How come the bank failure destroy the wealth???

[johnyj]

Banks can fail and banks should fail!

Let's say, 1 million people have their saving account in a bank, where 20% of the people made a default on their loan from this bank, and the bank went bankrupt. It means the rest 80% of the people lose their savings in this bank, although they did not do anything wrong.

Who should be responsible for the loss?

It is both government (who gave stimulation through housing) and FED (who provided the liquidity) started this pyramid game. In a real pyramid game, the early player draw their profit from the later joined players, but in this case, the later joined players select default to escape from the game, then the early player took the loss instead.

But anyway, I still think that society as a whole, both money supply and house numbers are higher than 2007, total wealth increased, it is just a wealth redistribution, some people actually get much richer in this process, it's those who sell the houses before 2008

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[DeathAndTaxes]

Who is responsible?  Or who pays?

Deposit accounts are insured (FDIC). 

Bank should fail.  FDIC insurance should pay depositers (note FDIC is funded via insurance premiums charged to functional banks).
Shareholders should be completely wiped out.
Bondholders wiped out and/or take major haircut depending on level of insolvency.

Ig any value can be salvaged the FDIC takes bank into receivership, recapitalizes it and then sells it back to private market.
If not then FDIC takes remaining performing assets and sells them to healthy bank.

It worked that way for decades without a problem until suddenly crooks in Wallstreet & Washington decided banks can't fail.  Shareholders and executives need to be rewarded for gross incompetence and the losses were passed to taxpayers and these worthless undercapitalized zombie banks continue to be a drain on our economy.

Bank Of America should be dead.
Countrywide should be dead.
Wachovia should be dead (no forced merged w/ Wells Fargo)
Citibank should be dead.

Shareholders & Bondholders should have been annihilated.  Executives should have been put on trial, lost personal assets via in-reim forfeiture and spend 10-20 years in prison.  That is capitalism.  Next time shareholders will look for more conservative investments and executives will be more inclined to not commit wholesale fraud.

Instead everyone who should have taken a loss was rewarded and taxpayers paid for it.  The moral of the story.  commit fraud, take excessive risk, destroy wealth you will be rewarded for it.

[johnyj]

Who is responsible?  Or who pays?

Deposit accounts are insured (FDIC).  

Bank should fail.  FDIC insurance should pay depositers (note FDIC is funded via insurance premiums charged to functional banks).

Of course those banks already bought insurance before play this game, but the crisis is enough powerful to knock down these insurance companies,  even fannie may and freddie mac can not take that amount of loss and needs to be take over by the government, I do not think that FDIC can survive a mass failure of banks. All the insurance company works the same way, they can take a single hit and still remain financially strong, but if they were hit multiple times in a short time, they go bankrupt. Actually fractional reserve banking act just as an insurance company, if more than 20% of the people go in ask for withdraw/insurance, it will broke

But wait, you have a point! If FDIC is backed by FED with fresh printed money, then it's a good idea to let those banks fail, or in another word, FED can become the final insurer for the whole society, since they can print money to pay the insurance

[kjj]

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

Do you have an example of a monopoly that was sustained without direct help from the government, and that also overcharged the market?  Just one example would do nicely.

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

Meh.  Life isn't fair.

[johnyj]

Do you have an example of a monopoly that was sustained without direct help from the government, and that also overcharged the market?  Just one example would do nicely.

Take Mcdonalds for example, I think anyone can make some food cheaper and tastes better than Mcdonalds, but they are not able to compete with them in a corporate level, since Mcdonalds have already occupied most of the place that has the highest rate of people flow in the last century. Due to economy of scale, when they get bigger, the cost will going down, and they have created a culture that many people can not live without it (real-estate monopoly)

Another example is japan's digital camera companies, I do not think their government helped, but that is really a monopoly in country level. They toy the users with minor upgrades of camera, but the sensor seldom improved in 10 years, this could never happen in IT industry (Technology monopoly)

[jtimon]

But wait, you have a point! If FDIC is backed by FED with fresh printed money, then it's a good idea to let those banks fail, or in another word, FED can become the final insurer for the whole society, since they can print money to pay the insurance

So what you want is let the banks gamble with our savings. If they win they take the wins and if they lose the central bank pays the losses.
Not very different from the current system.
But note that if the central bank pays the losses by printing, every money holder does pay for the losses through inflation.

The problem they're trying to solve through inflation (apart from bailing out their banker colleges) is deflation.
Some people here will tell you that deflation is not a problem, but it is: https://bitcointalk.org/index.php?topic=28276.msg421352#msg421352
But their solution is not sustainable. You can't have low interests rates through monetary inflation forever, you will get hyper-inflation eventually. And when the central banks decide they can't keep on printing like crazy, the interest rates will rise, the liquidation process will start again and you will have the deflation. Through inflation they're only postponing the problem and making it worse. They're feeding the ultimate bubble which is public bonds.
Keynesian inflation is not a cure for economic cycles but only a patch.

I think the cause of economic cycles is the basic interest and therefore the only solution is substituting capital-money with free-money.

[johnyj]

So what you want is let the banks gamble with our savings. If they win they take the wins and if they lose the central bank pays the losses.
Not very different from the current system.
But note that if the central bank pays the losses by printing, every money holder does pay for the losses through inflation.

I think the cause of economic cycles is the basic interest and therefore the only solution is substituting capital-money with free-money.

Inflation is a difficult measure. Let's say that the society have 20% annual inflation rate but the average income increase at 30% rate, it may not be a bad thing, just the price of everyting keeps rising, include income. The problem arises when prices rise but income do not increase, but this is quite impossible from a pure market point of view: When people's income get less, they will spend less, thus create deflation pressure

There is nothing strange with interest: Same money, if you put it into investment, you will get some return, if you save in a bank, you would also expect some return, that return is interest, and it works like a benchmark of the "general investment profitability"

In a rich society where effective demand is very low and business investment barely can generate some return, the interest rate will also be very low

[jtimon]

So what you want is let the banks gamble with our savings. If they win they take the wins and if they lose the central bank pays the losses.
Not very different from the current system.
But note that if the central bank pays the losses by printing, every money holder does pay for the losses through inflation.

I think the cause of economic cycles is the basic interest and therefore the only solution is substituting capital-money with free-money.

Inflation is a difficult measure. Let's say that the society have 20% annual inflation rate but the average income increase at 30% rate, it may not be a bad thing, just the price of everyting keeps rising, include income. The problem arises when prices rise but income do not increase, but this is quite impossible from a pure market point of view: When people's income get less, they will spend less, thus create deflation pressure

You're assuming hyperinflation. With 20% inflation the currency will be soon destroyed regardless of the income increase.
With 20% inflation you should expect (if the inflation is not being created through new money borrowed into existence at low interest rates) a 20% inflation premium on the interest rates. Say 5 + 20 = 25% interest rates. Madness.
With inflation you're not creating any wealth, you're just attacking money so that real capital investments look better compared to capital money.
But naturally the two types of capital would balance through the inflation premium.
You can't lower the interest rates through inflation forever, eventually you will stop or slow down printing to prevent the collapse of the currency and that's when the interest rates will rise in response to the created inflation.

There is nothing strange with interest: Same money, if you put it into investment, you will get some return, if you save in a bank, you would also expect some return, that return is interest, and it works like a benchmark of the "general investment profitability"

The problem with interest is that it has a minimum, because money holders can get a return from liquidity: exact the interest from the wares.
That minimum basic interest also represent a minimum for capital yields, no new investments will be made in a certain capital type if the yield is already lower than the interest rates, even if those investments were profitable.
What I mean by "the cause of economic cycles is interest" is that interest makes the credit/debt level grow more or less exponentially. When that type of growth in debt becomes unsustainable the debts begins to shrink causing deflation, which accelerates the liquidation process.

In a rich society where effective demand is very low and business investment barely can generate some return, the interest rate will also be very low

The interest rates will never be zero with non-perishable money and no central bank intervention.
With a currency with demurrage (free-money instead of capital-money), interest rates could be zero without central bank intervention (which is unsustainable in the long run).
This way capital yields could drop to zero by competition like regular profits do.

[johnyj]

The interest rates will never be zero with non-perishable money and no central bank intervention.
With a currency with demurrage (free-money instead of capital-money), interest rates could be zero without central bank intervention (which is unsustainable in the long run).
This way capital yields could drop to zero by competition like regular profits do.

In my understanding, it is very simple: If money are too abundant, it will be inflation, otherwise, deflation

Interest rate is just a measure of the standard investment return. A low interest rate together with inflation will encourage people to put more money into investment (even it's very difficult to find investment opportunities, it's still better than let inflation eating up the saving value). A high interest rate with deflation will cool down the economy activities

The real problem is at the income/consumption side, which can not always keep getting higher and higher. Sometimes people just want to take a rest and drink a cup of water   In such a case, keep lifting the price is the only way to push things forward

[jtimon]

The interest rates will never be zero with non-perishable money and no central bank intervention.
With a currency with demurrage (free-money instead of capital-money), interest rates could be zero without central bank intervention (which is unsustainable in the long run).
This way capital yields could drop to zero by competition like regular profits do.

In my understanding, it is very simple: If money are too abundant, it will be inflation, otherwise, deflation

Interest rate is just a measure of the standard investment return. A low interest rate together with inflation will encourage people to put more money into investment (even it's very difficult to find investment opportunities, it's still better than let inflation eating up the saving value). A high interest rate with deflation will cool down the economy activities

The real problem is at the income/consumption side, which can not always keep getting higher and higher. Sometimes people just want to take a rest and drink a cup of water   In such a case, keep lifting the price is the only way to push things forward

The problem is not at the consumption side, they boost consumption through inflation to keep the investment going. Also, they manipulate interest rates in the process (in a way that cannot be sustained forever) also to keep investment going.

The interest rate is not only a measure of the standard investment return. Basic interest with capital-money will always be greater than zero, even in a shrinking economy. This sets a minimum in the investment return that is unnatural, because investments should be done if there's some return (or even if the return is zero) even if the return is lower than the "utility of liquidity".
Crises don't begin when suddenly people stops to consume. Investments and loans is what are reduced suddenly.

[johnyj]

Just thought about another explanation: Bubble makers push the price up and sold the house near top to hard working people, but the house price were so high that normal hard working people could not afford without betting their next 10 years of labor, and so their consumption reduced dramatically during this 10 years period

From the construction point of view, even a non-professional worker could build a house in 3-4 years, it is not a technically complex and labor intensive work. If the house was built by professional construction companies, it will only take one man one year's work. Add material cost and 20% investment profit (which is very high), it should cost no more than 2 years of other equivalent work's income

[jtimon]

Just thought about another explanation: Bubble makers push the price up and sold the house near top to hard working people, but the house price were so high that normal hard working people could not afford without betting their next 10 years of labor, and so their consumption reduced dramatically during this 10 years period

You should ask yourself who those "bubble makers" are.
Here are some factors that contributed to the bubble:
1) Low interest and monetary inflation created by Greenspan to "save the financial market from the .com bubble burst".
2) Bush's regulations to promote the buying of houses. He said "own a house is the american dream".
3) Investments banks and saving banks are the same thing today, this allows banks to cheat the lenders on the real risk of their investment and take the risk premium for them.
4) Corrupt rating agencies giving AAA to financial crap: mortgages from people with no income and no assets.

Now Bernanke is "injecting liquidity" as his predecessor. Is this creating another bubble?
I think so: the public debt bubble.
Bubbles ultimately are capitals overpriced in relation to their yields.
But there's economic cycles even without bubbles. The liquidation starts when there's no (or very few) capital investment that will yield more than money can yield by itself (basic interest).

From the construction point of view, even a non-professional worker could build a house in 3-4 years, it is not a technically complex and labor intensive work. If the house was built by professional construction companies, it will only take one man one year's work. Add material cost and 20% investment profit (which is very high), it should cost no more than 2 years of other equivalent work's income

If one constructs his own house, it is going to be "profitable" for him even if the yield is zero, even if the total costs of production of the capital equal the utility extracted from it.
With capital-money, this is no longer true, because the investor will want at least the basic interest that he can extract from liquidity to spend his money or lend it.
Capital-money and basic interest (or liquidity premium) are the ultimate cause of economic cycles.
The bubbles we have had before the current crisis are just an undesirable effect of the keynesians "solutions", which don't really solve the problem, only postpone it and make it worse.

[johnyj]

Just thought about another explanation: Bubble makers push the price up and sold the house near top to hard working people, but the house price were so high that normal hard working people could not afford without betting their next 10 years of labor, and so their consumption reduced dramatically during this 10 years period

You should ask yourself who those "bubble makers" are.
Here are some factors that contributed to the bubble:
1) Low interest and monetary inflation created by Greenspan to "save the financial market from the .com bubble burst".
2) Bush's regulations to promote the buying of houses. He said "own a house is the american dream".
3) Investments banks and saving banks are the same thing today, this allows banks to cheat the lenders on the real risk of their investment and take the risk premium for them.
4) Corrupt rating agencies giving AAA to financial crap: mortgages from people with no income and no assets.

Now Bernanke is "injecting liquidity" as his predecessor. Is this creating another bubble?
I think so: the public debt bubble.
Bubbles ultimately are capitals overpriced in relation to their yields.
But there's economic cycles even without bubbles. The liquidation starts when there's no (or very few) capital investment that will yield more than money can yield by itself (basic interest).

From the construction point of view, even a non-professional worker could build a house in 3-4 years, it is not a technically complex and labor intensive work. If the house was built by professional construction companies, it will only take one man one year's work. Add material cost and 20% investment profit (which is very high), it should cost no more than 2 years of other equivalent work's income

If one constructs his own house, it is going to be "profitable" for him even if the yield is zero, even if the total costs of production of the capital equal the utility extracted from it.
With capital-money, this is no longer true, because the investor will want at least the basic interest that he can extract from liquidity to spend his money or lend it.
Capital-money and basic interest (or liquidity premium) are the ultimate cause of economic cycles.
The bubbles we have had before the current crisis are just an undesirable effect of the keynesians "solutions", which don't really solve the problem, only postpone it and make it worse.

These are all valid points, but it does not solve the problem, since human's speculative nature will always make bubble happen once they accumulate enough money. Of course government and FED helped to worsen the situation. As I know, chinese government has rules to prevent people from buying second house with loan

Using bubble (easy money) to bring country out of recession is the most easy way, but that resulted in even deeper crisis afterwards(actually I think recession is just a sign of money has been redistributed to a few people), so how to recover from recession without inject lots of easy money is the question here

[johnyj]

Back to my basic understanding:

There is very little wealth saved, it is only the "proof of work" saved in money's form, most of the wealth has been consumed

Although there is not so much wealth exist, Money ("proof of work") can request service/consumable products depends on the productivity of the society, e.g. money have credit. In a society with high productivity, excessive money is not a problem since there will always be enough goods to exchange the money. But in a society with low productivity, excessive money will cause inflation

[jtimon]

...how to recover from recession without inject lots of easy money is the question here

If you don't won't the velocity of money to slow down and you don't want inflation, only one idea comes to mind: demurrage.
http://en.wikipedia.org/wiki/Demurrage_(currency)

Back to my basic understanding:

There is very little wealth saved, it is only the "proof of work" saved in money's form, most of the wealth has been consumed

Although there is not so much wealth exist, Money ("proof of work") can request service/consumable products depends on the productivity of the society, e.g. money have credit. In a society with high productivity, excessive money is not a problem since there will always be enough goods to exchange the money. But in a society with low productivity, excessive money will cause inflation

You previously said (in another post) that the "proof of work" should not be everlasting and people should save through investments or non perishable goods. What do you think about demurrage?

[Mageant]

Nothing physically is destroyed.
It is just the perception of wealth changes.
The perception may be more accurate or less accurate after the bank failure, remember these are only estimations and can sometimes be manipulated too.
What matters more is how the people *react* to it. If they *think* wealth is destroyed then that is what will happen then too.

[jtimon]

Nothing physically is destroyed.
It is just the perception of wealth changes.
The perception may be more accurate or less accurate after the bank failure, remember these are only estimations and can sometimes be manipulated too.
What matters more is how the people *react* to it. If they *think* wealth is destroyed then that is what will happen then too.

Is not that wealth is destroyed, is that wealth is prevented from being created because the financial market is key in real capital creation.
Real capital is not everlasting and needs to be replaced and repaired. Since nominal interest rates and inflation/deflation (or just real interest rates) are the most important thing (apart from the expected yields of the capitals) from the investor perspective, investments stop (or slow down) and that prevents further wealth from being created and destroys jobs.
If the real interest rates are above the expected yield of certain investment, it doesn't take place.
Creating inflation is a patch, it lowers the real interest rates by creating sudden inflation (and by providing new funds that don't come from savings), but the solution is wrong.
First because nominal interest rates will catch up by adding the proper inflation premium. But most importantly because you're making investments that are not based on savings. To invest you have to save first, that's almost common sense.
The solutions central banks and governments are taking are not real solutions, it would be better to just take the damage and wait for the deflation to disappear and the financial market to stabilize. They're just postponing the damage, maybe changing deflation for hyperinflation, which is worse.

[johnyj]

Nothing physically is destroyed.
It is just the perception of wealth changes.
The perception may be more accurate or less accurate after the bank failure, remember these are only estimations and can sometimes be manipulated too.
What matters more is how the people *react* to it. If they *think* wealth is destroyed then that is what will happen then too.

Good view, it is only a perception, and perception change only make the money re-distributed, not destroyed

So, if most of the society member get poorer while a few get richer, then it is a recession, although the total wealth might be increased

[johnyj]

Is not that wealth is destroyed, is that wealth is prevented from being created because the financial market is key in real capital creation.

Real capital is not everlasting and needs to be replaced and repaired. Since nominal interest rates and inflation/deflation (or just real interest rates) are the most important thing (apart from the expected yields of the capitals) from the investor perspective, investments stop (or slow down) and that prevents further wealth from being created and destroys jobs.
If the real interest rates are above the expected yield of certain investment, it doesn't take place.
Creating inflation is a patch, it lowers the real interest rates by creating sudden inflation (and by providing new funds that don't come from savings), but the solution is wrong.
First because nominal interest rates will catch up by adding the proper inflation premium. But most importantly because you're making investments that are not based on savings. To invest you have to save first, that's almost common sense.
The solutions central banks and governments are taking are not real solutions, it would be better to just take the damage and wait for the deflation to disappear and the financial market to stabilize. They're just postponing the damage, maybe changing deflation for hyperinflation, which is worse.

Financial market is key in money redistribution, but the wealth are created by labor and the money are created by central bank

Without central bank create money at the first place, it will not be possible to have saving in money's form. From this point of view, if central bank already created money, then it can be used to invest without saving first

[johnyj]

If you don't won't the velocity of money to slow down and you don't want inflation, only one idea comes to mind: demurrage.
http://en.wikipedia.org/wiki/Demurrage_(currency)

Yes, demurrage have the same effect as inflation, why it is not implemented, might only be a psychology issue, people always want more instead of less, in a inflation environment, people just feel richer and be happier