Friday, May 28, 2010

Big Oil vs. Big Banks

I'll send somebody a shinny new nickel if they can explain to me that when BP screws up we make sure they pay every dime in damages, but if a bank screws up we bail them out with taxpayer money.

17 comments:

W. T. said...

Debt keeps more Americans on the federal dole and thus, under control. Or free flowing credit keeps Americans spending more and thus keeps them too busy and too distracted and makes them oblivious to what's going on. Big Oil is eevviill and contributes to global warming. Err, I mean climate change. Or Big Oil can be taxed to high hell for a "fund" for federal cleanup of oil spills (despite the fact that they want to hold BP 100% accountable) and increase revenue for the government - taxes on oil goes up, what are we going to do, stop buying gas??

Anonymous said...

Banks are filled with politicians' chums from Harvard. Oil company execs may come from Harvard, but they made the mistake of going into a business that makes something icky with people digging in the dirt, for God's sake! It's all so...plebeian.

Nick Rowe said...

You know that story.

Banks create money through the process of taking deposits and lending out more than they have in deposits. The amount of money the banking system can create is the deposit base times one over the required reserve ratio.

If depositors run on banks, this process is reversed. Money is destroyed. Nobody stole the money, it just vanishes into thin air.

If you have a precipitous decline in money supply, we end up in a depression. If the price level adjusted instantaneously, this would not happen. But prices tend to be sticky. Even if prices fall, it creates expectations of future deflation which can cause an economic death spiral.

So bailing out the largest banks was a measure taken to prevent bank runs and the collapse of the banking system. The Great Depression was caused not by the crash of the stock market but by bank runs following the fall of New York Bank of the United States. We learned that if the big banks are allowed to fail, the small ones soon follow.

But keeping banks from getting large is foolish too. Banks have tremendous economies of scale and it's efficient to have them. We don't need to stop them from getting large, we need to stop the bubbles that kill them.

Oil companies do not create money. If an oil giant fails, they don't take 100 times their oil reserves with them to the grave.

jimc said...

I believe that we are talking about the banks failure as evidence of a systemic failure, rather than one oil company.

Plus, I do believe it is easier to demonize the oil companies. This one in particular, as it is British.

Ecclesiastes said...

BP - British Petroleum.

We make them pay damages because Great Britain's taxpayers get to bail them out.

Fenris Badwulf said...

That is easy.

Oil companies have long been on the leftist hit list. Anything bad about them is over exposed by the leftist infiltrated media. Good stuff is ignored. Bad stuff can be made up, as the media does not watch itself any more (team effort Bolshevism).

Banks ... well, I have no proof, but the scenario appears to be that some highly placed bank toffs are behind the financing for the Manchurian candidate Obama.

It is all good. Saul Alinsky would be proud.

Peter2012 said...

Answer (11 words): Because BP has its money and the Banks have our money.

I'd prefer a 1942-1945 Silver War Nickel "shinny and new".

jdhays said...

Since oil is a commodity, making BP pay damages raises the cost for everyone by a small amount and we won't notice. If you put your money in a bank, even though you should know the risks, you will bitch like a stuck pig if it disappears. If they didn't have to worry about being unelected by disgruntled depositors, they would demonize banks too.

W.E. Heasley said...

Captain:

“I'll send somebody a shinny new nickel if they can explain to me that when BP screws up we make sure they pay every dime in damages, but if a bank screws up we bail them out with taxpayer money.”

That is a most excellent question. Would that be crony capitalism or special socialism. Or, alternatively, special crony social capitalism.

Troy said...

Nick Rowe,

True capitalism is incompatible with bailouts.

I reject your Keynesianism.

Any firm that takes customer deposits, then loans out ten times that amount would be tried in a court for implementing a PONZI SCHEME.

A collapse in money supply leading to a correction in inflated asset bubble prices used to be known as a "RECOVERY".

Now, we just paper it over with more fiat, enrich the failures, and prolong the misery.

The Great Depression was caused by the public discovery of the great ponzi scheme known as fractional reserve banking doped-up by Fed monetary expansion in the 1920s (to prevent UK specie outflows). Eliminate the coercive government monopoly on money and bank runs go away.

Saving big banks leads to moral hazard, perpetuates the cycle of bankster looting of the economy and forestalls the recovery by preventing the asset liquidation.

Bailouts do not work. They only enrich the scoundrels that caused the calamity.

Let them fail.

BP's not having a plan to plug a leaking well is criminal negligence. NO BAILOUT. If they can't pay restitution than sieze them, liquidate them, and pay out the proceeds.

NOW THAT WOULD BE TRUE CAPITALISM.

Ryan Fuller said...

"Any firm that takes customer deposits, then loans out ten times that amount would be tried in a court for implementing a PONZI SCHEME."

But, but, they're convenient! Except when they blow up and take the rest of the economy with them. Unless you bail them out using the rest of the economy. Then everybody wins! Except for the bastards who should be losing. And the people who get screwed to pay for the bailout.

But other than making winners out of the people who should be out on the street, and screwing over the people who had nothing to do with it, bailouts are awesome. From each according to his ability, to each according to his lack thereof.

Nick Rowe said...

True capitalism is incompatible with bailouts.

Bullshit Troy. I reject your absolutism.

Capitalism is private ownership over the means of production. Nowhere in the definition of "capitalism" is there a proscription of government providing public goods, resolving externalities, and addressing market failures. There is nothing in the definition which precludes preventing economic catastrophe. Not every form of government intervention is "socialism" or "Keynesianism".

Keynesian policies address output gaps caused by business cycles. It does not address issues of wholesale collapse of the financial system. It relied mainly on fiscal policy because their assumptions made monetary policy in a depression ineffective.

It is a monetarist argument that the banking system must be rescued from systemic risk. It was Milton Friedman who said that monetary collapse caused the Great Depression. He was right.

But all I did was answer the Captain's question - explaining why banks were "different" than oil companies. I wasn't advocating the policy of bailout for a particular firm or bank. I would not have implemented the policies of the past year-and-a-half.

The fractional-reserve banking system is NOT a Ponzi Scheme. I wish I had a dollar for everyone who misused the term Ponzi Scheme. Ponzi Schemes necessarily collapse. There is nothing in fractional-reserve banking which condemns it to collapse. Liquidity concerns are manageable and are generally handled through private, not public, means.

If we had no fractional-reserve banking system, we'd have close to zero economic growth. The cost of raising capital would be sky-high. There would be no large ventures. People could not ever afford to own a home before age 60 because they'd never be able to take out that much debt. We'd be a society of renters where a few rich people owned all the houses.

A decline in the PRICE LEVEL is the classical interpretation of how the economy recovers from an aggregate demand shock. A collapse in the banking system results in an uncontrolled destruction of money supply and a deflationary spiral. That is NOT the same as the controlled descent of prices toward a full-employment equilibrium.

When financial markets collapse, this is not "capitalism" at work. It's the destruction of the market, not the recovery of it.

I'm not in favor of any of the home owner bailouts, the GM bailout, or the excessive government spending. Letting the huge banks fail was not an option. We've observed enough depressions to have learned not to allow that anymore.

There is moral hazard in bailing out large banks, which is why I said we need to prevent them from taking undue risk in the first place. This crisis was entirely caused by government policy and entirely preventable. But wherever you go, there you are.

Your notion of what caused the Great Depression is laughable. Nobody "discovered a Ponzi Scheme." It was caused by a banking panic. We haven't had a widespread, large scale bank run since the depression largely due to the lessons we learned from the GD.

I find your lack of faith disturbing. I find your dogmatic view of free markets even more disturbing. I have great respect for libertarian views and Austrian economics, but the nexus of those philosophies are filled with people who blindly and thoughtlessly parrot absolutist nonsense.

I see this drivel, almost verbatim, on nearly every economics website I visit laced with conspiracy theories. You're no Hayek or von Mises.

V said...

Someone needs to infiltrate an Obama press conference and ask this exact question!

Ryan Fuller said...

"Capitalism is private ownership over the means of production. Nowhere in the definition of "capitalism" is there a proscription of government providing public goods, resolving externalities, and addressing market failures."

Or imposing a 95% tax rate and instituting a $40,000/year guaranteed minimum income, but I wouldn't call that Capitalism. Government picking winners and losers grates a bit against traditional capitalist sensibilities.

"The fractional-reserve banking system is NOT a Ponzi Scheme."

Correct. It's basically just a license to line your own pockets at the expense of everyone else's purchasing power, whether they like it or not. What's not to like?

"If we had no fractional-reserve banking system, we'd have close to zero economic growth."

That's just ridiculous. Economic growth predates fractional reserve banking and a free banking system can create new cash on an as-needed basis. There's still a few banks out there that have that option. The desire to not make their own notes worthless keeps currency creation at a reasonable level.

"The cost of raising capital would be sky-high."

Uhhh... no? There are options for raising capital that don't involve getting a loan from a bank financed by the fractional reserve system. Incorporating and issuing shares in an IPO isn't exactly a deep arcane secret. Venture capital doesn't always come from a bank either.

"There would be no large ventures. People could not ever afford to own a home before age 60 because they'd never be able to take out that much debt. We'd be a society of renters where a few rich people owned all the houses."

Even if banks were required for some reason to have enough reserves on hand to cover all claims that could be called in at any given time, they could use financial instruments designed to reduce the amount that could be withdrawn at any given time and loan the rest. CDs would largely replace traditional savings accounts. Without the ability to create money from nothing, demand for deposits would increase significantly and we'd see interest rates on those accounts that are much closer to what banks charge for loans. Constant depreciation of money combined with artificially low demand for loanable funds encourages people to take on much more debt than they otherwise would.

"When financial markets collapse, this is not "capitalism" at work. It's the destruction of the market, not the recovery of it."

I don't see anything in your definition of capitalism that equates capitalism with recovering markets or not having widespread failures in a particular sector.

"Letting the huge banks fail was not an option. We've observed enough depressions to have learned not to allow that anymore."

By bailing them out, we set ourselves up for the next one. Removing artificial barriers to entry in the financial sector would ensure that any gaps left by failing companies would be filled as quickly as possible.

"It was caused by a banking panic."

People realized that the banks didn't have enough money to cover their obligations. It wasn't a Ponzi scheme, but the public reaction was much the same; upon realizing that their money was in hands that were insolvent, they tried to get it out as quickly as possible.

Troy said...

Nick,

Decrying a free market view as "dogmatic" or "absolutist" is a smear all to often employed by the interventionist establishment.

There are many definitions of 'capitalism'. Your net is obviously wider than mine and that is okay.

I would limit the definition of 'capitalism' to an economic system that acknowledges private property and market based price discovery. Thus, by my definition, a system that has a central bank that can fix interest rates, money supply, and print money for bailouts is not 'capitalist'.

But we can disagree on semantics.

At the end of the day the difference between Monetarism and Keynesianism is negligible as both systems REQUIRE a central bank that can create money and monetize government debt. But that is a topic for another thread...

You are right...banks ARE different than oil companies.

Oil companies cannot wave a magic wand and double the "oil supply" when their ventures go south.

I agree, "There is nothing in fractional-reserve banking which condemns it to collapse". Except the implicit BAILOUT PROMISE which causes these banks to take on too much risk in the first place.

The problem with interventionist economics (Keynesianism, Monetarism, et al) is that they treat a liquidation phase as the illness and prevent it from cleansing the bad debts, unsustainable investment projects, and failed business models from the economy.

The Great Depression was not "Great" because Mellon didn't print money fast enough in 1930, it was "Great" because Hoover and FDR insisted on intervening with price controls, cartelization of industry (NIRA), starving the economy of capital by wasting it on public works boondoggles, confiscatory tax rates on the wealthy, and pro union/high wage policies which compounded the unemployment problem. That's the free market perspective, anyway. Bernanke thinks it was caused entirely by not cranking up the printing press.

In other words, they, just like today, (and unlike 1921) refused to let the liquidation phase to occur causing a repetitive cycle of false-recovery and re-collapse throughout the 30s.

As far as banks and Oil producers...

We should apply "free market" ideas to BANKING to make them MORE like Oil companies.

How about introducing competition in currency for starters? How about hard money alternatives (no cap gains or sales tax on commodity money)? But that, of course, would render the Fed all but impotent and put all interventionist economists out of work.

:(

Nick Rowe said...

Troy, you were making absolute statements so I called you an "absolutist." Even Austrians like Hayek and von Mises admitted fractional reserve banking was necessary for economic growth.

Don't let your idealism of free markets equal the idealism of socialism - neither works. A serious proponent of any viewpoint must acknowledge and accept limitations in their theories because THAT is where opponents will attack you. Denial is not an option.

You and I both agree government intervention often screws things up worse than markets.

We learned in the 19th century that interest rates fluctuate with the ag cycle, causing a MARKET FAILURE. We learned elastic currency smooths out those cycles and improves efficiency. We agree the Fed has taken on too much power, but if you think we don't need a Fed, then you are unlearning lessons from 150 years ago.

Monetarists and Keynesians are a MILE apart. They only look similar to anti-government absolutists. Friedman believed fiscal and monetary policy were ineffective at best and pro-cyclical at worst. His prescription was a constant growth rate of money supply. Inflation must be low and PREDICTABLE. Since money supply can change with no government intervention, he believed in smoothing money supply, NOT smoothing out business cycles. Keynesians believe in economic engineering.

The moral hazard of bailouts is evident EX POST. We did not bail out Lehman or Merrill Lynch. The other banks paid for their bailouts - it wasn't free. I do not believe those banks counted on government bailouts. They took risk because they had distorted MARKET incentives to do so.

Fannie Mae, Freddie Mac, and GM shareholders got WIPED OUT. That's not what I call a "bailout." You could say we bailed out GM UNIONS.

The collapse of a failed bank is "cleansing." The collapse of the entire banking system is not. You are ignoring the negative externalities (a market failure) from bank failures. A large bank failure increases the probability of other bank failures BEYOND their operational risk.

I agree Hoover and FDR made the GD WORSE and LONGER but their intervention was not the CAUSE. The crash of the stock market wasn't the proximate cause. The CAUSE was the collapse of the banking system due to bank runs. The FDIC and the Fed Discount Window has nearly eliminated bank runs. The free market could not and would not do these things.

Banks usually lose money in their first 3-5 years and are most prone to failure. Making entry easier will only result in MORE failures; banking has extensive economies of scale. Bank concentration ratios are increasing because "big" banks (over $1B) are buying failed banks. These "big" banks are not BoA, Wells, Citi, etc. They are probably banks you've never heard of.

I'm not quite sure what you mean by "competition in currency."

I support lowering taxes to the minimum essential tax rate to provide public goods. I support getting the Fed out of tinkering with interest rates to achieve macroeconomic objectives.

Malcolm said...

Socialism?