You can provide a service that is a net loss overall, but still a benefit to a few. It's the tragedy of the commons.
Let's make it simple and say there are two villages. Some people in village A decide to start raiding crops from village B, because they find they can steal crops more easily than growing them, so stealing is a net benefit to village A.
Village B, noticing the theft, decides to start paying some farmers to defend the village instead of farming. This is a positive outcome for Village B, because the cost of their new security force is less than the cost of the stolen crops.
Ostensibly there are two positive outcomes; both sides now maintain a security service and find themselves at an equilibrium.
But if you look at Village A and B together, you'd see that they'd both be better off if there were no raiders and no defenders and could concentrate on farming. The overall drain on society gets worse as the situation escalates.
Imagine that Village A decides to create more thieves to overwhelm B's security, and that turns out to be profitable.
Now imagine that this exact thing is taking place, at every scale, millions of times a day.
Let's say I'm competing with Dave to buy a house we both want. The only thing holding that price down is our collective willingness not to borrow huge sums of money to outbid each other. Let's say the bank starts to offer a 60 year mortgage, so that Dave can outbid me by shackling himself to a loan he probably won't pay off in his lifetime. Dave is a moron, so he does that. It's a free country.
Dave, in this circumstance, is acting like Village B, where he shoots himself and the rest of society in the foot by dedicating most of his future income to paying a bank in order to get a short term gain and win a house bid with me.
But the real winner in the scenario is the bank, not Dave.
Edit to add: I believe the article was talking about "service" in terms of the overall gain to society, not the individual services that a bank typically provides, many of which are completely legitimate like helping you sell a business.
What is unjust or inefficient about your example with purchasing the house?
Should Dave not be allowed to borrow money to own a house? Should only the wealthy, with sufficient cash reserves, be permitted to buy a house, without financing?
If you don't value the house as much as Dave -- on a net present value of the future payments you have to make to own it -- why should you have it, instead of Dave?
Should real estate prices be capped, by a central planning board, so that Dave cannot borrow too much to own it? If so how does the seller choose who to sell to, between you and Dave? Who says the house is worth X, and not Y, when Dave is happy to pay Y?
Or is it unjust that Dave likes the house enough to commit much of his future income to it?
Why is Dave a moron? Because he disagrees with you on what to use his future income for? Should you be able to tell Dave what to spend money on, and what not, out of your view of what is socially efficient?
Perhaps not just you; you could get a few of your neighbors together and call a vote on what Dave can spend his money on. Based on social utility, of course.
But to go back to your example. Suppose you choose not to outbid Dave, because you are smarter, and instead opt to rent an efficiency studio and save up over your life and build a sizable amount of investment assets (because you did not spend frivolously on a large house). As you age, you look for your savings to work for you, because you were smart enough to defer consumption and now you feel you should be rewarded.
Where to put your assets? There are many choices. Should one of them not be the option to lend Dave's son, Dave Jr., money for his own house, in return for a level of interest to compensate you for use of your capital? But that's a pain to find the borrower and vet him, and risky if it's just relying on Dave Jr (who may be a moron like his father).
What if there was an agent you could pay, who would originate the loan, check that the title was valid, check Dave Jr.'s credit, author the loan documents, and then provide it to investors like you -- or even bundle them together, so that you could spread risk of default over a few different mortgages, instead of just one?
That would be great -- you could earn a return on your saved capital, and Dave Jr. would get what he wants too (even if you disagree with what he should want)!
Ah, but of course, agents like that are just parasites. So instead of reinvesting your saved capital with someone willing to borrow the money, you stuff it in your mattress.
The prices of things are not what they are worth, but what the market will bear.
The 30 year mortgage allows a rich man to outbid you on the home that you want to buy to live in, a property that he has no personal interest in, so that you can pay interest on the money you only had to borrow so that it could not be loaned to someone else, such that they could afford to pay more than you. That money pumped into the market only serves to raise prices. Houses are built larger and more expensively than they otherwise would be because the buyers are able to pay more.
If there were no mortgage loans available, the market would be producing a greater number of cheaper homes for sale, and a greater number of rental homes for investors, with more economic separation between those markets. The rich man outbidding you for property would have to actually assume ownership of it, and would shoulder some risk of carrying vacant rental units. Venturing into property-owner-land as a rentals investor would evoke a nasty NIMBY response.
Believe me when I say that it is possible for every person in America to own their own home, even with just a single minimum wage job for the whole household. But it isn't bloody likely, thanks to mortgage lending, zoning laws, and building and occupancy codes that completely eliminate entire classes of low-cost housing as either unprofitable for developers or outright illegal.
This same phenomenon is now occurring in higher education, wherein loans inflate the price, the product remains essentially the same, and the buyer is saddled with an enormous burden of debt. Debt is a trap laid by the wily for the foolish. But it persists because the practice nestles snugly into a Nash equilibrium. The practice is not at an absolute maximum, but neither player alone can improve his position by making a different move.
The only way for the erstwhile borrower to win is to form a cartel able to punish anyone who takes a loan to pay for a good or service too scarce to supply everyone in the cartel. In other words, non-rich folks win by regulating the hell out of lending, to reduce the number and amount of loans available.
Precisely. Now the real question is, why isn't everyone outraged over this practice? Why is none of this taught in junior high school? Why are we told that personal debt is a fact of life, and makes the world go around?
The answer lies within another question: Cui bono?
OK, so loans taken for purposes of speculation on scarce goods are a Bad Thing. But loans taken to build up real infrastructure and support innovation still seem to be a very valuable service that the financial industry provides.
And they have leveraged this one valuable service into a massive industry that, while still engaged in the valuable service, has also branched out into destructive parasitic services. One cannot remove the parasite, because no effective alternative exists for the necessary and valuable function.
So what is to be done? The only plan likely to work even a little bit would be to establish a government bureau of capital and infrastructure investment, such that if the financial industry vanished overnight, the small businesses engine would not putter out. But such an agency would be an obvious target for lobbying, regulatory capture, and personnel rotation to and from the financial industry.
They have us over a barrel, and they know it.
If lending were abolished entirely, people who would otherwise lend would be forced to buy shares, with all the associated risks of ownership.
when you want to borrow, they lend. when companies raise capital, they put the issuance on their balance sheets first. when banks make markets, they hold inventory with no ready buyer/seller.
we pay them so that we avoid having to take on that risk.
in your scenario, what if Dave is buying the house to move to a new city to take a job paying twice what he was making before? if the bank never stepped in, he could never have realized that opportunity. the bank is, of course, indifferent to Dave's motivations. For all we know Dave could really be an idiot. the bank simply bears the risk of Dave defaulting and as a consequence makes money from doing so.
Smoke and mirrors aside, the taxpayers have actually taken a huge loss on these bailouts. The official figures say: $608.9B out; $621.4B in. Looks like a $12.5B profit. But looks can be deceiving. First, it neglects the fact that we had to borrow that $608.9B and pay it back with interest. Second, and more importantly, it ignores inflation-- If we computed inflation the way we used to, before Greenspan took the helm of the Fed, we've been running 8-9% inflation per year recently. So the money we taxpayers got paid back isn't worth as much as the money we paid out. This devaluation of currency is especially evident when you consider that Ben Bernake printed up $3T out of thin air, and used half of it to buy up worthless mortgage backed securities.
But there's an even bigger issue at stake: While the US pays a lot of lip service to capitalism, this is not the way capitalism is supposed to work. AIG, Goldman Sachs, Fannie/Freddie,... they should have all been allowed to go out of business in a real capitalist economy. And that $608.9B should have been put to more productive purposes.
"Many people criticized the Fed for its response to the Great Depression. How is the Fed's response to the current crisis different?"
"The key difference between the 1930s and today is how the Fed has reacted to the crisis. In the ‘30s, the Fed more or less let the banking system collapse, allowed the money supply to collapse and allowed the price level to fall."
I'd hardly call the Fed's response to the current crisis a success-- The U6 unemployment rate for the US is currently 12.6%; when we add back housing, healthcare, food, fuel, and education into the inflation statistics, its been running at 8-9%; and the Income Gini coefficient in the US is about 0.477. Meanwhile, the TBTF banks are even bigger, and the Fed's own balance sheet is a disaster waiting to happen.
Yes - you're right, it isn't a pretty picture. That being said, can you imagine the outcome of letting major institutions fail? It is likely things would be much worse. Otherwise healthy institutions may have been brought down in the process.
Letting the banks fail doesn't entail doing nothing and letting people suffer. Hank Paulson's bank bailout proposal got rammed through Congress by the Bush Administration without much consideration of any alternatives. Paulson's plan helped banks and bankers at the expense of everybody else. There were lots of other proposals that got ignored by the press. Here's three different approaches. While I personally favor the third approach, I think its very important to dispel the idea that we didn't have any choice but to bailout the banks, so I want to illustrate a variety of approaches:
(1) Steve Keen suggested a debt Jubilee: "monetary injections by the Federal Reserve not into the reserve accounts of banks, but into the bank accounts of the public--but on condition that its first function must be to pay debts down. This would reduce debt directly, but not advantage debtors over savers, and would reduce the profitability of the financial sector while not affecting its solvency" quoted from http://www.debtdeflation.com/blogs/2012/07/22/the-crisis-in-...
(2) Mortgage assistance: put a moratorium on foreclosures; freeze rate hikes in adjustable rate mortgages; help homeowners refinance their mortgages; or replace home borrowing with renting.
(3) Ron Paul proposed we abolish the Fed. While the Fed's profits belong to the federal government, the Fed itself is owned by the nationally chartered banks. Therefore, it's power to create money is used to benefit the banks, not the government or "we the people." Take that power away from the banks and put it back in the federal government, where the US Constitution says it belongs. This has many immediate advantages. Here three: (i) The federal government can tear-up the $1.6T of debt on the books of the Fed. (ii) The federal government no longer needs to borrow money. (iii) Eliminate the asset bubbles created by the Fed's artificially low interest rates and quantitative easing. See http://theeconomiccollapseblog.com/archives/14-reasons-why-w...
Let's make it simple and say there are two villages. Some people in village A decide to start raiding crops from village B, because they find they can steal crops more easily than growing them, so stealing is a net benefit to village A.
Village B, noticing the theft, decides to start paying some farmers to defend the village instead of farming. This is a positive outcome for Village B, because the cost of their new security force is less than the cost of the stolen crops.
Ostensibly there are two positive outcomes; both sides now maintain a security service and find themselves at an equilibrium.
But if you look at Village A and B together, you'd see that they'd both be better off if there were no raiders and no defenders and could concentrate on farming. The overall drain on society gets worse as the situation escalates.
Imagine that Village A decides to create more thieves to overwhelm B's security, and that turns out to be profitable.
Now imagine that this exact thing is taking place, at every scale, millions of times a day.
Let's say I'm competing with Dave to buy a house we both want. The only thing holding that price down is our collective willingness not to borrow huge sums of money to outbid each other. Let's say the bank starts to offer a 60 year mortgage, so that Dave can outbid me by shackling himself to a loan he probably won't pay off in his lifetime. Dave is a moron, so he does that. It's a free country.
Dave, in this circumstance, is acting like Village B, where he shoots himself and the rest of society in the foot by dedicating most of his future income to paying a bank in order to get a short term gain and win a house bid with me.
But the real winner in the scenario is the bank, not Dave.
Edit to add: I believe the article was talking about "service" in terms of the overall gain to society, not the individual services that a bank typically provides, many of which are completely legitimate like helping you sell a business.