Such a last-century understanding

The Reality-Based Community: Virtual financial particles

The equivalent of Intrade’s margin requirement for banks is the reserves that they have to set aside to cover the risks in their derivative positions. The banks lobbied hard to allow these to be calculated with their own in-house models – this laxity will have to go. The total amount of capital tied up, even at current inadequate ratios, must be in the tens of billions. These capital requirements are also, as noted above, inherently more volatile; so banks become more dependent on each other to meet their regulatory obligations. What brought the house down however was the systemic informational risk; the subprime mortgage derivatives couldn’t be priced.

But the folks who’ve been failing aren’t (in regulatory terms) banks. Published accounts have leverage ratios (very roughly the reciprocal of margin requirements) at 30:1 to 100:1. And even that’s not really a reserve requirement, because who knows where the original money for the pyramid came from. Imagine that someone lent you money for that Intrade bid, and someone lent them money…

But the real misunderstanding is thinking that all this deadweight and all the cuts taken out for processing are bugs. This is the financial industry we’re talking about. Who gets all the fees, and who collects all the spare interest? So the more layers and the more opaque each layer, requiring more advice and more fees, the more profitable. If bankers could find a way to spin money around that was all deadweight and fees, with no benefit to the physical economy at all, they’d be so there.

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