dinsdag 16 juli 2013

Perverse Banking Incentives

According to political consensus, it's because of the wrong incentives that we have arrived at the current financial crisis. Too many excessive bonuses have been given to bankers, to reward huge short term profits, causing huge long term losses. Naturally, these bonuses are perverse incentives, which despite all discussion we still have.

Yet, there is a much more perverse incentive in our current banking system. It's a deeply anchored incentive, which costs not just many millions, but it actually devours all of our money. Does this sound strange? I'm talking about the way our bank balance sheets now are organised. The problem forces us to go into debt continuously, just to keep the economy going.


Suppose, I get a mortgage to pay for my house. I'd like to borrow three hundred thousand, but I have thirty thousand of my own. Fine, the bank tells me, because the bank can lend out more than ten times its cash reserves. My thirty thousand will be a reserve, and with the flick of a computer keyboard my thirty thousand is inflated to three hundred thousand of bank credit. That's ten times as much as I had. It's just bank credit, but it's as good as money – or in fact, it currently is our money.

On one side of the balance sheet it now says “credit to lender: 300,000”. On the other, nicely balanced, it says “to be repaid by lender: 300,000”. To be repaid with interest, by the way, but that's another thing. My autograph, and my promise to pay have enabled the bank to create 270,000 of new money. That's 270,000 to be used in the economy to invest or speculate, buy things, hire people, and pay taxes.

Virtually all our money is continuously being created this way. Once someone promises the bank to pay back the money, and the bank wants to believe it, then the money can be created. It's rather bizarre when you think about it, but that's what our money is now: bank debt tokens.

But what happens when I pay back my mortgage? In that case the loan is extinguished, and not only the debt, but also the money disappears! On one side of the balance sheet my debt to the bank is crossed out, but on the other side the money I used to pay back is also crossed out. The two hundred seventy thousand I borrowed are taken out of circulation. We cannot use this money any longer, and nobody has it any longer. It's taken out of existence, and can't be used for investing, nor for buying stuff, nor for paying interest.

So our economy loses out, when we pay back (too much) of our debts, at least in the sense that we'll have less money to go around with. That's a rather strange and counter-intuitive incentive. It also means that in this system some kinds of austerity will be deadly to our economy.

The bankers also do not really want me to pay back my loans. They don't get the money that I pay back, because it's crossed out against the debt. At the most my paying off unburdens their balance sheets a bit. Instead, the bank makes its money from the interest I pay on my loans. Interest does not have to be extinguished on the balance sheet. Interest is much more “real” to the bank, as they can keep it as their profit. It's much more interesting – pun intended.

If the bank could choose, we would pay interest for eternity. If we want to keep our money in the economy, we'd never pay off our debts. If we would, we would shrink the money supply – which we are currently doing. So, if we want to keep the economy going we will have to borrow money forever. Yet we can't. Even if we learn not to worry about insane debt levels, we can't.

The way our bank balance sheets work now, we have to borrow until the system bursts. One day the interest we have to pay, just to be able to use our money, will be more than what we can collectively earn.

That day may already have arrived.

donderdag 4 augustus 2011

Real Estate Fairy Tale

Once upon a time there was a businessman, a banker, and a Mexican. The Mexican might also have been a Polish worker or a Bulgarian. The businessman did his business, the banker could do magic with money, and the Mexican built houses. And all three they needed a house.

The businessman saw how things went well, and he asked the Mexican to build his house.  A house with many rooms, ten acres of soil, a fine kitchen, extensions, garage, shed, garden and so on. The Mexican agreed, because this way he could also earn a little money. The businessman was happy, and went to the banker to borrow enough money for the land, materials and labour.

The Mexican saw how things went well, and he decided to build a house for himself too. A smaller house, as he earned less than the businessman. Labour relations, profit margins, bigger bosses, and all that. He too went to the banker and asked for a loan for his future house. The banker said it was a good idea, as there was enough work in construction. This was a reliable debtor.

The banker saw that things went very, very well, and he too decided to build a house with his magically made money. He saw that he would profit from the interest the businessman an the Mexican would pay him on their loans, so he bought the biggest piece of land for himself. Naturally he also hired the Mexican to build his house, because he did a fine job and was cheap. Besides, the Mexican would pay him back in interest payments anyway.

The Mexican worked hard and efficiently. Amazingly. And finally he finished the house of the businessman, topped off the bankers estate, and he could evan start living in his own humble abode. He was proud. He had done a fine job indeed.

But then something happened that noone had foreseen. There was no more work for the Mexican. Because everybody already owned a house. The banker lived like a prince, the businessman was well to do, and the Mexican had a nice little home. Everyone lived under his own roof.

Perfect? No! Because the houses had not been paid for yet. Their loans were still outstanding. The Mexican did no longer earn money, because there was nothing left to do. The businessman soon also earned no money, because he mostly sold to the Mexican. And the banker no longer gained interest, because the businessman and Mexican could no longer pay him. There was only one thing left to do. They had to sell their houses.

But to whom? None of them earned enough money to buy the house that they wanted. Even if they already lived in it. Was there then nothing they could do? Couldn't the banker create some more magic money? No, said the banker, because then I will need another house. Only then I can make new magic money. The new house will be mortgaged, and it will be there.

Full of joy the businessman declared that he would build this new house. He would hire the Mexican to do the work for him, and the would also give the new house a swimming pool. Then certainly a rich new someone would come and buy the house, and pay for their debts. The banker thought it was a beautiful plan. There would be a new house, so he could mortgage it and magically make some new money. He used all the money already paid and let the businessman do his work. It would be a new palace: "Fata Morgana".

But even before the palace was finished it became clear that there would be no buyer. Because there was only the three of them. And none of them could earn enough money to buy the palace. And so they were all forced to leave their homes, to live next to their front porch. Because the money was gone, even if all their houses were built.

And they lived unhappily ever after. Shame.

Or do you think they would have dared to squat in their own homes?

dinsdag 21 september 2010


A thought experiment.

In the Lexus factory there are just two people left working. One monitors the processes in the factory hall. The other one drives the car from the assembly train to the parking lot. The car itself is built entirely by robots.

My father in law always shines, when he tells about it. Himself he used to work in a department with forty accountants. Now there only are two left to do the same work. The second one being there to replace the first during illness or holidays. The rest is automated. That's why my father in law has gone with an early pension, and now is touring the world.

Automation is everywhere. The robots are coming. They start doing all the monotonous and heavy jobs for us. And if we like, they may be able to do much more.

Does that mean we will all be able to enjoy superfluous wealth, and that we will hardly have to work for it anymore?

I fear not. The robots and computers will most probably be bought by large investors. And they will reap the profits, beceuse they will need to hire fewer people. They are the ones that at first will become richer.

Those that will be fired may be compensated if they are lucky. Those that will no longer be hired will not. And those who never had to do anything with the production at all will be none the wiser either. Except maybe in that products may be cheaper, as they are produceed more efficiently. By robots. But whetheer they will be able to buy the products, that's the question.

Many people will lose their jobs because of the robots. And those who do not work, those who don't have jobs, seem to have no right to money. And those who do not have money, cannot live. At least not within the current system.

Then it will not be a world where hardly anyone has to work, and everyone lives in wealth. Instead it will be a world where no one may work, and almost all have to live in poverty.

Think about it.

That is why we have to revise our ideas about fair distribution of income, wealth, and about our work ethic. Or we may be too late.

Picture: Kuka Roboter, Augsburg

donderdag 22 oktober 2009


Iceland is going to pay back its debt! Hurrah! This week the Icelandic government will be signing an agreement. The four billion euros (3,4 billion pounds) the Dutch and British governments loaned to pay back the duped savers in Icesave, will now be reimbursed from the pockets of the common Icelander. Great! Or no?

I think not. There happen to be three hundred thousand Icelanders. Who have to pay... four billion divided by three hundred thousand... that's thirteen and a half thousand per person. Or a bit more than forty thousand per family. That's quite a lot. Especially since it's not the only debt the Icelander must face.

Icelanders with high education, who do not feel like joining in the repayment schedule, have already started emigrating. Understandable. But it also means that those who cannot pay must pay even more. I wonder how much can really be paid back, without literally selling Iceland to either the Russians or powerful bank J.P. Morgan.

Sourest may be that the debt is not even the fault of the average Icelander. They never promised to repay the money now lost. Maybe some did borrow too much money for a car or house. Maybe some did try to live above their station. But what they borrowed they also have to pay back. Over and above the aforementioned forty thousand per family. And added to both is interest. Come to think of it, I don't have to think at all whether it's possible. With the current Icelandic economy it's not possible in any case.

Iceland promised to pay back in fifteen years, with interest. To start in 2016. With an interest rate of five percent they will have to muster another 50 to 100%. That's between six and eight billion euros in total, or between sixty thousand and eighty thousand per Icelandic family. That's half a house.

Actually most Icelanders are just as guilty of the Icesave losses as we are in the Netherlands, Brittain, or the rest of Europe. Namely: entirely not.

We could also share the loss. If we add the population of the Netherlands and the UK to the Icelanders, then we are with eighty million people. Four billion divided by eighty million is... fifty euros per person. Let's say one hundred fifty per family.

If we spread the cost over three years, at five percent interest, then it will cost us... less than five euros per family per month. Less than the national lottery or a mobile phone insurance. Four point six billion will be raised this way. The debt is then paid for. In three years. And we'll pay two to four billion interest less to the banks. This way they at least will not profit from the very misery they helped bring about.

If we share costs among all Europeans, the amount of money per person is ridiculously low. Then it's four billion divided by four hundred sixty million people. That's less than ten euros per person. Say thirty euros per family in total.

As compensation for our effort we can then demand that Iceland joins the European Union, and will use euros from now on. That's better for trade. And we will gain a huge nature reservation for Europe this way: Iceland itself. With huge clean energy reserves, from geothermic sources and electricity gained from waterfalls. Of which they have plenty.

maandag 5 oktober 2009


There is one thing everyone seems to agree upon since the first credit crisis this century. The rewards for top bankers and top executives have been unjust. They were exorbitantly high, exorbitantly manyfold, and most of all without any meaningful results. Shame.

Therefor these rewards, salaries and bonuses must be pruned down. Not only because our prime minister Balkenende would then earn less than the rest. It's really not just for his ego. He is one of the pack even if his name is not on top in the Quote 500. Just give it a maximum. All top bankers should earn the same. You'd expect that this proposal would be unanimously voted in. Even internationally.

But no. Many negotiators for the USA and Britain at the latest G20 thought it a bad idea. Leave the bonuses as is. They would disappear underground otherwise. You'd get illegal bonus dealers, bonus smuggle, bonus addicts and an endless war on bonuses.

Would it really make a difference, if you could forbid these exorbitant rewards? Except morally, that is? How many human beings might actually be paid from such a bonus? Let's count. A one million bonus could pay for ten typical managers, or you could hire forty secretaries for a year, or maybe you could keep eighty mothers on welfare. For ten million you could buy ten times as many people. If there are a thousand bankers who each get a million too much, they misdeal eighty thousand welfare mothers. And for the three hundred million ING held in reserve for rewards one could indeed avoid three to five thousand layoffs.

The top five of bankers in the US of A divided ninety million dollars among themselves, last year. That is seven thousand welfare mothers. Would all these mothers fit in their five pleasure estates with pool?

But of course that's not how it works. Not exactly anyway. If all went well the top earners would also pay a hefty tax on their bonuses. If that would be a fifty percent income tax, then fifty percent of mentioned mothers on welfare would also profit. Or at least the civil servants who would be paid from that tax. Bonus catchers would be a welcome help in fattening the treasury. Each on his or her own would actually add an exordinate amount to our common wealth.

It's another matter that the tax will seldom come close to fifty percent in practice. Indeed, most of the moneys probably disappear in tax havens and secret back pockets. That's slightly unfortunate.

But what interests me much more, is that there are obviously parties who are prepared to pay these bonuses in the first place. And the rewards are also paid when businesses go entirely to waste, because of the deals made. If you were a cynic, you might think that this was exactly the purpose of the whole exercise. Who pays these rewards? And if they are willing to shell out such sums, how much profit do they make for themselves? Who are these people?

Suppose that top executives merely made a deal amongst themselves, and hollowed out businesses and economy to reward just each other. Wouldn't that be a simple case of theft? And if there really are others who pay them consciously, aren't then these others eluding justice? Should we not regard as a crime exactly the destruction, plunder and sucking dry of our economic livelihood, instead of the bonus you might receive for accomplishing these things?