Capital, Not Toasters, Dr. Krugman

It wasn’t Dr. Krugman’s hate-mail treatment of securitization that made my brain go tilt.

(I say this even though we concur with Barry Ritholz’s reasoning in his blog article, “Paul Krugman is Wrong About Securitization.” )

What really got to me was the reference to toaster giveaways.

Toasters! Sylvain paid $5 for ours — used — twenty years ago, and it works just fine, thank you very much. A new toaster would not motivate any of my friends or family members to open a bank account. Nor anyone in my daily life: postman, hairdresser, restaurant manager, butcher, bus driver. I do not think any of the octogenarians who called us last year to ask if their pension plans were in imminent danger of going bust would take solace in a toaster, either.

(What a sad commentary on the general state of trust in American institutions that is — that people looking for truthful answers would turn to strangers quoted in a newspaper!)

The depositor has gone the way of the toaster. After expenses, interest and taxes, few Americans in their earning years have any income left over to put in a savings account, and retirees can’t live on deposit interest either. But something else is going on, too. Trying to make ends meet in our service economy has turned most of us into unwitting entrepreneurs. The average working American knows the meaning of the phrase “ownership society,” because an increasing share of the operating and financial risks in our economy have been foisted on us by commercial entities seeking infinite returns through endless expense management, not genuine growth. As we reach the limit of self-reliance in an economy that is stacked against us, working Americans are coming dangerously close to realizing that we are the real capitalists; that it is our energy, optimism and ideas that feed the growth of the economy.

And capitalists do not need toasters. We need capital.

Working Americans need access to funding at a fair cost of capital — meaning at rates that reflect the value of what we produce and the reliability with which we repay our financial backers. Small business owners, freelancers and entrepreneurs need access to finance, no different than corporate CFOs. We need to be able to respond to business opportunities and, at the same time, plan for the provision of care and education for our children, who are the future intangible wealth of the economy. Yet we have far fewer resources at our command than CFOs, and we are the first to be taxed by the government or be saddled with hidden taxes by the banks.

Let’s not kid ourselves. A 70s-style banking system cannot serve the American small business owner any better today than it did in the 1970s. Nor can a 70s-style education system, which failed us in math and science, enable us to thrive in an information-based economy. By now it is abundantly clear that our economy cannot be pumped up by consumption. We have consumed ourselves and our environment to death, literally.

Economic revival requires that the tables be turned: ordinary Americans need to be treated with respect as the capable producers we are, or can be, not the mindless consumers that we are expected to be. For this inversion to take place, the economy must be re-engineered to listen, think, judge, respond, take responsibility and above all adapt, through the use of informational feedback. In an economy that rewards responsible resource allocation and renewability, informational capital is uniquely important because its value increases – rather than being depleted — through utilization.

All of which brings me back to securitization: the only form of credit extension that can realign the incentive structure so as to reward value creation by transforming data into informational capital and using it as a partial substitute for monetary capital.

That is what securitization was before the banks set out to sabotage it. Sylvain and I watched the abuses begin in earnest after 1998 and the failure of Long-Term Capital. It took about a decade to completely dismantle the securitization market by subverting its rules, which were not well known outside the circle of practitioners. Because ignorance kept the easy money machine well-lubricated, everyone had a hand in its destruction, including the people whose best interest it was not to destroy it: investors, regulators, finance professors, journalists and ordinary Americans who were allegedly too dumb to understand it.

Supposedly, the economic crisis is going to teach the American consumers a lesson or two about their spendthrift ways: more second-hand toasters, and fewer plasma TVs funded by the “home ATM.” But what about the people who got off scot-free with our equity? What have they learned?

And more importantly, when can we expect the return of a real economy?

We are used to being taxed. We accept the necessity of sacrifice. Yes, there is pride and honor and a sense of due accountability in the label “taxpayer.” At the same time, we have a right to expect that the economy we help finance has incentives in place for our children to live secure, wholesome, meaningful lives. Because we live in a commercial society that regulates itself through information, raising the incentives means raising the standards on informational disclosure, which will have the effect of lowering the barriers to entry for anyone who demonstrates the ability to generate that which others value.

As a good faith gesture towards the re-establishment of the economy on a fairer footing, we ask the government to acknowledge that we are being made the lenders of last return in the attempt to restart a baking system that, as yet, we have no reason to trust. We deserve to know precisely how big our transfers of wealth are going to be. And then, we’d like reasons to believe we will never be asked again.

— Ann Rutledge