[cletus]

Investment banks do provide valuable services: market making (providing liquidity in many markets), capital raising, the creation of financial instruments so investors can hedge against certain kinds of risk and so on.

Unfortunately I think we're reaching the point of banks overstepping their bounds and creating far more problems than they really should.

This strategy seems similar to the "demand shock" approach they used in driving up wheat prices in recent years. And of course the subprime crisis was the result of lax regulation, arguably criminal negligence by Standard & Poor's and Moody's (who rated certain baskets of loans as AAA) and a lot of players who simply didn't have to bear any risk.

I'm really not sure what the solution is here but something really needs to bring this system into check. Such paper shenanigans are having real negative consequences.

In Australia we have a strict financial regulation regime, arguably too strict in some cases, but we didn't have the bubble in real estate prices that the US did. "No doc" and "low doc" lending never reached the point of collapsing the market.

One could argue that financial regulation is to blame and you're probably right but I have no faith in the US government's ability to correct this or pretty much anything else. Washington now seems to be nothing more than a battleground for special interest lobbying and ideologues devoid of rationality.

In the past ~30 years or so investment banks have generally undergone a change from being a partnership to being a corporation. The major difference between the two is partnerships have unlimited liability. Much like a law firm, the partners are personally liable for losses.

I've come to the conclusion that this change has been detrimental to the function of the financial industry as a whole. Combine this with Federal government bailouts and investment bankers seem to act with complete impunity with regards to risk.

Something needs to change.

[Alex3917]

"Investment banks do provide valuable services: market making (providing liquidity in many markets), capital raising, the creation of financial instruments so investors can hedge against certain kinds of risk and so on."

I hear this argument a lot. While I think it would be an exaggeration to say that what Wall Street does benefits no one, at the same time it's clear that what Wall Street does is designed primarily to benefit themselves. Any benefit to society is merely a happy accident that gets leveraged for propaganda purposes, whereas on a day to day basis what they're really doing is earning money off the backs of those that are actually trying to do things that benefit society.

[cletus]

> at the same time it's clear that what Wall Street does is designed primarily to benefit themselves.

So what?

I don't begrudge them making a profit. Capitalism is the engine that propelled us from riding around on horses to putting a man on the Moon in the span of one man's lifetime.

But there are builders and extractors [1]. Allowing a farmer to forward-sell his crop so his income is known adds value. It also allows consumers to know what price they're paying in advance. Both of these make a profit for the bank but they provide value to both parties. This is not a zero sum game.

But when banks create funds that stockpile food for the purpose of driving up prices, the only real beneficiary is the bank's investors. In the short term, suppliers benefit from higher prices but long term you face increased inflation if the price rise is sufficiently large and you start applying the inevitable "me too" to other industries.

If you'd like to see how well denying the profit motive works you need look no further than the former Soviet Union.

[1]: http://cdixon.org/2010/06/19/builders-and-extractors/

[umarmung]

There is really only ONE possible and proven sustainable solution to this mess. It was realised in the aftermath of worst financial crisis ever seen, the Great Depression. It worked so well to create such stability, or at least certainly did not cause any harm to the real economy for so long, that the world saw the longest sustained period of growth it has ever seen and is also considered by all economists to be the "golden age" of capitalism from 1945 to 1971 (they only differ on precisely how the combination of all factors came together).

The solution in the aftermath of the Great Depression was Glass-Steagal and capital controls globally. This meant,

1. The money supply effectively only circulated within each country and transfers between countries were always linked to trade. Since jobs follow business investment, this meant very high employment per nation.

2. Financial instability had minimal to zero systemic impact in advanced countries because banks were only permitted to engage in funding and financing directly related to the real economy.

3. In addition, a side effect due to the partitioning and lack of artificial wealth interconnectedness, TBTF was not possible.

4. All manner of speculators were able to exist even then, but they knew they only had one chance with the capital they had since completely different types of financial activity were not allowed to co-mingle under the same organisation or group.

5. Finally, money was linked to the gold standard and debt creation (including printing) that did not relate to trade was very difficult - though not impossible, especially for governments which wanted to run or extend huge war machines for their empires.

Having to pay for the Vietnam War and coinciding with domestic inflation, caused Nixon to move the dollar off the gold standard in 1971, a fitting end to the Golden Age on 15 August 1971. Almost exactly 40 years later, here we are - in real (inflation-adjusted) economic terms per capita for median person effectively back to square zero with the worst in the real economy still to come as the ripples of the crises continue on through entire sovereigns.

An alternative way to look at it, is that the combination of financial deregulation and financial "innovation" since 1980 caused capital to move well-ahead of the globalisation of the real economy. Like a very strong wave, it caused ripples and bubbles in the assets available to it before real growth and high quality assets (including highly educated workers) backing it caught up. In a sense, the financial industry became too efficient at shifting liquidity and wealth transfer relative to the underlying economy. Combine this with the enormous increase in money supply generated by the political masters of the new fiat currencies, this meant the mother of all deleveraging and financial crisis was being deferred into the future. Well, the future is here now.

In short, there is a reason why in every country above subsistence level in the world, the financial industry is almost as heavily regulated as the nuclear industry. Like writing a good, large and complex computer program, having a few huge procedures with many side effects is far worse along every dimension than having many much smaller and well-organised functions with minimal to no side-effects.

The solution is "Compartmentalization" aka. Glass-Steagall on steroids for the financial industry. It is even advocated by high profile economists and others who publicly foresaw the 2007 crisis.

[yummyfajitas]

2. Financial instability had minimal to zero systemic impact in advanced countries because banks were only permitted to engage in funding and financing directly related to the real economy.

Um, the dotcom bubble happened under Glass-Steagall. So did 1987, the 1997 Asian financial crisis, and the 73-74 crash.

3. In addition, a side effect due to the partitioning and lack of artificial wealth interconnectedness, TBTF was not possible.

No. The Savings&Loan bailout and LTCM bailout both occurred under the Glass-Steagall regime.

4. All manner of speculators were able to exist even then, but they knew they only had one chance with the capital they had since completely different types of financial activity were not allowed to co-mingle under the same organisation or group.

You have no idea what you are talking about. The decline of product-specific trading desks was caused by the onset of stat-arb and had nothing to do with Glass-Steagall.

40 years later, here we are - in real (inflation-adjusted) economic terms per capita for median person effectively back to square zero...

This is a statistical artifact. The median person who's parents were in the united states in 1968 has income (adjusted for chained CPI, which is not the same as inflation) 29% higher than their parents. Immigrants lower the average/median.

http://crazybear.posterous.com/did-immigrants-and-simpsons-p...

[rayiner]

> Capitalism is the engine that propelled us from riding around on horses to putting a man on the Moon in the span of one man's lifetime.

Ironic that it was Communism that beat us at every milestone except for the last one, and only due to an accident of history (the death of the leader of the Soviet space program just before a push for a moon mission and the lack of someone to fill his shoes).

[toyg]

And the Apollo program was hardly a poster-child for capitalism: federal government-run program, very centralized and partly militarized, very wasteful and expensive, at a time when marginal rates of taxation where above 70%.

Let's be honest: massive technological pushes that do not deal with production efficiency have nothing to do with capitalism or even democracy.

[diminish]

in addition all this was motivated by the stiff rivalry with the centralized and militarized soviet union,

[Alex3917]

"Capitalism is the engine that propelled us from riding around on horses to putting a man on the Moon in the span of one man's lifetime."

Except for that it was actually socialism that put a man on the moon, seeing as it was a government project.

[gaius]

Paid for with... Magic beans?

[paganel]

> Capitalism is the engine that propelled us from riding around on horses to putting a man on the Moon in the span of one man's lifetime.

Unfortunately, having your own former employees moving into positions holding political power (http://en.wikipedia.org/wiki/Jon_Corzine , http://en.wikipedia.org/wiki/Henry_Paulson) is not Capitalism, it's Oligarchy.

[justsee]

Why do you assert that Australia "didn't have the bubble in real estate prices that the US did"?

We have a significant asset bubble here. It hasn't popped primarily because we've had government-sponsored inflation of prices via the First Home Owner's Grant.

The unwinding of the asset bubble finally seems to be happening in Australia now and will trigger many of the same financial issues for our banks (for instance Commonwealth bank is holding far more housing debt than any of the US and UK banks at the point their markets went south).

[cletus]

You're either understating (or simply unaware of) the extent of the real estate bubble in the US or you're overstating that bubble in Australia (or both).

To suggest the FHOG (which is $7,000 now and only ever got as high as $14,000) is responsible for this is disingenuous at best. What's your argument for this?

There are two basic components in house prices: the cost of land and the cost of construction.

Land is essentially scarce. Sure there is lots more land that we haven't built on than we have (particularly in Australia) but desirability comes into play here as do infrastructure costs. There is only so far you can effectively live from work centres. The further you have to build out the more roads, public transport (if you even have it), water, electricity, etc cost.

Land has certainly increased in value in Australia but a huge component of the increases is in the cost of construction. Nowadays it's hard to build a house for less than about $200,000. That is (IMHO) a huge problem. Building apartments now is in most capital cities prohibitively expensive for the middle class.

To give you an example, I pay less for my one bedroom in downtown Manhattan than the apartment I used to live in in West Perth now costs. Manhattan.

Conventional wisdom is that property is a good hedge against inflation. The massive inflation in construction costs should tell you something about inflation. Despite what the ABS may say about the CPI, the standard of living in Australia has dropped massively in the last decade, particularly in Perth.

This probably mirrors the massive housing inflation and the after-effects you saw in Sydney in the 70s and 80s, which results in those with homes being cash-poor and asset-rich and those left standing when the music stopped just being poor.

You just can't compare what's happening in the US and Australia. In the US in many large cities you can still buy a house for <$100,000. Where can you say that in Australia?

[podperson]

As an Aussie living in the US and somewhat out of touch with what's going on back home, I'm fascinated and confused by this. Are you arguing FOR or AGAINST the idea that there's a significant asset bubble in Australia?

We were recently looking at relocating to Sydney and were blown away by how prices (including rents) had increased since I last lived there (in 2002).

The interesting thing to me is that rents in Australia seem to have skyrocketed while prices have not (they're high, but rents are higher). In the US the housing bubble was characterized by prices increasing far faster than rents (which led to an illusory improvement in standard of living as people borrowed against "equity" and spent the difference). It looks to me as though Australian rents have risen faster than prices, which presumably has the reverse effect.

[cletus]

I'm saying what's happened in the US and Australia is different.

US prices were driven by rampant speculation fueled by shady lending practices where the lenders weren't accountable for defaults and a product that was doomed to failure from the start.

While there has been speculation in Australia, it seems driven largely by structural changes in the economy. Resources has brought a lot of money in. Those people traded up for property closer to the ocean and/or the city, driving up those prices leaving new entrants to live further and further out.

This is basically a natural phenomenon that happened in a somewhat accelerated fashion. I see a plateauing of prices for some years to come as a result.

Rents are simply playing catch up with the change in house prices. They always lag. There's nothing surprising here.

It is however concerning because Australia is very much dividing between the haves (construction/resources) and the have nots (everyone else).

I largely missed this bubble as I was working in Europe at the time (2001-2004). As it turns out, financially speaking I would've been better off buying a house for $80k (in 2000, worth $350k+ in 2004-2005) and sitting on a beach in Spain for 4 years than working.

Australia just isn't that attractive a place to live (for me) now and that's kinda sad.

[Goladus]

> There are two basic components in house prices: the cost of land and the cost of construction.

Those are the components of house cost, not price. Price is determined by supply and demand. Take two identical houses on the same street, the one in the superior school district will command a much higher price.

[Suan]

Unfortunately I feel not much is going to change until something even more drastic happens (think brink of revolution), and that makes me sad.

[anamax]

> In Australia we have a strict financial regulation regime, arguably too strict in some cases, but we didn't have the bubble in real estate prices that the US did. "No doc" and "low doc" lending never reached the point of collapsing the market.

The "no doc" and "low doc" lending was "encouraged" by US govt regulation, specifically "if you're not loaning enough money to {the disadvantaged}, we're going to shut you down". Meanwhile, the "govt sponsored enterprises" that ran the secondary market for mortgages were buying portfolios of crap and lying about it. The latter meant that no one knew how much crap was in the market.

> Combine this with Federal government bailouts and investment bankers seem to act with complete impunity with regards to risk.

Of course they're going to bail out their buddies, future employers, and campaign funders (I'm talking about Obama here).

> Much like a law firm, the partners are personally liable for losses.

Partners at major law firms are NOT personally liable. They've all moved to LLPs and the like.

[shareme]

We go back to having banks regulated similar to the laws in the 1970s or ask banks to pay off the Fed deficit to keep them un-regulated..