T-bills as a substitute for financial regulation

by on June 10, 2011 at 5:25 am in Economics | Permalink

Let’s say that somehow — miraculously — the United States achieved a balanced budget, and furthermore assume that this did not interfere with cyclical goals.  There would be many fewer T-bills, especially since the current structure of the debt is quite short-term.

Fully safe collateral would be hard to come by.

I see the paucity of safe assets, and safe collateral, as a major financial problem looking forward.  Our economy desires to extend more short-term credit than we can back by ready safe collateral or that we can cover by FDIC-like insurance.  Yet credit moves forward, in part because of bailout incentives but also because failed managers simply aren’t, and cannot be, punished very hard.  We return to the 19th century problem of bank runs, this time on the shadow banking system, and we realize to our horror that 1934-19?? was the exceptional and now-disappeared “safe period.”  We shudder to think of the next crisis, which is one reason why so many people are skittish about the Greek situation.

T-bills limit one agency problem, but create another.  If there were T-bills “coming out our noses,” finance would be much safer, although of course we would have to face the moral hazard problem of what the government does with so much borrowed money.  When the quantity of T-bills goes down, financial regulation becomes a tougher act to pull off.

When the Fed pays interest on reserves, cash becomes like T-bills.  Interbank lending falls, because there is less need to dispense of “idle” reserves.  I agree with Scott Sumner that interest on reserves is contractionary and that has had negative macroeconomic consequences.  Still, I worry that if we eliminate interest on reserves, the regulation of interbank credit becomes more problematic.  Much more overnight lending would go on.  In essence fear of inadequate bank regulation pushed the Fed to contract in this manner.

If you want to get rid of all or nearly T-bills, you are very optimistic about bank regulation.  I am not very optimistic about bank regulation.

1 Ian Deans June 10, 2011 at 5:51 am

I understand that when faced with this situation five(ish) years ago, the Australian government chose to continue issuing bonds despite having no net debt.

2 Vacslav June 10, 2011 at 5:51 am

Tyler, there is no such thing as “fully safe collateral”: treasuries are dollar-denominated.

3 Andrew Edwards June 10, 2011 at 9:48 am

Right but the problem is that a huge chunk of financial theory as practiced relies on the implicit assumption of the existence of a safe asset. A whole lot of very important models stop working without them.

That they don’t exist is true, but pretending they exist is a very important implied part of day-to-day finance.

In my view it is correct to view this as an analytic bug in the heart of modern finance. Doesn’t change the massive implications if there stopped being any T-Bills.

4 Vacslav June 10, 2011 at 11:32 am

Right. A huge chunk of financial theory is therefore incorrect and is long overdue for a correction.

5 Yancey Ward June 10, 2011 at 11:47 am

Exactly right in both this and the reply comment.

6 rh June 10, 2011 at 5:59 am

Just like Vacslav, I think that any manager of an internationally diversified portfolio might laugh at this post.

7 Tom June 10, 2011 at 10:37 am

Yet when everything goes sideways T-Bills are the safe-haven. Name once when they were not the destination in the flight to safety.

8 Yancey Ward June 10, 2011 at 11:50 am

“Safe-haven” means safest haven in this case. In other words, safe!=safest. There will always be a “safest haven”.

9 Jonathan June 10, 2011 at 6:17 am

So forced savings into Tbills, denominated in dollars, funding feckless government spending is better than the period that led up to the crisis ? Frying pan, fire….

10 J Thomas June 10, 2011 at 6:26 am

I see the paucity of safe assets, and safe collateral, as a major financial problem looking forward.

Well, duh?

Nothing in the real economy is safe at the moment. So people want to park their money someplace safe, where they can get a safe return. How can that possibly work?

The more precarious the US economy, the less we can depend on importing oil at reasonable prices. (And other imports that we depend on, too.) That means that we can’t depend on stable prices for anything that depends on oil or other imports. That implies inflation, maybe substantial inflation. Inflation makes your safe assets not safe.

But inflation is something the government can manage. When everything gets expensive, all they have to do is decrease the money supply as fast as the real assets decrease, and the inflation disappears. In fact, if they decrease the money supply enough to get real deflation then all those safe investments can get a handsome profit even while the economy goes from bad to worse.

Better yet, if somebody wants to keep increasing their investment in “safe assets”. As long as money flows into financial instruments faster than it flows out, they provide a sink for money. We inject more money into the system, and it turns into blips in financial computers, and it doesn’t really affect anybody so long as they don’t try to withdraw it. The most gigantic Ponzi scheme ever.

The more I think about all this, the more unreal it feels. The more I feel unreal myself. “What’s it all about, Alfie?”

I’d almost like to try another gold standard, but we all know how that worked out. Basing inflation on random gold strikes was, well, random. The only thing that could make it better than a planned economy was that political human beings predictably do worse than random.

How about this — when the system collapses and we need a new system, let’s have 2^32 dollars, each with its own unique serial number. And each dollar has 2^32 cents, or maybe bits, so a 64-bit number will describe every single unit of money in the whole system. And that’s all the money there is and all the money there can be. Money becomes something other than a commodity where dollars are exchangeable, every dollar is unique and tracked as unique. Maybe there would be a market in “special” dollars whose serial numbers spell out something in some language.

And when somebody says “I don’t have your dollar right now, but I promise I’ll give you some other dollar whenever you want” what they’re saying is they don’t have your money. We might still have a rousing trade in promises to provide money someday, but there’s a big distinction between “I promise to give you this list of dollars” as opposed to “I don’t have the money right now but I’ll give you the number of dollars you want”.

We could have an unlimited market in promises, but the actual dollars would rise and fall with the economy. The more there is to buy, the more of it each dollar will buy, not counting dollars that somebody is keeping out of circulation. When the economy contracts 3% then every circulating dollar buys 3% less.

Would that be so bad?

11 Roy June 10, 2011 at 6:27 am

I will look forward to this problem when we get to it…

We should be so lucky

12 Don June 10, 2011 at 6:35 am

Your second sentence does not follow from your first. Achieving a balanced budget (whatever that means) still leaves the existing $14T in debt, which can be financed any way you like. I suppose one could argue that we’d grow out of that eventually. But with TGS style growth rates, that would take quite a while indeed.

13 Andrew' June 10, 2011 at 6:42 am

What about dollars? Just not constantly eroded by inflation?

14 Matthew June 10, 2011 at 7:19 am

When the FX or commodity markets “snap” and holders of T-bills face a 25% loss in a day against other paper currencies and/or against real money (gold), do you want us to wave this post in your face?

15 E. Barandiaran June 10, 2011 at 7:40 am

Tyler starts with the premise that
Fully safe collateral would be hard to come by.

Let me say it again (and I’ll be repeating it as many times as needed to overcome the nonsense of certainty or fully safety):
“As stated by the Spanish coach Juan Manuel Lillo, football intelligence lies in living with the certainty of uncertainty and not on building certainties that make us believe that there is no uncertainty “

Please Tyler stop repeating the nonsense claim of intellectuals and bankers that you can build certainties about the future. If you reviewed the thousands of papers and books on financial regulation, you would understand how silly most proposals are because their authors want to believe that they are able to eliminate uncertainty (of course top economists say to minimize it). One approach you may take for that review is to ask yourself in whom you trust, in addition to God. Alternatively, ask yourself how you react when someone you know tells you “don’t worry, it’s safe”.

And remember: stop relying on journalists and nonsense pundits to inform yourself and your readers. They are a source of uncertainty because they know nothing and they talk too much. They don’t reduce uncertainty, they increase it.

Finally, in your post you say “When the Fed pays interest on reserves, cash becomes like T-bills”. I know how much we like to assume perfect substitution so we can aggregate and undertake macro analysis, but let me tell you something that I learn from Hayek as well from my experience: you can put four wheels to your bike but it doesn’t mean you have a car (yes, call it a car if you want, but please don’t tell anyone).

16 Andrew' June 10, 2011 at 9:30 am

Agreed. The problem is the expectation that there can/should be safe capital. The other problem is that rather than subscribing to “first, do no harm” we inflate away what actually should be relatively safe.

17 Andrew' June 10, 2011 at 9:31 am

On the other hand, I speculate that the best face on Tyler’s argument is that if people don’t believe they have safe savings options they won’t postpone consumption.

18 E. Barandiaran June 10, 2011 at 11:10 am

We postpone consumption because we bet today that we will be alive tomorrow and ready to pay a price tomorrow to be alive the day after-tomorrow. We have learnt to live with uncertainty about the type of life we will enjoy tomorrow and the day after-tomorrow. We know we may have to regret a disaster and so we are willing to pay a price for reducing uncertainty. We also know that many people want to take advantage of it by selling junk promises. Unfortunately we trust some people that we shouldn’t.

19 E. Barandiaran June 10, 2011 at 1:31 pm

In case there is any doubt about what I mean when I talk about trust, read this Boudreaux’s letter
that concludes with this clear paragraph
“Instead, ask this simple question: why should Americans trust Mr. Weiner with substantial power to decide how to annually spend $3.8 trillion dollars of other people’s money if he, a 46-year-old college graduate who’s earned a six-figure salary for each of at least the past 12 years, has neither saved enough to pay his bills should he be unemployed for a while nor developed any skills that would allow him to earn a decent living in the private sector?”

20 Alex Hoopes June 10, 2011 at 4:02 pm

Passionately argued, but I believe the onus is on you to logically and empirically demonstrate that the existence of T-Bills do not contribute towards a more stable financial system, and that a hypothetical world in which the US government held no debt and issued no T-Bills (all else equal) would not suffer from a less stable and less functional financial system.

I do not believe anyone has satisfactorily done so, and though I haven’t finished going through the comments, I sincerely doubt anyone has.

21 E. Barandiaran June 10, 2011 at 4:44 pm

The main reason why economics still finds so difficult to deal with finance in a market economy –don’t be confused by thousands of books and reports on banks and financial systems– is uncertainty. In particular, one main consequence of uncertainty about other people’s behavior is a demand for security or safety, meaning that we are willing to pay a price for it –often in the form of assuming a legal or contract or moral obligation to others. All theoretical approaches to uncertainty and security –regardless of significant progress in the past 60 years– have yet to deliver insights that can be a foundation for arguing the conditions under which we can judge a particular financial system more stable and functional than anything we have experienced (the success of NT’s Black Swan was largely due to his ability to highlight how important the issue was, although NT did not contribute to old or new theoretical approaches). To make matters worse, from the history of financial systems we learn that their structure, behavior and performance have been highly conditioned by governments too eager to control “where the money is”. Indeed we would be very naive to ignore this fact and assume that it will not happen again. Under Tyler’s assumptions, even government-issued confetti would be a close substitute to currency.

22 Ashwin June 10, 2011 at 8:12 am

To achieve macro-stability, the central bank can increase the supply of “safe” assets. But macro-resilience is achieved when we accept that no asset is “safe”. There is no rule that says that collateral needs to be riskless. Reduce the supply of “safe” assets, remove the implicit protection to creditors and the economy will move to a system of risky collateral with variable haircuts that will break often but rarely in a catastrophic manner i.e. it will not be stable but it will be resilient.

23 joe June 10, 2011 at 8:19 am

You can’t eliminate real risk. You can try to spread it around — that’s what insurance companies do — but no one, not even the government, can create a perfectly risk-free asset if there is real risk to be borne.

24 Heath White June 10, 2011 at 9:49 am

The first commenter has it right. The gov’t can issue all the T-bills it wants, so long as it keeps the cash on the books.

25 E. Barandiaran June 10, 2011 at 10:31 am

This comment is an invitation to understand the Fed as a financial institution –that is, one that intermediates between other intermediaries of funds by issuing its own liabilities to purchase liabilities issued by others. Unfortunately our understanding of the Fed policies in the past four years is still too much biased by old ideas about money and central banking (and also by some misunderstandings about the new monetarism).
You may start by reading
In this paper the authors rely on the Fed’s balance sheet to explain its policies. It’s critical to understand correctly what the Fed reports in its balance sheet and to compare it with a bank’s standard balance sheet. To review the details of the Fed’s balance sheet and to compare with the tables reported in the linked paper see
and then take a look at a few of the weekly releases. Please read the footnotes, otherwise you will be confused about what the Fed has been doing.
Indeed, the Fed’s balance sheet is only the beginning of the analysis. Then you have to take a look at the statistics of U.S. flow of funds accounts as reported by the Fed in
Yesterday they released the data for the 2011 Q1. In table L.108 (p.70) you’ll find the Fed’s balance sheet but with the high degree of aggregation required by the flow of funds accounts and you have to compare it with the data you got from the detailed balance sheet. Then in table F.108 (p.25) you’ll find the flows, that is, the changes in assets and liabilities associated with transactions with the other sectors or units identified in the flow of funds accounts (if you compare two balance sheets of the Fed you have to be aware that some of the changes are not related to transactions, such as changes in the market value of assets and liabilities). Just look at table F.108 in yesterday’s report and you will understand that Fed policies may have been quite different from the standard characterization of “monetary policy” in reports and debates. To understand how much different it requires a lot of additional analysis.

I’d appreciate greatly any reference to research based on that data.

26 George Selgin June 10, 2011 at 11:37 am

Tyler’s suggestion that banks are “normally” subject to frequent failures and runs, with the period after 1934 constituting an exception, is U.S.-centric and, on that account, just plain wrong. Frequent U.S. bank failures both during the early 1930s and before were a product of legal restrictions on U.S. banks, among which the most damaging consisted of restrictions on branch banking. Canada, which had branch banking (and no central bank, by the way), avoided such failures and had an otherwise very sound system. Man other countries also didn’t experience any banking crises during the Great Depression.

U.S. authorities knew damn well that the failures of the 30s were largely connected to the lack of nationawide banking. So, unfortunately, did the surviving independent bankers, who lobbied hard for deposit insurance as a way to regain business while heading off structural reform. No other country followed the U.S. example until Canada did so, for entirely political reasons, in the late 60s. After that, and thanks to pressure from U.S. “money doctors,” national insurance schemes spreed like a disease.

What’s the alternative to insurance? Bank capital. Tyler also fails to mention this in suggesting that Treasuries are the only way to keep uninsured banks safe. “Regulated” capital–the kind bank’s can’t dip into when exposed to shocks, won’t due. It has to be the freely-held sort. And the only way to get banks to have hefty freely-held capital cushions is…to abolish insurance and thereby bake potential bank customers insist upon it. In other words, start unspinning the regulatory web we’re in, instead of using historical fables to justify making an even worse tangle of it.

27 Vacslav June 10, 2011 at 1:16 pm

Excellent. Too bad demagoguery stands in the way of making “politically profitable for the wrong people to do the right things”.

28 Doc Merlin June 10, 2011 at 1:32 pm

exactly true.
I especially like the part about how the capital must be freely held. Required capital ratios won’t work, because the bank has to be able to dip into them when a crisis happens, but they can’t dip into required reserves.

29 Michael F. Martin June 10, 2011 at 12:25 pm

Tyler’s argument is at an awkward level of generality. If the budget were miraculously balanced, then the need for safe assets would (and will) also be lower.

The real economy has not stood still through this crisis. There is a combinatorial problem to be solved through restructuring and reestablishing patterns for human capital development that will be sustainable for the decade or two ahead, a problem that we are still in the middle of solving. But I remain optimistic that the problem will be solved because the basic tools we have for solving difficult combinatorial problems are more sophisticated now than ever before, and dwarf the capabilities available in the last major crisis of this kind.

In short, there are worse things than to have a huge group of college educated adults sitting around thinking about what more useful things they could be doing with their lives. People are down right now, but not out.

30 Prakash June 10, 2011 at 1:31 pm

Cash will always be the safest asset. Even if a government attains fiscal solvency and proceeds to pay down its debt, cash will still be around. People and institutions will hold cash when they need a safe asset and since the government is not printing any unwanted money, there will be no inflation risk as well.

31 E. Barandiaran June 10, 2011 at 4:02 pm

As an Argentine that has studied hyperinflation and lived through some episodes of hyperinflation, let me tell you that you’re wrong. It doesn’t matter what sort of paper the government (directly or through a central bank) issues –dollar bills, T-bills, confetti, toilet paper, monopoly money, 30-year bonds, gold-backed bonds, IOUs– it can always decide to produce much more than anyone had expected. One has to be very naive to think that governments will deliver as promised. Large, unexpected excess supplies of government paper are eliminated quickly through a large decline in its price or by burning it (a small amount is always saved by collectors and antiquarians). Despite the many magic economists advising kings, presidents and prime ministers, the resources to produce government paper are scarce (an important consideration at least in the production of toilet paper) and more important the resources to deliver the promises printed in government papers are quite limited (to make things worse, in the 21st century it’s harder than ever to find a lender so stupid to lend a government –even the U.S. government– a large amount backed by a large share of the government’s projected tax revenue for the next xx years). So, again and again, when discussing government financing we go back to a basic question, in whom do we trust?

32 E. Barandiaran June 10, 2011 at 4:10 pm

Let me add this story about some bondholders that are getting anxious

33 Noah Yetter June 10, 2011 at 1:34 pm

Only one solution is safe: the total elimination of fractional reserve banking.

34 George Selgin June 10, 2011 at 5:53 pm

100-percent reserve banks don’t need capital, and for that reason wouldn’t have much of it. But in fractional-reserve systems capital makes up for some of the risk of having fractional reserves, so long as insurance doesn’t make it seem redundant. The claim that fractional-reserve banking is necessarily inferior is therefore wrong for this (as well as a hot of other) reasons. Arguing that there’s “no” solution except getting rid of it is just a way of saving the trouble of having to think much about the relevant trade-offs.

35 E. Barandiaran June 10, 2011 at 7:25 pm

Your point about deposit insurance and bank capital has been known for some time so I will not argue about it. I must say, however, that 100-percent reserve banks need capital because of uncertainty –none can guarantee that the value of whatever is backing deposits will match every minute the nominal value of demand deposits (indeed I’m talking only about demand deposits). If tomorrow I were allowed to open a bank just to provide demand deposits and had to choose freely how “to invest” the funds, I’d invest them in the most liquid assets I could get in financial markets but their value would be changing quite often (in Chile, fund managers of “private pensions” are required to have capital as proof of their commitment not to steal the funds and to cover losses other than those directly derived from the market value of the portfolios they manage). Private banks wouldn’t need capital if they provided only safety boxes (although here in Chile they have not been able to protect the rented boxes and they need to have capital or insurance to cover losses). State banks (including the World Bank and the regional development banks) don’t need capital because they can issue any liability with a government guarantee, enough to make the capital redundant. Having participated in over 20 banking reform-plans in several countries and given the technology available for electronic payments, I strongly believe that payments systems have to be separated from the other functions that banks and other intermediaries perform today. Unfortunately there is no interest in such a radical change that would eliminate most of the huge rents earned by commercial banks (indeed part of this rent is diverted to politicians).

36 J Thomas June 11, 2011 at 12:30 am

Having participated in over 20 banking reform-plans in several countries and given the technology available for electronic payments, I strongly believe that payments systems have to be separated from the other functions that banks and other intermediaries perform today.

I’m not sure I understood all the nuances of that sentence. It sounds like it has a whole lot of implications.

I talked with a disabled person who got $450/month from the government for “support”. They had a government-issued debit card. Every month the government put $450 into the account and they could spend it. A few times a month they could withdraw cash from any ATM.

Isn’t that about a third of what you’re talking about? It wouldn’t be such a big step for the federal government to issue debit cards to every American. And if there was a way for individuals to deposit money into their accounts, then the government would have its own system for demand deposits. Presumably this would be a “free” service, and banks that wanted to compete would pay their customers to have demand deposits — if that was still legal. So that’s the second step needed. And the third is for withdrawing cash. People can get small amounts of cash-back whenever they buy anything, but to get large amounts of cash requires a bank or equivalent. On the other hand, why would the government need to issue cash? Make it convenient to transfer funds from one account to another, and cash becomes obsolete except for illegal transactions.

Unfortunately there is no interest in such a radical change that would eliminate most of the huge rents earned by commercial banks (indeed part of this rent is diverted to politicians).

If an expert were to write a popular book explaining the details about the huge rents, and offering a good alternative, he might generate popular interest. He could get a ghostwriter to help him make the book popular.

Even if there was no practical result, he might make considerable money off book sales and add-ons.

37 E. Barandiaran June 11, 2011 at 9:59 am

To answer your question I’d need too much time. I can tell you many stories –for example, how Communist Mongolia was dealing with the situation you mention in your comment and the proposals that were made to reform the country’s payment system after the Communists. My stories, however, will never convey a clear picture of how payment systems can be in the future. I recommend you to read some of the reports –in particular, the country reports– mentioned in this World Bank’s page

I hope you take time to read about the extraordinary transformation of China’s system of payments in the past 20 years. In addition to World Bank reports, you can find in the web other reports.
Unfortunately most economists still want to discuss the old systems of payments without realizing the changes that the new technologies may bring about.

38 J Thomas June 11, 2011 at 12:50 pm

To answer your question I’d need too much time.

For that matter, I have no experience as a ghost writer.

Still, you might keep it in mind if you ever become unemployed or retired. Or you might take time to write interesting pieces to put up on a blog, and then before you expect you may have enough to publish as a book.

Or you might recommend the idea to your competent friends.

You have ideas which have developed no interest, but which could get a great deal of popular interest if presented with sufficient outrage.

39 E. Barandiaran June 11, 2011 at 8:13 pm

I retired five years ago to complete something that I started 50 years ago. I’m working full time on it and I know I’ll never finish it (I’ll have succeeded with my project only if others continue working on it). Since it’s not related to payment and financial systems –my areas of specialization for 25 years until my retirement first as a professional economist and then as a professor– I’m not interested in doing additional research on them or advocating for their reforms (when I retired I gave away my collection of books and documents on monetary and financial economics to my colleagues). Unfortunately the last crisis has prompted a huge debate in which most people cannot distinguish between those that had a long experience in financial systems and the pundits that talk and write about issues that they hardly had some knowledge. Today my comments on money, banking and finance are aimed first at highlighting some ideas that the former need to take into account in their debate, and second at pointing the latter’s ignorance.

40 George Selgin June 11, 2011 at 3:50 am

Your reference to ‘whatever is backing the deposits” begs the question: what do you suppose that 100-percent reserve banking means? It is usually understood to mean that bank demand liabilities are backed 100-percent by actual cash, meaning either fiat or commodity base money. There’s no uncertainty concerning the value of such assets, which therefore remains fully equal at all times to the nominal value of the liabilites they support. There is, in other words, no default risk.

41 E. Barandiaran June 11, 2011 at 9:08 am

You are looking at the past. I’m talking about how payments systems can work in the future. To simplify, you may know E. Fama’s distinction between monetary and accounting systems of payments. Old systems were largely monetary, relying either on a commodity (gold) or a fiat paper (dollar bills). New systems will rely largely on accounting, like the one based on checking accounts that we already know but we will be using mainly electronic means to give orders and to register transactions. To move toward accounting systems we need to separate banks’ payments functions from other functions. Now your question is what assets will be backing the checking accounts and we know that the answer depends on a government decision: if a monopoly, government will dictate what assets can back the accounts, but if free-competition is allowed (please check the several papers written about the competitive supply of money in the 1970s, including those by Hayek) the firms providing checking accounts and payments services will choose the assets (I think the choice will be largely determined by liquidity –both liquidity as a characteristic of an asset and liquidity as a concern in risk management).
Indeed those firms –even if a monopoly– will have to deal with the risk of default (as Chile’s fund managers of pensions have to do it). Let me repeat it again –there is always uncertainty and there is always a need to cover the possibility of losses. Even in a 100-percent reserve requirement system (BTW, I was a child in my native Argentina when Peron introduced his system of 100-percent RR on all types of deposits to control the allocation of so-called loanable funds by private banks), there is default risk because (as shown by the experience of Argentina, particularly in December 2001 when people were not allowed to withdraw funds from their checking accounts) governments can prevent conversion (as you must be aware because you have studied the gold standard for a long time). Default risk is not a question about how enforceable a legal or a contract obligation may be, but a question about the debtor’s ability and willingness to deliver what he is promising.

42 TallDave June 10, 2011 at 3:06 pm

Fully safe collateral would be hard to come by. I see the paucity of safe assets, and safe collateral, as a major financial problem looking forward

Is this a feature or a bug? A lack of a “safe” place to put money encourages investment.

I think this might actually be one of the problems we have right now — the flood of T-bills at a time when investors are risk-averse is leading to a situation in which lending is tight even though rates are low.

43 Floccina June 10, 2011 at 4:41 pm

Are T-bills really safer than KO, PG, PEP stock and commodity futures?

44 Floccina June 10, 2011 at 4:43 pm

Add to that list insulation for your home and land. It seems to me that it is bad that Gov. money and t-bills out compete other investments in a downturn.

45 mulp June 10, 2011 at 7:05 pm

Before Reagan, there was amply supply of safe bonds other than US Treasuries:

– munis issued to fund building transportation system, water and sewage, schools, etc, backed by specific revenue streams or the general tax base

– utilities bonds backed by the utility assets and the revenues generated by those assets

– corporate bonds issued to fund factory construction, backed by the revenue growth of the corporation and the high net worth on its balance sheet

– securities issued by the Federal government on behalf of FHA backed by real estate mortgages with at least 20% down on carefully reviewed properties assessments and verified borrower credit histories with real assets and inome requirements, which were then covered by Federal mortgage insurance.

But hey, that was before capitalism was redefined as pump and dump asset price inflation with bonds issued for 90%+ of purchase price with safety based on the skill of the managers in driving up asset prices while shedding assets. And before capitalism was defined as borrowing to fund consumption, instead borrowing only for building real productive capital assets. Before capitalism shifted from a focus on increasing the stock of productive capital, to a focus on driving up the price of highly debt burden capital and dumping them to reap lightly taxed capital gains profits.

Shiller stated yesterday the truth of all capital assets, especially real estate: the value is always falling. That was the message before 1980 – you buy a house or a car and the value immediately falls and keeps in falling. That is the reason debt was limited to 80% of the assessed value – a few years later, the property value would fall by 20%, whether a car or a house.

Before 1980, debt for consumption was extremely restricted. Financial “innovation” has been based on issuing debt to fund consumption in the hope the borrowers income stream would increase, or this debt would be repaid before the borrower went bankrupt.

And Republicans have run government like households, borrowing to fund consumption instead of building capital assets in the hopes they won’t be faced with making good on the debt, or forced to replace the depreciating capital stock build in the decades before 1980.

46 Hondo69 June 11, 2011 at 6:43 am

Economic theory is all well and good as long as you avoid the underpinnings of every type of financial transaction: trust. It doesn’t matter if you’re talking T-Bills, Mutual Funds or depositing your payroll check at the bank, they all involve the basic element of trust. And it can be as simple as trusting the bank deposits the money into the correct account. Or, it can be a bit more complex like trusting our fearless leaders won’t erode the value of the dollar another 10 percent. Either way, it’s the same at it’s core.

But what happens when that trust erodes?

47 Master of None June 13, 2011 at 1:08 pm

You can make the same argument for debt vs. equity. There are some corporate bonds that yield less than treasuries (IBM and JNJ, I believe); the market says that these are safer assets than US T-bills, and I am sympathetic to that argument.

As I said recently to a friend, there are non-crazy reasons why some corporations are seen as more sustainable/viable than the US Government, but there are no non-scary reasons!

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