Topic: How come the bank failure destroy the wealth??? - page 4. (Read 8896 times)

Back to my basic understanding:

There is very little wealth saved, it is only the "proof of work" saved in money's form, most of the wealth has been consumed

Although there is not so much wealth exist, Money ("proof of work") can request service/consumable products depends on the productivity of the society, e.g. money have credit. In a society with high productivity, excessive money is not a problem since there will always be enough goods to exchange the money. But in a society with low productivity, excessive money will cause inflation

These are all valid points, but it does not solve the problem, since human's speculative nature will always make bubble happen once they accumulate enough money. Of course government and FED helped to worsen the situation. As I know, chinese government has rules to prevent people from buying second house with loan

Using bubble (easy money) to bring country out of recession is the most easy way, but that resulted in even deeper crisis afterwards(actually I think recession is just a sign of money has been redistributed to a few people), so how to recover from recession without inject lots of easy money is the question here

You should ask yourself who those "bubble makers" are.
Here are some factors that contributed to the bubble:
1) Low interest and monetary inflation created by Greenspan to "save the financial market from the .com bubble burst".
2) Bush's regulations to promote the buying of houses. He said "own a house is the american dream".
3) Investments banks and saving banks are the same thing today, this allows banks to cheat the lenders on the real risk of their investment and take the risk premium for them.
4) Corrupt rating agencies giving AAA to financial crap: mortgages from people with no income and no assets.

Now Bernanke is "injecting liquidity" as his predecessor. Is this creating another bubble?
I think so: the public debt bubble.
Bubbles ultimately are capitals overpriced in relation to their yields.
But there's economic cycles even without bubbles. The liquidation starts when there's no (or very few) capital investment that will yield more than money can yield by itself (basic interest).


If one constructs his own house, it is going to be "profitable" for him even if the yield is zero, even if the total costs of production of the capital equal the utility extracted from it.
With capital-money, this is no longer true, because the investor will want at least the basic interest that he can extract from liquidity to spend his money or lend it.
Capital-money and basic interest (or liquidity premium) are the ultimate cause of economic cycles.
The bubbles we have had before the current crisis are just an undesirable effect of the keynesians "solutions", which don't really solve the problem, only postpone it and make it worse.

Just thought about another explanation: Bubble makers push the price up and sold the house near top to hard working people, but the house price were so high that normal hard working people could not afford without betting their next 10 years of labor, and so their consumption reduced dramatically during this 10 years period

From the construction point of view, even a non-professional worker could build a house in 3-4 years, it is not a technically complex and labor intensive work. If the house was built by professional construction companies, it will only take one man one year's work. Add material cost and 20% investment profit (which is very high), it should cost no more than 2 years of other equivalent work's income

The problem is not at the consumption side, they boost consumption through inflation to keep the investment going. Also, they manipulate interest rates in the process (in a way that cannot be sustained forever) also to keep investment going.

The interest rate is not only a measure of the standard investment return. Basic interest with capital-money will always be greater than zero, even in a shrinking economy. This sets a minimum in the investment return that is unnatural, because investments should be done if there's some return (or even if the return is zero) even if the return is lower than the "utility of liquidity".
Crises don't begin when suddenly people stops to consume. Investments and loans is what are reduced suddenly.

In my understanding, it is very simple: If money are too abundant, it will be inflation, otherwise, deflation

Interest rate is just a measure of the standard investment return. A low interest rate together with inflation will encourage people to put more money into investment (even it's very difficult to find investment opportunities, it's still better than let inflation eating up the saving value). A high interest rate with deflation will cool down the economy activities

The real problem is at the income/consumption side, which can not always keep getting higher and higher. Sometimes people just want to take a rest and drink a cup of water   In such a case, keep lifting the price is the only way to push things forward

You're assuming hyperinflation. With 20% inflation the currency will be soon destroyed regardless of the income increase.
With 20% inflation you should expect (if the inflation is not being created through new money borrowed into existence at low interest rates) a 20% inflation premium on the interest rates. Say 5 + 20 = 25% interest rates. Madness.
With inflation you're not creating any wealth, you're just attacking money so that real capital investments look better compared to capital money.
But naturally the two types of capital would balance through the inflation premium.
You can't lower the interest rates through inflation forever, eventually you will stop or slow down printing to prevent the collapse of the currency and that's when the interest rates will rise in response to the created inflation.


The problem with interest is that it has a minimum, because money holders can get a return from liquidity: exact the interest from the wares.
That minimum basic interest also represent a minimum for capital yields, no new investments will be made in a certain capital type if the yield is already lower than the interest rates, even if those investments were profitable.
What I mean by "the cause of economic cycles is interest" is that interest makes the credit/debt level grow more or less exponentially. When that type of growth in debt becomes unsustainable the debts begins to shrink causing deflation, which accelerates the liquidation process.


The interest rates will never be zero with non-perishable money and no central bank intervention.
With a currency with demurrage (free-money instead of capital-money), interest rates could be zero without central bank intervention (which is unsustainable in the long run).
This way capital yields could drop to zero by competition like regular profits do.

Inflation is a difficult measure. Let's say that the society have 20% annual inflation rate but the average income increase at 30% rate, it may not be a bad thing, just the price of everyting keeps rising, include income. The problem arises when prices rise but income do not increase, but this is quite impossible from a pure market point of view: When people's income get less, they will spend less, thus create deflation pressure

There is nothing strange with interest: Same money, if you put it into investment, you will get some return, if you save in a bank, you would also expect some return, that return is interest, and it works like a benchmark of the "general investment profitability"

In a rich society where effective demand is very low and business investment barely can generate some return, the interest rate will also be very low

So what you want is let the banks gamble with our savings. If they win they take the wins and if they lose the central bank pays the losses.
Not very different from the current system.
But note that if the central bank pays the losses by printing, every money holder does pay for the losses through inflation.

The problem they're trying to solve through inflation (apart from bailing out their banker colleges) is deflation.
Some people here will tell you that deflation is not a problem, but it is: https://bitcointalksearch.org/topic/m.421352
But their solution is not sustainable. You can't have low interests rates through monetary inflation forever, you will get hyper-inflation eventually. And when the central banks decide they can't keep on printing like crazy, the interest rates will rise, the liquidation process will start again and you will have the deflation. Through inflation they're only postponing the problem and making it worse. They're feeding the ultimate bubble which is public bonds.
Keynesian inflation is not a cure for economic cycles but only a patch.

I think the cause of economic cycles is the basic interest and therefore the only solution is substituting capital-money with free-money.

Take Mcdonalds for example, I think anyone can make some food cheaper and tastes better than Mcdonalds, but they are not able to compete with them in a corporate level, since Mcdonalds have already occupied most of the place that has the highest rate of people flow in the last century. Due to economy of scale, when they get bigger, the cost will going down, and they have created a culture that many people can not live without it (real-estate monopoly)

Another example is japan's digital camera companies, I do not think their government helped, but that is really a monopoly in country level. They toy the users with minor upgrades of camera, but the sensor seldom improved in 10 years, this could never happen in IT industry (Technology monopoly)

Do you have an example of a monopoly that was sustained without direct help from the government, and that also overcharged the market?  Just one example would do nicely.


Meh.  Life isn't fair.

Of course those banks already bought insurance before play this game, but the crisis is enough powerful to knock down these insurance companies,  even fannie may and freddie mac can not take that amount of loss and needs to be take over by the government, I do not think that FDIC can survive a mass failure of banks. All the insurance company works the same way, they can take a single hit and still remain financially strong, but if they were hit multiple times in a short time, they go bankrupt. Actually fractional reserve banking act just as an insurance company, if more than 20% of the people go in ask for withdraw/insurance, it will broke

But wait, you have a point! If FDIC is backed by FED with fresh printed money, then it's a good idea to let those banks fail, or in another word, FED can become the final insurer for the whole society, since they can print money to pay the insurance

Who is responsible?  Or who pays?

Deposit accounts are insured (FDIC). 

Bank should fail.  FDIC insurance should pay depositers (note FDIC is funded via insurance premiums charged to functional banks).
Shareholders should be completely wiped out.
Bondholders wiped out and/or take major haircut depending on level of insolvency.

Ig any value can be salvaged the FDIC takes bank into receivership, recapitalizes it and then sells it back to private market.
If not then FDIC takes remaining performing assets and sells them to healthy bank.

It worked that way for decades without a problem until suddenly crooks in Wallstreet & Washington decided banks can't fail.  Shareholders and executives need to be rewarded for gross incompetence and the losses were passed to taxpayers and these worthless undercapitalized zombie banks continue to be a drain on our economy.

Bank Of America should be dead.
Countrywide should be dead.
Wachovia should be dead (no forced merged w/ Wells Fargo)
Citibank should be dead.

Shareholders & Bondholders should have been annihilated.  Executives should have been put on trial, lost personal assets via in-reim forfeiture and spend 10-20 years in prison.  That is capitalism.  Next time shareholders will look for more conservative investments and executives will be more inclined to not commit wholesale fraud.

Instead everyone who should have taken a loss was rewarded and taxpayers paid for it.  The moral of the story.  commit fraud, take excessive risk, destroy wealth you will be rewarded for it.

Let's say, 1 million people have their saving account in a bank, where 20% of the people made a default on their loan from this bank, and the bank went bankrupt. It means the rest 80% of the people lose their savings in this bank, although they did not do anything wrong.

Who should be responsible for the loss?

It is both government (who gave stimulation through housing) and FED (who provided the liquidity) started this pyramid game. In a real pyramid game, the early player draw their profit from the later joined players, but in this case, the later joined players select default to escape from the game, then the early player took the loss instead.

But anyway, I still think that society as a whole, both money supply and house numbers are higher than 2007, total wealth increased, it is just a wealth redistribution, some people actually get much richer in this process, it's those who sell the houses before 2008

If I recall correctly, that act prevented banks from using their consumers' deposits to invest in risky derivatives and such by physically and legally separating the commercial banks from the investment banks.

O, wait, here it is:
"The repeal of provisions of the Glass–Steagall Act of 1933 by the Gramm–Leach–Bliley Act effectively removed the separation that previously existed between investment banking which issued securities and commercial banks which accepted deposits. The deregulation also removed conflict of interest prohibitions between investment bankers serving as officers of commercial banks. Some economists believe this repeal directly contributed to the severity of the Financial crisis of 2007–2011 by allowing Wall Street investment banking firms to gamble with their depositors' money that was held in commercial banks owned or created by the investment firms."

(emphasis from me)

Apparently you decided that it's a good investment, the moment you bought it.
Why? Because you looked at the fundamental mechanism behind the price increase.
1) If you estimated a speculative bubble, then it's just that: you surf the bubble and try to estimate where the top is and take your speculative gain.
2) If you want to use the storage value of gold because you fear a demise of the fiat currencies, then you're just using it as a store of your wealth and sell the gold when this 'crisis' (please define 'crisis') is over.
3) If on top of that you think the exchange value is increasing because more and more people want gold for reason 2), then you may an added advantage from that.

... and create a mega crisis in the process.
Anyway, one of the characteristics of a bubble is rising prices. And how is price established? Because there is a seller, and a buyer who is willing to buy at the high price. This is already a guarantee that prevents that 'everyone become(s) super rich', because the buyer will become poor and only the seller will be rich. That is, during the last transaction (per item) that occurs before the bubble pops and price comes crashing down. So the last sellers become rich, and the last buyers poor.

Mwaaahh... I don't agree with the last part but I'm too lazy to comment

Banks can fail and banks should fail!
Banks (even the federal reserve) are private companies with stockholders and directors who have the responsibility to take good care of the money invested.
If banks fail then the stockholders have been sleeping and let the boards 'play' with their money. As a result the stockholders lose their money.
No harm done. Government will bail out the clients through the PDIC and through the process of (finally) printing their own money to reimburse the banks' clients.
And the population can decide what they want to do: trust the remaining banks enough, or demand a government bank and do their business with them.

At least, that's how it should be in my opinion.

Most monopolies and cartels are in fact caused or guaranteed by governments. There's more factors though.


Maybe greenspan was jocking or he was just talking about the .com bubble arguing "Who knows? Is the internet, no one can know when that was a bubble".
 
Actually calculating if some capitals are bubbles or not is not very difficult.
For a house (assuming stable prices):

1) Take the annual gains from renting the house (it doesn't matter if you're going to actually rent it or live in it)
2) Subtract all the taxes and maintenance costs. Now you have the annual yield of your capital (Y)
3) Compare it to the price of the capital (P): (Y / P) * 100 = proportional yield, a percentage.
4) Compare it with the interest rates
   If the interest rates are higher than your percent yield, you prefer to rent
   If the interest rates are lower than your percent yield, you prefer to buy

Of course, if there's non sustainable regulations promoting buying, there are distortions in prices you have to account.
If the interest rates are lowered in a non sustainable way (monetary inflation), you have to account that too.
If rate agencies misreport about risks, they create the impression that the basic interest is greater than actually is (by suppressing the risk premium as a part of the interest).

I have to read and think more about the effects of the mentioned glass-steagal act. As far as I can tell, before that deregulation, investment banks and regular commercial banks were not compatible. Probably also altering risk perceptions for final lenders.

I have some further thoughts:

The problem of free market is that the price will affect the fundamental, investment capital will chase something that have continuously rising price, and drive its price even higher, so one after one bubble is unavoidable. You can only tell after it busted. I bought gold at 1300, now it is 1600, is it a malinvestment?

But a bubble can not get big enough to let everyone become super rich, because FED is looking at the inflation all the time. When more people had easy money, there will be less people doing the real production, this will raise the price of everything, then FED will step on the break and freeze the liquidity.

Every investment have some risk, but there are different type of malinvestment. If people have lots of saving and doing malinvestment with savings, then the final result is just money transfered from some people to some other people, the purchasing power of those money stay the same, society as a whole do not affected that much. If people relies on the loan from the banks to do this investment, then they will not only lose their savings in the future, but also lose the interest they pay to the banks, so they simply select default and let banks take that loss. The bank holds many people and organization's savings, it can not fail, eventually government have to take over and becomes the biggest debt taker

But that is kinda the whole point.  The housing bubble couldn't have happened without federal involvement.

a) a dubious mandate to raise homeownership rate (shared by both parties and both prior Presidents).
c) an easy money policy pushed by the Fed which was like oxygen into that fire.
c) regulators allows the amount of concentrated risk & leverage taken by the banks durring the boom.

It was like stepping on three accelerators at the same time.  Had the government been even marginally competent and removes one of those sources of artificial stimulus at a minimum the bubble would have been much smaller and the effect much less pronounced.

It's easy to say now, but Greenspan said, you never know it is a bubble before it busted. It's very difficult to evaluate the "right" price of the house,  mostly it is decided by market, and if the house value continously rise, it will become a good investment, thus attract more capital inflow and the price will be driven higher and higher, unless the capital supply is constrained by the FED one day