The Fourteenth Banker Blog

August 20, 2010

Finance as Dictator

Filed under: Running Commentary — thefourteenthbanker @ 3:18 PM

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.



  1. Thanks for a lovely post. Both links are superb. I intend to order Prof. Bhide’s book. It is interesting though that deeper thinking about the problem of finance being connected to software application algorithm’s keeps circling back to full destruction of the entire system including the personal wealth of the elites that benefitted the most in the last thirty or so years. An Algorithmic Religious Mania no different than all the other national psychoses current in the land.

    It looks like, the political power elites are learning how trapped they are . that every move they and other elites within the frameworks of their personal beliefs blow up or spawn consequences they never considered.

    Here is a really direct tie in piece seemingly having no relation to Financial Entrapment. The BP Macondo Oil spill. In reality ,a BP failure would make Lehman look like chump change. Why is the U.S.Government Protecting BP?

    My latest print basis Oil & Gas Journal discusses the BP Spill accrual for their second quarter financial statements of $32.2 Billion. They have only paid out $2.9 billion and expect to pay out all spill related costs by the end of the year. That means perhaps 85 % of the loss accrual will be paid out over many years and I bet mostly not at all. The mostly ” not at all” will later be a huge income increase , probably as they need it over time. It includes litigation estimates and they will litigate to the death.

    Comment by Jerry J — August 20, 2010 @ 7:43 PM | Reply

    • Good link. That is dead right. A BP bankruptcy would be very disruptive to the financial system. As usual, there is probably no way to know the extend of the ripple effects. Another reason complexity is the enemy of capitalism.

      Comment by thefourteenthbanker — August 21, 2010 @ 1:55 AM | Reply

      • The effects of the government’s acts over the Macondo Spill keep growing or at least the touting is ever growing. My own oil interests center on tertiary recovery in North America plus alternates in gas and oil. What I am looking into long term are the local strategic materials available for North American industrial and agricultural survival. Since , societal survival is local by definition local logistics allow or disallow survival in a global collapse. From a working perspective global estimates are as meaningless as Patton’s Third Army needing 1 million gallons of gasoline a day when the US produces 20 million gallons a day. The only thing that mattered was what gasolines Patton could cause to be distributed daily to his thratre of operations not the 20 millions produced daily by the US.

        The upshot of what Professor Bhide discusses is the misallocation of capital arising from not sufficiently understanding statistics as they apply to the local issue… in his case the question of can this specific borrower more than likely repay his loan and what leeway exists in the contract to aid that result.

        We have the same shallow , albeit totally expected, misuse of information to produce disconnected countervailing effects arising from the spill. The Colonel in direct command in the field has an entirely different understanding of effects than the Field Marshall inside the beltway let alone the Ministers of state on up to the Head of Government and State in our case.

        Only a moron corporate head in oil and gas would risk the hit that BP alleges it will incur. What independent can even afford 10 % of the risk BP alleges they will incur? They will go elsewhere. In the attached link, that place will be tar sands in Canada. Tar sand exploitation has developmentally come a very long way in the last few years.

        What facts , from all viewpoints, guide Obama? On one hand, he holds a knife to BP’s throat to appease the emotional American in the street and surrepticiously does the opposite to stave off disaster. What horrid to good software based ” information” serves as a base for state decisions? Whose spreadsheet gibberish is being accepted here?

        Just for counterpoint. An Estonian oil firm experienced in shale oil now has a 50 year deal to develop a shale oil industry in Jordan, of all countries, to relieve Jordon from oil imports. They flat out state that Jordan has shale that will produce the oil needed. Shale oil development technology has also been advancing too!In fact, Jordon already has a producing shale oil plant with an output of 38,000 bbl a day.

        Do anticipatory non cash bookkeeping entries now define economic survival choices?

        Comment by Jerry J — August 21, 2010 @ 12:41 PM

  2. Amar Bhide’s book is titled ” A call For judgement”. Judgement over acceptance of systemically induced gibberish. That call’s for a gathering of as many facts as is needed to make an effective judgement.

    In my link above from 321 energy .com , ” A run On the Canadian Border, the author Marin Katusa sites global proved reserves of 1.34 trillion bbl of crude oil. This is an accounting number required by the SEC. United States Proven Reserves total only 22 billion bbl of crude oil. Factually , though Proven Reserves mean little in evaluating any nations or even global future recoverable crude oils. In fact, to the uninitiated, it looks like the US has only a pittance of crude oil.

    The following is taken from Working Paper 19 of the NPC global study issued in 2007. The Working Papers are very extensive.

    The United States has future recoverable oil in 2007 foreseeable terms ,economics and technologies of an estimated 430 billion bbl entirely exclusive of oil shale. This is summarized on page 7 of the study in a table titled ” Original,Developed and Undeveloped Domestic Oil Resources”. Conventional technology amounts to 190 billion bbl and Enhanced Oil Recovery 240 billion bbl . These figures would include deep water. Transition Zone Original Oil In place is probably considerably larger than the estimate of 100 bn bbl. ( Only 20 bn bbl are in recoverable numbers) This is a very new development area. A heavy plurality of undiscovered oil in place includes deep water.

    Keep in mind that total US recoveries since 1859 amount to 208 billion bbl from all US oil basins.

    Some very, very big names are associated with these studies and each sub group is diversified.

    My point here is that personal judgement value that is meaningful requires enormous study of disparate sources with an open mind to get even a glimmer of what the reality might really add up to.

    This is an example of where information sources are rapidly becoming wittingly or otherwise sources of disinformation that might well be fatal to complex civilization.

    Might the very structures of complexity be so vast and disconnected that no state is capable of integrated judgements that advance the entire social complex of high tech societies? Obama or any other Head of State is now incapable of balanced judgement from pollution of the alleged facts he relies on ?

    Comment by Jerry J — August 21, 2010 @ 8:42 PM | Reply

  3. Prof Bhide and every one else is plain naive. Taking away of the judgement piece from underwriting was not an accident at all, it was done so the top guys can amass complete control. With complete control comes the ability to replace any and evryone. And therefore creates am atmosphere of fear and subsequent compliance. It was then sprinkled with incentives based on peoples personal ability to game the system….. The bigger the cheater, the higher the I-comp……the more pervasive and impossible the problem.

    Poeple on wall street are masters of ponzi schemes. They know underwriting judgement creates good loans…….. but that’s not what they’re after guys!

    Comment by Vocalbanker — August 26, 2010 @ 10:51 AM | Reply

    • Vocalbanker is dead on. And it’s more pervasive than even this would indicate. I’ve been mulling around various bits of ideas that all have a common thread – that EVERY aspect of our lives have become monetized (is that the right word?) Everybody wants a slice of every activity, every piece of landscape (and now cars and even foreheads) are offered for rental as ad space for a price. Taking a flight? Food, drink, pillow, luggage – all extra charges. Going to a concert? You’ll have to deal with Ticketmaster, who now gets a cut of just about every artist on every tour on the planet. To paraphrase Chuck Schumer, our quality of life is being nickled and dimed to death. At every turn, someone has their hand out. This may seem to be contradicting the premise of centralization, but in fact, it is because of centralization of power and control that we are all power-LESS in today’s world.
      Where I work is a case in point. The purchasing system for maintenance items has been “centralized”, which means that my department, who used to have relationships with our own vendors -which included personal knowledge and expertise of our situations, not to mention personal service over all – is now gone. Replace by a cookie cutter system that does NOT fit all, and ends up costing time and money when their template doesn’t fit our specific needs and we end up undoing what their centralized system thought we should have, and we have to go get what we really needed ourselves! Counterproductive in the extreme. I predict that eventually this idea that everything can be centrally controlled will come back to bite us, because we lose too much – personal service, knowledge of the customer, etc.

      Comment by Sandi — August 26, 2010 @ 5:29 PM | Reply

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