The downstream consequences of bailing out the banks, Robots and Rioters.
The past week has seen commentators reflecting on the death of Northern Rock in Sept 2007 and Lehman Brothers in Sept 2008. The govt on behalf of the nation asked taxpayers to bail out everyone with money in the bank. The sums involved were astronomical but they would be paid back over time. In addition to this, interest rates were slashed to zero to stimulate the economy.
You, the taxpayer, spent money to help the savers keep their money in the bank. Had the banks gone bust, they would have lost a lot in savings, pension funds, devalued ISAs. Bank would have called in loans and businesses would have collapsed. Unemployment would have soared.
You, the saver, then had the return on that money cut to zero to help taxpayers. All new govt debt has interest that needs to be paid.
Read on
Banks were told that they must increase the level of capital they hold on their balance sheets to ward against bad debts. To stimulate the economy the Bank of England pumped lots of money into the banks to allow them to pay off their bad debts from the boom of past decade. It told them that they must be careful in their lending and they had to loan the money out to the rest of the economy. They had to lend it out the extra money while improving the level of capital they hold to avoid losses.
You must loan out the extra capital while keeping it to buffer against losses. If this sounds contradictory it is because it is. Many banks kept the trillions they were given by the Central Banks on their accounts at the Central Bank earning a small amount of interest.
Imagine a simple bank. It has £1 in equity (shares) and it borrows £9 to invest in money producing assets and to make loans. It is leveraged to 10 to 1 in a ratio of assets to equity. In the good times when it makes a 10% return on its assets that is 100% on equity, which means bonuses all round. In the bad times, a 10% loss means its equity is wiped out; The bank is insolvent. It can keep on trading until all its creditors (those who lent it the original £9) ask for their money back. If the truth about the bank were to become public knowledge other banks would not wish to do business with it. A bank run begins and everyone races to withdraw their funds. Fear becomes the primary motivation. Fear of contagion can drive good banks to become insolvent. A domino effect can take place and within time even the safest bank can become under threat. Those money producing assets could be other bank debts or more likely govt debt.
Govts fund banks and banks fund govts. The two are tied together. When a govt issues debt it relies on banks to buy that debt. It tells the banks that can hold those govt bonds on their balance sheets as risk free assets that do not count against the level of capital they must hold and are not supposed to lend out. The bank gets a new source of income from the govt debt and they get to borrow on cheap money terms to buy the debt. Everyone wins as long as the govt can always sell its debt. If it couldn't then all that risk free debt would turn into potential losses.
The banks used all this new capital for their latest and greatest inventions, High Frequency Trading and Algorithmic Trading. In Superman 3, a genius programmer finds there are sub fractions of interest of less than a penny in every bank account. He takes them all and builds a super computer that takes over America. That's kind of how it is for High Frequency Trading (HFT). The big banks are making millions and millions from taking sub fractions of trading all the market they can stuff into their machines. People are wondering whether HFT is leading to increased instability.
Banks and Hedge Funds use robot systems to trade news releases and breaking stories. They parse the text and instantly buy and sell to create new positions in the markets. These machines are turbo charged by govt bailouts and massive data centres, beyond the reach of the average man. Not just beyond the 1% but the 0.0001%.
In his report on Northern Rock, Newsnight reporter Paul Mason said the response of govt and regulators was a fiasco. The regulators completely failed to see the crash coming and seem to be part of the problem, not part of the cure. The public sector has failed in its own fashion.
These new ways of making money for the banks and the vast wall of money from the central banks have meant that the robots have been pushing prices up, down and are changing the very fabric of markets. Prices can shoot up and within a few months, govts fall and we have the Arab Spring. They can shoot down and we can bankrupt mining companies in Brazil and Australia.
The rioting over austerity and cuts is fed back into the robots who trade without a care or consideration. Rational, Logical, Emotionless. The ability of politicians to fashion a consensus and lead is one of the key failings of the past few years.
Debt remains the problem. We can inflate it away, which help the taxpayers but not the savers. We can erode it with deflation, which helps the savers, but not the taxpayers. We could even forgive the debts and start afresh. Perhaps that's too radical. It could hurt the saver and the taxpayer. Which resolution do you prefer, quick and painful or slow and lingering?
You, the taxpayer, spent money to help the savers keep their money in the bank. Had the banks gone bust, they would have lost a lot in savings, pension funds, devalued ISAs. Bank would have called in loans and businesses would have collapsed. Unemployment would have soared.
You, the saver, then had the return on that money cut to zero to help taxpayers. All new govt debt has interest that needs to be paid.
Read on
Banks were told that they must increase the level of capital they hold on their balance sheets to ward against bad debts. To stimulate the economy the Bank of England pumped lots of money into the banks to allow them to pay off their bad debts from the boom of past decade. It told them that they must be careful in their lending and they had to loan the money out to the rest of the economy. They had to lend it out the extra money while improving the level of capital they hold to avoid losses.
You must loan out the extra capital while keeping it to buffer against losses. If this sounds contradictory it is because it is. Many banks kept the trillions they were given by the Central Banks on their accounts at the Central Bank earning a small amount of interest.
Imagine a simple bank. It has £1 in equity (shares) and it borrows £9 to invest in money producing assets and to make loans. It is leveraged to 10 to 1 in a ratio of assets to equity. In the good times when it makes a 10% return on its assets that is 100% on equity, which means bonuses all round. In the bad times, a 10% loss means its equity is wiped out; The bank is insolvent. It can keep on trading until all its creditors (those who lent it the original £9) ask for their money back. If the truth about the bank were to become public knowledge other banks would not wish to do business with it. A bank run begins and everyone races to withdraw their funds. Fear becomes the primary motivation. Fear of contagion can drive good banks to become insolvent. A domino effect can take place and within time even the safest bank can become under threat. Those money producing assets could be other bank debts or more likely govt debt.
Govts fund banks and banks fund govts. The two are tied together. When a govt issues debt it relies on banks to buy that debt. It tells the banks that can hold those govt bonds on their balance sheets as risk free assets that do not count against the level of capital they must hold and are not supposed to lend out. The bank gets a new source of income from the govt debt and they get to borrow on cheap money terms to buy the debt. Everyone wins as long as the govt can always sell its debt. If it couldn't then all that risk free debt would turn into potential losses.
The banks used all this new capital for their latest and greatest inventions, High Frequency Trading and Algorithmic Trading. In Superman 3, a genius programmer finds there are sub fractions of interest of less than a penny in every bank account. He takes them all and builds a super computer that takes over America. That's kind of how it is for High Frequency Trading (HFT). The big banks are making millions and millions from taking sub fractions of trading all the market they can stuff into their machines. People are wondering whether HFT is leading to increased instability.
Banks and Hedge Funds use robot systems to trade news releases and breaking stories. They parse the text and instantly buy and sell to create new positions in the markets. These machines are turbo charged by govt bailouts and massive data centres, beyond the reach of the average man. Not just beyond the 1% but the 0.0001%.
In his report on Northern Rock, Newsnight reporter Paul Mason said the response of govt and regulators was a fiasco. The regulators completely failed to see the crash coming and seem to be part of the problem, not part of the cure. The public sector has failed in its own fashion.
These new ways of making money for the banks and the vast wall of money from the central banks have meant that the robots have been pushing prices up, down and are changing the very fabric of markets. Prices can shoot up and within a few months, govts fall and we have the Arab Spring. They can shoot down and we can bankrupt mining companies in Brazil and Australia.
The rioting over austerity and cuts is fed back into the robots who trade without a care or consideration. Rational, Logical, Emotionless. The ability of politicians to fashion a consensus and lead is one of the key failings of the past few years.
Debt remains the problem. We can inflate it away, which help the taxpayers but not the savers. We can erode it with deflation, which helps the savers, but not the taxpayers. We could even forgive the debts and start afresh. Perhaps that's too radical. It could hurt the saver and the taxpayer. Which resolution do you prefer, quick and painful or slow and lingering?