I’m Not Seeing Capital Growth (Blue Line)

And look over here, all those derivatives? They are not hitting the real world, they are just trading amongst themselves, and generating commissions, but, “it is a revealing indicator that the non financial companies for whom these products were prescribed did not themselves use them.” Imagine that.

One of the alibis presented by those who created the current crisis in the financial system is that this innovation made capital more available, and hence increased economic growth.

So Adam S. Posen and Marc Hinterschweiger take a look at this theory, and they discover that there are no facts to back up this hypothesis:

….

But not every innovative product is safe, let alone productive. Unlike pharmaceuticals, aerospace, and a host of other technical fields, financial innovations have been allowed to proliferate unscrutinized and untested for safety or effectiveness. Yet the negative spillovers on the public at large from faulty financial engineering and toxic products have now been clearly demonstrated to be enormous. In particular, there is some solid evidence that the most recent batch of financial innovations was used in manners inconsistent with their labeling, and not only had terrible side effects, but did not even yield the advertised benefits.

….

Between 2003 and 2008, US gross fixed capital increased by about 25 percent, a reasonable number during an economic expansion, but hardly a boom. During the same five-year period, the global amount of over-the-counter (OTC) derivatives increased by 300 percent, while derivatives held by the 25 largest US commercial banks rose by 170 percent.

The reality is that people were not aiding capital formation of the “real” economy, they were creating products that would best allow them to feather their own nests.

In other words, this world of innovation was actually an exercise in personal selfishness.

There is a word for this, capitalism, and the same capitalism that creates a hybrid car also gives us the crack dealer and the stock broker, and the crack dealer harms far fewer people.

In the Wall Street Journal (!), Paul Romer is suggesting something rather similar to my proposal, you know, the one where I suggest amputating the financial industry:

Everyone agrees that the United States urgently needs a few good banks. Turning bad banks into good banks is a difficult and risky way to get them. It’s simpler and safer to start entirely new banks.

In this context, “good” means a bank with assets and liabilities that are easy to value using market prices. At a good bank, officers, regulators and investors can be confident about the value of the bank’s capital.
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The government has $350 billion in Troubled Asset Relief Program (TARP) funds that it can use to encourage new bank lending. If this money is directed to newly created good banks with pristine balance sheets, it could support $3.5 trillion in new lending with a modest 9-to-1 leverage. Right out of the gate, the newly created banks could do what the Fed has already been doing — buying pools of loans originated by existing banks that meet high underwriting standards.

This sounds an awful lot like what I was suggesting.

BTW, it also appears that Timothy Geithner is backing away from the bad bank idea, and looking at having equity shares that have votes, as opposed to preferred stocks.

He’s fighting this kicking and screaming, but the banks are insolvent, and need to be nationalized or otherwise cut loose.