The bank is dead, long live the markets!
In my cursory investigation into the machinations of modern banking, one thing has become abundantly clear. The George Bailey model of small town banking died a long time ago. In its place is the towering might of large scale financial institutions.
The key weapon at their disposal is the markets.
No longer do banks perform the traditional role of match-making lenders & borrowers; referred to in the industry as intermediation.
Instead, the modern firm has a great armoury of financial instruments, most of which involve converting some form of investment or title of ownership into a re-saleable asset. The mortgage on your house, the credit card bill you may have and even that car loan you took out, no longer reside with the institution you dealt with. Your loans have been packaged up, chopped into pieces and scattered to the four corners of the globe.
The new model is referred to as dis-intermediation to reflect the destruction of the long established integrated model. However, the consequences are far from innovative, instead creating instability, uncertainty and even ripe conditions for mass scale profit siphoning.
The current financial shock waves are nothing less than the creaking symptoms of a flawed model. One that is reaching the upper limits of what can realistically be converted into a viable asset class and re-packaged and re-sold:
|Academic argument:||Rough translation:|
|1) The very structure of separating loan origination from ownership awakens deep rooted concerns about the exploitation of asymmetric information, namely Adverse Selection and Moral Hazard||Lending money has always been problematic (i.e. risky and prone to exploitation), but recently it has been handed over to the markets to deal with these problems|
|2) The expectation of market operations to effectively regulate credit risk is shown to be unfounded, instead resulting in ill-conceived and excessive lending practices||Markets give the impression that they have discovered alchemy and so the appetite for lending is increased. However, markets can’t reduce or manage this risk better than banks, in fact they are worse at it.|
|3) The recent growth in debt levels therefore may be masking a more fundamental issue of declining debt quality, such as debt for consumption and Ponzi financing||Markets instead disguise this risk and make it look like gambles are worth paying off, so everyone joins in the Ponzi scheme|
|4) Risk transfer practices mean that poor credit risk judgements are increasingly likely to be borne by unsuspecting counter-parties such as underwriters of Credit Default Swaps and central banks enjoying Government support||When it goes wrong, just make sure that you aren’t holding the risk (instead pass the problem on to Gvt, they created the climate for this and were the ones always banging on about Perpetual Growth anyway, so let’s stick it to them|
|5) Finally, the climate for fraudulent activity is amplified as Government support for institutions with the potential for suffering losses (on securitised assets) increases||Given that the Gvt is helping to disguise the REAL problem, us bankers can all make out that everything is going to be OK whilst stuffiing our trousers with loot|