Self-referential securities and wealth bubbles

November 2, 2015 § 22 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”.

§ 22 Responses to Self-referential securities and wealth bubbles

  • Mike T says:

    The distinction between indirection and abstraction is important because the two functions are rather different. An abstraction would, hypothetically, make the buyer more secure from the finer details of their purchase and give them more flexibility to move around their investment capital. Indirection just makes it a bit harder to know what you have actually bought, though in cases like demand deposits that’s a very limited increase that doesn’t trouble any person of reasonable intelligence. I would guess that its mainly pernicious when you have indirections built on financial instruments like a mutual fund that buys into mortgage backed securities. In such a case, the indirection gives enough opacity that they can conceal fraud (as they did was MBS investments in spades) quite well from the average investor.

  • Zippy says:

    Mike T:

    An abstraction would, hypothetically, make the buyer more secure from the finer details of their purchase and give them more flexibility to move around their investment capital.

    Right, I guess securitization really often involves both abstraction and indirection, if I understand your use of the former correctly. A newly issued security often creates a diverse capital structure made up of bundles of property (often other securities) and different claims to that property — say how an index fund abstracts away from its component stocks and treats the basket of companies in which it holds stock as an abstraction.

    And it is also an indirection inasmuch as it moves one step further from the property: the index fund actually does create actual title to actual shares in the underlying basket of stocks, themselves securities representing interests in the underlying properties (balance sheets of the companies). So whereas a share of stock is a claim against the company’s balance sheet, an index fund share is a claim against a basket of claims against the individual balance sheets of the basket of companies.

    The point though is that the indirections need to be ultimately non-looping chains terminating in actual property (trees with actual property in terminal nodes), or else it becomes possible to make circular pathways (unconstrained nets looping back on themselves).

    I am still trying to think of a simple ‘decline to enforce’ rule like my Usury for Dummies amendment which would avoid the situation. At the very least each security should be required to record its entire ‘chain’ of claims to the properties in which it terminates. That way investors could at least look for ‘loops’.

  • Mike T says:

    The point though is that the indirections need to be ultimately non-looping chains terminating in actual property (trees with actual property in terminal nodes), or else it becomes possible to make circular pathways (unconstrained nets looping back on themselves).

    Finance started with a tree, then ended with a graph. That’s the problem when you’re too smart by half. It’s also an argument for why quasi-math illiterate blue bloods should have never given up control over Wall Street. They’d not have the background to get halfway down a route that stupid without getting prosecuted.

  • vishmehr24 says:

    “world of high finance.”
    Here is Weaver (Ideas have Consequeces, pp 132-133) on the abstract finanical property:
    “…the last metaphysical right [i.e., the right of private property] offers nothing in defense of that kind of property brought into being by finance capitalism. Such property is, on the contrary, a violation of the very notion of proprietas. This amendment of the institution to suit the uses of commerce and technology has done more to threaten property than anything else yet conceived. For the abstract property of stocks and bonds, the legal ownership of enterprises never seen, actually destroy the connection between man and his substance without which the metaphysical right becomes meaningless. Property in this sense becomes a fiction useful for exploitation and makes impossible the sanctification of work. The property which we defend as an anchorage keeps its identity with the individual.

    “Not only is this true, but the aggregation of vast properties under anonymous ownership is a constant invitation to further state direction of our lives and fortunes. For, when properties are vast and integrated, on a scale now frequently seen, it requires but a slight step to transfer them to state control…we should discover that business develops a bureaucracy which can be quite easily merged with that of government…Ownership through stock makes the property an autonomous unit, devoted to abstract ends, and the stockholder’s area of responsibility is narrowed in the same way as is that of the specialized worker. Respecters of private property are really obligated to oppose much that is done today in the name of private enterprise, for corporate organization and monopoly are the very means whereby property is casting aside its privacy.”

    1) The degree of abstraction may in itself be problematic, irrespective of whether you have “ultimately non-looping chains terminating in actual property ”
    2) Property is ordered to due stewardship of the earth and the cultivation of a human person by the exercise of the virtue of due stewardship.
    Does abstraction help in this exercise? Does a unit-holder in a pension fund exercise stewardship of actual property?
    3) IF abstraction is potentially problematic, what does it say about the abstract nature of fiat currency as imagined by Zippy?

  • Zippy says:

    I am open to the idea that too many degrees of abstraction may become problematic, even without self reference. But fiat currency is actually less abstract than gold-backed currency (in the sense of ‘abstraction’ used here), since the latter conflates the tax power to which it corresponds with an industrial commodity, whereas the former represents the tax power more directly, that is, less abstractly.

  • buckyinky says:

    This post may be of interest from The Thinking Housewife. Laura Wood is referring to a home equity loan, which is not usurious, yet the transaction is disdainful (i.e., “Something doesn’t quite make sense here, don’t you think?”) to her. She may be right in the particular case of her neighbor, but if I understand correctly, there was nothing about the contract per se (including the bank’s foreclosure upon the home) that was worthy of disdain.

    I haven’t had time yet to read her response to a reader in the comment section where she quotes at length from a book by Ellen Hodgson Brown.

  • Zippy says:

    Interestingly, possibly the most helpful “aha!” moment I had in my usury research was when I read this, in which Pope Callistus III takes the side of lenders in the case of non-recourse mortgages. There is nothing unjust in Laura Woods’ neighbor being required to pay rent for the time he used the bank’s share of the house, under a non recourse contract.

    The rest of the discussion seems to be about fractional reserve banking, with the usual confusion and failure to make the distinction between usurious and non-usurious loans. A bank doesn’t ‘put up nothing’ when it issues a collateralized loan: it impairs its balance sheet with a newly issued security.

  • Zippy says:

    I went ahead and emailed some links back to a few things here, to Laura Wood.

  • buckyinky says:

    Thanks for your interaction there. Your explanations are helpful.

  • buckyinky says:

    I’ve never really had experience with bank accounting, mostly dealing with closely-held businesses in my line of work, so I may be oversimplifying things in my translation of what is occurring in a securitized loan from a bank to accounting language.

    A bank can either exchange one of its assets for one of its customer’s assets, or it can record a liability on its balance sheet (an IOU) for one of its customer’s assets. When a customer deposits cash into his checking account, the bank records that cash as an increase of its own assets and in turn increases its liability (its IOU) to that customer. When the customer withdraws from the account, the bank reduces its cash asset and also reduces the IOU liability associated with that customer.

    In a collateralized loan, the customer exchanges his asset (part or all of the value of his home, car, jewelry, etc.) for the bank’s IOU in the form of a customer deposit. The customer may then withdraw cash from the bank to the extent of that customer deposit that was created. From the bank’s side the accounting entries look like 1. When the loan is made: Increase asset (the claim on customer’s property)/Increase liability (the customer deposit/IOU) 2. When customer realizes the cash from the loan: Decrease asset (customer’s withdrawal of cash upon the loan)/Decrease liability (the customer deposit/IOU).

    I think the confusion may come in by the tendency to remove the intermediary accounting entry in our minds. We think of the loan being made as simply the bank gives its cash to the customer in exchange for the customer’s assets. It becomes alarming then to think of a customer deposit being created when a loan is made. The rest of the story is that the deposit is reduced, likely to nothing, when the customer receives in cash the amount loaned to him. If it’s a revolving line of credit, the deposit account may go up and down depending upon how much the customer has out in cash upon the line at any given time.

    Another confusing thing in understanding where usury comes in: the bank probably calls the claim upon the customer’s property in a collateralized loan simply a ‘note receivable’ on its balance sheet (I could be wrong though – as I said, not particularly familiar with bank accounting). In an unsecured loan it is probably called the same thing – simply a note receivable. The reality, however, is that in the collateralized loan what is behind the ‘note receivable’ is the bank’s claim on something that both parties agree as to its value. In the unsecured loan there is nothing of value behind the note receivable, unless it is the proverbial pound of flesh. It is the pretense of the lender calling a person an asset.

  • Zippy says:

    In addition to the pretense of calling a claim against a person an asset, there is the pretense that an “IOU” asserted and bounded by a pool of property is the same kind of thing as an IOU from a person: the same error in reverse, if you will. In effect the usurer has to pretend that a pool of property is an “I” and that a person is a pool of property: that they are the same thing.

  • buckyinky says:

    …there is the pretense that an “IOU” asserted and bounded by a pool of property is the same kind of thing as an IOU from a person…

    Which pretense I was seeming to make in my description of a customer deposit as an IOU I think.

  • Zippy says:


    Which pretense I was seeming to make in my description of a customer deposit as an IOU I think.

    Well, at the very least using the same term for these two very different kinds of things lends itself to conflating them. I try to use terms like ‘personal guarantee’ for the one, and ‘claims against property’ or ‘claims against the balance sheet’ or the like for the other, for that very reason.

  • […] property, or it can mean that a person is on the hook to come up with some amount of money — an IOU.  The ‘fractional reserve’ is either cash and equivalent liquid property kept on hand […]

  • […] Self-referential securities entitle you to run around in circles looking for the thing of value to which you think you are entitled.  It must be somewhere! […]

  • […] our imaginations, and money as if its value were spun into existence by magical incantation and pagan circle dances. Contrariwise, securities granting specific rights issued by the most powerful economic […]

  • […] was not the only kind of morally fraudulent financial activity involved, however. See this post for my gloss on the circular securitization which was layered on top of the pyramid of usurious […]

  • […] is selling what does not exist; but because there are many ways to sell what does not exist which are not usury, clarity on usury specifically can be […]

  • […] to property with actual property often serves the interests (no pun intended) of usurers and other financial hucksters, so it is no surprise that this conflation is fostered by ‘the powers that be’. […]

  • […] and finance.  They simple didn’t see all the holes in their theories; holes through which creative financial engineers could and eventually did drive trucks. Modern financial technology has made the traditional […]

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