Banking Isn't Evil: software dev's view of how banking works and what went wrong

http://www.lifebeyondfife.com/86-banking.html

by lifebeyondfife • 14 years ago

12 11 14 years ago

Apparently this blog post reminded a friend of mine about an article he read in the nineties called The Hybrid Manager. Essentially, we as developers love technology as it really interests us. But unless we're writing tools to aid development we need to understand at least one other business i.e. the business we write code for.

I don't think enough coders know how the high-end financial world works or what opportunities and interesting work it has. More computer scientists in my industry please, we need your pragmatism!

ryanmolden• 14 years ago

The idea that business is or should be amoral is wrong. Business, and corporations in particular, exist and have the leeway they do because it is generally believed the good outweighs the bad, on the balance. By saying "we have no reason to have any scruples" you are veering into "no longer beneficial to society on the whole" territory. While I believe there is definitely value provided by finance (duh), some things they engage in clearly are self serving and detrimental to an orderly society. Bundling toxic mortgages and selling them to people under the guise "if they're stupid enough to buy them then it's their own fault" is wrong really no matter how much one waves his hands, yells "capitalism" and tries to act like they are doing it for some legitimate reason.

lifebeyondfife2• 14 years ago

I don't think business should be amoral but I think it is. Businesses can do great things, help charities, help their employees, reduce carbon footprints - but anytime they do any of these things they squeeze all the good press they can out of it i.e. turn it into free positive advertising.

When times are tight those are the things that businesses cut first because they are concerned solely with money. I agree with you the toxic mortgages were an appalling thing to offer people who don't understand about, say, the effects of potential raised interest rates and how that might affect them. But that's why I say businesses (all businesses) are amoral - they don't care. So if we spot a bad business practice, like the toxic mortgages, we have to understand that we're going to have to rely on either the government or ourselves as consumers to fix it because business won't stop themselves from trying to make that buck.

I'm not saying I like this being the case but that how I see it.

anonymoushn3• 14 years ago

The profitability of unsound lending is mainly an artifact of fairly recent policy. Historically, if you were to give out loans that you knew could not be paid, you would lose money. That does not seem to be the case any more.

If you were at a casino and wanted to make money, you might go count cards at blackjack or try to beat the other gamblers at poker. But, if you knew that the casino would fully reimburse you any losses, you would probably just sit down at a roulette table and bet the house on double zero. This may or may not be an evil thing to do, but certainly it is a rational thing to do. If millions of Americans are harmed as a result of your policy of consistently betting the house on double zero, perhaps they should take it up with the casino who encourages this behavior by consistently compensating you for your losses using money taken from the pockets of millions of Americans.

tristan_louis• 14 years ago

One the thing that is missing in the discussion of whether banks are evil or not is a better dichotomy: what he describes in this entry is primarily about transaction banking (and more particularly cash management), which one can argue is not evil as it allows for the free flow of capital through the financial system.

On the other hand, when banks start trading against their own book (ie. creating financial transactions that are used to leverage the bank's own money), then things can go wrong.

Ultimately, what failed in this crisis is that 1. The risk around mortgage distribution got to be so removed from the actual mortgages that it increased carelessness. 2. Confidence in the system was shaken, leading to a "run on the bank" for broker-dealer banks, creating a substantial crisis of confidence in the banking system as a whole.

Anyone interested in how the crisis came about should read "The Big Short", by Michael Lewis, and "Too Big to Fail" by Andrew Ross Sorkin. Those two books provide a lot of perspective on what happened in the months leading up to and the days during the crisis.

anonymoushn3• 14 years ago

I'm not sure that "crisis of confidence" is the right turn of phrase in a situation in which there was a real lack of ability to pay. If there is a "crisis of confidence" and an institution's balance sheet is actually as it says it is, it can wait until people start behaving rationally. If there is a "crisis of being materially insolvent," and its own solvency is dependent on the solvency of counterparties who are materially insolvent, then it is not a victim of a lack of confidence as much as a victim of its own lack of diligence. Perhaps if the institution is sufficiently sophisticated then we should consider the possibility that it knew that its counterparties could not pay and lied about that knowledge.

cs702• 14 years ago

I find the writer's explanation of the main cause of the financial crisis too simplistic and dangerously naive: "interest rates were historically low which made lending cheap, [so] banks had more money to lend than there were responsible borrowers. This created a credit bubble that once over, resulted in banks suffering large monetary losses and an atmosphere of being scared to lend to each other."

IMHO, the structure and behavior of financial firms was a major destabilizing force leading to the crisis.

In the years preceding the crisis, financial firms created a vast network of complex financial claims and obligations of their own that greatly exceeded the real economy’s needs. These financial claims and obligations were at the center of the financial crisis.

A recent working paper at the Bank of International Settlements shows that financial flows exceeded the real economy's needs by a factor of at least 60 (!): http://www.bis.org/publ/work346.pdf -- an irreverent translation of the paper in easy-to-understand lay language is available here: http://www.nakedcapitalism.com/2011/09/the-very-important-an... .

Instead of just providing a mundane but critical service to the real economy (interconnecting the real economy's savers with its borrowers), the financial system was driving the real economy – for instance, by pushing up the prices of many assets, particularly residential properties, simultaneously feeding on and magnifying a housing bubble of historic proportions.

IMHO, these nonlinear feedback loops and network-amplification effects -- typical of complex, tightly interconnected, dynamic systems -- were important root causes.

bryanlarsen• 14 years ago

We allow and expect corporations to be amoral because of Adam Smith's guiding hand: if you make a profit it's because somebody thought that your product was worth at least as much as they paid for the product, probably even more. In other words, win-win.

When a transaction isn't win-win, it's time for regulation to step in. That's why there are limitations (but not bans) on monopolies.

The most common case of a transaction not being win-win is when the information is asymmetrical. That's why selling a "pig in a poke" is illegal.

Banks and traders operate in this "asymmetrical information" grey area. Arbitrage is allowed and is useful because it brings prices to their correct level and provides liquidity to a market. But high-frequency trading is clearly not useful to society. Who cares if it takes prices 10ms or 1 second to complete a sale and get prices to the correct level? HFT takes money out of the system and provides no benefit to society or the other party, and therefore is "evil".

HFT should therefore be outlawed. But you have to be very careful. Such a law would be very difficult to write correctly, and due to the law of unintended consequences and the pace of change and the cost of regulatory burden, we're probably better off without such a law.

HFT is evil. But companies that practice HFT are simply being amoral, not immoral. So perhaps the fault lies with the government for improper regulation, not necessarily with the companies for practicing it.

HFT is only one of the 'evil' practices that banks and large investors use. The linked article touches others, some of which are 'evil' and some of which aren't.

anonymoushn3• 14 years ago

What is the alternative to permitting HFT? If we ban direct communication between the algorithms and the exchanges, we will merely create a great deal of busywork for the thousands of people who will be hired to manually enter the orders produced by the algorithms. If we ban the use of algorithms altogether, we will be legislating inefficiency into the market, to the extent that there can be inefficiencies that are not worth the man-hours to manually discover. We may also have a hard time enforcing either of these approaches. I wonder how much it would cost us?

benblack86• 14 years ago

According to sources on Wikipedia High-frequency trading does provide benefit, it provides liquidity.

yardie• 14 years ago

I read the entire thing and not once did the author even touch CDSs or even where the banks got 40 trillion dollars from[1].

Most people don't believe banks are inherently evil. Just in this case in the last decade they spent so much time screwing each other they ended up screwing every one of us.

[1] For those that don't know, from 2000 until 2008 the global money supply went from 36 trillion to over 70 trillion. Listen to NPRs "Giant Pool of Money"

Banking Isn't Evil: software dev's view of how banking works and what went wrong

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