, bond, house) is held.

The capital tax rate starts at 100% and decreases to 0% over 8 years and 4 months. You can save unlimited amounts, tax-free, for retirement. But speculation becomes non-profitable.

Consider the microtrader with a few milliseconds advanced insider knowledge -- this actually was revealed to be commonplace recently. He used to be able to make millions siphoning wealth out of the system (and from other people) by having software exploit the few microseconds difference. Under my tax proposal, all his profits are taxed at 100%. He did nothing to earn them, generated no wealth, in fact decreased wealth through inefficiency and transaction costs. Even ignore ethics and morality, there is no economic justification for him profiting at all.

Now consider someone who actually creates wealth, builds a business, or invests in a company that over a few years builds something worthwhile. At year 5, the tax is 40%, a bit higher than normal income. At year 6, the tax is 28%, less than the highest marginal tax rate for income earned through sweat and blood. That's a pretty good deal already. At year 7, the tax is 16%, about the current long-term capital gains tax. At year 8, the tax is a mere 4% and it drops to 0% in four months.

My capital gains tax proposal is extremely generous to investors while eliminating almost all speculation. As such, it is great for the economy as a whole. Real wealth generation takes time. It can't be accomplished in a few milliseconds or a few weeks.

Dan8267 says

Owning something for a short time (a few milliseconds or a few days) and then selling it is speculation. Real wealth creation (the creation of products, jobs, infrastructure, and markets), takes time.

Yes, but the former is fun. The latter is work. Nobody likes work.

Vicente,
End of 2011, FIRE sector was 8.4% of GDP.
http://blogs.wsj.com/economics/2011/12/10/number-of-the-week-finances-share-of-economy-continues-to-grow/

Dan8267 says

Consider the microtrader with a few milliseconds advanced insider knowledge -- this actually was revealed to be commonplace recently. He used to be able to make millions siphoning wealth out of the system (and from other people) by having software exploit the few microseconds difference. Under my tax proposal, all his profits are taxed at 100%. He did nothing to earn them, generated no wealth, in fact decreased wealth through inefficiency and transaction costs. Even ignore ethics and morality, there is no economic justification for him profiting at all.

You can stop the front-running by simply requiring the bid & ask to stand long enough for a human/manual trader to react to it. That would bring back enough tail risk so that the skimming would stop. And there is something useful in this activity, it's price discovery, so I disagree with the 100% tax, in favor of a transaction tax. Of course more useful/productive long term investments can be encouraged by lower tax rates (as they already are). Good discussion!

mell says

a transaction tax.

Tax want you want to discourage. Don't tax want you want to encourage. A transaction tax would discourage transactions, which in principle should decrease the liquidity of markets and increase the overhead.

The tax I propose discourages short-term, zero-sum games and encourages long-term economic development. Naturally, we could implement many different variations. For example, instead of a linear decrease in tax, we could use a decreasing sigmoid function that rapidly decreases the tax over a few days than slowly decreases the tax over a few years.

The point is to use the tax policy to make "bad things" non-profitable. Of course, one must have a criteria for what is "bad". I submit that we consider things that harm the economy as a whole "bad" and things that benefit the economy as a whole "good".

Dan8267 says

The point is to use the tax policy to make "bad things" non-profitable. Of
course, one must have a criteria for what is "bad". I submit that we consider
things that harm the economy as a whole "bad" and things that benefit the
economy as a whole "good".

This is true, but we must examine how making rapid transactions is "bad."

I generally agree, however, the downstream effect tax policy of this sort would have on liquidity can not be understated.

I suspect the loss of liquidity would be great, adding risk that when one desires to liquidate a buyer would be hard to find.

The added liquidity provided by the speculators is certainly good for price certainty. See 2007 housing crash for market value where there are no bids.

control point says

This is true, but we must examine how making rapid transactions is "bad."

I wouldn't say that rapid transactions are bad. You want transactions to be quick and as costless as possible.

What's bad is
1. The zero-sum games.
2. The irrational price instability.

And both of these things are strongly related to short-term holding of assets. It's nearly impossible to play a zero-sum game that lasts five years or more. It's impossible to play a non-zero-sum game that lasts less than a few hours.

Perhaps the fundamental problem with #2 is that the market sets prices. Maybe an entirely different system should be used. Just a vague idea, but something like pooling money across all commodities, setting prices based on performance, and distributing profits based on shares of the totality rather than individual. I'd have to think more about that possibility.

sbh says

mell says

Good discussion!

What kind of regulations do you advocate for business in the Libertarian ideal? As much as I think we cannot be America without capitalism, I consider capitalism to be like Hannibal Lector: sociopathic and amoral. Surely your "free-market" context has some rules and numbers other than "less", "more", "over" and "under".

Here are some examples:

- Environmental regulations, because pollution infringes on personal liberty. Those need to be followed though by private AND government entities, no pass for military etc.

- Fraud, in fact violation of all EXISTING laws, should be prosecuted to the fullest extent. nobody is above the law. This is an area where the US has turned into a banana republic.

- Some sort of monopoly regulations and oversight need to exist, but I'd keep them simple and small.

- Most laws need to be simplified and turned from thousand-pages monsters into short and concise statement that everybody can and will read before passing them or doing business in an area where those laws apply. This would cut down on armies of lawyers employed by banks, real estate firms, heath-care companies etc.

- Information will be public good, e.g. leaked documents, homes for sale or wanted (no prosecution for bringing information to others ever) and all non-essential business functions can be legally carried out without a license. This will cut down on middlemen such as realtors, financial advisors and "economists".

- Banks can only be called banks if they engage in traditional banking business (not speculate like a hedge fund) and only those are eligible for FDIC.

Just a couple of ideas to start with ;)

CL says

Does someone who say, works in auto finance help or hurt GDP? Does the insurance business help or hurt GDP?

It seems to me that insurance distorts prices, especially in healthcare. It also disconnects the consumer from making cost-driven choices. Is insurance parasitical?

Would auto finance be considered so too, in this climate? Are auto companies getting the same kind of skim from their finance dealings?

Heraclitusstudent says

And the reason why I think banks should be private is that someone needs to decide where to lend the money. This capital allocation is critical for economy. The assumption is that private people investing money at their own risk will do a better allocation than government bureaucrats reacting to various political pressures.

Bankers are people. Government Officials are people.

Either way, people are making the decisions.

CL says

Would auto finance be considered so too, in this climate? Are auto companies getting the same kind of skim from their finance dealings?

Oh yeah. No-Fault, the best thing that ever happened to Auto Insurance.

thunderlips11 says

Oh yeah. No-Fault, the best thing that ever happened to Auto Insurance.

Can you expound? (and thanks)

Sure. Back in the day, I think it was the 70s if memory serves, insurance companies insisted that the legal costs associated with assigning proportional blame was too expensive, and that by lowering the legal costs, customers would save on insurance.

So they lobbied for states to pass no-fault laws.

The result was a boom of fraud and bad driving, as well as rapidly increasing costs for insurance, which results in people driving without insurance they can't afford.

Since there is no legal process involved, no-fault states enjoy much higher rates of fraud than no no-fault states. Also, good drivers are punished along with the bad equally; since no determination is made as to whose fault the accident primarily was.

Similar effects happened in England as well when no-fault was introduced:
http://www.theguardian.com/money/blog/2012/feb/15/car-insurance-no-fault-claims-elephant

CL says

Is the Financial Sector parasitical

In my opinion, not in general no.

I think that those who invest in real estate and other rentier type investments are parisitical, in a way. But I don't blame them. They are trying to put capital to work in the best way they believe they can.

To the extent that the financial sector facilitates rentier capitalism, by providing leverage at good rates to those who have the back up assets to participate, and then by having policies (the fed) and investment vehicles (Goldman and other inv bankers) that promote the success of rentier investments, they are perhaps also parasitical.

One might argue that the reason for our current employment depression (and liquidity trap etc), is that the cycles I try to allude to above went too far.

Also, about bubbles, it's my belief is that the boomer generation over hyped the 21st century, that is the rolling over of the calendar in 1999 - 2001. THe financial sector was very much involved in the pre 2000 irrational exuberance, that had to lead either to a depression (at some point) or to blowing other bubbles to replace the the stock market bubble. The piper had to be paid eventually.

We're still working on that. IT would have probably been better to just go ahead and have a really bad recession starting in 2001 without the huge tax cuts, wars, and housing bubble to postpone it. (not that that was the purpose of the wars).

donjumpsuit says

Cheap credit is parasitical.

In other words, if you are rich, you should have to take your assets and make bets on buying companies, goods, or capital improvements.

However, it doesn't work that way.

If you are rich, you have earned the privilege of borrowing super cheap money to grow your portfolio.

That is wrong on a number of different levels.

I've argued for some time that one of our problems as a nation has been cheap money for too long.

There is another recession coming, bad one. Why? We're getting a few Fed chairman who will be no doubt forced to begin taking away the punch bowl. There is simply no way around it.