How come the bank failure destroy the wealth???

[EhVedadoOAnonimato]

banks and other corporations fucked the US....but we need _less regulation of corporations....

right.

Please, make some effort, at least read what I just said above and try to understand it. It's the same regulators you're asking "help me!" to that created this whole mess.

Sure, banks and corporations benefit a lot from all this, and will benefit even more if more "government control" is created. The financial sector is probably the most regulated of all economic sectors. The most important financial unit, money, is a state monopoly, and a major price in finance, the interest rate, is decided by a state agency. And all that central planning isn't helping, quite on the contrary.
There's no regulation more efficient that that of free competition. State regulations create barriers to entry that kill competition. No wonder why big banks have made huge profits for years and, yet, you don't see hundreds of new banks being opened every day... that's what would normally happen in a profitable market sector in which there is no barrier to entry: competition would come from all over, trying to also get a share of that profit. The increase in competition would increase the offer, thus decreasing the price without changing the inherent costs of that economic activity. In other words, profits (price - costs) would decrease down to the average profit level of all other economic activities.

Stop trusting governments (which, let's always remember, are organized armed groups which force people to finance them) to solve all your problems. Instead, they'll just create more.

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[EhVedadoOAnonimato]

Good question (for once) and even better answer.

Thanks

But because bubbles produce an increase in GDP some economist argue that the economy is growing, when in reality the increase in GDP is not real economic growth, just the result of economic activity that squanders resources.

And the worst is that's not only statistics to please economists. During the boom, it becomes easier to invest in the long term. Many new investments start. These investments hire people, create capital and all that. The "prosperity feeling" goes beyond silly statistics: people really feel they're getting richer, while actually it's the other way around.

Messing with prices is really bad. We base a lot of our decisions on them.

[Sannyasi]

very good post. Putting value on anything is capatalism.... how could anything have any value if everyone was happy with what they have right now? All you need is food and water- those are the only 2 things that have real value.

[evolve]

It's the same regulators you're asking "help me!" to that created this whole mess.

bullshit.

the mess (at least in the us) was caused by massive deregulation of the financial industry. here was a reason why we didnt have a boom and bust economy for several decades after the great depression....it was called the glass-steagal act.  after being slowly weakened (and eventually repealed) from years of government pandering to their corporate handlers, we end up where we are now...fucked.

dont believe me? look up the percentage of subprime loans previous to and after the repeal of G-S. in case you are unaware, subprime lending practices (and the bundling and sale of those loans as junk securities) were THE MAJOR cause for our economy failing. 

[mobodick]

banks and other corporations fucked the US....but we need _less regulation of corporations....

right.

Please, make some effort, at least read what I just said above and try to understand it. It's the same regulators you're asking "help me!" to that created this whole mess.

Sure, banks and corporations benefit a lot from all this, and will benefit even more if more "government control" is created. The financial sector is probably the most regulated of all economic sectors. The most important financial unit, money, is a state monopoly, and a major price in finance, the interest rate, is decided by a state agency. And all that central planning isn't helping, quite on the contrary.
There's no regulation more efficient that that of free competition. State regulations create barriers to entry that kill competition.

That's bullshit.
It all depends on the type of goods or services we are talking about.
Fierce competition means banks will fall over and people will lose money all over the place.

The thing is that some goods or services benefit from being sold/distributed through a monopoly.
You wouldn't want the bank you have your savings on to be outcompeted by another bank so that you lose your money.
It would be a hassle to have savings in a bank account.
Another problem happens when there is no more room for differentiation but the competition is fierce.
This will give incentive to the organisation to cut some corners or otherwise cheapen their service.
This can leads to a degradation of the product and can lead to a downward spiral of ever decreasing quality.
Furthermore, it can lead to a splintering of the market and too much (false) choice for the consumer.
This is not always in the interest of society.

So there are markets that benefit enormously from competition and there are those that benefit from centralization and monopolization.

And with such 'natural' monopolies i would say that since the monopoly is granted by society (because it's the most beneficiary form) it should have some control over it.
The problem is, of course, that the people we give the power to control these monopolies need to be controlled (and held accountable) themselfs by society. Otherwise they will act as the monopoly itself.
Monopolies can be usefull to society, but need to be controlled by society.

[Iseree22]

Another thought related to saving:

One gold miner found a small piece of gold, he use that piece of gold to exchange for several bag of bread from a farmer, and he eat those bread for one week

After one week, farmer still holds the gold, but there is no bread, since farmer think that he could use that gold to buy same amount of bread 

This means: Farmer need some incentive to continously produce the bread, otherwise there will be inflation 

So how do you give the farmer the incentive?

It might be my opinion and I'm different than others' in this forum, but money is wealth. Real Wealth.

That is exactly most of the people think, not those from economy school. Because this, we can say that wealth is destroyed if there is a rate hike (money destroyed by central bank)

Now I have a better view!

Imagine a simple game:
First year,  A sell his house to B for $3 million
Second year, B sell the house to C at $4 million
Third year, C sell to D at 5 million

In this process, the amount of money required for transaction increased so much that bank must provide them bigger and bigger loans, thus lots of money must be created to facilitate the trades, and wealth is created from newly provided loans for this bubble (or bad investment, but you can never tell in forehand, if the price continously rise, then it is a good investment!)

Then, at certain point, most of the people have joined the game and bought a house, there is not enough new buyers join the game to keep the price hype, at the same time, FED has realized this might be a bubble and start to tighten. Then the house price will fall back to 4 million and 3 million. It's this tighten really detroyed the wealth (or money), what we see after 2008 is the consequence of tightening during 2007, but the wealth is already destroyed in 2007

How do you deal with the mess afterwards?

IMO you would need to keep prices as stable as possible. Which would mean offsetting the contraction in Horizontal Money(Credit Money) with an expansion in Vertical money. The expansion in vertical money would offset the unemployment and related suffering caused by the Horizontal Money contraction. If prices are not kept reasonably stable then it is harder for economic participants to plan ahead, which may lead to significant malinvestment. Furthur, whenever the financial system is disproportionally distorted by a subset of economic participants, then prices in the economy will not reflect their actual relative worth. This is what actually causes the malinvestment too begin with.

The sources of such distortion varies depending upon who you ask. Some say there is too much regulation, some say too little. However, given that the financial system is formed on the basis of common ownership, then all participants of the financial system should have an equal say in how price information flows through the financial system. Therefore the value of any regulatory framework upon the financial system should be judged on this basis, that is, how well does it allow participants to equally decide how price information flows through the financial system.

[johnyj]

There's no regulation more efficient that that of free competition.

Questions for this statement:

Do you really need a very high efficiency to give everyone a comfortable life, at the current technology level?

And, free competition always end up with monopoly, due to difference of each organization's capital/resource/intelligence etc... winner take it all. So, if you are already at the monopoly situation when it comes to money and financial, why do you want to start the whole process again (and bring chaos into society)?

As mobodick said above, regulated monopoly could be very efficient, but anyway I don't see the need for higher efficiency, all these efficiency talk only suits a society in low technology level


For many enterprises, they have the ability to produce enough utilities and services for everyone, but they can not do that, just because they have to sell the product/service for a profit, and the consumers do not have enough money. Money and its distribution is the problem here, not the technology

[johnyj]

So how do you give the farmer the incentive?

Good question

If the farmer is very poor, it will be easy for him to get the incentive, he need to continuously sell his products to get money, and buy other things he want

Actually, all classical economics are based on the assumption that the farmer's incentive is kept forever due to that human's desire is endless

But, if the farmer is very rich, it will be much more difficult for him to get enough incentive to work

So, chasing for profit is the last incentive for a rich society?

[johnyj]

How do you deal with the mess afterwards?

IMO you would need to keep prices as stable as possible. Which would mean offsetting the contraction in Horizontal Money(Credit Money) with an expansion in Vertical money. The expansion in vertical money would offset the unemployment and related suffering caused by the Horizontal Money contraction. If prices are not kept reasonably stable then it is harder for economic participants to plan ahead, which may lead to significant malinvestment. Furthur, whenever the financial system is disproportionally distorted by a subset of economic participants, then prices in the economy will not reflect their actual relative worth. This is what actually causes the malinvestment too begin with.

simple example of mal-investment:
A bought a house from B at 3 million and wish it to rise in value, but it actually dropped to 2 million, A lose 1 million

In this example, I just see it as a speculation game: A think the value of the house will rise (thus make the value of money less), so A exchanges money for house. But B think the value of house will drop (thus make the value of money more), so B exchanges house for money. When the house price dropped to 2 million, B still holds 3 million and he now can buy 1.5 houses; A hold the house which only worth 2 million

Looking at the total,  before and after house price change, A+B always holds one house and 3 million. If we take money as the measurement of value, then total value changed from 6 million to 5 million, 1/6 wealth were destroyed. But if we take house as a measurement of value, then total value changed from 2 house to 2.5 house, the wealth increased by 25%!

So, only when measuring the wealth in money's form, you get that strange " wealth destroyed" conclusion

[DeathAndTaxes]

One clarification I would like to make is that the BUBBLE DESTROYED ACTUAL WEALTH.

It also caused "fake wealth" to be wiped off the books but the countries recourses (labor, intelectual capital, raw resources) were improperly aligned.

During the house boom more houses were built than necessary.  Since all aspects of the economy compete for resources other areas of the economy were undeveloped.  Companies had to compete against massive increase in mortgages (considered low risk) to raise capital.  Companies which are labor intesnive saw their availability of labor decrease as construction firms expanded.  Companies using natural resources similar to housing saw their input costs rise.

When a bubble occurs it diverts resources away from parts of the economy which HAVE SUSTAINABLE GROWTH.

So the wealth lost includes that opportunity cost, the wealth never created in other parts of the economy.  Then the bubble collapses and the bubble wealth is "marked to maket".  Granted that bubble wealth never existed but it has a psychological impact when it returns to normal.


A hypothetical example.

Say with optimal efficiency the US economy would have grown by 4% real GDP growth from 2000 to 2008.  The boom made it look like the economy was growing at 4.5% but in reality priced with realistic valuation on housing maybe it was only growing at 3.8%.

Now the difference between 4.5% and 4% that is imaginary value lost BUT the difference between 3.8% and 4% represent misallocation of resources.  The economy grew less that is COULD HAVE and that is true wealth destroyed. 

Worse this misallocation of resources has a lingering effect.  Say someone went into construction rather than trucking, another guy started a housing company instead of a landscaping company.  Another guy became a Realtor instead of an accountant.  All individual sob stories but on a macro economic basis you have a lasting misallocation of resources.  It will take time (time the economy is operating less efficiently) for those misallocations to be absorbed.  So we also lose future wealth (difference between economies potential growth and actual growth).




 

[Crypt_Current]

There's no regulation more efficient that that of free competition.

Questions for this statement:

Do you really need a very high efficiency to give everyone a comfortable life, at the current technology level?

And, free competition always end up with monopoly, due to difference of each organization's capital/resource/intelligence etc... winner take it all. So, if you are already at the monopoly situation when it comes to money and financial, why do you want to start the whole process again (and bring chaos into society)?

As mobodick said above, regulated monopoly could be very efficient, but anyway I don't see the need for higher efficiency, all these efficiency talk only suits a society in low technology level


For many enterprises, they have the ability to produce enough utilities and services for everyone, but they can not do that, just because they have to sell the product/service for a profit, and the consumers do not have enough money. Money and its distribution is the problem here, not the technology

+1

[kjj]

There's no regulation more efficient that that of free competition.

Questions for this statement:

Do you really need a very high efficiency to give everyone a comfortable life, at the current technology level?

Yes.  But it kinda depends on what you mean by "everyone".  And by "comfortable".  And who the hell is going to be satisfied with the "current technology level"?

And, free competition always end up with monopoly, due to difference of each organization's capital/resource/intelligence etc... winner take it all. So, if you are already at the monopoly situation when it comes to money and financial, why do you want to start the whole process again (and bring chaos into society)?

Which isn't a bad thing.  As long as they are unable to use violence (aka, government) to prevent competition, they have to remain the best, or they won't stay on top for very long.  This means they won't abuse their monopoly position, unless we give them the power to.

There are a few exceptions, such as where a monopoly is natural.  For example, not everyone can build their own road, rail, power or communication network in the same place.  Some regulation seems necessary there, but hard core libertarians would disagree on that point.

As mobodick said above, regulated monopoly could be very efficient, but anyway I don't see the need for higher efficiency, all these efficiency talk only suits a society in low technology level

For many enterprises, they have the ability to produce enough utilities and services for everyone, but they can not do that, just because they have to sell the product/service for a profit, and the consumers do not have enough money. Money and its distribution is the problem here, not the technology

For a static, unchanging world where every day was exactly the same as before, I'm pretty sure that we could eventually develop an excellent planned economy.  But people die, and new people are born, and preferences change from day to day, and the world changes around us.  The only way to cope with that sort of changing world is to decentralize, and let each man make their own decisions to create their own futures.

[kloinko1n]

There is one thing always confused me: People always say that financial crisis destroyed trillions dollar worth of wealth

Based on general economy definition, only consumable goods and services are wealth, money is just a medium of exchange. So, if a house used to worth 5 million now worths 3 million, the actual wealth (the house) do not change, it is just the price of the house changed, and I think this price change are mainly caused by two things: money supply and people's desire

In my opinion, only war or natural disaster can really destroy wealth massively, any kind of financial loss is just a illusion, since people mistakenly think that money is wealth

The real question is: The country as a whole did not lose any wealth in the financial crisis, but why many people are getting poorer and the real tangible and consumable products are getting less produced?

Money is not only an exchange medium, but also a temporary storage of wealth. People can 'store' some of their wealth in money, stocks and bonds, in order to postpone acquisition of what you call 'real wealth'.

You are right when you state the house itself does not change during a 'crisis' (whatever the exact scientifically economic definition of that may be), but it's value on the market does. So there will be people in the 'consumer class' who acquired a house for 5 and are (forcibly?) selling it for 3, or end up with a value of 3 but with a debt of 5.
This price changing mechanism simply transfers wealth from the consumer class to the bankers class.

Same with inflation, in the sense of inflating the money supply.
If a bank prints money, the bank can spend it by loaning it to a consumer, who now owes the bank and spends it at the original value. After spending, the money supply has increased with the spent amount, say x%, so now the money for all consumers has a value of x% less than before that money was created and spent. That is a transfer of wealth from the consumer class to the bankers class, and, through the interest due, from the original consumer to the bank.

These are in my view the mechanisms through which the wealth of the consumer class is transferred to the bankers class.

[johnyj]

Which isn't a bad thing.  As long as they are unable to use violence (aka, government) to prevent competition, they have to remain the best, or they won't stay on top for very long.  This means they won't abuse their monopoly position, unless we give them the power to.

I believe, monopoly is caused by lack of regulation, and once it established, it will last generations, since the later comer will not have enough accumulation of capital/resource/knowledge/credit etc... And, due to the limitation of resource and space on the planet, most of the monopoly will last even longer once it established

For a static, unchanging world where every day was exactly the same as before, I'm pretty sure that we could eventually develop an excellent planned economy.  But people die, and new people are born, and preferences change from day to day, and the world changes around us.  The only way to cope with that sort of changing world is to decentralize, and let each man make their own decisions to create their own futures.

I do not favor a planned economy, to make the game rule fair to every one is more interesting.  Unfortunately, everyone was not born the same, so its actually a question if it is possible to make game rules that are fair to everyone

[johnyj]

One clarification I would like to make is that the BUBBLE DESTROYED ACTUAL WEALTH.

It also caused "fake wealth" to be wiped off the books but the countries recourses (labor, intelectual capital, raw resources) were improperly aligned.

During the house boom more houses were built than necessary.  Since all aspects of the economy compete for resources other areas of the economy were undeveloped.  Companies had to compete against massive increase in mortgages (considered low risk) to raise capital.  Companies which are labor intesnive saw their availability of labor decrease as construction firms expanded.  Companies using natural resources similar to housing saw their input costs rise.

When a bubble occurs it diverts resources away from parts of the economy which HAVE SUSTAINABLE GROWTH.

So the wealth lost includes that opportunity cost, the wealth never created in other parts of the economy.  Then the bubble collapses and the bubble wealth is "marked to maket".  Granted that bubble wealth never existed but it has a psychological impact when it returns to normal.

It's easy to say now, but Greenspan said, you never know it is a bubble before it busted. It's very difficult to evaluate the "right" price of the house,  mostly it is decided by market, and if the house value continously rise, it will become a good investment, thus attract more capital inflow and the price will be driven higher and higher, unless the capital supply is constrained by the FED one day

[DeathAndTaxes]

But that is kinda the whole point.  The housing bubble couldn't have happened without federal involvement.

a) a dubious mandate to raise homeownership rate (shared by both parties and both prior Presidents).
c) an easy money policy pushed by the Fed which was like oxygen into that fire.
c) regulators allows the amount of concentrated risk & leverage taken by the banks durring the boom.

It was like stepping on three accelerators at the same time.  Had the government been even marginally competent and removes one of those sources of artificial stimulus at a minimum the bubble would have been much smaller and the effect much less pronounced.

[johnyj]

I have some further thoughts:

The problem of free market is that the price will affect the fundamental, investment capital will chase something that have continuously rising price, and drive its price even higher, so one after one bubble is unavoidable. You can only tell after it busted. I bought gold at 1300, now it is 1600, is it a malinvestment?

But a bubble can not get big enough to let everyone become super rich, because FED is looking at the inflation all the time. When more people had easy money, there will be less people doing the real production, this will raise the price of everything, then FED will step on the break and freeze the liquidity.

Every investment have some risk, but there are different type of malinvestment. If people have lots of saving and doing malinvestment with savings, then the final result is just money transfered from some people to some other people, the purchasing power of those money stay the same, society as a whole do not affected that much. If people relies on the loan from the banks to do this investment, then they will not only lose their savings in the future, but also lose the interest they pay to the banks, so they simply select default and let banks take that loss. The bank holds many people and organization's savings, it can not fail, eventually government have to take over and becomes the biggest debt taker

[jtimon]

I believe, monopoly is caused by lack of regulation...

Most monopolies and cartels are in fact caused or guaranteed by governments. There's more factors though.

It's easy to say now, but Greenspan said, you never know it is a bubble before it busted. It's very difficult to evaluate the "right" price of the house,  mostly it is decided by market, and if the house value continously rise, it will become a good investment, thus attract more capital inflow and the price will be driven higher and higher, unless the capital supply is constrained by the FED one day

Maybe greenspan was jocking or he was just talking about the .com bubble arguing "Who knows? Is the internet, no one can know when that was a bubble".
 
Actually calculating if some capitals are bubbles or not is not very difficult.
For a house (assuming stable prices):

1) Take the annual gains from renting the house (it doesn't matter if you're going to actually rent it or live in it)
2) Subtract all the taxes and maintenance costs. Now you have the annual yield of your capital (Y)
3) Compare it to the price of the capital (P): (Y / P) * 100 = proportional yield, a percentage.
4) Compare it with the interest rates
   If the interest rates are higher than your percent yield, you prefer to rent
   If the interest rates are lower than your percent yield, you prefer to buy

Of course, if there's non sustainable regulations promoting buying, there are distortions in prices you have to account.
If the interest rates are lowered in a non sustainable way (monetary inflation), you have to account that too.
If rate agencies misreport about risks, they create the impression that the basic interest is greater than actually is (by suppressing the risk premium as a part of the interest).

I have to read and think more about the effects of the mentioned glass-steagal act. As far as I can tell, before that deregulation, investment banks and regular commercial banks were not compatible. Probably also altering risk perceptions for final lenders.

[kloinko1n]

I have some further thoughts:

The problem of free market is that the price will affect the fundamental, investment capital will chase something that have continuously rising price, and drive its price even higher, so one after one bubble is unavoidable. You can only tell after it busted. I bought gold at 1300, now it is 1600, is it a malinvestment?

Apparently you decided that it's a good investment, the moment you bought it.
Why? Because you looked at the fundamental mechanism behind the price increase.
1) If you estimated a speculative bubble, then it's just that: you surf the bubble and try to estimate where the top is and take your speculative gain.
2) If you want to use the storage value of gold because you fear a demise of the fiat currencies, then you're just using it as a store of your wealth and sell the gold when this 'crisis' (please define 'crisis') is over.
3) If on top of that you think the exchange value is increasing because more and more people want gold for reason 2), then you may an added advantage from that.

But a bubble can not get big enough to let everyone become super rich, because FED is looking at the inflation all the time. When more people had easy money, there will be less people doing the real production, this will raise the price of everything, then FED will step on the break and freeze the liquidity.

... and create a mega crisis in the process.
Anyway, one of the characteristics of a bubble is rising prices. And how is price established? Because there is a seller, and a buyer who is willing to buy at the high price. This is already a guarantee that prevents that 'everyone become(s) super rich', because the buyer will become poor and only the seller will be rich. That is, during the last transaction (per item) that occurs before the bubble pops and price comes crashing down. So the last sellers become rich, and the last buyers poor.

Every investment have some risk, but there are different type of malinvestment. If people have lots of saving and doing malinvestment with savings, then the final result is just money transfered from some people to some other people, the purchasing power of those money stay the same, society as a whole do not affected that much.

Mwaaahh... I don't agree with the last part but I'm too lazy to comment

If people relies on the loan from the banks to do this investment, then they will not only lose their savings in the future, but also lose the interest they pay to the banks, so they simply select default and let banks take that loss. The bank holds many people and organization's savings, it can not fail, eventually government have to take over and becomes the biggest debt taker

Banks can fail and banks should fail!
Banks (even the federal reserve) are private companies with stockholders and directors who have the responsibility to take good care of the money invested.
If banks fail then the stockholders have been sleeping and let the boards 'play' with their money. As a result the stockholders lose their money.
No harm done. Government will bail out the clients through the PDIC and through the process of (finally) printing their own money to reimburse the banks' clients.
And the population can decide what they want to do: trust the remaining banks enough, or demand a government bank and do their business with them.

At least, that's how it should be in my opinion.

[kloinko1n]

I have to read and think more about the effects of the mentioned glass-steagal act. As far as I can tell, before that deregulation, investment banks and regular commercial banks were not compatible. Probably also altering risk perceptions for final lenders.

If I recall correctly, that act prevented banks from using their consumers' deposits to invest in risky derivatives and such by physically and legally separating the commercial banks from the investment banks.

O, wait, here it is:
"The repeal of provisions of the Glass–Steagall Act of 1933 by the Gramm–Leach–Bliley Act effectively removed the separation that previously existed between investment banking which issued securities and commercial banks which accepted deposits. The deregulation also removed conflict of interest prohibitions between investment bankers serving as officers of commercial banks. Some economists believe this repeal directly contributed to the severity of the Financial crisis of 2007–2011 by allowing Wall Street investment banking firms to gamble with their depositors' money that was held in commercial banks owned or created by the investment firms."

(emphasis from me)