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Volcker: Financial Innovation is Worthless, and Banks Should Be Limited to Traditional Depository Functions
The Telegraph notes:
The
former US Federal Reserve chairman told an audience that included some
of the world's most senior financiers that their industry's "single
most important" contribution in the last 25 years has been automatic
telling machines, which he said had at least proved "useful".
Echoing FSA chairman Lord Turner's comments that banks are "socially
useless", Mr Volcker told delegates who had been discussing how to
rebuild the financial system to "wake up". He said credit default swaps
and collateralised debt obligations had taken the economy "right to the
brink of disaster" and added that the economy had grown at "greater
rates of speed" during the 1960s without such products.
When
one stunned audience member suggested that Mr Volcker did not really
mean bond markets and securitisations had contributed "nothing at all",
he replied: "You can innovate as much as you like, but do it within a
structure that doesn't put the whole economy at risk."
He
said he agreed with George Soros, the billionaire investor, who said
investment banks must stick to serving clients and "proprietary trading
should be pushed out of investment banks and to hedge funds where they
belong".
It is not just George Soros.
Nassim Nicholas Taleb has repeatedly said
that speculation should be limited to hedge funds, and that banks
should solely engage in traditional depository functions, and - because
of their power to create credit - be treated as public utilities.
Many other top economists and financial experts
have said that financial innovation is harmful, and have called for
reimposing Glass-Steagall and for separating traditional banking from
investment banking.
As I wrote in June:
Geithner said we need [credit default swaps] for financial "creativity" and "innovation"...
Is Geithner right that financial "creativity" and "innovation" are good things?
No.
The Canadian banking system is the world's most stable banking system precisely because it is boring instead of innovative.
Paul Krugman writes
that banking has to be made boring again, to prevent the kinds of
results which came from high -flying finance in the 1920's (the Great
Depression) and late 1990s early 2000s (the current melt down). Krugman
also notes:
Part of the problem is that boring
banking would mean poorer bankers, and the financial industry still has
a lot of friends in high places. But it’s also a matter of ideology:
Despite everything that has happened, most people in positions of power
still associate fancy finance with economic progress.
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It difficult to know these days if people in finance and politics actually know what they often do is bad for the country and are merely lying about believing it isn't, or if they are really so stupid as to believe in what they are doing.
It is a simple fact that financial "instruments" beyond stocks only increase the distance between the money and true investment fundamentals.
Stock fundamentals are speculative enough. One never knows if a firm whose stock you purchase can survive in a market even if they have the best product.
However any increase in information distance such as occurs when one bets on the bet o n the stock or the ability of someone else to cover their bet on a stock simply will ALWAYS lead to pure unguided gambling.
You simply can't quantize over the long term any averages of returns on speculative investments becuase the action of having the investment grades creates a constant force redefining the averages.
This is why Triple AAA grade paper in home mortgages became financial objects which performed way outside the averages. When you can bet on the performance of the bet on the performance and one thing has a grade that can only change AFTER being proved wrong then there is a time distance that will only fill with sucker money.
The time between when a financial instrument is graded AAA and the time it has to be redefined after having been proven to have been over graded is when the sucker money gets taken.
Leveraged bets on leveraged bets on leveraged bets cannot change the fact that NO ONE ever knows the true value of any investment whose cash flow is expected to come from the sales of some actual product in the future. Highly advanced math hasn't changed that simple fact. Not chaos theory, not Markoff or Monte Carlo models. You still don't know if the stock traded business's actual real world product will do well in the market in the future -EVER.
The swarm of money that flows to the "Safe bet" always turns the "safe bet" into a highly speculative marginalized profit pressured "unsafe bet." ALWAYS!
Lastly the effect of large ignorant pools of third party controlled money (like small groups of fund advisor's that lunch together or read each other's comments in the news) investing in stock markets actual distort the business marketplace the financial market is betting on.
This is what hurt the ORIGINAL PROFITABLE dot com industry so much when wall street got involved.
So many cash flow positive small guys ( they did exist) were forced out of business by darlings of wall street like Pets.com who had far too much cash based on bets they would succeed. Those cash rich companies distorted market prices for everything killing the actual businesses which had profitable cash flow models.
By the time the financial darlings had crashed, the actual good dot com business models had already been forced out of business and were long gone. So in that case the stock market investment model didn't HELP the marketplace but actually destroyed the real marketplace.
The same thing happens in the Steel industry, the toy industry, retailing, auto industry - those overcapitalized becuase they are wall street darlings distort the costs in their own business market by being able to pay too much for rent or any other cost of doing business and killing the margins for the ones who used to actually be able to make money.
Thus swarm investing is a huge problem.
Pooled investment funds can also transfer far too quickly today and this is one time when speed is NOT good.
If you really want to get back to markets that invest and realize returns based on fundamental profitable businesses then it should only be legal for any funds to transfer to new investments once every six months. ( 50% capital transfer tax -not GAINS but TRANSFER Tax- on any funds traded more than once in six months would do the trick)
THAT time delay for investment change combined with elimination of options, derivatives and any other than common stock share owning would eliminate most of the distortive effects of modern financial markets on the business community and force a return to investment based on fundamentals.
It's what we need but enough people aren't yet starving to demand it from the politicians. For that we have to wait for unemployment funds to dry up.
When the soup lines fill people will finally start voting for their own interests.
Until then Wall Street money will override voters at the Politician directed regulatory agencies.
Vivzizi
It difficult to know these days if people in finance and politics actually know what they often do is bad for the country and are merely lying about believing it isn't, or if they are really so stupid as to believe in what they are doing.
It is a simple fact that financial "instruments" beyond stocks only increase the distance between the money and true investment fundementals. Stock fundamentals are speculative enough. One never knows if a firm whose stock you purchase can survive in a market even if they have the best product. However any increase in information distance such as occures when one bets on the bet o n the stock or the ability of someone else to cover their bet on a stock simply will ALWAYS lead to pure unguided gambling. You simply can't quantitize over the long term any averages of returns on speculative investments becuase the action of having the investment grades creates a constant force redefining the averages. This is why Triple AAA grade paper in home mortgages became financial objects which performed way outside the averages. When you can bet on the performance of the bet on the performance and one thing has a grade that can only change AFTER being proved wrong then there is a time distance that will only fill with sucker money.
The time between when a financial instrument is graded AAA and the time it has to be redefined after having been proven to have been over graded is when the sucker money gets taken.
Leveraged bets on leveraged bets on leveraged bets cannot change the fact that NO ONE ever knows the true value of any investment whose cash flow is expected to come from the future. highly advanced math hasn't changed that simple fact. Not chaos theory, not Markoff or Monte Carlo models. You still don't know if the stock trading business's product will do well in the market.
The swarm of money that flows to the "Safe bet" always turns the "safe bet" into a highly speculative marginalized profit pressured "unsafe bet." ALWAYS!
Lastly the effect of large ignorant pools of of third party controlled money investing in stock markets actual distort the business marketplace the financial market is betting on.
This is what hurt the dot com industry so much.
So many cash flow positive small guys ( they did exist) were forced out of business by darlings of wall street like Pets.com who had far too much cash based on bets they would succeed. Those cash rich companies distorted market prices for everything killing the actual businesses which had profitable cash flow models.
By the time the financial darling shad crashed the actual good dot com business models had already been forced out of business and were long gone. So in that case the stock market investment model didn't HELP the marketplace but actually destroyed the real marketplace. the same thing happens in the Steel industry, the toy industry, retailing, auto industry - those overcapitalized becuase they are wall street darlings distort the costs in their own business market by being able to pay too much for Rent or any other cost of doing business and killing the margins for the ones who used to actually be able to make money.
Thus swarm investing is a huge problem.
Pooled investment funds can also transfer far too quickly today and this is one time when speed is NOT good.
If you really want to get back to markets that invest and realize returns based on fundamental profitable businesses then it should only be legal for any funds to transfer to new investments once every six months. ( 50% capital transfer tax -not GAINS but TRANSFER Tax- on anything traded more than once in six months would do the trick)
THAT time delay for investment change combined with elimination of options, derivatives and any other than common stock share owning would eliminate most of the distortive effects of modern financial markets on the business community and force a return to investment based on fundamentals.
It's what we need but enough people aren't yet striving to demand it from the politicians. for that we have to wait for unemployment funds to dry up.
When the soup lines fill people will finally start voting for their own interests.
Vivzizi
OK, if we can bring back red-lining.
Good luck reforming a damn thing while the Senate and White House remain in the hands of the Repwhorecrats.
Credit creation is a government-granted franchise that must be government regulated.
The Canadian banks are currently lending money that would embarrass Fanny and Freddie.
The only reason they have not been wiped out like the U.S. investment banks was that the Canadian public nearly rioted when the banks wanted to merge to become "world-class" like all the other dinosaurs.
The Canadian banks have yet to have the decency to thank the Canadian public for saving their asses, by stopping that idiocy. They know the truth, it' too bad they can't cowboy up and tell it.
A bank will not be able to compete for my deposits if it is not able to beat the rates offered by their competitors. Therefore, they must make good money from my deposits to survive. Innovative investment devices are not dangerous if the bank is required to hold a specific amount of reserves against the investment.
A workable plan is to set reserve requirements based on risk. A high risk investment requires a high reserve requirement. For example, if a bank has $ 20 billion in high risk investments, then it would be required to send to the FDIC $11 billion in reserves. The FDIC would audit every bank on an 18 month cycle. If the auditors found that the bank had failed to meet its reserve requirement during the audit period, the FDIC then would require the bank to pay immediately into the reserve account at the FDIC, the amount of the deficient reserve. If a bank wanted to withdraw an amount from the reserve at the FDIC, an audit would be conducted to insure that the withdrawal did not place the bank into a reserve deficit position.
Thus, the higher the risk the bank takes, the less money it has to make low risk investments.
In theory, that might work, but the risk of many innovative instruments is literally impossible to measure. That's why innovation must be restricted. Accurately measuring the risk in a mixed bundle of mortgages would take far too long for a market to function. That's why the ratings had to be paid for and fraudulent. The actual risk of a bond slice of those bundles not performing is even more difficult to measure. The ratings were fraudulent and paid for. They didn't involve due diligent examination of the life circumstances of each and every family in each and every sub-prime loan in each and every MBS bundle that had been collateralized into junk paper. The holders of trillions of those slices KNEW THAT, that's why they suddenly went out and bought 60 trillion dollars worth of fraudulently rated CDS insurance against that risk. That's why the assets became toxic, because the fraudulent value, based on that fraudulent risk rating, had been exposed.
And that activity is still going on, brother, and the ratings agencies are not being reformed, or haven't you heard?
If you can't measure the risk, how do you determine the amount of reserve banks are required to hold?
They want us to put our heads in the sand and pretend, because the other option is widespread governmental default. And that is actually already happening in places like Greece and Russia and Venezuela. The dominoes are starting to fall and it's every man for himself.
You are correct in that measuring a risk is a problem. All we have is the past. I agree with your points.
I have heard things in the last 10 months I wish I had not. So, brother, I am listening.
you're a good man.
Volcker is right, of course, and his candor is very refreshing. Financial innovation is often worthless. The recent innovations were designed to skim value off the top in the short term and transfer risk in the long, and boy did it work. When sociopathic children are given free rein, here's what they do:
Take a bunch of people's lives and pile them all up. Then, using your hands, shape those piles into things that look like other things. Call them something else. Decide among yourselves how much they are worth. Then create little imaginary slices, like pieces of carrot or apple or doggy doo and decide how much that crap or pieces of crap are worth. And turn off all the lights and trade them in the dark! This is the coolest game ever!
And then, after you all realize, gee, look at the mess we all made in the living room, there's doggy doo and gum EVERYWHERE, and, WHOA, THE PLACE IS ON FIRE, DUDE, I TOLD YOU NOT TO SMOKE IN HERE!- take your mom and dad's credit cards, which you stole while they weren't looking, and buy trillions of dollars of insurance on the house you just trashed. And, wait! It doesn't have to REAL insurance. Nobody is paying attention. Buy the insurance from EACH OTHER! Oh, my god. What a great idea! Come on, let's go outside and play with our toys before our parents get home from work. Nobody knows anything, okay? Nobody knows how this happened. Nobody could have predicted it, okay? Got that? We're all shocked!
The problem, of course, is that at the end of the game WE now own the worthless innovations. The toxic assets are in our bank accounts. The doggy doo is all over our faces. And we have to rebuild the house.
More later.
As for Krugman,why do we listen to him again ? Oh yeah, because he wrote a few mathematical models for Phd's about FX markets and international trade, as seen from his Princeton-ivory-tower-world of champagne socialism. Oh sorry did anyone forget Krugman was saying we had to nationalize every single bank in the US in January and that the only solution to stop the crisis was to become like one big Sweden??
Great situation we would be in now as taxpayers, the markets would likely have completely imploded and we would have even more massive equity exposure in banks.
Great one Paul! Give us more advice!
Lets all listen obediently to George Soros on how to make finance boring - the very man who, for a living, did everything in his power to force entire countries into bankruptcy is now telling us that financial speculation is evil evil evil. Of course the fact that he's personally already pocketed billions and he continues to run a hedge fund is just a minor insignificant detail.
Give me a break !
He's what's called an "enlightened" (read: "I got mine") capitalist.
Soros has a seat at the table now, so he wants to save the system.
I think Soros is making these comments:
1. Because they are true, that way he can't be condemned as a complete evil liar.
2. Because he hates the competition that the banks are giving him.
3. Because he will look like a "voice of reason" and a Good Guy when those mobs with pitchforks and torches come to town.
Volcker is no angel either, but I think he's at least got some pangs of guilt in his old age. If the Men Who Stare at Goats phenomenon worked reliably, all these f---ers would be dead via the millions of burning stares of the financially fucked.
If allowed, people will naturally seek every avenue in order to obtain something for nothing. It's a 'free for all,' literally, out there.
Again...no insurance industry in his right mind will allow me to take a fire policy on my colleague home.
He has one, if they let me take one and maybe someone else do the same...for one home that goes up in smoke there will be 3 claims or as much as claims as policies have been allowed...for a 500k replacement cost of the home there will be several million dollars of claims..and the insurance company may even go under.
Of course, if it doesn't burn, the insurere may be more than happy to collect 3, or 6 or 100 premiums every year on that very same home...but they cannot. Insurance is regulated by normal people.
Since finance is regulated by lawyers and political cronies that don't know what they do...that is exactly what it has been allowed to happen with CDS. the notional value of CDSs around is several orders of magnitude bigger than the underlying.
If i am a normal institution with a normal credit standing i can take out a CDS contract with a counterparty to cover the default risk of say...Greece.
The only little tiny unimportant detail, is that no one will EVER ask me if Iam holding Greek bonds and what quantity.
If someone did, and I had to supply proof, as I have to supply proof of ownership of the home to insure it...it will be all well.
But this is the kind of brain damaged "innovation" against which VolKer is railing...
And he is dead right...
And politicians and regulators who are not craking hard and swift against this thing are not only retarded brain damage cases...they are utterly dangerous criminals that should be removed from office with prejudice by specifically trained SWAT teams.
Even Tiger Woods is not TBTF....
Even Tiger Woods hasn't fucked as many people as the banks.
Hell, Magic Jordan couldn't fuck that many if he had 1,000 clones to help him.
double whammy
At least hedge funds can take the risk, and die if they bet wrongly.
So - a perfect risk taker until they go TBTF like LTCM...
You had me until you mentioned Krugman. The man lacks credibility.
I agree with the basic premise, disagree with the "public utility" part. Banks do need to be a bit more boring, more walled off. Protecting deposits is the #1 goal of banking.
If I put my money in a stock and it goes to zero - that's a risk I was willing to take.
When that happens at my bank? It's not supposed to - that's fraud.
Speculation limited to hedge funds? Depends on the speculation. Are you referring to puts and calls? Why can't I do that as an individual investor? Why should I be shut out?
Limitations are fine. Restrictions shouldn't wall off the individual, however.
The main problem is that the productivity curve and the wage curve became disconnected in about 1973. All the money went up to the investment crowd and they needed places to put it. So they created all these new methods to grow money and fantacy finance was created.
See The Looting of America, by Les Leopold
There are really no profits in most of our current businesses, only creative accounting.Volcker, Whitney and Taleb tell the TRUTH, which has no place on Wall Street.
Banks will never relinquish their capital markets operations and will fight any curbs on financial innovation. Going back to the bread and butter of business lending is simply not as profitable as the financial rape of institutions and corporate clients. That's where the big profits are generated on fat fees. You really think they're going back to the good old conservative days of banking? Not a chance in hell.
And Soros is right. Those investment banking wimps should speculate with their own money. You want to get paid like a big time hedge fund manager? Go ahead, put some skin in the game and earn your performance fees by risking your own capital alongside that of your investors.
1000+ And the big banks will vilify the hedge funds all the way.
"Banks will never relinquish their capital markets operations and will fight any curbs on financial innovation."
Leo, you must be a young man. "Never" is a very long time.
I should have qualified that statement with "barring a major social revolution and bloodshed"...
What you are witnessing now is the result of a major social (economic) revolution. There's a pretty good chance that the counter-revolution is beginning to happen. Needless to say, things will look very different ten years from now.
Right ... I think any call to reinstate Glass-Steagall has about as much chance to pass as a first grader in med school.
We will bail-out, extend-pretend, print more money, goose the stock market or some other asset until ... well, I am beginning to wonder if we can do it forever. (Or certainly until all the wealth is in the hands of the kleptocrats and the rest of us are enslaved.)
Something will pop and it will be big and global. Expect the unexpected.
An international fraud of this magnitude has too many inter-related component parts to expect a fail-safe performance forever.
I suspect you are merely underestimating how long an "international fraud of this magnitud" has been going on.
Accidental double post...in leau of a repeat of my previous comment, I'm trying to figure out how much I like this song
http://www.youtube.com/watch?v=X6b9VM963GU
Volker is Obama's Paul O'Neill. Only there to add creidibility to what others are doing. It seems that Volker will be gone long before Summers, Geithener or Bernanke.
Volcker's as dirty as any of them. Read Timberlake's "Monetary Policy in the United States" for the story of how he convinced Congress to let the Fed buy defunct loans to LDCs from his bankster buddies. Reason? He was "worried" that the Fed was running out of crap to monetize.
You just don't make it to the top of the Family with a pair of clean hands.
Volcker's as dirty as any of them.
Yes. If you observe what is going on and try to pick a model that fits the behaviour, the model that fits best is "criminal conspiracy."
More Bankster Consumer Scams (C-Checks)
Dec. 9 (Bloomberg) -- Andrea Allan used a convenience check she received in the mail from JPMorgan Chase & Co. for Home Depot purchases. The check cost her almost $700 in interest and fees when the bank cut her credit limit and wouldn’t honor it.
“Why during this economy would Chase put out checks to people to entice them?” said Allan, a 50-year-old aesthetician in North Hollywood, California, whose credit limit was cut to $1,100 from $3,500 after she received the checks in September. “It feels predatory, not convenient.”
http://tinyurl.com/yakcxqt
aesthetician = Greek word for hairdresser LOL (aka, beautician)
I wonder if she owns a $500,000, 4,000 square foot home and can't pay the mortgage?
... sorry, I just don't feel sorry for her ...
...and drives an S-series Mercedes that you and I are now paying for, since the bank will never get that HELOC money back.
now let's not be hatin... they charge pretty good hourly rates and do a lot of cash biz.
Having spent 15 years watching the derivatives market grow and become ever more complex, I always felt it would be something with a finite lifespan. Each new product seemed to push the envelope of innovation with scant regard for the moral probity of the products.
What I experienced was that those who drove the innovation were almost borderline sociopaths, incapable of feeling how these things might harm others or how bad it would go when things went wrong. The complexity of products created an asymmetry of understanding, which has a great deal to do with what is wrong now. On one side there was a banker, making a high profit in present value terms, which was booked as profit and on the other side was the hapless counterpart who had no idea how much he would have to pay away. This is especially true with CDOs and other complex securities, were the banks make a few percent for slicing and dicing a pool of assets which they sell at par, the investor has no idea of the fair value, utterly reliant on rating agencies (who are utterly reliant on a model from the bank and a scattering of historic data) and on a pass the parcel secondary market who will pay whatever they can feel comfortable they can get from someone else.
As far as the bankers were concerned, the game would end either with the system blowing up and the central banks having to step in, or the products being prohibited. Either way, I don't think they expected it to last forever, but hoped to make as much as they could for as long as they could.
You can make weak arguments about the benefits to society about expending the investor pool, but at the end of the day, it's more about ways of putting lipstick on a pig.
+1 Thank you.
I think the banker's and Harvard MBAs over-reached with their financial engineering. I don't think they anticipated coming this close to the precipice. Most of them probably go home at night and wonder why people don't like them. What a small circumference their world must have.
it is too bad the administration and the financial industry view volcker as a relic, because he is the most candid voice of reason around right now. spot on with the atm observation.
without innovation you don't have mass-scale larceny perpetrated by banks and the accompanying bottomless pot for campaign contributions, not to mention cupcake mortgage deals. by the way wtf happened to the friends of angelo story? did dodd and conrad ever pay the difference? where is the accountability for these pirates?
I wish I had been in the room when Volcker made that speech.
I would have been the guy standing on his chair and applauding at the end.
I wouldn't have waited until the end to stand on the chair and applaud.
It is the only thing we have exported in the last 35 years too. We can't export anything we manufacture from "materials" so we exported our own version of the cheap "knockoff." Serves the suckers right if they bought it. (Of course, the problem is folks here bought the crap as well.)
Do away with the financial innovation, ponzi schemes and get rich quick on Wall Street schemes and people would have to go back to making stuff -- God forbid.
Anyone know how tall Volker is? How about Greenspan? Bernanke? (Hint, two of them are basketball player height.)
The biggest group of those "suckers" is patriotic baby-boomer Americans who dutifully put part of their paychecks every payday into 401Ks, IRAs, and State pension funds. I predict that their children and grandchildren will not entrust nearly as much to Wall Street, and that a lot of baby-boomers will not add any more to their 401Ks or IRAs, but will find other things to invest in.
It's too late for them to save their spots on top of the heap. They broke the heap, not us. This is them pining away for what they know is lost: their primacy in the global system. Let the internal squabbling and recrmination begin, the last stage of the demise of any power structure.
"If we promise to be good boys, can we go back to being in charge?"
Fuck them.