July 3, 2015

It's about institution-building, stupid

Comment on Michael Hudson on ‘Finance as Warfare’


Finance has not necessarily much to do with warfare — but it can if things are messed up.

Mortgage financing, for example, is an ancient and rather simple business. In Germany, it was institutionalized in 1900 with the Mortgage Banking Act. This law was so well-crafted that it worked with minor modifications until 2005 when it was abolished in an act of institutional suicide. The new law was sold under the slogan ‘Strengthening Germany as a Financial Centre.’ This was when deregulation was the hype of the day, which lasted until Wall Street's meltdown. This financial mega-crash, first of all, showed one thing: what happens when you do mortgage banking the American way.

Note, that a mortgage debtor saw and heard nothing for 10, 20, or 30 years of his creditor if he paid his fixed annuity monthly. If a loan became non-performing, mostly due to private misfortune like unemployment or divorce, the mortgage bank tried to help the debtor back on his feet because the last thing a mortgage bank wanted was the real estate that had been pledged as collateral. All it ever wanted was the money back plus interest as agreed upon in the mortgage contract. Then it could, in turn, fulfill its obligations vis-à-vis the Pfandbrief owners, mostly pension funds, and other long-term buy-and-hold investors.

This changed when it became possible to sell non-performing loans to firms that were specialized in making money from talking to the debtors in the bone breaker jargon which people had hitherto only encountered in Hollywood movies.

Note further, that the margins of mortgage banks were usually seen as razor-thin and not something an investment banker would get out of bed for in the morning.

Most importantly, note that Germany has never had a real estate boom-bust cycle. That is quite remarkable when you consider that Japan, the US, Britain, Spain, and many other economies have been badly damaged by a real estate bust.

Likewise, the margins of commercial banks like Deutsche Bank were unspectacular. Yes, until Mr. Ackermann came and announced that he aimed at something about 20 or so percent — like the American investment banks. This made the stock market happy.

Now, whoever has been long enough in the banking business knows that margins way above the average can only be made by magic or fraud. People preferred to believe in magic while the latter happened as a trivial reality throughout the banking industry.

After everything had duly crashed against the wall in 2008/09 the actual resume is this. There is no use to lament too long over banksters. It has been convincingly demonstrated that, for example, mortgage lending can be institutionalized in such a way that it works smoothly to the benefit of lenders, borrowers, and the economy at large. It can be done for other financing businesses, too.

The point is whether a country is good at institution-building or not. There is a lot at stake. If you mess up your political institutions you end up in a banana republic, if you mess up your banking institutions, first and foremost the central bank, you end up in large-scale bankruptcy and QE.

I think it would be acceptable to get out of this war rhetoric, not because there is nothing to it, but because it keeps us from building proper functioning political and economic institutions.

There is a way to get rid of financial war, banksters, and — not to forget — the small-scale corruption of people who do not belong to the one-percenters. Economics is, in the first place, not about good guys vs. bad guys, it is about effective vs. ineffective institutions (including laws, judges, and prisons for financial warmongers).

Egmont Kakarot-Handtke