When metaphors collide
Apr. 2nd, 2008 02:03 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
peterbirksThe experts in white coats like to use metaphors when it comes to describing how 'the city' works. Joe Plumeri (Willis boss) refers to insurance as "the DNA of capitalism". One could argue in response that it's more the DNA of wimp capitalisam where no-one is willing to take a gamble that might leave them broke. But, well, since wimp capitalism is now the default, I guess that this does not devalue the strength of his point.
The financial services sector (passim Mikey a few posts down) talks about the banking system prioviding "liquidity" and (not Mikey's quote, but one that you find in many places) "oiling the wheels of capitalism".
The problem with these metaphors, as with the Descartian model of the body as some kind of mechanistic clock and the mind as its controller, is that one can mistakenly take things which happen in the metaphor with things which actually happen in real life.
If you oil a wheel, but put on too much oil, then the excess just runs off. You might make a bit of a mess of the pavement, but no lasting harm is done. However, the oil is necessary. An unoiled wheel might, like an unoiled engine, cease to work.
The capitalist system follows the metaphor up to a point. Without the provision of liquidity by the banking system, the whole capitalist system can seize up. Nothing gets done.
However, a problem arisees when the banks are providing enough liquidity, but still have excess funds.
In other words, what happens when the level of available credit (oil) is too great for the economy (the engine)?
If you follow the metaphor, you might think that it would "run off onto the floor", but that isn't what happens. Once the banking system has performed its 'task" of oiling the wheels of capitalism, it still wants to make a return on its capital. If that capital (oil) is pumped into the economy (the engine) then it doesn't run off. It causes the economy to run differently.
We've seen the result of this in the past few years, with that oil turning itself into unsound credit, insured with insurers that, it transpires, won't be able to pay up if the bonds default. UBS, which a few months ago had $37bn-worth of such 'liquidity' pumped into the economy, suddenly realizes that the money is gone. Far from performing a function vital to the smooth running of capitalism, it was, in reality, transferring wealth from institutional investors in London to single-parent subprime borrowers in Missouri.
Whether that's a good or a bad thing is debatable. But there's little doubt that it isn't the kind of thing that UBS would cite as part of its positive contribution to the smooth running of capitalism.
++++
The UBS scenario is interesting because it raises an interesting hypothetical scenario. Many a political and (to their shame) economic commentator, appears to have assumed that there's a sequence of scenarios, each worse than the last.
Basically, if a bank gets into trouble, you go for a rights issue -- appeal to the investors to back you (see UBS). If that fails, then you look to be taken over at a cut-down price (see Bear Stearns). And if all of that fails, you look to the government to bail you out or take you over (see Northern Rock).
In other words, the worst case scenario is a government rescue.
This is all very fine if the financial institution is relatively small (e.g., Northern Rock, although even that is straining the Bank of England) or if the government is relatively large (the Fed). But what if UBS can't get a rights issue to work (even institutional investors have their limits) and can't find a white knight to take over its liabilities? There's no "state rescue" option here because, to be blunt, the Swiss National Treasury isn't that big. And you can hardly expect the American Fed to ride to the rescue of a Swiss bank.
In this worst-case scenario -- a bank which is large relative to the size of its domicile and is lalso a reasonable part ofthe global banking system — then you have the potential for a bank failure that could, indeed, cause some kind of systemic global financial crisis ('we've used up all the oil!!!!!'). What form that crisis would take and what its implications would be, I simply don't know, because we have never been in any situation that remotely resembles it. My guess would be that the world's banks would club together, take over the liabilities in bits and pieces, and the system would "muddle through". But a lot of people would suffer a lot of pain in the process.
_____________
The financial services sector (passim Mikey a few posts down) talks about the banking system prioviding "liquidity" and (not Mikey's quote, but one that you find in many places) "oiling the wheels of capitalism".
The problem with these metaphors, as with the Descartian model of the body as some kind of mechanistic clock and the mind as its controller, is that one can mistakenly take things which happen in the metaphor with things which actually happen in real life.
If you oil a wheel, but put on too much oil, then the excess just runs off. You might make a bit of a mess of the pavement, but no lasting harm is done. However, the oil is necessary. An unoiled wheel might, like an unoiled engine, cease to work.
The capitalist system follows the metaphor up to a point. Without the provision of liquidity by the banking system, the whole capitalist system can seize up. Nothing gets done.
However, a problem arisees when the banks are providing enough liquidity, but still have excess funds.
In other words, what happens when the level of available credit (oil) is too great for the economy (the engine)?
If you follow the metaphor, you might think that it would "run off onto the floor", but that isn't what happens. Once the banking system has performed its 'task" of oiling the wheels of capitalism, it still wants to make a return on its capital. If that capital (oil) is pumped into the economy (the engine) then it doesn't run off. It causes the economy to run differently.
We've seen the result of this in the past few years, with that oil turning itself into unsound credit, insured with insurers that, it transpires, won't be able to pay up if the bonds default. UBS, which a few months ago had $37bn-worth of such 'liquidity' pumped into the economy, suddenly realizes that the money is gone. Far from performing a function vital to the smooth running of capitalism, it was, in reality, transferring wealth from institutional investors in London to single-parent subprime borrowers in Missouri.
Whether that's a good or a bad thing is debatable. But there's little doubt that it isn't the kind of thing that UBS would cite as part of its positive contribution to the smooth running of capitalism.
++++
The UBS scenario is interesting because it raises an interesting hypothetical scenario. Many a political and (to their shame) economic commentator, appears to have assumed that there's a sequence of scenarios, each worse than the last.
Basically, if a bank gets into trouble, you go for a rights issue -- appeal to the investors to back you (see UBS). If that fails, then you look to be taken over at a cut-down price (see Bear Stearns). And if all of that fails, you look to the government to bail you out or take you over (see Northern Rock).
In other words, the worst case scenario is a government rescue.
This is all very fine if the financial institution is relatively small (e.g., Northern Rock, although even that is straining the Bank of England) or if the government is relatively large (the Fed). But what if UBS can't get a rights issue to work (even institutional investors have their limits) and can't find a white knight to take over its liabilities? There's no "state rescue" option here because, to be blunt, the Swiss National Treasury isn't that big. And you can hardly expect the American Fed to ride to the rescue of a Swiss bank.
In this worst-case scenario -- a bank which is large relative to the size of its domicile and is lalso a reasonable part ofthe global banking system — then you have the potential for a bank failure that could, indeed, cause some kind of systemic global financial crisis ('we've used up all the oil!!!!!'). What form that crisis would take and what its implications would be, I simply don't know, because we have never been in any situation that remotely resembles it. My guess would be that the world's banks would club together, take over the liabilities in bits and pieces, and the system would "muddle through". But a lot of people would suffer a lot of pain in the process.
_____________
no subject
Date: 2008-04-02 04:35 pm (UTC)To me, it seems more logical that these losses should only be realised once the bank actually sells the assets at an enormous discount to the price at which it bought them. Except, of course, it probably can't sell them in the current market.
Still, that's OK, so long as they are still receiving income (interest payments) from these assets and they don't HAVE to sell them just yet.
Ah. You say they are not receiving interest payments? Well, not from all creditors? I begin to see the problem.
One of the reasons that the UK banks have not suffered as much as their overseas counterparts is that they don't "mark to market", which is to say they don't value their assets at the price they could get for them RIGHT NOW in the market; instead they value them according to an internally devised valuation model.
As mentioned above, this approach is fine if the bank is not a forced seller. Indeed, if all banks worldwide followed this approach then the whole credit crunch issue would have been much less of a big deal than it has been, and much less of a self-perpetuating crisis.
Er ... what was my point again? Dunno, guv.
I do think Mervyn King has been harshly criticised for his handling of the crisis. In principle, his approach that banks who cock it up should pay the consequences pour encourager les autres is an admirable one, though I concede that once things started to fly off the handle he stuck to this view a bit longer than was prudent.
Still, never mind all this high-brow stuff. The Harrington family are off to the west coast of the USA this year if we can get our blood samples, retinal scans, CRB files, fingerprints and seven generations of family history to the US authorities in time to secure clearance.
We were wondering how long to spend in Las Vegas, given that we will have 4 teenagers (aged 18,17.999999, 15 and 14) with us, and so I thought I would ask your advice. Is there much to do for that age group?
Must meet up soon for a meal and a chin-wag.
John H.
Mark to market
Date: 2008-04-02 05:27 pm (UTC)I think that you will find that IFRS
I think that you will find that IFRS <b)does</b> require m-to-m valuation in the UK, although the auditors do have various ranges of leeway when preparing final accounts for the year, and it might be to this that you are referring.
More, on Vegas etc, later. When did you acquire extra children?
PJ
[Debbie] does [/Dallas]
Date: 2008-04-02 06:38 pm (UTC)Irreparable invalid markup ('the ascii character formerly known as 0x3C b)does the ascii character formerly known as 0x3C/b the ascii character formerly known as 0x3E' -- these people are so very smart, it's impossible to "escape" anything) in entry. Owner must fix manually.
Markup, dont'cha love it? Hard to see why this shouldn't be auto-corrected, particularly since "markup" is not supposed to alter the sense, merely the presentation. Still, it's not like Six Apart are supposed to know what they're doing. Why spend good advertising income on technical support?
Re: Extra children
Date: 2008-04-08 03:17 pm (UTC)Look out Americans! Apparently I will be eligible to drive a hired car in your fine country, as the requirement is not for years of experience driving a car, just years of experience. Which makes sense, I suppose.
We've booked to go to Flagstaff (Arizona) to see a friend and the Grand Canyon, San Diego to swim with dolphins, Lost Wages to lose our wages and LA to get shot or arrested for not being inside a car. I would have liked to have included San Francisco on the intinerary as well but we can only afford so much. Oh, somewhere in there is a trip to Disneyland for number one son's 18th birthday.
Yes, I said 18th. Time doesn't fly, it leaps in a Tardis that's stuck on fast forward.
Lin, being Lin, has pre-arranged as much of the trip as possible (and at 3:35pm on the first Wednesday we will have an ince cream float at a Dairy Queen in Phoenix ...) and we, being (mostly) males will do all we can to stay in bed late enough to ensure we don't do any of the pre-arranged activities.
John
Vegas for non-gamblers
Date: 2008-04-02 09:35 pm (UTC)The place is mind-boggling if you've never been. The sheer size and scale of everything, the absurdity of having a Venetian canal on the first floor of a building, the insanity of the Luxor's diagonal lifts, the heaving plates of food. We spent a couple of days there, did a day trip up to the Grand Canyon, and then idled about for another couple of days. By then we'd eaten and seen enough.
The teenagers will of course not be able to gamble or drink, but they will probably get a buzz out of Stratosfear - a tall building with rollercoaster dangling off the top and sides of the thing. Not for the faint-hearted.
If you actually do want to gamble, then Pete's your man of course, but the whole manipulatory culture reduced my plan to dabble slightly to 'you're not going to get a nickel out of me'. Enjoy and
Re: Vegas for non-gamblers
Date: 2008-04-02 11:30 pm (UTC)New York New York has its rollercoaster although it was expensive and unpleasantly violent. I didn't do the 'Speed' ride at the Sahara as the clowns don't open it until 3 or something. Check out the shows on offer. I saw Phantom at the Venetian and it was an excellent production even though I have little interest in musicals. The Luxor has an IMAX theatre with some good 3D yet educational National Geographic stuff. Also a corny but amusing attraction 'In Search of the Obelisk'.
matt
no subject
Date: 2008-04-03 10:59 am (UTC)The whole culture is now based on an asset being valued at the price you believe you would get should you sell it Right Now. Or thereabouts. This prevents banks from accumulating huge amounts of non-performing toxic crap and continuing to hold them on the balance sheet at face value. Which may or may not be a Good Thing, it depends on your point of view, I suppose.
Must meet up soon for a meal/beer and a chin-wag.
no subject
Date: 2008-04-03 12:12 pm (UTC)The "right here right now" model is far better than the old toxic crap model, except when there is no market. Theoretically, this means that you may have to value your product (which, if held to maturity, would be worth $5bn) at zero, because no-one at the moment wants to (or is able to) buy it. I mean, that's the point about recessions -- cash is king. If there's a property crash, it's no use knowing that something will double in price within five years if you are broke and no-one is willing to lend you any money. That's why the product is so obviously cheap.
However, if you own something, and don't plan to sell it, and you know that in five years it will be worth double what you can get for it today, the right-here-right-now accounting system begins to look a bit shaky.
And this, in a nutshell, is where many institutions (including, for example AIG) find themselves. Other institutions, however, are genuinely owning shit, which is probably near or near-worthless. Accountants can't make a judgement call on which product is which and which company is which.
Hence the problem.
PJ
no subject
Date: 2008-04-03 07:20 pm (UTC)It looks to me as though accountancy (or, perhaps, auditing) lags seriously behind other monetary professions. (Geoff is more than welcome to disagree with me here -- this is a comment through ignorance.)
There's no obvious reason why one shouldn't mark-to-market and mark-to-value at the same time. There is presumably a (possibly discrete) continuum here, a la the Lasser Curve; for what that's worth. I'd imagine that it might be modelled, at the simple end, as a time series; or, on a more complex level, using the Monte Carlo method.
However, even publishing both (simple) sets of figures at the same time would confuse the markets, ie the people who are buying and selling. I'm starting to think that this is a central reason why CDOs and the like have been so popular in an era of cheap credit -- there's really only one number to remember and price by, plus a percentage risk factor that you can supposedly ignore, because everybody else does.
Accountancy (to use the term broadly) seems to me to be stuck in the age of double-book-keeping; ie simple addition and subtraction. Banking is getting more and more perverse. It would be nice if the two could meet up in the middle, somewhere.
no subject
Date: 2008-04-03 07:28 pm (UTC)But then, you can't expect these people to get their scientific metaphors right, can you?
DNA, RNA? It's all R&R to me.
Date: 2008-04-08 03:32 pm (UTC)"Investment banking is the NRA of capitalism" - Charlton Heston.
John H.
Re: DNA, RNA? It's all R&R to me.
Date: 2008-04-08 05:47 pm (UTC)On mature reflection, I believe that I would classify the insurance industry as the mitochondrial DNA of capitalism, which is of course an entirely different thing altogether.
And by R&R, do you mean Rock'n'Roll, or Rest'n'Recuperation? Both, as far as I recall, featured sex and drugs quite heavily...
no subject
Date: 2008-04-03 07:58 pm (UTC)And don't get me started on life reinsurance....
PJ
no subject
Date: 2008-04-04 08:43 pm (UTC)* Actually I don't think you can get a PhD in whatnot.
One example of this:
Date: 2008-04-04 09:04 pm (UTC)You are spot on here, Mikey. It's the contention of AIG (that being an area where I know my stuff -- banks are probably saying the same) that the writedown requirements are too onerous. Here's a bit from their earnings release for Q4 2007 (you know, the one where they lost $5.3bn).
In other words, that the situation will unwind and AIG will start releasing numbers into the bottom line over coming years.
Insurers release reserves all the time, so this isn't actually an unusual situation. It's a bit like Hurricane Katrina. "We'll put aside $20bn for that", they say. Then, as it begins to look as if the total cost will be nearer $15bn, they start releasing that reserve to the bottom line. The same will happen with the CDS "losses", where the $5.3bn loss will unwind to something like $500m or thereabouts. Still a fair chunk of change, but not armageddon for a company the size of AIG.