This very insightful piece from Naked Capitalism resonates. The source for Yves comments is a new book, out in two weeks, titled A Call for Judgement, by Amar Bhide of Harvard Business School. Yes, some good things do come out of Harvard Business School, just not in the years that produced most of today’s CEOs.
Yves titles her piece the Stalinization of Finance. I did not want to copy that title exactly, but did want to echo the essence. Finance occupies a unique space in our culture. It has often been a force for good, generally when it exercises good judgement. It can be a force for harm when it becomes unbalanced, unwholesome. Was it ever really wholesome? I don’t know. But I know it was more wholesome than it is today. Generally speaking, Finance has the promise of allocating resources more efficiently than if there were no Finance. It serves an intermediary function. That function should display attributes of moderation. As an intermediary, the profits should be moderate and stable. When the expectation is that Finance intermediates and “greases the gears of commerce”, it behaves in a certain manner. When causes and conditions are such that it becomes an ends in itself, rather than a fairly compensated means for the greater society, it behaves in a different, less civil manner.
One of the ways this occurs is discussed in the Naked Capitalism introduction and the Harvard Business Review article referencing the book. The grasping for ever-increasing revenue with ever decreasing costs created a system of centralization of decision-making, standardization of product around the dictates of the securitization market, and a dependence on statistics and assumptions to make all that work. Which, in case you didn’t notice, failed.
So back to the titles. Stalin was a dictator, governing a land that was supposed to be class-less and in which all were to have an equal voice. In fact, the class-less-ness and equal voice parts were an illusion, much as US democracy has become an illusion. We do not have a Stalin in power, but we do have oligarchs and kleptocrats.
Oligarchs become oligarchs by the concentration of power. Developments in Finance served to facilitate that concentration of power, sometimes in surprising ways. For example, why should the failure of the financial system increase the concentration of power in the financial system? Simply because Big Finance controlled the refs. When Finance was down on the mat, instead of counting them out in 10, the boxing ref gave them an adrenaline shot, B-12, a cold towel, a boost up, a seat in the corner, put the mouth guard back in, winked and said, “go get ’em, tiger!”
I digress. Perhaps we should address the dehumanization of finance. Here is Yves:
I’ve decried the fact that shifting lending from loan officers in branches to standardized, score-based templates resulted in considerable loss of information: face to face assessment of the borrower (does he understand what he is getting into? Does he regard the loan as a serious commitment?) and knowledge of the community (How healthy is his employer? What is the outlook for the local economy?)
Not specifically mentioned but implicit in this description is the loss of relationship between borrower and lender and the corresponding loss of considerations of the best interests of the borrower. All that is left is the grasping part of the exchange, sometimes on the part of all parties.
From Bhide is a description of the mechanisms by which all this is done:
Over the past several decades, centralized, mechanistic finance elbowed aside the traditional model. Loan officers made way for mortgage brokers. At the height of the housing boom, in 2004, some 53,000 mortgage brokerage companies, with an estimated 418,700 employees, originated 68% of all residential loans in the United States. In other words, fewer than a third of all loans were originated by an actual lender. The brokers’ role in the credit process is mainly to help applicants fill out forms. In fact, hardly anyone now makes case-by-case mortgage credit judgments. Mortgages are granted or denied (and new mortgage products like option ARMs are designed) using complex models that are conjured up by a small number of faraway rocket scientists and take little heed of the specific facts on the ground….
and consequences at the individual level:
The replacement of ongoing relationships with securitized, arm’s-length contracting has fundamentally impaired the adaptability of financing terms. No contract can anticipate all contingencies. But securitized financing makes ongoing adaptations infeasible; because of the great difficulty of renegotiating terms, borrowers and lenders must adhere to the deal that was struck at the outset. Securitized mortgages are more likely than mortgages retained by banks to be foreclosed if borrowers fall behind on their payments, as recent research shows.
and the systemic consequences:
When decision making is centralized in the hands of a small number of bankers, financial institutions, or quantitative models, their mistakes imperil the well-being of individuals and businesses throughout the economy. Decentralized finance isn’t immune to systemic risk; individual financiers may follow the crowd in lowering down payments for home loans, for instance. But this behavior involves a social pathology. With centralized authority, the process requires no widespread mania—just a few errant lending models or a couple of CEOs who have a limited grasp of the risks taken by subordinates.
So this will be a book worth reading to see if it provides clues to the way out of this morass. I suspect it may. Whatever that may be, we as people need to realize that by our own grasping we have laid the axe at our own root. Whether it is buying the cheapest goods from China in place of US produced goods, or finding the cheapest loan regardless of any relationship we have with a bank, , or eating inexpensive but heavily processed non nutritious foods, we have in the end paid a far greater price than the dimes we saved in the process. The ultimate solution will require more discriminating consumers, who exercise choice based on their values. Liberating.