Comment in the Economist
Traders did what comes naturally given the commodity they were trading. The problem is not with traders and the solution is not to be found in their operations. The problem is in the system where all asset classes use the same money. That is the traders trade money not assets. Money is not an asset it is a measure. Loans are assets but the money that is created is not an asset. There is a solution to be found by adjusting the system so that money and the asset against which it backed becomes linked.
The key phrase in the article is:
“As risk managers we should have insisted that all structured tranches, not just the non-investment-grade ones, be sold.”
Because we have made money highly fungible and increasingly so with the bundling of money this then means that all money is now the same level of risk because the underlying reason for its existence (the asset against which it takes its value) no longer applies.
Hence when an asset suddenly drops in value then all the money that was created against the asset should now drop but because it is no longer attached to the asset that means all money has to drop in value. This does not matter too much when there are assets also increasing in value but when we get whole asset classes being over priced and people being willing to create loans against them then we have a real problem because all money has less value.
The traditional solution is to let inflation reduce the value of all money but that is not a good outcome.
Another solution is to restrict the fungibility of money. We do not need to do it all the time or to everything but we do it with those asset classes that are subject to price bubbles like real estate or asset classes where we have a large amount of money loaned against the value of the assets in the class. When we create a loan against an asset class (a dwelling class) then we create tagged money. This money can now only be used for assets in that class – to buy a dwelling or to build a dwelling. You can of course sell your money to someone who wants to buy a house and the value of the tagged money will reflect the price inflation of the asset class. When someone uses the tagged money to build a new dwelling then the money they receive looses its tag because the asset class has increased in value. This system will work immediately it was introduced. That is, the US sub prime crisis would be restricted to the USA house and dwelling asset class and liquidity for the rest of the world would not “dry up”.
Another slower solution but perhaps a better one for the world is to increase the value of the assets under pinning the money. This of course is the theory on why we make money fungible but of course if people think that the value of their money is higher than the value of the assets they can buy then no one will spend their money until they see that inflation is going to take away its value. What if we now took some of the money that is used to purchase energy and we tagged it and required it to be spent on renewable energy infrastructure?
If we ignore finance charges a renewable energy power plant produces power more cheaply than fossil fuel burning plants because we do not have to purchase the fuel. So once a renewable energy plant is built you can always compete and sell your power so these power plants have increased the asset base.
Of course if we did both things at the same time then the financial systems of the world would stop gyrating and we would reduce greenhouse emissions – not a bad outcome.