I have been thinking, since the Great Recession, about strategies to divide the economy so that a failure in one section will not roll over into other sections, and so that financial stimulus can be applied in a targeted manner, without creating bubbles outside of the areas that are flagging. Most ideas have had practical difficulties for implementation, but I feel like a new one might at least be decent enough to throw to the hounds to tear apart.
In essence:
Define specific industries (tech, real estate, etc.)
Any banking organization within the country must either divide into separate entities that are industry specific or divide their accounts in a non-cross-pollinating manner into industry specific segments.
The Federal Reserve will divide the interest rate into industry specific interest rates and manage them separately.
Any business may seek a loan for any type of industry. However, these loans will be reported to the government, and the government can freely ask the business to demonstrate that the majority of money from that loan was spent within the sector that the loan was taken out of. E.g., a loan for $100k in real estate would require that you have spent $50,001+ in real estate within a 1 year period of taking the loan. Failure to do so will grant the bank the right to increase their interest rate on that loan by 1.25x (e.g. 8% -> 10%) and the government will raise the business’ tax load by +5% (e.g. 15% -> 20%) for five years.
Obviously, point 4 will be the one where things are liable to fall apart.
Suppose I invent something that creates a whole new industry. Before I can get any loans do I have to lobby Congress to create a new category? Do we then require banks to all create a new subdivision for my industry, or do I just have to hope that I can find one that will be willing to go to the effort and expense of doing so, and will I have to then pay the maximum legal rate since there will be little or no competition to loan me money?
Maybe I’m already in industry A and want to add industry B to my company’s ventures. Can I use my own money to do so without the government raising the rates on any outstanding loans?
Will bonds be considered to be loans? How will individuals who buy bonds firewall their investments?
Right-wingers sometimes accuse us moderates of wanting “Soviet-style central planning.” I predict that this thread will refute that: I predict you will get Zero Dopers endorsing your plan.
Banks set their interest rates based on their assessment of the chance the loan will be repaid, NOT per the advice or mandate of a government regulator. IIUC, the Federal Reserve sets exactly one interest rate directly and even it is more of a suggestion than a mandate: They set a target for the rate federally-chartered banks charge each other for overnight (not even 24-hour) loans made electronically on FRB computers. (They also set the interest rate paid on their deposits.)
Suppose I invent something that creates a whole new industry. Before I can get any loans do I have to lobby Congress to create a new category? Do we then require banks to all create a new subdivision for my industry, or do I just have to hope that I can find one that will be willing to go to the effort and expense of doing so, and will I have to then pay the maximum legal rate since there will be little or no competition to loan me money?
[quote]
This could be treated like the census, where we say that an accounting needs to take place and the economy repartitioned every 10 years.
Rates for a loan are set when you sign the loan document with your bank. The rate doesn’t fluctuate after that point.
But if what you’re saying is that, for example, I take a loan out in order to get into tech and then, midway through spending all of the money, I realize that I have way more money than I need and maybe I’d like to use the bulk of money to go into some other venture…well…
I think the best way to handle that would be to return the excess funds back and arrange a different loan in the appropriate industry. Technically, there might be some way to create a transfer scheme or something, but I’m not sure it’s worth it when such an eventuality is so unlikely (really).
This proposal doesn’t cover bonds, stocks, angel investment, etc., if for no other reason than to keep the scope fairly small and (if implemented) see how it goes before trying to attack a wider swathe of the economy along similar thought-lines.
But math is math. The optimum value you (as a bank) should charge is based on the numbers in the environment around you for defaulting rates, interest rates at federally-chartered banks, how optimistic the market is, labor rates, etc. While fuzzy, there is in theory an optimum that can be gleaned through the mist, using some rough math, and when the numbers in the environment change, your formulas will spit out a different number that you should be applying in your business. While the FRB interest rate is not a mandate, it does affect the economy through a trickle-down effect via the simple math of the situation. Everyone wants to profit, and so they’re going to change their numbers to maximize profit. It’s the law of running a successful business that has people who can do math running the books.
If you split the FRB interest rate and can target it, then we would expect there to be some amount of actual effect. There might be no law mandating that banks adjust their interest rates along with the FRB, but there aren’t today either.
Hm…maybe I wasn’t aware now that my brain has squished along a little more.
That does make the scheme less clear how it maps to the current system. But I think it should be possible to patch it over. But I’ll wait till my brain is more awake again to propose something.
I’m not averse to the government encouraging or discouraging specific sectors. Want to encourage domestic clothes makers? Put a tariff on clothing imports. Want to discourage gas-guzzling cars? Increase the gas tax. Encourage home ownership? Have a mortgage tax deduction. Encourage major advances in system and materials design? Take bids for a trillion-dollar fighter jet. :eek:
But forcing banks to set interest rates unrelated to their risk doesn’t seem like a proper market-based approach to pursue such objectives.
You can’t silo economic activity like that. Let’s suppose we want to set the residential housing industry in its own little corner. Then imagine the largest housing builder in - Phoenix, for instance - gets in financial trouble. The builder lays off all their craftsmen, who then look for jobs in commercial construction. The construction trades get into an argument with those contractors because the contractors are hiring laid off residential workers at a lower wage than the industrial craft workers.
The next thing you know, there’s a strike in the construction industry, which drags down the entire economy of Phoenix. Businesses can’t expand, which means their banks can’t loan money for new construction. Those businesses stock prices slide, which drags down the entire industry, not just those businesses directly located in Phoenix.
As a real-life example, consider what used to be called the Savings & Loan industry. Those institutions were tightly regulated so that the majority of their business revolved around residential mortgages. The industry regularly had boom and bust cycles, and by 1980, it had convinced the Feds to make S&L institutions pretty much like banks. That caused even bigger turmoil, and pretty much destroyed “Savings & Loans” as a separate industry. This demonstrates the business principle known as “damned if you do, damned if you don’t.”
I think the right thing to do is to put certain checks in place to regulate stuff like mortgage backed securities and collateralized debt obligations, so that they don’t get out of control like they did in 2007-2008.
The problem back then wasn’t the interconnectedness and integration of the financial industry, but the deeply sketchy shenanigans that some players were engaging in w.r.t. subprime mortgages, car loans. MBSes and CDOs.
Besides the clear infeasibility of it, I don’t even see what or how it is supposed to help. What benefit does this system provide, in your opinion? Or is this just obstacles for obstacles’ sake?
“so that a failure in one section will not roll over into other sections, and so that financial stimulus can be applied in a targeted manner, without creating bubbles outside of the areas that are flagging”
Which of these specific industries does not spill over into every other industry?
It actually makes more sense from a risk management standpoint to separate banks by function (investment banking, savings & loans, etc), similar to Glass–Steagall and have each function be cross-industry so that a failure in manufacturing or high tech doesn’t bring down the entire banking industry in that sector.
I don’t think this is really needed as lenders are usually pretty good at assessing risk in a particular industry and adjusting their rates accordingly.
Yeah…really all this is what we call “shitty regulations”. Complex and bureaucratic without actually accomplishing it’s intended purpose.
In reality, what makes more sense is to ensure that financial services companies maintain large enough reserves to cover their “bets”. Whether its home loans, shorting stock or trading in complex derivatives, if the institution doesn’t have enough reserves to cover their losses (or are perceived to not have enough), they can go out of business. It’s the “going out of business” of banks that are so large they are “too big to fail” which has the potential to reverberate through the entire economy.
This wouldn’t work, and I’m not sure you understand how banks fundamentally work. You will be basically increasing systemic risk.
Banks need lending capital in some format in order to load it out, and by definition that capital cannot come from the entities that want to borrow. Jus the first-glance problems with your idea are that (a) few, if any, industries would even have the aggregate capital to lend to the banks, (b) the firms that did have the capital wouldn’t lend it to the banks to the competition can borrow it, (c) many industries are sufficiently concentrated that a bank would be dependent on them, and (d) you’d massively reduce competition in the banking industry, while also (e) increasing loan interest and decreaing availability.
The biggest point, however, if this does not, and cannot change he basic accounting equation at the floor of this. The banking system, in and of itself, does not cause the kind of problems you mean. The aggregate loss or debt wouldn’t be different under your proposal - but it would be born by a much smaller and weaker banks much more prone to failure.
Are you asking about my savings & Loan example? Simple. When it was restricted to a single segment (residential real estate), it was subject to cyclical boom and bust cycles. When the regulations were loosened to allow the industry to compete in other segments, it was still subject to cyclical boom and bust cycles.
It’s impossible to segregate the U.S. economy into separate silos.
That may be true, but we’re already doing it so that’s really sort of a “that ship has sailed” sort of thing.
And, I assume, the reason is because the powers of tariff and tax deductions, etc. are controlled by Congress not by the macroeconomic elites. The people who have the knowledge to fiddle with economic policy have limited access to the tools to do it and that’s a much harder change to make. You’re unlikely to get the Fed turned into something that has the power to change those independent of Congress. And, one could even argue, the current divide is for the better.
I do agree with the basic idea that central management of the economy is problematic. And my previous solution to deal with that was to remove sticky numbers from the economy, with the idea that this allows the free market to correct for recessions/depressions in the classical way that we would expect, and without needing central planning. (Unfortunately, I don’t think this idea is sufficiently “sexy” to ever be implemented.)
But, given central planning, you’re better off to divide the levers between a variety of organizations, operating on different principals. This, in theory, creates something like the free market itself, with different actors operating on it freely, based on their view of valuation and likely outcomes, while limiting the control to a subsection of the market who is (in theory) operating on some rational principals. So having some parts controlled by Congress and some by the Federal Reserve, and yet others by the state governments, all contributes to an “overseer” market that manipulates the free market, to try and keep it healthy.
One nice feature of splitting things by sector, for example, is the potential that you can divide out management of each interest rate to a different group of overseers, bringing in more views to the overseer market.
Define specific industries (tech, real estate, etc.)
You’ve just created a new government department defining industries and, worse, a new class of professional financier whose raison d’etre is subverting the regulations to get their client classified into the industry grouping with the most advantageous interest rates.
I’m not sure that your example makes your case, but I follow your argument at least.
I don’t know whether this strategy would have any effect. There are real reasons for crashes to extend beyond the sector in which they occurred. But I do think that it is greater than it should be, due to panic and irrationality.
I mean let’s take the example that the total cost for the Federal government to have opted to cover the interest for all of the real estate loans that caused the Great Recession would have been something like $39 billion, which is basically less than the Federal government spends on impulse purchase midnight snacks. But, in end effect, the whole thing caused a five year reduction in the US GDP of trillions of dollars. That’s stupid.
And, if we look at the case of the Greek economic crisis, there were a whole bunch of people saying that a hard issue for the Greek government was that they shared their money with the rest of the EU, and that limited the ability to target them.
The proposal can affect all of this in three ways:
If a sector of the economy is running “hot”, i.e., it looks like a bubble might be forming, the Fed would be able to cool it down, helping to prevent the likelihood of the bubble, without having to cool down the entire economy. So, it makes crashes less likely, because it gives the Fed more freedom to act. Right now, they are limited to acting in cases where it looks like the whole economy is going to hell, not just subsections.
If a sector of the economy is flagging, the Fed can stimulate them without risking other areas of the economy that are hot from blowing up.
The marketplace, knowing about #1 and #2, can trust that the Fed will be more keen to take corrective actions and capable of taking corrective actions when a bubble has popped in some part of the economy. There is less anxiety, overall, that they won’t act or won’t be able to act in a strong enough way in that sector, because their actions affect the whole economy. As such, the market is less likely to panic, and the financial dominoes are shrunk. This isn’t to say that the crash won’t snowball, just that we would expect the ramifications to not be quite as large.
We already define industries. You can look up taxation, employment, etc. records from the Federal government and you will see things broken up by industry.
At the moment, it may only be for reporting purposes. But my suspicion is that there are already laws targeting specific industries on the books, in terms of cutbacks, regulations, etc.
Yeah, but the “only for reporting purposes” is a get out of goal free card to a evade the consequences of the OP.
At the moment US businesses probably define themselves; they do on this side of the puddle.
But if that classification defines their essential access to and rate of financing then that’s a whole different hill o’ beans.