Comment by wegs | Hacker News Reader

Comment by wegs | Hacker News Reader

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The central friction is there are two conflicting views of banking:

1) Lending, insurance, and investment as a social service. People need homes. Businesses sometimes need to weather crises without bankruptcy. Startups need funding. People need educations.

2) Lending as a private investment. You want interest rate to reflect risk.

Evolving monetary theory means federal interest rates are set to reflect #1. The underlying view is that financial system is a bunch of bits used for accounting designed to keep businesses productive, people working, and the economy running, much as you might have in a video game. You make and destroy money as needed to support what needs to happen to make that work, much as a game developer might engineering money sources and sinks into an MMORPG. It's just bits on a computer.

Historical practice and the structure of banks is set around #2. This is a really sound theory if your currency is either backed by gold, or even is fiat currency, but running on the same principles.

Defaults aren't a problem with #1, unless they encourage bad behavior. If a bunch of poor people buy homes, and later default on mortgages, it's really not a big deal; bits on a computer appear and disappear. If 50% of those people come out owning homes, you're still ahead if 100% were still renting. But in #2, it's a financial crisis. Conversely, if a bunch of poor people can't buy homes and have to rent, it's a crisis in #1. It's not a problem in #2.

I'm not sure the mixture model works well -- indeed, I think that's the source of our problems. I think if we killed the banking sector, and folded all of this into the fed, it'd work great (that's what China does). I think if we had the gold standard again, that'd work pretty well too. But when you mix the two, things get a bit ugly.

That is not at all what china does. China has a huge banking sector, much bigger than the US. And no ... almost all of those banks are independent of the central bank. US and Chinese systems are very similar. Europe is a bit different. England, spain, italy, don't really have the large number of small and mid sized banks that the US or China does (germany does have many small banks however... noticing a trend? small(er)/more banks = industrial might). And ECB is obviously in a bit of a different spot than the Fed or Chinese central bank since they control the currency for disparate countries.

Are you trying to suggest that diversity in banks leads to a market having more industry, or that more industry leads to more diversity in banks? And what is the cause and effect?

domestic credit finances, and is the best way to finance, industrial expansion

Doesn’t China still have some shadow banking activity also ? You can’t abolish private banking completely, because ultimately loans are just IOU’s. Anyone can speak or write them. Even accounts receivable are very similar to loans. Private banks are just outsourced service arms of the fed anyway. you can’t really stop people from using future income to plan current investments. leverage comes from spending expected future streams of money.

There isn't some fundamental distinction between 1 and 2. For 1, there is obviously some positive social utility in the end or else it wouldn't be good policy. But such lending may require too much capital, too large a risk pool, or too long a time horizon for an individual private bank to take on. Instead a public or policy bank steps in.

It's good to have banks of different sizes serving different niches, as long as they assess risk prudently and price rationally. What you don't want is politicians micromanaging in domains in which they have no expertise, especially when they are driven by short-term, personal political objectives.

The fundamental difference is in incentives. If your incentive is to generate profits, you don't want to lend to the high-risk needy because you'll lose money. If your incentive is to provide another form of social security, you're willing to subsidize.

The problem comes when you force a business that really wants to align to the profit incentive (banks) to provide social subsidy by effectively charging their profit-generating customer base a premium. 1. They're incentivized to do the bare minimum necessary. 2. They're incentivized to stick to the letter and not the spirit of the law. 3. The transfer of wealth from paying to subsidized customers is opaque and nobody can do proper accounting.

This is a major source of corruption and inefficiency. It's the sort of problem that's all over the place whenever the private sector is forced into providing this sort of opaque cross-subsidy.

If I were to re-do this from scratch I'd privatize all the banks and let them do just the profit-making part, and have social programs solely as a function of the government, with a set yearly budget.

That's why the fed was set up -- to make sure monetary policy is decoupled from short-term political objectives. It ain't perfect, but it's ain't bad either.

We could do better than the Fed in 2020. Tech makes transparency easier.

I think you have left out a third, which the GP was alluding to, and which I see written everywhere in UK lending literature:

3) Lending "responsibly", where responsible means protecting borrowers by not allowing borrowers to get into more debt than is good for them. (As opposed to responsible being for the lender's benefit.)

There's a paradox in this, because it exarcerbates some problems that it is supposed to be helping with (the assumption is it's to protect would-be borrowers from problems).

For example, if someone has multiple high interest loans with different providers and would like to convert them to one lower interest loan with a longer payback period (a consolidation loan), that would be good for the borrower. It would be a responsible thing to provide that. But it's all but impossible for borrowers who would be most helped by these to get one.

In the UK it is has been the law for a few years that lenders are not allowed to lend to private borrowers without evidence that the borrower can repay, regardless of what criteria the lender would like to apply. This is separate from credit risk assessment, and is done after the borrower has been approved for the loan. The result is that a number of borrowers would could pay, are no longer able to obtain good quality credit because the necessary evidence is too difficult to provide, and end up in a more vulnerable situation as a result. For example, self-certified mortgages for self-employed small-business owners used to be a thing, now borrowers in that position can only get a foreign self-certified mortgage, with significant loss of protections. Personal loans are subject to income proof now, which mean people with variable income use credit cards instead at much higher rates of interest.

The mortgage thing, combined with high property prices and very low interest rates, has widened the "haves and have nots" gap, where those who managed to get a mortgage at some time have much lower property costs and falling while gaining equity, compared with those who didn't get one and are trapped with high and rising rents. It would seem responsible to offer the latter mortgages when they have shown a long-term pattern of consistently paying higher rents than an equivalent mortgage, but it is not taken into account, bizarrely.

Your comment reads just like a lecture I had from an excellent econ professor. Nice job!

Nationalizing banking doesn't work either. If you lend money without penalty upon default, then you encourage defaults. If you encourage defaults, then people no longer pay attention to the price of things they buy, since they can borrow however much they need without consequence. The result is rapid inflation, which wipes out the wealth of the working classes.

If you keep strict controls on the amount of fiat currency issued, and lend for reasons other than earning a good interest for financing risk, then you end up with a shortage of capital to lend. Then loans are issued for criteria that aren't publicized - in polite terms, politically motivated lending. Society stagnates as the engine of progress itself turns into a zero-sum game.

There is a better way to ensure the delivery of socially-beneficial goods - to deliver them directly, taking care that public options provide only minimally sufficient goods and services, and only in response to the failure of the private market to provide alternatives.

The key question is what the penalty is. The penalty is different if the goal is profit-maximization than it is to promote pro-social behavior, for a few reasons:

* Very few people want to lose their homes or to go bankrupt.

* Investors try to act optimally from a game-theoretic point of view. This usually means maximizing their own income (which isn't always the same as maximizing returns on the many they manage).

* People aren't always rational.

Let's look at the two systems for how we handle bankruptcies and defaults:

1) Money is bits / a game: We attempt to structure penalties to minimize structural damage to the system, while slapping you hard enough on the wrist to make defaults an undesirable outcome.

2) Money is real: We attempt to extract enough money out of you to balance interest. If we have harder penalties, with rational investors, interest rates go down, so keeping high penalties promotes a strong economy.

And for how we decide to loan:

1) Money is bits / a game: I loan you if the loan is perceived to benefit society. E.g. if you are engaged in an activity with a lot of positive externalities (e.g. going to school, buying a home for your family, or making a new startup), I will give loans with lower interest. I discourage bad debt (e.g. credit card debt, or mortgages I know will fail.

2) Money is real: I expect returns. This might be due to good debt (e.g. business investment) or bad debt (e.g. you're buying a home you can't afford, but interest + sales price when you default results in net income for me when / if you do default, payday loans, etc.).

Both of these systems are rational. Both, in practice, have politics we need to manage. The problem happens when e.g. monetary policy sets interest rates, in conflict with what the market wants. The risk is astronomical right now, and system #2 says don't loan, which is where the private sector wants to go. But without cheap credit, the economy goes down, which is where the fed steps in. And, of course, private investors can try to arbitrage the two forces.

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