Home > Economics - General > We are all Melmottes now

We are all Melmottes now

January 9th, 2010

Hot/cold on the heels of Iceland’s quasi-default, the Roger Lowenstein in the NY Times urges underwater/negative equity homeowners to “Walk Away From Your Mortgage!”. . Lowenstein’s key point is that businesses (including those owned or controlled by the banks themselves) treat default as a straightforward business decision, to be adopted whenever it is profitable to do so. Lowenstein gives a number of examples where leading banks like (inevitably) Goldman Sachs have engaged in strategic default and urges his readers to do likewise. The piece is in a section headed “The Way We Live Now” and it’s striking that it’s taken more than 100 years for the business ethics of Augustus Melmotte to percolate through to the American middle class

To be fair, it’s only in the last thirty years or so that such ethics have become dominant in the corporate sector, to the point where a board that rejected profitable opportunities to stiff their creditors would now be regarded as having violated its fiduciary obligations to shareholders (particularly if the creditors are workers). And despite all the talk about shareholder value, a CEO who passed up opportunities for personal enrichment at the expense of shareholders would be regarded by his or her fellows as a mug.

Millions have defaulted already – (one in eight mortgages is currently in arrears). Bankruptcy is once again as common as divorce. When defaulting on debt is this common, it is hard to sustain any sort of social stigma or internalised notion that this is anything other than a financial option, like refinancing an existing loan. And, as with divorce, we must soon be reaching the point where most people who take out loans will do so in the knowledge that default is an option.

The question is – can the consumer credit system survive this? Probably it can, but the system will need some radical changes. It’s worked for several decades on the basis of creditworthiness criteria that work on the assumption that (nearly) everyone will repay their debts if they can. Until recently, the checks could also rely on the assumption that people would be more-or-less honest in the information they provided in their applications. The financial system, by promoting ‘liar loans’ colluded in the destruction of the second assumption, and by leading the way in strategic default, helped to destroy the first.

The problem for lenders now is that they will increasingly have to act on the assumption that their borrowers (including those who appear creditworthy on the old standards) are planning, at a minimum, to use default as an insurance option. The only good way to protect against this is to demand lots of secure collateral. That means less liberal credit (and, given higher default rates, higher interest rates) for everyone and no credit at all for lots of us.

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  1. gerard
    January 12th, 2010 at 14:40 | #1

    So the mere fact that governments are supposed to look out for the public interest, or that is their stated objective, is good enough to justify their moral superiority, regardless of whether or not they actually achieve that in practice?

    No, but the fact that they can behave in a self-interested manner is not much of a point in favour of institutions that must behave in a self-interested manner, if that’s the only alternative on offer.

  2. Alice
    January 12th, 2010 at 15:13 | #2

    @Ernestine Gross
    Ernestine – I wont you to explain where I did this “You are using a similar method to the one used by Alice – you ignore my qualification.”
    Im not sure what qualification I ignored, but I confess I may have done so because Terje only has one point of view – and that is “all regulation is bad regulation.”

    I do find that argument singularly unbalanced and not at all compelling.

  3. TerjeP (say Tay-a)
    January 12th, 2010 at 15:22 | #3

    Fran – Feasible is not the same as practical. It is feasible for me to travel to London in a hot air balloon but far more practical for me to buy a seat on a Qantas jet.

  4. TerjeP (say Tay-a)
    January 12th, 2010 at 15:25 | #4

    Alice – where have I ever claimed that all regulation is bad. And given your use of quotation marks I’d like you to be quite specific in providing a reference or else please retract your statement.

  5. TerjeP (say Tay-a)
    January 12th, 2010 at 15:27 | #5

    Gerard – corporations are not meant to operate for their own interests. They are meant to operate for the interests of their shareholders.

  6. Fran Barlow
    January 12th, 2010 at 15:44 | #6

    @TerjeP (say Tay-a)

    Feasible is not the same as practical. It is feasible for me to travel to London in a hot air balloon but far more practical for me to buy a seat on a Qantas jet.

    sigh

    Feasibility is evaluated by examining all of the constraints bearing upon whether something is worth doing.

    Some of the most common include:

    1. schedule f … can the proposal be implemented within the time required to make it worth doing?
    2. organisational f … can the proposal be reconciled with the institution’s goals and ethical mandate(s)?
    3. technical f … do the material, technical and human resources exist (or can they be contrived) to carry out the task?
    4. financial/cost benefit f … can the institution afford the financial outlays to implement the proposal and would the benefits of the proposal to the institution within the most pertinent timeline exceed these outlays?

    To return to your example of taking a hot-air balloon to London, feasibility analysis would likely show that compared with taking a QANTAS Jet to London that it would fail [4.] and depending on your time needs, [1.]. It might not pass [3.] either save by even more radically violating [4.]

    Of course, if you really wanted a balloon trip to London and were willing to spend any funds on the trip then [2.] would trump all the others in relation to using QANTAS.

  7. Alice
    January 12th, 2010 at 15:54 | #7

    @TerjeP (say Tay-a)
    Then Terje – Id like you to enlighten me as to what regulation you think is good or useful, because I have never seen you pro regulation anywhere.

  8. Alice
    January 12th, 2010 at 15:56 | #8

    Ill retract the quotation marks Terje …not the comment…the quotation marks were not intended as a quotation of your comments (otherwisen I would have linked to a post). The quotation marks were intended to frame a school of thought that generally is promoted by ALS.

  9. gerard
    January 12th, 2010 at 16:05 | #9

    Gerard – corporations are not meant to operate for their own interests. They are meant to operate for the interests of their shareholders.

    … well obviously. That’s the whole point of them being privately owned, isn’t it?

  10. Alice
    January 12th, 2010 at 19:17 | #10

    @TerjeP (say Tay-a)
    Terje says “Gerard – corporations are not meant to operate for their own interests. They are meant to operate for the interests of their shareholders.”

    Well hello Terje – Are you iving in the 20th century or the 19th century? What Goldman paid out as salaries last year (and likely quite a few years before that) was close to 50% of is gross revenue….yes thats right – half of all sales inremunerations. So – take a big company – imagine the hundreds and tens of thousands of shareholders

    Then imagine that half of gross sales goes to the few hundreds relatrively.

    Thats crap Terje – lots of corporations these days are working for their employees (and the upper echelon employees – not even the lower echelon ones), and certainly not the damn shareholders. Are you happy with a 2% dividend payment and a freaking promise??

    Thats all a lot pay – 2% real but 10% hype.

  11. TerjeP (say Tay-a)
    January 12th, 2010 at 21:00 | #11

    Alice – yes in some instances the workers are ripping off the capitalists. Quite ironic isn’t it. Given that the board is supposed to protect the interests of the capitalists and given the board is elected using a form of representative democracy it also says something about representative democracy that is somewhat tragic.

  12. TerjeP (say Tay-a)
    January 12th, 2010 at 21:09 | #12

    Alice – I’m in favour of reasonable regulation of soot emissions from cars and factories.

  13. Barni
    January 13th, 2010 at 02:13 | #13

    @gerard
    Gerard, I have no idea where you got such a ridiculous notion about government. Whatever might be possible with good government oversight, three decades of right agenda Republican/conservative capture of and reduction of government and the media to Wall Street boot licking has resulted in government with no money and no legislation capable of preventing any perversion of economic morality or anti-social animus.Reagan’s darling – Grover Norquist, the current Republican oracle has said government should be reduced in size until it can be drowned in a bath tub – after thirty years of continuous effort they have succeeded in corrupting & almost destroying ogvernment

  14. Alice
    January 13th, 2010 at 05:51 | #14

    @TerjeP (say Tay-a)
    The trouble is Terje – the real capitalists are the shareholders and the executive management of the corporation, who are really the employees of the shareholders and supposed to be managing the corporation to get the best returns for the shareholders, are seen as the entrepreneurs. The picture is wrong when the executive management are dispensing 50% of gross revenue as salaries, bonuses and wages before the shareholders get to carry the remainder of the expenses and get a much reduced return after that.

  15. TerjeP (say Tay-a)
    January 13th, 2010 at 07:51 | #15

    Alice – yes the top dog workers are often running the enterprise according to their own interests and the system of representative democracy (ie company boards) that is intended to protect the interests of the capitalists has at times been captured.

    However when I ran my own company the bulk of the revenue (certainly more than 50%) went in salaries and bonuses and the return to shareholders was always slim. So on the face of it the figure doesn’t shock or concern me overly. It is quite normal in many businesses for labour cost to consume most of the budget. The fact that the return to capitalists is lean isn’t something we should worry too much about. The notion that any capitalist is entitled to a good return, or a risk free return is misguided.

  16. TerjeP (say Tay-a)
    January 13th, 2010 at 07:54 | #16

    p.s. You say that the real capitalists are the shareholders as if I had suggested otherwise. I didn’t and if you thought I did then you need to re-read what I wrote.

  17. Alice
    January 13th, 2010 at 08:27 | #17

    @TerjeP (say Tay-a)
    Is that all Terje?

  18. January 13th, 2010 at 09:11 | #18

    @Alice
    Terje only has to provide one example to refute your claim about “all regulation is bad regulation”. In fact, Terje is on record as supporting a great deal of regulation, but since regulatory cheerleaders are a dime a dozen, the public interest is best served by his speaking out against bad regulation, because there’s not enough people doing that.

  19. Monkey’s Uncle
    January 13th, 2010 at 17:22 | #19

    gerard :

    No, but the fact that they can behave in a self-interested manner is not much of a point in favour of institutions that must behave in a self-interested manner, if that’s the only alternative on offer.

    The difference is that corporations only exist through the voluntary decisions of individuals to invest their resources in them and the consensual decisions of others to undertake business with them. Government exists due to a monopoly on the legal use of force which is used to transfer resources to politically favoured groups.

    There is a big difference between self-interest backed by voluntary transactions and self-interest backed by the monopoly use of force. It is like comparing a small social club merely looking after the interests of its members with an invading army looking after its own interests.

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