Self-referential securities and wealth bubbles
November 2, 2015 § 21 Comments
As I have stressed repeatedly, the specific category of usury does not exhaust all possible immoral contracts. And although declining to enforce usurious contracts would be tremendously healthy for our economy, since it would ground our banking system in actual property as opposed to securitizing personal promises as if they were property, it is important to acknowledge that usury is not the only way in which financiers create the fake appearance of wealth out of nothing. Another way that financiers create the fake appearance of wealth out of nothing is through self-referential securities. (The spectacle of investment banks doing just that was what got me interested in the subject of usury in the first place).
A financial security, generically speaking, is a contract or bundle of rights which entitles the bearer/owner to something else other than the paper on which it is written or the computer memory in which it is recorded. Financial securities make great currencies for trade, because ownership, unlike property itself, can be easily transferred from one party to another without reference to the physical limitations of space and time. I can transfer ownership of something to you even if we live thousands of miles apart, and the thing in question can be thousands of miles away from both of us. (This might be a good time to remind readers that a usurious loan – a personally guaranteed loan charging interest – is always immoral no matter what is lent or borrowed: securities, commodities, or any other property).
Many securities are themselves entitlements to other securities. For example, a demand deposit at a bank is a security which entitles the owner to fiat currency on demand (to the extent of the bank’s capacity to provide it from the base of property in which the bank has a stake); and fiat currency is itself a kind of security. Folks who comment on this kind of structure, where one security represents entitlement to another security, often refer to this as abstraction. But upon reflection I think a better term might be indirection, because a bundle of rights representing a structure of entitlements to another bundle of rights is not really a mere “abstraction”. Computer nerds can think of it as a pointer to a pointer: in a case of two levels of indirection, the first pointer references the second and the second references the actual object. (That oversimplifies it a bit, because the kind of property claims associated with each ‘pointer’ can be different).
Now as you can imagine, this all gets rather complicated rather quickly in the world of high finance. And when the path of securities granting rights to other securities becomes complex, it is possible for a security to ‘point back’ to itself, such that the estimated value of security A is itself ultimately dependent upon the estimated value of security A. This self-reference obviously introduces unreality into the picture: I’ve been known to call this kind of thing a ‘horizontal Ponzi scheme‘.
A concrete example I’ve given before comes from the 2008 financial crisis. During that crisis, under-collateralized usurious mortgages – mortgages on homes with prices which were themselves overinflated by the easy availability of usurious mortgages – were ‘securitized’ through a complex structure of rights into ‘bonds’. The ‘bonds’ on their own would have had (and should have had) crappy ratings, so to make them look less risky than they actually were the investment banks in effect ‘insured’ each others’ bonds: bank A insured bank B’s bonds, bank B insured bank C’s bonds, and bank C insured bank A’s bonds. This obviously did not increase the actual pool of actual property available to satisfy the bond obligations: like a usurious loan it merely created the appearance of wealth, not actual wealth, building the balance sheets of the investment banks in question with bricks made literally of nothing.
So circular paths through the rights created by securitization are another way, in addition to usury, that modern financiers create pseudo wealth out of nothing. It isn’t usury strictly speaking but is still, in Aquinas’ words, “selling what does not exist”.