Your Life is More Financialized Than You Think

There are really only two things that get the financial sector in trouble: excess leverage, and maturity transformation. Excess leverage is easy to understand. If you have $100 of assets, and you borrow $50 against it, you’re safe as long as the value of your assets never declines by

There are really only two things that get the financial sector in trouble: excess leverage, and maturity transformation.

Excess leverage is easy to understand. If you have $100 of assets, and you borrow $50 against it, you’re safe as long as the value of your assets never declines by more than half. If you borrow $95, you’re taking more risk: a 5% decline can wipe you out.

Maturity transformation is a little more complicated. Suppose there’s a bank that offers demand deposits, i.e. you give them money, you get interest on your money, and you can demand it back any time. The bank uses this money to make long-term loans. This is a nice, profitable business: in simpler times people talked about the 3/6/3 rule (“Pay 3% on deposits, make 6% on loans, be on the golf course by 3 every day.”) There are two problems with this, one practical and one social.

  1. The practical problem is: what do you do when a lot of depositors want their money back, and you run out of cash? You have to sell loans. But loans are illiquid, and if depositors want their money back because they’re panicking, the market price for loans will have dropped a lot. Additionally, borrowing short and lending long leaves you unhedged: if interest rates rise, the cost of your deposits will rise, but the value of your assets will drop. This is not pleasant.
  2. The social problem this introduces is flattening the yield curve. Classically, long-term debt pays more than short-term debt, because of credit risk (more can go wrong in 10 years than in 30 days), because of interest rate risk (a long-term loan’s value is more sensitive to rates), and for transaction cost reasons (borrowing for a ten-year term is, in part, a way to pay not to go to the trouble of borrowing for a month, 120 times in a row).

A couple times a decade, the real world gets to feel smugly superior to the financial world when either excess leverage or maturity transformation comes home to roost. We told you this was a bad idea, we say.

But the real world needs to take a real long look in the mirror, because the difference between finance and everything else is that finance explicitly formalizes what’s otherwise informal and explicit.

What is a loan if not a promise? And, conversely, what’s a promise if not a loan? Suppose you tell your boss: Sure, I’ll finish that project by the end of the week. You’re the debtor to an implicit loan; you’ve borrowed credibility and promised to repay it with completed work by end-of-day Friday. And how do you fund that promise? What’s your liquidity source? It’s your ability and willingness to show up at work every day, marshal the resources you need, and get the project done — you’ve made a long-term commitment funded by the expectation that you can get something done in the series of short terms contained in that long-term.

In other words, you’re a maturity transformer.

Similarly, the aggregate scope of your commitments represents a kind of leverage. If you’re the sort of person who maintains a loose schedule, with lots of free time, you’re not very levered. In the event of a financial disaster, you can probably work harder. But if you’re one of those people who works flat-out all the time, has a ton of social obligations, and lives exactly within your means, your life has enormous artificial leverage; if either your job changes or you accrue another social obligation, you instantly risk defaulting on some of your promises.

John Kenneth Galbraith once wrote about “The Bezzle”:

To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in — or more precisely not in — the country’s business and banks. This inventory — it should perhaps be called the bezzle — amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

Since borrowing costs money, access to borrowing constitutes an asset; we can say that an economy in which people promise at the limit of their abilities is an economy with a large amount of implicit bezzle, and that if they start defaulting on those promises, the bezzle leaves. And most schools of economic thought agree that anything that temporarily increases credit, in any form, will raise GDP — just as a rise in consumer or corporate leverage juices economic growth (for a while), a rise in people’s willingness to make promises will do the same.

It’s worthwhile to think of this implicit leverage, this shadow of a shadow banking system, in light of the rise of productivity gurus and hustle culture. Some productivity tricks are pure Pareto improvements — keeping a to-do list is simply better than not doing so. But many of the tricks, especially the psychological ones, are really about convincing yourself to work harder than you really want to work. The ideal seems to be that if you read the right productivity manual, you’ll eliminate some of the slack in your life and work as hard as someone who really, desperately, needed to get the job done.

Which, in equilibrium, is great! More productivity at work either means owning nicer stuff or having more free time. But it also raises your leverage: if you can produce the same output as an inspired person, inspiration doesn’t raise your output. And nothing inspires hard work quite like a recession.

Slack, lunch breaks, lazy Sundays, unscheduled downtime — these are all nice things, and from the perspective of your personal balance sheet they’re an equity cushion. Deplete that balance sheet at your peril.