Daniel Davies’s effort to become the most popular man in Britain has, apparently, not developed to his advantage, to quote the Emperor Hirohito. It struck me that there are two opposed explanations for the unusual toxicity of the comments thread that ensued, and they tell us quite a lot about the Great Bubble and the Great Recession that followed.
The first would be Daniel’s explanation. Look at them! It took only six comments for someone to analogise him to a soldier whose commander pays him in whiskey and cigarettes to cut the ears off prisoners, and sixty-five for someone to compare him to one of the anonymous organisers of the Holocaust. We got to Josef Stalin by comment 115 and to Megan McArdle by 108. Surely, this is evidence that there is an unreasoning and unproductive rage around at anything that smacks of banks, bankers, or banking.
The second would be mine. Fans of Daniel Davies’s work since the distant era of Adequacy.org will appreciate that he is a practised and expert troll, and distinguished among the guild of ancient Norwegian bridge-guardians by the fact he can turn it on and off as desired. Knowing that bankers are unpopular (were they ever popular?), and that Crooked Timber is a website full of left-wing people, he crafted a post that would cause them all to freak out amusingly.
You will of course notice that the basic distinction here is that one explanation is demand-driven and one supply-driven. The first assigns agency to the buyer, the second to the seller. The distinction is important in economics – one of the most standard assumptions is that consumer sovereignty holds and that firms are generally price-takers. Another key assumption is that industry fundamentally responds to demand. Electrical engineers would say that it is load-following, like a power plant whose output can be throttled up or down to respond to the needs of the grid.
In itself, this isn’t controversial. Industries produce what they can sell. There are lags in the supply-chain, and it’s possible to have temporary shortages or surpluses, but basically, the rate of production is both constrained and driven by demand. But the stronger form of this argument, and the one that is baked into essentially all economic models, is that not just the quantity of goods, but also their quality and kind, is demand driven. The distinction between drivers and constraints is important here. It is obvious, and trivial, to say that things nobody will buy won’t be produced for very long. But that is only half the argument.
How did we decide to try making fireguards out of chocolate, or self-certifying mortgages with negative-amortising interest rates, in the first place? Obviously, there are cases where new products do respond to an identifiable demand. At the level of the whole economy, though, this implies that every conceivable product or service already exists in latent form in the minds of customers, as if there was a statue in every block of stone waiting to get out. This is…somehow implausible and unsatisfying. Among other things, it has the curious consequence that being really true to the core assumptions of economics implies eliminating the role of the entrepreneur, at least as an inventor or product designer rather than as an operational manager.
If entrepreneurs are a thing, on the other hand, we have to accept the possibility that firms have agency in structuring the markets they sell into, that even if aggregate supply doesn’t create its own aggregate demand, it is possible for specific supply to create its own specific demand. It’s Milan fashion week, after all – an institution exquisitely dedicated to the proposition that producers can at least try to define what consumers will want.
Now, back to the mortgage market. Mortgage brokers are a fine example of a business that really is demand-driven. People come to them and say how much house they are trying to buy, and the broker tries to find someone who will lend them the money. As they were both in competition as firms, and usually rewarded on commission as individual workers, their structural incentives were to follow the housing market wherever it went. In that sense, property buyers had real agency and hence culpability. The broker/originator sector was also meant to evaluate their creditworthiness, but as it didn’t take the risk on the loans itself, it didn’t have any incentive to turn people down. It had agency, and therefore also blame.
But what about the banks? Just treating them as a normal business is illuminating. Businesses invent new products all the time – sometimes following demand, sometimes reaching ahead of it. Sometimes, what they invent is dangerous to the public and they have to be restrained. Nobody would argue, for example, that in inventing the RBMK nuclear reactor, the Soviet nuclear industry wasn’t berserkly irresponsible and directly to blame when one blew up.
And one product the banks surely did invent was outsourced mortgage-servicing. This practice may yet prove to be one of the most pernicious of the Great Bubble, not because it led to illegality as such (although there’s plenty of that), but because it is a major obstacle to recovery, and it is the more profitable the longer it stays that way. When lenders were responsible for collecting payments and dealing with borrowers themselves, they were much more likely to be reasonable with borrowers who struggled to keep up the payments. They had good economic reasons for this; typically, they would recover much more of their money in a negotiated settlement than in a foreclosure, an expensive process in itself that usually ends with the property going for auction at a fire-sale price.
But once the servicing function is outsourced, the incentives are actually reversed. Not only does the servicer, the party who has direct contact with the borrower, have no incentive to agree a modification of the original loan, they have every reason to insist on foreclosure. They get paid based on the tasks they carry out, and foreclosure generates a lot of lawyering and letters, all of them chargeable to the lender.
Now, there are three ways out of a balance-sheet recession. One is economic growth itself. As, I recall, Daniel Davies once said, if you are in debt as an individual, the best solution of all is to increase your income if it is at all possible. And the Kulmhof-Ranciere study argues that increasing real wages is the best way out of the crisis at the macro-level. Another is inflation. And the point has been made, by one Daniel Davies among others, that inflation is a rather simple mechanism to adjust all sorts of contracts that were set at nominal prices that have become unpayable, one which avoids all the complex machinery of courts and loan officers.
And a third is bankruptcy, in which we recognise by law the fact that both the lender and the borrower agreed on a contract that has become impossible to honour, and both of them share in the cost of cramming it down to a realistic level. Here is a case in which a major new product invented by the financial sector, in advance of demand, is directly blocking one of the three roads to economic recovery. To what extent the banks are responsible for the lack of progress on the other two is left as a topic for discussion.
In my next post, I’m going to look at some more people who are to blame. They are not Greek schoolteachers.