A brief note about our financial system: Intermediation, disintermediation, and soon re-intermediation

This is a brief note expanding on one forecast in The USA *after* this financial crisis – part 2, a new economy for America:

The changes might be larger than this, but space and time limitations prevent exploring them in this post.  Just to mention one:  an end to disintermediation, a return to when household investments were channeled into financial institutions which in turn allocated long-term capital to the economy.

This was an illustration of the radical changes coming to our finanical system.  Talking of reform now is like suggesting a diet for Joe — while viewing his coffin.   When the dust settles from this collapse, we will consider what form of financial system will work better for a free-market economy plus large-government State.  While I doubt we will move to either a Socialist or Libertarian system, the changes probably will be substantial.

Hopefully this will be done after much research, wisely and carefully.  Thoughtless short-sighted decisions brought us to this crisis.

When voting in November, please consider who you want directing this process.

We had Intermediation, then disintermediation, and soon re-intermediation

An end to disintermediation” was poorly phrased as a double negative.

“Intermediation” was the usual method of financial management in the US until the late 1960’s and esp the early 1980’s.  Individuals placed their savings in banks and insurance companies, who invested the money. Any losses belonged to the financial institution, not individual savers.

Disintermediation means people directly invest in the economy, so that they own the resulting gains or losses (institutions facilitate this, as agents). This might work if people were locked into their investments, forced to become long-term investors. But the system (for many and complex reasons) offered the illusion of liquidity, allowing people to be short-term investors — providers of “hot money” — to the economy.

This was a illusion since people cannot collectively buy and sell in response to systemic events. Who will take the other side of their trades? This system is inherently unstable, and I doubt will last through this cycle. It also has other flaws, such as being both extremely expensive and inefficient.


For almost anything about economics, Lord Keynes has a powerful insight (most of his lay critics have never read his work).  Such as this…

The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only.

But a little consideration of this expedient brings us up against a dilemma, and shows us how the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is “liquid” (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk. If individual purchases of investments were rendered illiquid, this might seriously impede new investment, so long as alternative ways in which to hold his savings are available to the individual.

This is the dilemma. So long as it is open to the individual to employ his wealth in hoarding or lending money, the alternative of purchasing actual capital assets cannot be rendered sufficiently attractive (especially to the man who does not manage the capital assets and knows very little about them), except by organising markets wherein these assets can be easily realised for money.

— From “The General Theory of Employment, Interest, and Money” (1936), Chapter 12 – The State of Long-term Expectation.


If you are new to this site, please glance at the archives below.  You may find answers to your questions in these, such as the causes of the present crisis.  I have been writing about these events for several years; since November 2007 on this site.  As you will see explained in these posts, the magnitude of the events now happening is beyond what most Americans have — or can — imagine.

Please share your comments by posting below.  Please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp interest these days:

Key posts about the financial crisis

  1. America has changed. Why do so many foreigners see this, but so few Americans?, 1 October 2008
  2. A sitrep on the financial crisis: why has the treatment been so slow, so small?, 8 October 2008
  3. Forecasting the results of this financial crisis – part I, about politics, 13 October 2008

5 thoughts on “A brief note about our financial system: Intermediation, disintermediation, and soon re-intermediation”

  1. I suspect the issue is not intermediation or disintermediation. Are we investing, using credit and amassed savings, for increased productivity? More often than not today it’s for consumption or for speculation.

    The stock market is for speculation, making money through legalized, mass gambling, not for investment in productivity. Companies, for the most part, get their working capital via other means. We’ve shifted growing percentages of the returns from productive activity to speculation, and we’ve fed our speculative pursuits via credit.

    This is a house of cards, and today we’re watching the fall. We need to be asking some fundamental questions. What is the economy for? Gaining personal riches or increasing collective wealth? I opt for the second. If societal wealth generation is the goal, we’ll create a rather different economic system.

    For one, we’ll recognize that wealth generation is a cooperative endeavor, much more than a competitive endeavor. Energy and resources are abundant. We’ll relearn that the root meaning of “capitalism” is not “money” but “head” or intelligence.

    Intelligence unlocks the abundance that surrounds us. Cooperative intelligence, both with those living and working today and with past generations, best unlocks that abundance.

    This is an exciting time when we are pushed to rethink the fundamentals. There are more opportunities to develop and use our creative genius than ever before in history.

    Great flex points can bring out either the best or the worst in us. I trust we’ll rise to the occasion.

  2. William, I agree with you about the need to be asking fundamental questions even as I understand where FM is coming from in insisting that worriting about reform now is premature.

    However, the very challenge presented by any crisis is that it literally brings things to your above-mentioned head meaning that the way out is to truly confront the fundamentals of what has brought the crisis to this pass, which is often a fork in the road.

    In other words, some fundamental fallacies, if you will, have engendered this and rather than patch up the old warrior and send him back into the fray in order to finish the same battle, it is perhaps time to reframe the context so that the current conflict is thoroughly resolved, even transcended.

    Fundamental societal mores/value systems are at the root of this whole affair. Not derivatives, too much debt, corrupt government and so forth, all of which are now playing powerful tactical parts but are merely footsoldiers in the larger campaign waged, ultimately, by all of us as the collective ‘generals’.

  3. What scores have been settled during the crisis? Certainly was/is a perfect opportunity. Pull the credit in the right(wrong) moment, that’s how it was ever done.

  4. On the ‘scores’ being settled, certainly Lehman Brothers lost out to Paulson’s pals at Goldman. More of the gov’t descretion is a big reason to oppose the bailout, rather than X amount for every firm or some other impersonal formula. Gov’t does a very lousy job at picking winners from losers.

    On the fundamental issues, one clear fundamental is the falsity of the Marxist goal of ‘workers owning the means of production’. When ownership requires foregone consumption, workers will choose ‘gaining the means for consumption’ over ‘owning’. The house bubble pop is especially dangerous because so much ownership equity (investment) was taken out in loans for consumption.

    When you invest instead of consume, you’re likely to be richer in the future … when you consume more than you make, by borrowing, you’re almost certainly to be poorer in the future. And the future is now! sooner than you thought.

  5. Here is an interesting article about financial system from another point of view altogether, in this case the cost of deforestation. I have no idea if the analysis is reasonable, but even assuming a fairly broad margin of error, it is worthy of consideration, namely that the annual cost of (ever-increasing) deforestation comes to about 2-5 trillion a year, the burden falling mainly on poor people in undeveloped regions. That’s quite a bill! More importantly it does raise the issue of how we evaluate ‘progress’ and ‘the economic system’ in general.

    Of late we seem to define it in terms of net profits, rather than productivity or quality of living. Most Americans regard ‘socialist’ countries like Sweden and Norway with scorn, but they consistently score very high in terms of health, education, contentment, political stability and so forth. They have dynamic economies, or at least sufficiently so, Sweden (as did Canada more recently) dealt with a major banking crisis efficiently, so in general perhaps they are onto something we should be paying more attention to if it is time to rethink many aspects of our own system.

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