Negative rates as a precursor to death of banking, redux
Back in 2012, we argued that:
We also argued (and have been continuously arguing for a very long while) that contrary to popular belief the central bank is and always has been more worried about preventing natural rates from collapsing below zero than pushing them down. And that most of its efforts post crisis have, as a consequence, been focused on keeping these rates propped up.
Well, none other than Paul Krugman draws attention on Friday to the fact that “a major source of the urge to hike interest rates despite low inflation is the self-interest of bankers, whose profits suffer in a low-rate environment.”
To support the thesis Krugman draws attention to the following passage from the BIS’ new paper on the influence of monetary policy on bank profitability:
What the BIS is saying is that the spread between the market rate and the rate at which deposit rates can be raised — and capital essentially skimmed without over stressing the economy — is entirely dependent on the oligopolistic discipline of the banks. It is this discipline which in turn determines the “retail deposits endowment effect” which in turn determines the “capital endowment effect” for the capital system as a whole.
A concept best summed up by Einstein as:
As a rule, this is why bank oligopolies must be disciplined and subtle with their behaviours. Consider the former bankers’ paradise known as Switzerland. Suspiciously boring.
If there’s too much of a free-for-all, the behaviour risks ruining the party for all rent-extraction beneficiaries.
In 2008, sadly, this party was rudely interrupted by the near collapse and death of the host.
Shortly after this became obvious to everyone, the bank system realised it had no choice but to reduce its footprint on the economy. Therent interest rate was allowed to fall to zero and a few
token sacrifices were made (Bear Stearns, Lehman) in a bid to return
just enough capital entitlement to the real-economy (you know, to allow
the good productive layer of society to keep ticking over).
Sadly, all the act of contrition did was expose the Russian roulette nature of banking sacrifices, which caused the entire system to freak out in a systemically damaging way because nobody could be sure they wouldn’t be on the chopping board next.
What happened next is well known history: it wasn’t the bankers who got burned, it was the real economy which was forced to back stop their excessive claims due to the weirdly entangled nature of the system. Albeit with some major conditions.
Fast forward to today, and the real economy is just about breaking free of the burden which was the too big to fail banking sector and beginning to thrive for itself. And what do the bankers want? They want their rents back.
Why?
Because liquidity isn’t enough. In fact, all that central bank liquidity does is crowd out safe assets or force capital into risk elsewhere — until it burns by way of natural risk or negative interest rates.
So what’s a limited-by-size and burden on the economy banking sector to do in that context?
As we explained earlier today, the easiest thing really is to disguise itself as something else and hope and pray nobody figures out that when it calls itself the “technology sector” or “fintech” it’s just old-fashioned rent-seeking by a different name.
To conclude, what the economy needs is fewer bankers; not the substitution of many institutional bankers for an even greater number of ‘independent’, ‘lean’, ‘nimble’ and ‘small’ entrepreneurial fintech banker developers.
Related links:
Why fintech is a jobs story – FT Alphaville
Exposing the “If we call it a blockchain, perhaps it won’t be deemed a cartel?” tactic – FT ALphaville
“The simple fact of the matter is that in a negative carry world – or a flat yield environment for that matter – there is no role or purpose for banks because banks are forced into economically destructive practices in order to stay profitable.”Which was short for: banks and zero interest rates don’t get on.
We also argued (and have been continuously arguing for a very long while) that contrary to popular belief the central bank is and always has been more worried about preventing natural rates from collapsing below zero than pushing them down. And that most of its efforts post crisis have, as a consequence, been focused on keeping these rates propped up.
Well, none other than Paul Krugman draws attention on Friday to the fact that “a major source of the urge to hike interest rates despite low inflation is the self-interest of bankers, whose profits suffer in a low-rate environment.”
To support the thesis Krugman draws attention to the following passage from the BIS’ new paper on the influence of monetary policy on bank profitability:
The “retail deposits endowment effect” derives from the fact that bank deposits are typically priced as a markdown on market rates, typically reflecting some form of oligopolistic power and transaction services. If the markdown becomes smaller as interest rates decline, then monetary policy tightening will increase net interest income. The endowment effect was a big source of profits at high inflation rates and when competition within the banking sector and between banks and non-banks was very limited, such as in many countries in the late 1970s. It has again become quite prominent, but operating in reverse, post-crisis, as interest rates have become extraordinarily low: as the deposit rate cannot fall below zero, at least to any significant extent, the markdown is compressed when the policy rate is reduced to very low levels.Just to translate that a bit.
What the BIS is saying is that the spread between the market rate and the rate at which deposit rates can be raised — and capital essentially skimmed without over stressing the economy — is entirely dependent on the oligopolistic discipline of the banks. It is this discipline which in turn determines the “retail deposits endowment effect” which in turn determines the “capital endowment effect” for the capital system as a whole.
A concept best summed up by Einstein as:
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”Which comes down to the point that for rent-extraction to be a long-term effective strategy, it can’t afford to be so egregious that it ends up killing the hand that feeds it.
As a rule, this is why bank oligopolies must be disciplined and subtle with their behaviours. Consider the former bankers’ paradise known as Switzerland. Suspiciously boring.
If there’s too much of a free-for-all, the behaviour risks ruining the party for all rent-extraction beneficiaries.
In 2008, sadly, this party was rudely interrupted by the near collapse and death of the host.
Shortly after this became obvious to everyone, the bank system realised it had no choice but to reduce its footprint on the economy. The
Sadly, all the act of contrition did was expose the Russian roulette nature of banking sacrifices, which caused the entire system to freak out in a systemically damaging way because nobody could be sure they wouldn’t be on the chopping board next.
What happened next is well known history: it wasn’t the bankers who got burned, it was the real economy which was forced to back stop their excessive claims due to the weirdly entangled nature of the system. Albeit with some major conditions.
Fast forward to today, and the real economy is just about breaking free of the burden which was the too big to fail banking sector and beginning to thrive for itself. And what do the bankers want? They want their rents back.
Why?
Because liquidity isn’t enough. In fact, all that central bank liquidity does is crowd out safe assets or force capital into risk elsewhere — until it burns by way of natural risk or negative interest rates.
So what’s a limited-by-size and burden on the economy banking sector to do in that context?
As we explained earlier today, the easiest thing really is to disguise itself as something else and hope and pray nobody figures out that when it calls itself the “technology sector” or “fintech” it’s just old-fashioned rent-seeking by a different name.
To conclude, what the economy needs is fewer bankers; not the substitution of many institutional bankers for an even greater number of ‘independent’, ‘lean’, ‘nimble’ and ‘small’ entrepreneurial fintech banker developers.
Related links:
Why fintech is a jobs story – FT Alphaville
Exposing the “If we call it a blockchain, perhaps it won’t be deemed a cartel?” tactic – FT ALphaville
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