Banking Bathwater and Financial Innovation

No talk of bathwater would be complete without first speaking of babies, so let's start there.

Raising your $299,000 baby

If you're self-employed, you can deduct 50% of your meals and entertainment, if business related. If your children refer clients or customers to you, you can deduct the cost of taking them to a restaurant if business is discussed.

Dad, how's business? Son, business stinks. Thanks for asking.

*Badum ching!*

Okay, now on to our regularly scheduled bathwater programming. The following article was written when the Dow was 10,325.38 (closing price on October 3, 2008). The Dow is now 8,577.91. If you are a long time reader of this blog then surely you can feel the pent up hindsight sarcasm about to flow. I sure can. Oh yeah baby, here comes the bathwater!

October 5, 2008
Don’t throw the banks out with the bathwater

There is need for some calm reflection, however. Capitalism is not dead and banking is not a fundamentally evil and immoral business. Capitalism is not perfect, but it is still the only viable economic system - a view even China’s communist party is prepared to accept. Banking, as history shows, has been responsible for enormous growth in the global economy over the last few centuries.

Capitalism is not dead. Hurray! There won't be any need for the government that has the reserve currency of the world to start buying stakes in its top nine banks then. As a side note, it must really stink to be bank #10 right now. You simply weren't big enough to make the cut.

The problems we are facing today are not due to a fundamental flaw in banking, but to excesses that have arisen in particular parts of the system. The fact that sub-prime lending has been found to be lacking does not invalidate a wide range of other banking practices which are fundamental to the financing of a broad range of economic activities.

There's no fundamental flaw in banking. As with Vegas, what happens in sub-prime stays in sub-prime. Uh huh, right. There's nothing to see here. Please disperse.

The 19th and 20th centuries were further characterised by periodic banking crashes, the most notable of which occurred in the US, producing the Great Depression.

Banking crashes and Great Depressions seem to be something the US is rather good at.

These banking crashes and financial disturbances arose because of the permanent tension that exists between financial prudence and financial innovation.

Say what? Doesn't that imply that financial innovation is somewhat the opposite of financial prudence? Interesting. That's not quite what we've been told. If I didn't know any better, I'd start to suspect that financial innovation is another way to describe a financial scam. Surely there must be some example of what financial innovation might be and how it might help to prevent future problems though. I must be misunderstanding the concept entirely.

For example, it was a major financial innovation to move from the gold- and silver-based monetary system to a paper money and credit system. This metamorphosis of the monetary system enabled credit to become more freely available to a wide range of borrowers.

Financial innovation is falling off a gold standard in the 1970s because we could no longer afford to stay on one? Seriously? Wow, thanks for offering such a great example. So financial innovation really is a scam. Got it. I now have a much greater respect for its power of financial destruction. In fact, I can't wait to see how the hundreds of trillions of dollars in exponentially growing derivatives financial innovation plays out. They're what Warren Buffett calls financial weapons of mass destruction. One wonders if they are powerful enough to obliterate capitalism entirely. That's just crazy talk though, for crazy times.

This all makes sense now. This is not the death of capitalism at all. Not even close. This is innovation in action. As with the "major financial innovation" of falling off of the gold standard, we're simply falling off the capitalism standard because we can no longer afford to stay on it either. Brilliant!

Gold Standard

However, under the fiscal strain of the Vietnam War, President Richard Nixon eliminated the fixed gold price in 1971, causing the system to break down.

Major financial innovation for the win!

It could be worse I suppose. What if we find out that it isn't actually bathwater we've been drinking? I've seen dogs drink from another water source in the bathroom and I'll tell you this... it is not pretty.