CHANGING AMERICA'S MIND
Chapter 1 - Part9
The Insatiable Demand that Became an Addiction
Note: If you are just arriving to this blog, please start with the Introduction.
The book is being published sequentially as it is written.
The promise of Wall Street and the financial markets for double digit returns and beyond is one of the factors that seems to have fostered an insatiable demand by Big Money for ever higher returns. Perhaps the other major factor was described by Thomas Geoghegan, in the April 2009 Harper Magazine article entitled, “Infinite Debt” as the legalization of usury. He describes how the previous state usury laws limiting the interests that banks and other lending institutions could charge were overturned by a 1978 Supreme Court ruling in the Marquette National Bank vs. First of Omaha Service Corp. In this ruling, the court said that Minnesota could not enforce its usury law against a credit card issued by a Nebraska bank. The National Banking Act of 1864, it said, allowed banks to lend at interest rates set by the state where the bank is chartered, not where the loan is made.
In effect, this opened the doors to higher and higher rates leading up to the 30% rates now charged on credit cards and the much higher rates assessed by payday loan type companies. State after state repealed or loosened their typical limit of 9% in an effort to keep their banks competitive. (I will discuss this further in Chapter 3.) With this change, the Big Money began shifting out of manufacturing and other productive investments and into the financial sector, with its higher rates of return. This, I suggest, was the dope on which the markets got hooked, creating an insatiable demand for more – no matter the costs.
What Can Be Done?
As I said earlier, I do not believe in extensive regulations that attempt to bring such predatory practices under control. Big Money will simply recruit and provide incentives for fresh young minds to devise new games of “keep away.” It is impossible to create enough regulations to stop this theft and it would require far too many people to police them.
Instead, as I have implied throughout this chapter, I believe that the answers lie in an overhaul of tax policy. There, it is possible to find relatively simple, high leverage and lasting solutions. These will be further developed in the next chapter.
Your comments and thoughts are valuable in this discussion. Please forward the posts to friends who may be interested.
Chapter Two begins in the next installment.
Larry
Changing America's Mind is on Facebook - "Like" it and recommend it to your friends - Thanks!
Thursday, September 9, 2010
Friday, September 3, 2010
Chapter 1.8 - WALL STREET & THE GREAT INVESTMENT MYTH
CHANGING AMERICA'S MIND
Chapter 1 - Part 8
The Insatiable Demand that Became an Addiction
Note: If you are just arriving to this blog, please start with the Introduction.
The book is being published sequentially as it is written.
The financial markets of the world are places where people who have excess money (more than they require for current living expenses) put that money in an effort to gain the greatest possible return of interest for its use. The concept is that the money is then used for productive purposes enabling a producer to make or grow more of something. That “more” has a value and if it is sold at a profit, the ‘investor’ then takes a legitimate and appropriate cut for his part in making it possible. Such excess money is also known as ‘capital’ which is ‘invested’ in hopes of achieving a ‘return’.
Small businesses, family farms, and startups are certainly examples in which this concept is shown to be true. It is also true, when corporations or governments raise needed capital by selling bonds. But as I demonstrated earlier in the chapter, it is a myth when the ‘investment’ is not used for productive purposes. If it does not help in making more of something that people need and therefore will buy, enabling the producer (distributor, retailer) to make a living and hopefully a profit, then where does this ‘interest’ or ‘return’ come from. For that matter, even if it is used for productive purposes, but the demand is for an interest or return that is greater than the profit earned, where does it come from?
To attempt to answer that question, let’s consider the typical profit margins achieved by productive businesses. First there are a host of successful retail businesses – department stores, hardware stores, grocery stores as examples - whose annual profits are seldom greater than 3-4%. These are referred to as high volume, low margin businesses. Farming and ranching, in good years, maybe yields 5-6%, but often the weather or falling prices result in losses instead. Even in manufacturing and even with the best of lean manufacturing practices, the margins seldom exceed 9%; industry averages are usually closer to 6%. Yet Wall Street financial markets consistently expect double digit returns; many of the financial instruments it sells are designed to yield as much as 30%. So, if real businesses can’t earn that much, where does it come from?
Perhaps it can come from growth, you might conclude. One of the articles quoted above, states that for business in general an 8.9% average revenue growth would be a record. A business can only grow in one of two ways, it either offers products or services in a growing market or it gains a greater market share in an existing one. Growth in mature highly competitive existing markets requires heavy expenditures for marketing and sometimes for incremental product enhancements. Such expenditures cut into profits resulting in lower rates of return, not higher.
Investment in high growth markets, on the other hand, usually follows the introduction of a totally new technology – think early days of television, personal computers, or the internet. These are the realm of startups where entrepreneurs and venture capitalist achieve the high rates of return justified by their innovation and the high risks. Such companies often achieve growth rates exceeding 100% and thirty percent annual profits or also common. So perhaps a portion of Wall Street’s expected double digit returns come from these startups since some of the financial securities offered by Wall Street firms also bring money into these high growth markets. The problem with this theory, however, is that there are a limited number of such opportunities so a much greater % of Wall Street’s money goes into the more speculative areas of betting for and against such companies.
So again, I ask, how is it reasonable for the Wall Street Banks and financial funds to promise returns of up to 30%? Where will this money come from? It can only come from cost cutting in real businesses resulting in the off-shoring of jobs, cuts to R&D, the externalizing of costs at the expense of the environment, and other predatory means. Or from using insider information to pick up the losses suffered by ordinary 401K holders. That, I think, could be described as legalized piracy.
Welcome to the new age of finance capitalism. In an article he presented to the Academy of Management at its 1998 San Diego Conference (foot note), David Korten discussed finance capitalism, which as I understand it, can be described as the latest phase of capitalism following agricultural capitalism, industrial capitalism, and technological capitalism. In those earlier phases of capitalism, wealth was created when a surplus beyond immediate needs was diverted from consumption into investments in buildings, machinery, and technological change. Those investments also created jobs.
The theory or logic of finance capitalism, Korten explains, is different in the following way. “The key to rapidly and effortlessly increasing the wealth of a society” he writes, “is to convert ownership rights to its productive assets into freely traded financial securities. These securities should then be placed under the management of professional portfolio managers who have a single-minded focus on shareholder return. They will pressure the managers of the assets to squeeze every possible source of profit from the enterprise to inflate the share prices. This increases the total market value of the society’s productive assets and thereby the total wealth of society.”
“Note the logical fallacy here,” he continues. “The inflation of share prices puts more money in the hands of those who own the shares – more claims against society’s wealth – but it does not necessarily add a thing to society’s productive capacity or output.” … “It says nothing about – nor does it seem to care – where management gets the increased profits that the financial markets demand.”
Perhaps Korten’s strongest indictment is that this theory’s proponents praise “finance capitalism and its underlying logic as the greatest invention since King Midas got the golden touch – a nifty way to create wealth without doing anything useful.”
Next this section continues -
Footnote: Do Corporations Rule The World? And Does It Matter? David C. Korten; presented to the Organizations and the Natural Environment Section of the Academy of Management at the 1998 San Diego Conference on August 10, 1998. Organization & Environment, Vol.11 No. 4, December 1998 389-398. © 1998 Sage Publications, Inc.
Larry
Changing America's Mind is on Facebook - "Like" it and recommend it to your friends - Thanks!
Chapter 1 - Part 8
The Insatiable Demand that Became an Addiction
Note: If you are just arriving to this blog, please start with the Introduction.
The book is being published sequentially as it is written.
The financial markets of the world are places where people who have excess money (more than they require for current living expenses) put that money in an effort to gain the greatest possible return of interest for its use. The concept is that the money is then used for productive purposes enabling a producer to make or grow more of something. That “more” has a value and if it is sold at a profit, the ‘investor’ then takes a legitimate and appropriate cut for his part in making it possible. Such excess money is also known as ‘capital’ which is ‘invested’ in hopes of achieving a ‘return’.
Small businesses, family farms, and startups are certainly examples in which this concept is shown to be true. It is also true, when corporations or governments raise needed capital by selling bonds. But as I demonstrated earlier in the chapter, it is a myth when the ‘investment’ is not used for productive purposes. If it does not help in making more of something that people need and therefore will buy, enabling the producer (distributor, retailer) to make a living and hopefully a profit, then where does this ‘interest’ or ‘return’ come from. For that matter, even if it is used for productive purposes, but the demand is for an interest or return that is greater than the profit earned, where does it come from?
To attempt to answer that question, let’s consider the typical profit margins achieved by productive businesses. First there are a host of successful retail businesses – department stores, hardware stores, grocery stores as examples - whose annual profits are seldom greater than 3-4%. These are referred to as high volume, low margin businesses. Farming and ranching, in good years, maybe yields 5-6%, but often the weather or falling prices result in losses instead. Even in manufacturing and even with the best of lean manufacturing practices, the margins seldom exceed 9%; industry averages are usually closer to 6%. Yet Wall Street financial markets consistently expect double digit returns; many of the financial instruments it sells are designed to yield as much as 30%. So, if real businesses can’t earn that much, where does it come from?
Perhaps it can come from growth, you might conclude. One of the articles quoted above, states that for business in general an 8.9% average revenue growth would be a record. A business can only grow in one of two ways, it either offers products or services in a growing market or it gains a greater market share in an existing one. Growth in mature highly competitive existing markets requires heavy expenditures for marketing and sometimes for incremental product enhancements. Such expenditures cut into profits resulting in lower rates of return, not higher.
Investment in high growth markets, on the other hand, usually follows the introduction of a totally new technology – think early days of television, personal computers, or the internet. These are the realm of startups where entrepreneurs and venture capitalist achieve the high rates of return justified by their innovation and the high risks. Such companies often achieve growth rates exceeding 100% and thirty percent annual profits or also common. So perhaps a portion of Wall Street’s expected double digit returns come from these startups since some of the financial securities offered by Wall Street firms also bring money into these high growth markets. The problem with this theory, however, is that there are a limited number of such opportunities so a much greater % of Wall Street’s money goes into the more speculative areas of betting for and against such companies.
So again, I ask, how is it reasonable for the Wall Street Banks and financial funds to promise returns of up to 30%? Where will this money come from? It can only come from cost cutting in real businesses resulting in the off-shoring of jobs, cuts to R&D, the externalizing of costs at the expense of the environment, and other predatory means. Or from using insider information to pick up the losses suffered by ordinary 401K holders. That, I think, could be described as legalized piracy.
Welcome to the new age of finance capitalism. In an article he presented to the Academy of Management at its 1998 San Diego Conference (foot note), David Korten discussed finance capitalism, which as I understand it, can be described as the latest phase of capitalism following agricultural capitalism, industrial capitalism, and technological capitalism. In those earlier phases of capitalism, wealth was created when a surplus beyond immediate needs was diverted from consumption into investments in buildings, machinery, and technological change. Those investments also created jobs.
The theory or logic of finance capitalism, Korten explains, is different in the following way. “The key to rapidly and effortlessly increasing the wealth of a society” he writes, “is to convert ownership rights to its productive assets into freely traded financial securities. These securities should then be placed under the management of professional portfolio managers who have a single-minded focus on shareholder return. They will pressure the managers of the assets to squeeze every possible source of profit from the enterprise to inflate the share prices. This increases the total market value of the society’s productive assets and thereby the total wealth of society.”
“Note the logical fallacy here,” he continues. “The inflation of share prices puts more money in the hands of those who own the shares – more claims against society’s wealth – but it does not necessarily add a thing to society’s productive capacity or output.” … “It says nothing about – nor does it seem to care – where management gets the increased profits that the financial markets demand.”
Perhaps Korten’s strongest indictment is that this theory’s proponents praise “finance capitalism and its underlying logic as the greatest invention since King Midas got the golden touch – a nifty way to create wealth without doing anything useful.”
Next this section continues -
Footnote: Do Corporations Rule The World? And Does It Matter? David C. Korten; presented to the Organizations and the Natural Environment Section of the Academy of Management at the 1998 San Diego Conference on August 10, 1998. Organization & Environment, Vol.11 No. 4, December 1998 389-398. © 1998 Sage Publications, Inc.
Larry
Changing America's Mind is on Facebook - "Like" it and recommend it to your friends - Thanks!
Friday, August 27, 2010
Chapter 1.7 WALL STREET & THE GREAT INVESTMENT MYTH
CHANGING AMERICA'S MIND Chapter 1 - Part 7
Games Boys Play continued
Note: If you are just arriving to this blog, please start with the Introduction.
The book is being published sequentially as it is written.
With adolescent boys’ games perhaps the worst damage can be cleaned up by a school janitor. Not so with the games of the Wall Street boys. This last report is about the damage they do – the destructive economic consequences I described earlier in this chapter, the corporate responses to Wall Street pressures that drain the vitality from our nation.
In a July 25, 2010 NYT article, “Industries Find Surging Profits in Deeper Cuts.” Nelson D. Schwartz reported the following: “Many companies are focusing on cost-cutting to keep profits growing, but the benefits are mostly going to shareholders instead of the broader economy, as management conserves cash rather than bolstering hiring and production.” “This seeming contradiction – falling sales and rising profits – is one reason the mood on Wall Street is so much more buoyant than in households, where pessimism runs deep and joblessness shows few signs of easing.”
I can only add that to please Wall Street, one of the ways that corporate management cuts costs is to move production offshore to low wage countries. Increasingly, since President George W Bush’s 2003 capital gains tax cuts, they have been using this mechanism to lower costs, lay off long-term employees, renege on pension plans, and drive down wages for remaining US workers. I will demonstrate in the next chapter how such tax cut stimulus strategies that benefit the wealthy tend to send the country into recession or depression.
I want to close this section on the games of the Wall Street boys, by commenting on a recent development in the futures markets. In the mid-summer of 2010, the price of wheat has risen rapidly in response to a drought in Russia. In a Los Angeles Times article August 6, 2010, P.J. Huffstutter and Sergei L. Lolko, report that, “The price of wheat surged to a two-year high when Russian Prime Minister Vladimir Putin announced the ban (on exports) Thursday.” They point out that this is in the face of a bumper crop in the US and that “stockpiles of wheat and other grains worldwide are greater now than they were three year ago,” … when, “grain shortages and rising food prices in 2007 and 2008 sparked riots worldwide …” They go on to quote Jay O’Neil, a senior agricultural economist with Kansas State University’s International Grains Program, “The world is awash in feed grains,” O’Neil said. “This is silly. These grain prices shouldn’t be this high.”
I would echo that and say, amen! One of the most adolescent and destructive games played on ‘Wall Street’ and in this case, the Chicago Board of Trade, “puerile-y” for making money, is gambling in the futures markets. As alluded to earlier in the chapter, bankers and financial funds managers with wads of ‘loose wealth’ looking to score, drove up food and gasoline prices in 2008 when they could no longer make a killing in the subprime mortgage derivatives market. Then, and now, it has nothing to do with real supply and demand – or shortages. It is caused by this speculation driving up the prices that the rest of us must pay for the necessities of life. In my view, this is not only destructive, but supremely immoral. And under the Bush tax cuts, they get to pocket most of it since they are only paying a 15% capital gains tax.
For the most part, I do not favor extensive regulations as a means of reigning in such games, but in this case, I believe that there needs to be a law! There are plenty of legitimate and useful purposes for the futures markets in which a buyer takes an option on a certain quantity of a commodity at a preset price. Farmers are able to protect themselves from bad years, bread companies are able to assure an affordable price for flour, for years, Southwest Airlines was able to hold down the price of tickets by locking in fuel prices on the futures market, to name just a few. But for speculators to be able to gamble on commodities pushing up prices for legitimate businesses and consumers with no intention of ever taking delivery, is obscene. And worse, they are allowed to do it often with only 5% down, and during the TARP bailout, with taxpayer money. And they only pay half the taxes on their winnings that you and I have to pay on the wages we earn!
I propose a law which limits trading on futures markets to legitimate businesses who have a real business use for and facilities to receive delivery of the commodities they option. I also believe the law should require that they actually buy, pay for, and take delivery of at least half of what they option. That would put a stop to much of this puerile game of destructive speculation.
Coming next -
Insatiable Demand that Became an Additiction
Larry
Changing America's Mind is on Facebook - "Like" it and recommend it to your friends - Thanks!
Games Boys Play continued
Note: If you are just arriving to this blog, please start with the Introduction.
The book is being published sequentially as it is written.
With adolescent boys’ games perhaps the worst damage can be cleaned up by a school janitor. Not so with the games of the Wall Street boys. This last report is about the damage they do – the destructive economic consequences I described earlier in this chapter, the corporate responses to Wall Street pressures that drain the vitality from our nation.
In a July 25, 2010 NYT article, “Industries Find Surging Profits in Deeper Cuts.” Nelson D. Schwartz reported the following: “Many companies are focusing on cost-cutting to keep profits growing, but the benefits are mostly going to shareholders instead of the broader economy, as management conserves cash rather than bolstering hiring and production.” “This seeming contradiction – falling sales and rising profits – is one reason the mood on Wall Street is so much more buoyant than in households, where pessimism runs deep and joblessness shows few signs of easing.”
I can only add that to please Wall Street, one of the ways that corporate management cuts costs is to move production offshore to low wage countries. Increasingly, since President George W Bush’s 2003 capital gains tax cuts, they have been using this mechanism to lower costs, lay off long-term employees, renege on pension plans, and drive down wages for remaining US workers. I will demonstrate in the next chapter how such tax cut stimulus strategies that benefit the wealthy tend to send the country into recession or depression.
I want to close this section on the games of the Wall Street boys, by commenting on a recent development in the futures markets. In the mid-summer of 2010, the price of wheat has risen rapidly in response to a drought in Russia. In a Los Angeles Times article August 6, 2010, P.J. Huffstutter and Sergei L. Lolko, report that, “The price of wheat surged to a two-year high when Russian Prime Minister Vladimir Putin announced the ban (on exports) Thursday.” They point out that this is in the face of a bumper crop in the US and that “stockpiles of wheat and other grains worldwide are greater now than they were three year ago,” … when, “grain shortages and rising food prices in 2007 and 2008 sparked riots worldwide …” They go on to quote Jay O’Neil, a senior agricultural economist with Kansas State University’s International Grains Program, “The world is awash in feed grains,” O’Neil said. “This is silly. These grain prices shouldn’t be this high.”
I would echo that and say, amen! One of the most adolescent and destructive games played on ‘Wall Street’ and in this case, the Chicago Board of Trade, “puerile-y” for making money, is gambling in the futures markets. As alluded to earlier in the chapter, bankers and financial funds managers with wads of ‘loose wealth’ looking to score, drove up food and gasoline prices in 2008 when they could no longer make a killing in the subprime mortgage derivatives market. Then, and now, it has nothing to do with real supply and demand – or shortages. It is caused by this speculation driving up the prices that the rest of us must pay for the necessities of life. In my view, this is not only destructive, but supremely immoral. And under the Bush tax cuts, they get to pocket most of it since they are only paying a 15% capital gains tax.
For the most part, I do not favor extensive regulations as a means of reigning in such games, but in this case, I believe that there needs to be a law! There are plenty of legitimate and useful purposes for the futures markets in which a buyer takes an option on a certain quantity of a commodity at a preset price. Farmers are able to protect themselves from bad years, bread companies are able to assure an affordable price for flour, for years, Southwest Airlines was able to hold down the price of tickets by locking in fuel prices on the futures market, to name just a few. But for speculators to be able to gamble on commodities pushing up prices for legitimate businesses and consumers with no intention of ever taking delivery, is obscene. And worse, they are allowed to do it often with only 5% down, and during the TARP bailout, with taxpayer money. And they only pay half the taxes on their winnings that you and I have to pay on the wages we earn!
I propose a law which limits trading on futures markets to legitimate businesses who have a real business use for and facilities to receive delivery of the commodities they option. I also believe the law should require that they actually buy, pay for, and take delivery of at least half of what they option. That would put a stop to much of this puerile game of destructive speculation.
Coming next -
Insatiable Demand that Became an Additiction
Larry
Changing America's Mind is on Facebook - "Like" it and recommend it to your friends - Thanks!
Tuesday, August 24, 2010
Chapter 1.6 - WALL STREET & THE GREAT INVESTMENT MYTH
CHANGING AMERICA'S MIND Chapter 1 Part 6
Games Boys Play
Note: If you are just arriving to this blog, please start with the Introduction.
The book is being published sequentially as it is written.
About half of you know and the other half have heard about some of the competitive games played by boys who are just entering adolescence. Most of these games center around bodily prowess and many of them show off physical skills for which the young adolescent has yet to find a good use. Some of the more innocent ones focus on spitting – spitting accuracy, distance, and volume. Variations add the contest of projectile power such as in seed spitting contests and for the rougher boys, tobacco spitting. And then there are those naughty games that focus on other forms of bodily elimination. If you don’t know what I’m referring to, ask a boy - of any age.
When we consider a great many of the recent male exploits on Wall Street, it is hard not to notice the similarities to those earlier games. Except now, the games are about prowess in making money, and as I demonstrated earlier, not about prowess in doing anything useful with it. I do not include in the definition of “useful,” buying things primarily to show how much money you can make. After all, you only have time to enjoy so many houses and boats, after that it is merely conspicuous spending, demonstrating how “high up on the wall” you can hit.
In his excellent September 23, 2002 New Yorker article entitled “The Greed Cycle,” John Cassidy provides perhaps the most compelling analysis of the factors that led up to Enron and the other business scandals of that period. Early in the article, he quotes Paul Volker’s description of the business climate that prevailed at the time. “It became a competitive game to see how much money you could get. … Corporate greed exploded beyond anything that could have been imagined in 1990. Traditional norms didn’t exist. You had this whole culture where the only sign of worth was how much money you made.” The article goes on to describe not just corporate games, but the games of the financial sector and Wall Street that made the scandals inevitable.
Those games continued right up to and were the cause of the 2008 Great Recession and as of this writing, continue still. Here are just a few examples of the games recently reported in New York Times articles:
In the April 20, 2010 edition, Nelson D Schwartz and Eric Dash reported on the “byzantine creations of the brightest minds on Wall Street,” collateralized debt obligations, known as C.D.O’s, which they characterized as “among the most toxic financial instruments ever devised.” They went on to observe that, “until the bottom fell out, these instruments also powered an age of riches on Wall Street. Initially, bundling mortgage bonds into C.D.O.’s helped open the spigot of easy money that allowed Americans to buy more house than they could afford.” But, it did not stop there they report, “To lure investors who wanted higher returns, bankers increasingly stuffed C.D.O.’s with riskier assets like subprime mortgage securities, rather than traditional corporate bonds.”
“But,” they noted, it went further still, “Wall Street, as it is wont to do, took the concept to another level, creating securities that allowed investors to make side bets on the housing market. Known as synthetic C.D.O.’s, they did not raise money for home loans or serve any other broad economic purpose.” They go on to explain, “Once the air started coming out of the housing market and there were no more mortgage bonds to sell, they created synthetic C.D.O.’s, whose supply was unlimited because they did not rely on hard assets.” “Like a casino offering blackjack along with slot machines and Texas hold’em, they were just one more way to bet against the housing market.”
Gretchen Morgenson and Louise Story, in their article “Banks Bundled Bad Debt, Bet Against It and Won,” December 24, 2009, wrote that “In 2006, Wall Street had introduced a new index, called the ABX, that became a way to invest in the direction of mortgage securities. The index allowed traders to bet on or against pools of mortgages with different risk characteristics …”
Their article also reports on deals put together by Jonathon M. Egol, a young Goldman Sachs trader. The deals were known as Abacus. The authors write, “Abacus allowed investors to bet for or against the mortgage securities that were linked to the deal. The C.D.O.’s didn’t contain actual mortgages. Instead, they consisted of credit-default swaps, a type of insurance that pays out when a borrower defaults. These swaps made it much easier to place large bets on mortgage failures.” They go on to report that, “Rather than persuading his customers to make negative bets on Abacus, Mr. Egol kept most of these wagers for his firm.” This, they implied, meant that he bet against his customers and made Goldman a lot of money doing so. As a result, he was promoted and “named a managing director at the firm.”
Morgenson and Story quote Sylvain R. Raynes, of R & R Consulting in New York with the following statement which characterizes these types of deals, “The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen. When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”
In the April 4, 2010 NYT edition, Susan P. Koniak, George M. Cohen, David A. Dana, and Thomas Ross, published the op-ed, “How Washington Abetted the Bank Job.” They point out how the Securities and Exchange Commission did not discover that Lehman “got new loans to pay off old loans” and that Lehman had “pretended the new loans were ‘sales’.” This technique concealed the desperate financial condition of the firm which ultimately resulted in bankruptcy. Sarcastically, they suggest that the SEC might have suspected this potential since “The collapse of Enron back in 2001 revealed that the biggest financial institutions, here and abroad, were busy creating products whose sole purpose was to help companies magically transform their debt into capital or revenue.” They go on to point out that the practice went far beyond Enron. “Our banks had gone into the business of creating ‘products’ to help companies, cities and whole countries hide their true financial condition. Consider the recent revelations about how Goldman Sachs and J.P. Morgan helped Greece hide its debt.” They quote the CEO of Citibank, in justifying such transactions, of saying that “As long as the music is playing, you’ve got to get up and dance.”
They also point out that in 2006, the regulating “agencies jointly published something called the ‘Interagency Statement on Sound Practices Concerning Elevated Risk Complex Structured Finance Activities,’ that became official policy the following year. The definition for the “complex structured finance activities” described in the title, they point out, included deals that in the words of the document “lack economic or business purpose” and are “designed or used primarily for questionable accounting, regulatory or tax objectives …” Rhetorically, these authors ask, “How does one propose ‘sound practices’ for practices that are inherently unsound?” “Yet,” they write, “that is what our regulatory guardians did. The statement (from the document) is powerful evidence of the permissive approach bank regulators took toward the debt-dissolving financial products that our banks had been developing, hawking and using themselves for years.”
This op-ed ends by noting that Susan P. Koniak is a law professor at Boston University, George M. Cohen is a law professor at the University of Virginia, David A. Dana is a law professor at Northwestern University, and Thomas Ross is a law professor at the University of Pittsburg.
In “Hurrying Into the Next Panic,” a NYT July 29, 2009 Op-Ed, Paul Wilmott warned against “the latest fashion among investment banks and hedge funds: high frequency algorithmic trading.” He describes this as straightforward: “Computers take information – primarily ‘real time’ share prices – and try to predict the next twitch in the stock market. Using an algorithmic formula, the computer can buy and sell stocks within fractions of seconds, with the bank or fund making a tiny profit on the blip of price change of each share.” He goes on to observe that “there’s nothing new in using all publicly available information to help you trade; what’s novel is the quantity of data available, the lightning speed at which it is analyzed and the short time that positions are held.”
He worries that such trading would be faster than any human can react, and that large scale market disruptions could occur before human judgment can enter into the picture. “The contest,” he points out, “is now between the machines – and they’re playing games with real businesses and real people.”
I should point out that less than a year later, in early June 2010, the stock market experienced a 1000 point drop from just such a Wall Street computerized game.
Games Boys Play - continues
The next installment will be posted on Thursday - Watch for it.
Larry
Changing America's Mind is on Facebook - "Like" it and recommend it to your friends - Thanks!
Games Boys Play
Note: If you are just arriving to this blog, please start with the Introduction.
The book is being published sequentially as it is written.
About half of you know and the other half have heard about some of the competitive games played by boys who are just entering adolescence. Most of these games center around bodily prowess and many of them show off physical skills for which the young adolescent has yet to find a good use. Some of the more innocent ones focus on spitting – spitting accuracy, distance, and volume. Variations add the contest of projectile power such as in seed spitting contests and for the rougher boys, tobacco spitting. And then there are those naughty games that focus on other forms of bodily elimination. If you don’t know what I’m referring to, ask a boy - of any age.
When we consider a great many of the recent male exploits on Wall Street, it is hard not to notice the similarities to those earlier games. Except now, the games are about prowess in making money, and as I demonstrated earlier, not about prowess in doing anything useful with it. I do not include in the definition of “useful,” buying things primarily to show how much money you can make. After all, you only have time to enjoy so many houses and boats, after that it is merely conspicuous spending, demonstrating how “high up on the wall” you can hit.
In his excellent September 23, 2002 New Yorker article entitled “The Greed Cycle,” John Cassidy provides perhaps the most compelling analysis of the factors that led up to Enron and the other business scandals of that period. Early in the article, he quotes Paul Volker’s description of the business climate that prevailed at the time. “It became a competitive game to see how much money you could get. … Corporate greed exploded beyond anything that could have been imagined in 1990. Traditional norms didn’t exist. You had this whole culture where the only sign of worth was how much money you made.” The article goes on to describe not just corporate games, but the games of the financial sector and Wall Street that made the scandals inevitable.
Those games continued right up to and were the cause of the 2008 Great Recession and as of this writing, continue still. Here are just a few examples of the games recently reported in New York Times articles:
In the April 20, 2010 edition, Nelson D Schwartz and Eric Dash reported on the “byzantine creations of the brightest minds on Wall Street,” collateralized debt obligations, known as C.D.O’s, which they characterized as “among the most toxic financial instruments ever devised.” They went on to observe that, “until the bottom fell out, these instruments also powered an age of riches on Wall Street. Initially, bundling mortgage bonds into C.D.O.’s helped open the spigot of easy money that allowed Americans to buy more house than they could afford.” But, it did not stop there they report, “To lure investors who wanted higher returns, bankers increasingly stuffed C.D.O.’s with riskier assets like subprime mortgage securities, rather than traditional corporate bonds.”
“But,” they noted, it went further still, “Wall Street, as it is wont to do, took the concept to another level, creating securities that allowed investors to make side bets on the housing market. Known as synthetic C.D.O.’s, they did not raise money for home loans or serve any other broad economic purpose.” They go on to explain, “Once the air started coming out of the housing market and there were no more mortgage bonds to sell, they created synthetic C.D.O.’s, whose supply was unlimited because they did not rely on hard assets.” “Like a casino offering blackjack along with slot machines and Texas hold’em, they were just one more way to bet against the housing market.”
Gretchen Morgenson and Louise Story, in their article “Banks Bundled Bad Debt, Bet Against It and Won,” December 24, 2009, wrote that “In 2006, Wall Street had introduced a new index, called the ABX, that became a way to invest in the direction of mortgage securities. The index allowed traders to bet on or against pools of mortgages with different risk characteristics …”
Their article also reports on deals put together by Jonathon M. Egol, a young Goldman Sachs trader. The deals were known as Abacus. The authors write, “Abacus allowed investors to bet for or against the mortgage securities that were linked to the deal. The C.D.O.’s didn’t contain actual mortgages. Instead, they consisted of credit-default swaps, a type of insurance that pays out when a borrower defaults. These swaps made it much easier to place large bets on mortgage failures.” They go on to report that, “Rather than persuading his customers to make negative bets on Abacus, Mr. Egol kept most of these wagers for his firm.” This, they implied, meant that he bet against his customers and made Goldman a lot of money doing so. As a result, he was promoted and “named a managing director at the firm.”
Morgenson and Story quote Sylvain R. Raynes, of R & R Consulting in New York with the following statement which characterizes these types of deals, “The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen. When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”
In the April 4, 2010 NYT edition, Susan P. Koniak, George M. Cohen, David A. Dana, and Thomas Ross, published the op-ed, “How Washington Abetted the Bank Job.” They point out how the Securities and Exchange Commission did not discover that Lehman “got new loans to pay off old loans” and that Lehman had “pretended the new loans were ‘sales’.” This technique concealed the desperate financial condition of the firm which ultimately resulted in bankruptcy. Sarcastically, they suggest that the SEC might have suspected this potential since “The collapse of Enron back in 2001 revealed that the biggest financial institutions, here and abroad, were busy creating products whose sole purpose was to help companies magically transform their debt into capital or revenue.” They go on to point out that the practice went far beyond Enron. “Our banks had gone into the business of creating ‘products’ to help companies, cities and whole countries hide their true financial condition. Consider the recent revelations about how Goldman Sachs and J.P. Morgan helped Greece hide its debt.” They quote the CEO of Citibank, in justifying such transactions, of saying that “As long as the music is playing, you’ve got to get up and dance.”
They also point out that in 2006, the regulating “agencies jointly published something called the ‘Interagency Statement on Sound Practices Concerning Elevated Risk Complex Structured Finance Activities,’ that became official policy the following year. The definition for the “complex structured finance activities” described in the title, they point out, included deals that in the words of the document “lack economic or business purpose” and are “designed or used primarily for questionable accounting, regulatory or tax objectives …” Rhetorically, these authors ask, “How does one propose ‘sound practices’ for practices that are inherently unsound?” “Yet,” they write, “that is what our regulatory guardians did. The statement (from the document) is powerful evidence of the permissive approach bank regulators took toward the debt-dissolving financial products that our banks had been developing, hawking and using themselves for years.”
This op-ed ends by noting that Susan P. Koniak is a law professor at Boston University, George M. Cohen is a law professor at the University of Virginia, David A. Dana is a law professor at Northwestern University, and Thomas Ross is a law professor at the University of Pittsburg.
In “Hurrying Into the Next Panic,” a NYT July 29, 2009 Op-Ed, Paul Wilmott warned against “the latest fashion among investment banks and hedge funds: high frequency algorithmic trading.” He describes this as straightforward: “Computers take information – primarily ‘real time’ share prices – and try to predict the next twitch in the stock market. Using an algorithmic formula, the computer can buy and sell stocks within fractions of seconds, with the bank or fund making a tiny profit on the blip of price change of each share.” He goes on to observe that “there’s nothing new in using all publicly available information to help you trade; what’s novel is the quantity of data available, the lightning speed at which it is analyzed and the short time that positions are held.”
He worries that such trading would be faster than any human can react, and that large scale market disruptions could occur before human judgment can enter into the picture. “The contest,” he points out, “is now between the machines – and they’re playing games with real businesses and real people.”
I should point out that less than a year later, in early June 2010, the stock market experienced a 1000 point drop from just such a Wall Street computerized game.
Games Boys Play - continues
The next installment will be posted on Thursday - Watch for it.
Larry
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Thursday, August 19, 2010
Chapter 1.5 - WALL STREET & THE GREAT INVESTMENT MYTH
CHANGING AMERICA'S MIND Chapter 1 Part 5
What Other Wall Street Critics are Saying
One of Wall Street’s most compelling critics has unusual credentials to back up his critiques. John C. Bogle is founder and former CEO of Vanguard Group Inc, the second largest mutual fund company in the United States. Bogle is also a lifelong conservative and Republican.
Here is a selection of some of his critiques of Wall Street:
Roger Lowenstein, Author of a new 2010 book, “The End of Wall Street,” and also an outside director of the Sequoia Fund, in the March 15, 2010 New York Times wrote an article entitled, “Who Needs Wall Street?” In it he offered the following critiques:
Another seemingly unlikely Wall Street critic is David Stockman, a director of the Office of Management and Budget under President Ronald Reagan, as well as a past hedge fund manager. In a January 20, 2010 article entitled, “Taxing Wall Street Down to Size,” he offered the following critiques:
Next section:
Games Boys Play
Larry
Changing America's Mind is on Facebook
What Other Wall Street Critics are Saying
One of Wall Street’s most compelling critics has unusual credentials to back up his critiques. John C. Bogle is founder and former CEO of Vanguard Group Inc, the second largest mutual fund company in the United States. Bogle is also a lifelong conservative and Republican.
Here is a selection of some of his critiques of Wall Street:
- In September of 2007 during a Bill Moyer’s Journal interview, he said that “the financial sector of our economy has overwhelmed the productive parts – it takes $560 billion value out of the society annually.” He went on to point out that in relatively few years, the financial sector had grown from 8% to 74% ownership of the country’s assets.
- In an October 2008 column by conservative talk radio personality, Michael Smerconish, Bogle raised that estimate to $650 billion per year. He was further quoted as saying that, “there was too much speculation and not enough investment.”
- In his 2005 book, The Battle for the Soul of Capitalism, Bogle, in critiquing the Internet bull market bubble of 2000 and the following crash, that it was a “massive $ 2 trillion-plus transfer of wealth from public investors to corporate insiders and financial intermediaries …” He went on to say that “transfers of this nature and relative dimension happen over and over again whenever speculation takes precedence over investment.”
- In his commencement address, “Enough,” to Georgetown University MBA graduates in 2007 he made the following remarks. “We’re moving, or so it seems, to a world where we’re no longer making anything in this country; we’re merely trading pieces of paper, swapping stocks and bonds back and forth with one another, and paying our financial croupiers a veritable fortune. We’re also adding even more costs by creating ever more complex financial derivatives in which huge and unfathomable risks are being built into our financial system.”
Roger Lowenstein, Author of a new 2010 book, “The End of Wall Street,” and also an outside director of the Sequoia Fund, in the March 15, 2010 New York Times wrote an article entitled, “Who Needs Wall Street?” In it he offered the following critiques:
- After pointing out Wall Street’s historical role of aggregating the savings of disparate individuals through the sale of stocks and bonds, thereby giving industry access to capital, he went on to write, “Wall Street’s emphasis began to change “in the ‘90s, as financiers devised new securities” …. that “did not involve selling bonds so that a Dupont could build new factories; they were rearrangements – new permutations, new alignments of risk – on flows of cash that already existed. Most famous was the trading that stemmed from complex derivatives (like mortgages) with only a remote connection to the underlying product. For all the trading in mortgage-backed securities, homeownership increased only a trivial amount.”
- He goes on to write, “For much of Wall Street, capital-raising is now a sideshow. At Goldman, trading and investing for the firm’s (own) account produced 76 percent of revenue last year. Investment banking, which raises capital for productive enterprise, accounted for a mere 11 percent. Other than that, it could have been a hedge fund.”
- “Modern markets are more likely afflicted with too much trading.” “As the volume from speculators and momentum traders dwarfs that of long-term investors, prices gyrate further from fundamental value. Raising capital thus becomes, to paraphrase John Maynard Keynes, the byproduct of a casino.”
- In referring to the mechanism called credit default swaps that required a bailout for AIG, he writes, “The social utility of credit-default swaps is ostensibly the insurance function.” But he goes on to point out that “Thanks to swaps, banks write more suspect loans and, over all, society is more exposed. At least in an actual casino, the damage is contained to gamblers. The street’s undertow is more serious. Following the debacle, the economy lost eight million jobs.”
Another seemingly unlikely Wall Street critic is David Stockman, a director of the Office of Management and Budget under President Ronald Reagan, as well as a past hedge fund manager. In a January 20, 2010 article entitled, “Taxing Wall Street Down to Size,” he offered the following critiques:
- “The economy desperately needs less of our bloated, unproductive and increasingly parasitic banking system.” In the next sentence, he appears to applaud the White House (Obama), for scoring “populist points against the banksters ..” “Make no mistake,” he continues, “The banking system has become an agent of destruction for the gross domestic product and of impoverishment for the middle class.”
- And, “The baleful reality is that the big banks, the freakish offspring of the Fed’s easy money, are dangerous institutions, deeply embedded in a bull market culture of entitlement and greed.”
- And finally, in referring to the record profits of the Wall Street banks, he wrote, “But these profits were not evidence of Mr. Market doing God’s work, greasing the wheels of commerce and trade by facilitating productive financial transactions. In fact, they represented the fruits of hyperactive gambling in the Fed’s monetary casino – a place where the inside players obtain their chips at no cost from the Fed-controlled money markets (low to zero interest rates).”
Next section:
Games Boys Play
Larry
Changing America's Mind is on Facebook
Friday, August 13, 2010
Chapter 1.4 - WALL STREET & THE GREAT INVESTMENT MYTH
CHANGING AMERICA'S MIND Chapter 1 Part 4
Entrepreneurs and Real Investors
The Only Ones Who Should Get Tax Breaks
Small Businesses
When pundits and conservative politicians speak of the need for economic stimulus, particularly during a deep recession, they may grudgingly endorse (and sometimes even vote for) public works projects and maybe even extended unemployment benefits. Both liberals and conservatives acknowledge that such measures can foster a short term increase in spending that will help temporarily. More insistently, however, conservatives will advocate tax cuts as the means for longer term improvement and gains in employment. Liberals will agree with them when it comes to tax cuts for the middle class. The presumption is that in hard times, they must spend this extra money on necessities thereby stimulating the economy.
Conservatives argue that the wealthy should also have the tax breaks because they will invest it in the markets which will spark more business spending and growth. This is a supply side argument. Both conservatives and liberals speak loosely about the importance of stimulating the private business sector as the means to create an increase in permanent jobs. Both will also, in passing, mention the importance of small business in creating jobs, and may even point out that for the last decade, small businesses have produced almost 85% of all new jobs and currently employ over half of the workforce. For the most part, though, most of the policies they adopt benefit mainly big multinational corporations and the financial markets.
Coming out of the Great Recession of 2007 – 2008, with the earlier Bush tax cuts for the wealthy still in place, most of this business stimulus thus far enacted has benefited Wall Street firms. It has also benefited Wal-Mart, as well as the Chinese firms that supply it. The job growth that resulted (paid at slave wages) has been in China. In spite of a 30% rebound on Wall Street, the Big Money private sector has, as of this writing(7/25,10), produced scarcely any new jobs in the US. At the same time, small business has been deprived of needed funding for operations and growth. As a result, the job gains in the US that have occurred resulted primarily from public works programs. This is what loose thinking about tax cuts based on economic lies and myths gets us.
What if, instead, the politicians, including the conservative ones, actually provided an economic stimulus where it could make a clear and quick difference? What if, they actually invested in the private small business sector instead of feeding the cancerous economic forces that caused the recession in the first place? Since small business produces most of the new jobs, and since jobs are what are needed most, would this not make sense?
Let’s consider a simple example. Imagine a small business owner who, even in this economy, has managed to pay herself a reasonable salary and still manage a net profit of $75, 000. Let’s further assume that her tax rate is currently 25%. Under that scenario, she will pay $18,750 in taxes, leaving her with $56,000. Given the fact that her business is doing well, she will seriously consider adding an employee, but given payroll taxes and the high costs of benefits, this will be a squeeze. Now let’s imagine that instead, the government gives her a 50% tax cut (approximately the tax cut that Big Money investments get through the capital gains tax), she would pay only $9,375, leaving her with $65,625. With that amount, she will certainly add the new employee, and may even consider another part-time one. If we cut her taxes to $5,000, the part-timer becomes a certainty as well. But imagine that the government got really creative and gave small business a one-year tax holiday followed by the 50% tax cut. Our successful small business entrepreneur will likely now take the risk to add two employees. She won’t put her money into speculative things such as derivatives or the futures markets.
Startups
The other segment of our economy in which entrepreneurs and true investors occur, is in startup companies. Starting a small business could be considered a startup, but mostly the term is reserved to describe new business ventures that require a fair amount of capital to develop to the point of making a profit. Most frequently, such companies are technical, organized for the purpose of getting a new invention to the marketplace. The new products usually require such steps as prototyping of the product, patenting, testing, making modifications, engineering, fabrication, marketing, and finally sales. Startups often come about when an employee has an insight while working for a larger company and chooses to take the entrepreneurial risk of becoming self-employed in order to develop and own the new product. Typically, after such entrepreneurs have used their savings and tapped out their credit cards, they need other investors to have enough capital to get all the way to the marketplace.
There are two kinds of investors who put money into such start-up companies. Angel investors enter early and provide funds at the riskiest stage. When they do so, they have confidence that their assistance will make the crucial difference in the venture becoming a success. They expect to earn a substantial return on their investment for this help, usually 30-50%. They take an equity stock ownership position in the company and often either participate on the management team, or pay to add needed talent.
As the new product reaches the point that its commercial potential is more evident, another infusion of capital is often needed. People called venture capitalists provide that money, again in return for stock in the company. This infusion of funds is scaled to be sufficient to get the company into the market place earning revenues. If this works, at the point the company becomes profitable, and sometimes even before, the current owners (entrepreneur, angel, and VCs) determine that the venture has sufficient promise to offer the stock to the public. This is the Initial Public Offering (IPO) referred to earlier in this chapter. Such IPO’s are also the most common mechanism through which the angel investor and the venture capitalists achieve the desired return on their investments.
In a well managed IPO, the value of the stock increases overnight, sometimes doubling. The Angel and the VC sell their stock in this public offering at a profit, hopefully one justifying their investment, and move on to the next venture. The entrepreneur often also sells some shares so he/she can pay off credit cards and build up some savings again. The substantial remaining proceeds from the sale of company stock go to fund the operation and growth of the company, usually creating numerous jobs.
This is the kind of economic activity worthy of the word, “investment.” Startups, along with small businesses, are the principal parts of the economy deserving the incentives of investment tax breaks. Such incentives may also be productively used to encourage investment in developing new industries that can be beneficial to us all, like clean energy. The tax breaks that currently fuel Wall Street speculation are nothing more nor less than a lobby generated form of legalized piracy!
Coming next:
What Other Wall Street Critics are Saying
Larry
Changing America's Mind is on Facebook
Entrepreneurs and Real Investors
The Only Ones Who Should Get Tax Breaks
Small Businesses
When pundits and conservative politicians speak of the need for economic stimulus, particularly during a deep recession, they may grudgingly endorse (and sometimes even vote for) public works projects and maybe even extended unemployment benefits. Both liberals and conservatives acknowledge that such measures can foster a short term increase in spending that will help temporarily. More insistently, however, conservatives will advocate tax cuts as the means for longer term improvement and gains in employment. Liberals will agree with them when it comes to tax cuts for the middle class. The presumption is that in hard times, they must spend this extra money on necessities thereby stimulating the economy.
Conservatives argue that the wealthy should also have the tax breaks because they will invest it in the markets which will spark more business spending and growth. This is a supply side argument. Both conservatives and liberals speak loosely about the importance of stimulating the private business sector as the means to create an increase in permanent jobs. Both will also, in passing, mention the importance of small business in creating jobs, and may even point out that for the last decade, small businesses have produced almost 85% of all new jobs and currently employ over half of the workforce. For the most part, though, most of the policies they adopt benefit mainly big multinational corporations and the financial markets.
Coming out of the Great Recession of 2007 – 2008, with the earlier Bush tax cuts for the wealthy still in place, most of this business stimulus thus far enacted has benefited Wall Street firms. It has also benefited Wal-Mart, as well as the Chinese firms that supply it. The job growth that resulted (paid at slave wages) has been in China. In spite of a 30% rebound on Wall Street, the Big Money private sector has, as of this writing(7/25,10), produced scarcely any new jobs in the US. At the same time, small business has been deprived of needed funding for operations and growth. As a result, the job gains in the US that have occurred resulted primarily from public works programs. This is what loose thinking about tax cuts based on economic lies and myths gets us.
What if, instead, the politicians, including the conservative ones, actually provided an economic stimulus where it could make a clear and quick difference? What if, they actually invested in the private small business sector instead of feeding the cancerous economic forces that caused the recession in the first place? Since small business produces most of the new jobs, and since jobs are what are needed most, would this not make sense?
Let’s consider a simple example. Imagine a small business owner who, even in this economy, has managed to pay herself a reasonable salary and still manage a net profit of $75, 000. Let’s further assume that her tax rate is currently 25%. Under that scenario, she will pay $18,750 in taxes, leaving her with $56,000. Given the fact that her business is doing well, she will seriously consider adding an employee, but given payroll taxes and the high costs of benefits, this will be a squeeze. Now let’s imagine that instead, the government gives her a 50% tax cut (approximately the tax cut that Big Money investments get through the capital gains tax), she would pay only $9,375, leaving her with $65,625. With that amount, she will certainly add the new employee, and may even consider another part-time one. If we cut her taxes to $5,000, the part-timer becomes a certainty as well. But imagine that the government got really creative and gave small business a one-year tax holiday followed by the 50% tax cut. Our successful small business entrepreneur will likely now take the risk to add two employees. She won’t put her money into speculative things such as derivatives or the futures markets.
Startups
The other segment of our economy in which entrepreneurs and true investors occur, is in startup companies. Starting a small business could be considered a startup, but mostly the term is reserved to describe new business ventures that require a fair amount of capital to develop to the point of making a profit. Most frequently, such companies are technical, organized for the purpose of getting a new invention to the marketplace. The new products usually require such steps as prototyping of the product, patenting, testing, making modifications, engineering, fabrication, marketing, and finally sales. Startups often come about when an employee has an insight while working for a larger company and chooses to take the entrepreneurial risk of becoming self-employed in order to develop and own the new product. Typically, after such entrepreneurs have used their savings and tapped out their credit cards, they need other investors to have enough capital to get all the way to the marketplace.
There are two kinds of investors who put money into such start-up companies. Angel investors enter early and provide funds at the riskiest stage. When they do so, they have confidence that their assistance will make the crucial difference in the venture becoming a success. They expect to earn a substantial return on their investment for this help, usually 30-50%. They take an equity stock ownership position in the company and often either participate on the management team, or pay to add needed talent.
As the new product reaches the point that its commercial potential is more evident, another infusion of capital is often needed. People called venture capitalists provide that money, again in return for stock in the company. This infusion of funds is scaled to be sufficient to get the company into the market place earning revenues. If this works, at the point the company becomes profitable, and sometimes even before, the current owners (entrepreneur, angel, and VCs) determine that the venture has sufficient promise to offer the stock to the public. This is the Initial Public Offering (IPO) referred to earlier in this chapter. Such IPO’s are also the most common mechanism through which the angel investor and the venture capitalists achieve the desired return on their investments.
In a well managed IPO, the value of the stock increases overnight, sometimes doubling. The Angel and the VC sell their stock in this public offering at a profit, hopefully one justifying their investment, and move on to the next venture. The entrepreneur often also sells some shares so he/she can pay off credit cards and build up some savings again. The substantial remaining proceeds from the sale of company stock go to fund the operation and growth of the company, usually creating numerous jobs.
This is the kind of economic activity worthy of the word, “investment.” Startups, along with small businesses, are the principal parts of the economy deserving the incentives of investment tax breaks. Such incentives may also be productively used to encourage investment in developing new industries that can be beneficial to us all, like clean energy. The tax breaks that currently fuel Wall Street speculation are nothing more nor less than a lobby generated form of legalized piracy!
Coming next:
What Other Wall Street Critics are Saying
Larry
Changing America's Mind is on Facebook
Saturday, August 7, 2010
Chapter 1.3 WALL STREET & THE GREAT INVESTMENT MYTH
CHANGING AMERICA'S MIND Chapter 1 Part 3
Participants and Transactions
The above commentary [ previous post - Part 2] may seem too harsh. Daily you are bombarded with a more positive picture of Wall Street and its contributions to the economy and to our way of life. It is only appropriate that you be skeptical about the critique I have presented. In the section below, I will attempt to prove my case by presenting a more detailed analysis of the markets, the motives of those who participate in them, and the various types of transactions. I will start with the participants and types of transactions that have the greatest positive impact on the economy and work down to those that mostly drain money from it.
All of the transactions in the financial markets (“Wall Street”) serve one of four purposes:
1. Ownership – to buy and sell shares of ownership.
2. Funds – to lend or borrow funds needed for various business purposes.
3. Insurance – to protect against risks and loss.
4. Speculation – to make a quick buck with the least amount of risk possible.
These markets are supported by a number of professional types including brokers, analysts, rating services, investment bankers, and fund managers. Given the intertwined relationships that these managers and professionals have with the companies and products whose shares they handle, they have a great deal of insider information that they sell to the highest bidders or take advantage of them themselves. That is to say that mostly they serve Big Money (the financial affairs of the very rich). They have little to do with average investors other than to cost them money.
Beyond these support personnel, there are four principle types of participants in the markets (note that any particular person may participate in one, several, or all of these ways):
1. Investors – these are people who buy shares of ownership in a new or existing enterprise with the objective of receiving dividends (or profit distributions) as well as appreciation in the price of the stock over a relatively long time frame, usually several years. The risks range from low to high, depending on the businesses in which they invest.
Sometimes such investing takes the form of deliberately buying a particular company’s stock because of the company’s reputation or because the investor has some form of personal connection with it. Another method is to pool money in mutual funds that invest conservatively in stock as well as bonds and other securities. More commonly, however, people pay into a 401K or some other form of retirement plan or instrument, and that money is employed by fund managers to purchase corporate stock and other securities.
Most such transactions, however, do not bring new money into the economy, stimulating growth, innovation, and job creation. The proceeds from such transactions go from buyer to seller, with a portion going to pay various financial market fees. Furthermore, since a portion of Big Money’s Portfolio includes blocks of stock, this increases the short term quarterly pressure on the CEO’s of publicly traded companies to “meet the street’s expectations” to show good earnings, usually by cutting such cost items as jobs (sent offshore) and the research and development required to create new products. Jobs, salaries, and new patents in the United States are inversely proportional to gains in Wall Street Markets.
Less common, but of greater value to the economy, are the entrepreneurial investment activities of starting businesses. They may be small sole proprietorships, family owned ventures, or partnerships, but they may also be start-up companies needing greater capital and seeking additional funding from angel investors or venture capitalists, usually in exchange for equity stock. Such transactions are worthy of being called “investments” due to their contributions to increased value, growth, better and more beneficial products and services, increased ownership responsibility, and added employment opportunities. Most of this activity happens on Main Street, not Wall Street and these are the kinds of investments that deserve support from tax reduction incentives; not the speculative use of Big Money that currently pays less than half the tax rate paid by the rest of us.
2. Saver/Lenders – these are people whose objective is to receive interest on their extra money. Examples include CD’s, Money Market Accounts, and the purchase of Corporate or Government Bonds. The time frame for such investments can range from a few months to a few years and the risks range typically from low to medium. These activities provide funds that banks and other financial institutions use to lend money to existing businesses of all kinds, to help those businesses pay for operations and growth. Such funds can stimulate the economy, but as we have seen since the Wall Street bailout, the Big Money banks and financial firms have not been providing enough of these loans to enable existing businesses, particularly small ones, to operate and grow. Instead, they have chosen to use these funds, provided by others, to play in the speculative markets.
3. Speculators – these are people whose goal is to gain high rates of return by putting money into high risk ventures for the least amount of time possible. There is no interest in ownership, only in maximizing return. Examples of this include high yield bonds, futures markets options, the purchase of derivatives, hedge fund bets for or against anything, and credit default swaps. Most of these transactions are bets in the purest sense of the word and take either the form of a short term claim on something or insurance against loss. Such speculation mostly causes harm by funding risky bubbles that then burst and by driving up the costs of energy, food, and shelter. They pirate the liquidity needed for a vital economy, making themselves and a few people wealthier, but at the cost of our nation’s future.
4. Traders – these are people whose objective is to take advantage of small price changes in any of the ways described above. The only objective is to make a quick profit. They tend to create a great deal of volatility in the market and often drive up the prices that true investors (shares of stock) and ordinary consumers (oil, gas, food, real estate, etc.) must pay. Very little of the money resulting from any of these transactions serves to bring new money into productive businesses in a way that would stimulate the economy. Instead, they tend to drain money away from productive uses and depress the economy.
………
Have I proved my case yet? Are you beginning to understand the myths about investment and Wall Street and the damage they have caused?
Please post your comments below.
Larry
Next section:
Entrepenaurs and Real Investors
The Only Ones Who Should Get Tax Breaks
Participants and Transactions
The above commentary [ previous post - Part 2] may seem too harsh. Daily you are bombarded with a more positive picture of Wall Street and its contributions to the economy and to our way of life. It is only appropriate that you be skeptical about the critique I have presented. In the section below, I will attempt to prove my case by presenting a more detailed analysis of the markets, the motives of those who participate in them, and the various types of transactions. I will start with the participants and types of transactions that have the greatest positive impact on the economy and work down to those that mostly drain money from it.
All of the transactions in the financial markets (“Wall Street”) serve one of four purposes:
1. Ownership – to buy and sell shares of ownership.
2. Funds – to lend or borrow funds needed for various business purposes.
3. Insurance – to protect against risks and loss.
4. Speculation – to make a quick buck with the least amount of risk possible.
These markets are supported by a number of professional types including brokers, analysts, rating services, investment bankers, and fund managers. Given the intertwined relationships that these managers and professionals have with the companies and products whose shares they handle, they have a great deal of insider information that they sell to the highest bidders or take advantage of them themselves. That is to say that mostly they serve Big Money (the financial affairs of the very rich). They have little to do with average investors other than to cost them money.
Beyond these support personnel, there are four principle types of participants in the markets (note that any particular person may participate in one, several, or all of these ways):
1. Investors – these are people who buy shares of ownership in a new or existing enterprise with the objective of receiving dividends (or profit distributions) as well as appreciation in the price of the stock over a relatively long time frame, usually several years. The risks range from low to high, depending on the businesses in which they invest.
Sometimes such investing takes the form of deliberately buying a particular company’s stock because of the company’s reputation or because the investor has some form of personal connection with it. Another method is to pool money in mutual funds that invest conservatively in stock as well as bonds and other securities. More commonly, however, people pay into a 401K or some other form of retirement plan or instrument, and that money is employed by fund managers to purchase corporate stock and other securities.
Most such transactions, however, do not bring new money into the economy, stimulating growth, innovation, and job creation. The proceeds from such transactions go from buyer to seller, with a portion going to pay various financial market fees. Furthermore, since a portion of Big Money’s Portfolio includes blocks of stock, this increases the short term quarterly pressure on the CEO’s of publicly traded companies to “meet the street’s expectations” to show good earnings, usually by cutting such cost items as jobs (sent offshore) and the research and development required to create new products. Jobs, salaries, and new patents in the United States are inversely proportional to gains in Wall Street Markets.
Less common, but of greater value to the economy, are the entrepreneurial investment activities of starting businesses. They may be small sole proprietorships, family owned ventures, or partnerships, but they may also be start-up companies needing greater capital and seeking additional funding from angel investors or venture capitalists, usually in exchange for equity stock. Such transactions are worthy of being called “investments” due to their contributions to increased value, growth, better and more beneficial products and services, increased ownership responsibility, and added employment opportunities. Most of this activity happens on Main Street, not Wall Street and these are the kinds of investments that deserve support from tax reduction incentives; not the speculative use of Big Money that currently pays less than half the tax rate paid by the rest of us.
2. Saver/Lenders – these are people whose objective is to receive interest on their extra money. Examples include CD’s, Money Market Accounts, and the purchase of Corporate or Government Bonds. The time frame for such investments can range from a few months to a few years and the risks range typically from low to medium. These activities provide funds that banks and other financial institutions use to lend money to existing businesses of all kinds, to help those businesses pay for operations and growth. Such funds can stimulate the economy, but as we have seen since the Wall Street bailout, the Big Money banks and financial firms have not been providing enough of these loans to enable existing businesses, particularly small ones, to operate and grow. Instead, they have chosen to use these funds, provided by others, to play in the speculative markets.
3. Speculators – these are people whose goal is to gain high rates of return by putting money into high risk ventures for the least amount of time possible. There is no interest in ownership, only in maximizing return. Examples of this include high yield bonds, futures markets options, the purchase of derivatives, hedge fund bets for or against anything, and credit default swaps. Most of these transactions are bets in the purest sense of the word and take either the form of a short term claim on something or insurance against loss. Such speculation mostly causes harm by funding risky bubbles that then burst and by driving up the costs of energy, food, and shelter. They pirate the liquidity needed for a vital economy, making themselves and a few people wealthier, but at the cost of our nation’s future.
4. Traders – these are people whose objective is to take advantage of small price changes in any of the ways described above. The only objective is to make a quick profit. They tend to create a great deal of volatility in the market and often drive up the prices that true investors (shares of stock) and ordinary consumers (oil, gas, food, real estate, etc.) must pay. Very little of the money resulting from any of these transactions serves to bring new money into productive businesses in a way that would stimulate the economy. Instead, they tend to drain money away from productive uses and depress the economy.
………
Have I proved my case yet? Are you beginning to understand the myths about investment and Wall Street and the damage they have caused?
Please post your comments below.
Larry
Next section:
Entrepenaurs and Real Investors
The Only Ones Who Should Get Tax Breaks
Monday, August 2, 2010
Chapter 1.2 WALL STREET & THE GREAT INVESTMENT MYTH
CHANGING AMERICA’S MIND - Chapter 1 - Part 2
Wall Street Myth
Also according to popular media myth, Wall Street is synonymous with business. It is credited with stimulating the economy, spurring innovation, and creating jobs.
There is scant truth to any of these claims. Such claims are public relations fiction hyped by a misinformed media that serves to conceal the fact that Wall Street is a mechanism designed to make the rich richer – at everyone else’s expense. During the bull market in the spring of 2007, TV pundits and politicians alike pointed to soaring share prices as evidence that America’s economy was doing well. A deeper analysis revealed that the rising stock indices were being driven by corporate investments abroad while American wages were relatively flat. Furthermore, a statistical flaw in the methodology for computing GDP did not adequately account for these foreign investments and likely meant that annual growth was not the 3.2 % reported, but only a weak 1.4 %.
We learned later that the rising share prices were also being fed by the speculative instruments called derivatives, which were at that time driving the building “boom.” It did not take long for that “boom” to be known as the bubble that burst. Many middle class 401K purchasers and many retirees living on the proceeds from such retirement plans lost a great deal of money. In the mean time, when the quick profits from the real estate bubble ended, the derivatives speculators went looking for new prey and quickly drove up the prices of oil, gasoline, and flour, even though little had changed in terms of real supply and demand. At the same time, the distribution of income showed a wider and wider gap. The middle class was shrinking and the number of people in poverty was growing.
Wall Street is not Business. As many economists have pointed out, it’s much more like a casino. It’s a place where people place bets that stock prices will rise (or fall). They track the odds by frequently checking the scoreboards called The Dow Jones, the S&P, and the NASDAQ. According to the type bet they placed, it does not matter whether the market is rising or falling. They may win either way. It is a zero-sum game. These are not investments, they are bets. “Playing the market” it is correctly called just like in the phrase, “playing the horses.” Unfortunately, it is not just other gamblers who lose – it is also customers, workers, retirees, communities, taxpayers, and the environment.
Why then do these “players” get preferential tax treatment? Why do they get the capital gains rates which are approximately half the income tax rates paid by ordinary citizens? Beyond the IPO and perhaps the first purchase after that, these are mostly gambling gains, not true investments. Why don’t these speculators pay a gambling tax? Or come to think of it, why don’t they even pay a sales tax on these transactions like most of us must pay for most of our purchases. After all, they’re not buying food or other necessities.
“Well, at least the Market mirrors and measures the economy,” you might say in Wall Street’s defense. In 1929, it did not. In the run-up to Enron, it did not. In the Bull Market of 2007 it did not. In all those cases, it damaged the economy. These markets have little to do with reality, except for making a few people richer and causing adverse impacts for everyone else. Wall Street is an amusement park, filled with thrill rides, and runs on emotion, adrenalin, and greed.
But it does make the rich richer.
The popular belief has been that “As the Market goes, so goes America.” Yes, but that’s true only when it plummets!
“Buy American,” a grieving nation pleaded after 9/11. As part of this, many beseeched Wall Street traders to buy big when the markets reopened. Give America a boost.
You bet.
They sold.
And millions lost jobs.
The Markets may be American, but they are not patriotic.
They serve only self-interest. They’re designed to be that way.
“Well,” you protest, “the ‘invisible hand,’ described by Adam Smith in The Wealth of Nations, assures that such selfishness and greed unintentionally benefits the whole.” Wrong. The beneficence that the invisible hand bestows flows only from small businesses, start-ups, and closely-held mid-sized companies. Not share trading in multinational corporations and many of the other financial transactions that Wall Street traffics in.
Today’s “free market” ideologues need to reread Adam Smith. Multinational corporations in global markets are a form of the monopolistic forces he preached against. In addition, he advocated investment in ones own country as the only means of building a society’s wealth. “The Wealth of Nations,” his book was titled. Not the wealth of a few individuals.
Coming next -
Participants and Transactions The above commentary may seem too harsh.....
Comment here on the blog and on Facebook -
Larry
Wall Street Myth
Also according to popular media myth, Wall Street is synonymous with business. It is credited with stimulating the economy, spurring innovation, and creating jobs.
There is scant truth to any of these claims. Such claims are public relations fiction hyped by a misinformed media that serves to conceal the fact that Wall Street is a mechanism designed to make the rich richer – at everyone else’s expense. During the bull market in the spring of 2007, TV pundits and politicians alike pointed to soaring share prices as evidence that America’s economy was doing well. A deeper analysis revealed that the rising stock indices were being driven by corporate investments abroad while American wages were relatively flat. Furthermore, a statistical flaw in the methodology for computing GDP did not adequately account for these foreign investments and likely meant that annual growth was not the 3.2 % reported, but only a weak 1.4 %.
We learned later that the rising share prices were also being fed by the speculative instruments called derivatives, which were at that time driving the building “boom.” It did not take long for that “boom” to be known as the bubble that burst. Many middle class 401K purchasers and many retirees living on the proceeds from such retirement plans lost a great deal of money. In the mean time, when the quick profits from the real estate bubble ended, the derivatives speculators went looking for new prey and quickly drove up the prices of oil, gasoline, and flour, even though little had changed in terms of real supply and demand. At the same time, the distribution of income showed a wider and wider gap. The middle class was shrinking and the number of people in poverty was growing.
Wall Street is not Business. As many economists have pointed out, it’s much more like a casino. It’s a place where people place bets that stock prices will rise (or fall). They track the odds by frequently checking the scoreboards called The Dow Jones, the S&P, and the NASDAQ. According to the type bet they placed, it does not matter whether the market is rising or falling. They may win either way. It is a zero-sum game. These are not investments, they are bets. “Playing the market” it is correctly called just like in the phrase, “playing the horses.” Unfortunately, it is not just other gamblers who lose – it is also customers, workers, retirees, communities, taxpayers, and the environment.
Why then do these “players” get preferential tax treatment? Why do they get the capital gains rates which are approximately half the income tax rates paid by ordinary citizens? Beyond the IPO and perhaps the first purchase after that, these are mostly gambling gains, not true investments. Why don’t these speculators pay a gambling tax? Or come to think of it, why don’t they even pay a sales tax on these transactions like most of us must pay for most of our purchases. After all, they’re not buying food or other necessities.
“Well, at least the Market mirrors and measures the economy,” you might say in Wall Street’s defense. In 1929, it did not. In the run-up to Enron, it did not. In the Bull Market of 2007 it did not. In all those cases, it damaged the economy. These markets have little to do with reality, except for making a few people richer and causing adverse impacts for everyone else. Wall Street is an amusement park, filled with thrill rides, and runs on emotion, adrenalin, and greed.
But it does make the rich richer.
The popular belief has been that “As the Market goes, so goes America.” Yes, but that’s true only when it plummets!
“Buy American,” a grieving nation pleaded after 9/11. As part of this, many beseeched Wall Street traders to buy big when the markets reopened. Give America a boost.
You bet.
They sold.
And millions lost jobs.
The Markets may be American, but they are not patriotic.
They serve only self-interest. They’re designed to be that way.
“Well,” you protest, “the ‘invisible hand,’ described by Adam Smith in The Wealth of Nations, assures that such selfishness and greed unintentionally benefits the whole.” Wrong. The beneficence that the invisible hand bestows flows only from small businesses, start-ups, and closely-held mid-sized companies. Not share trading in multinational corporations and many of the other financial transactions that Wall Street traffics in.
Today’s “free market” ideologues need to reread Adam Smith. Multinational corporations in global markets are a form of the monopolistic forces he preached against. In addition, he advocated investment in ones own country as the only means of building a society’s wealth. “The Wealth of Nations,” his book was titled. Not the wealth of a few individuals.
Coming next -
Participants and Transactions The above commentary may seem too harsh.....
Comment here on the blog and on Facebook -
Larry
Wednesday, July 28, 2010
Chapter 1.1 WALL STREET AND THE GREAT INVESTMENT MYTH
CHANGING AMERICA’S MIND - Chapter 1 - Part 1
INVESTMENT – the word simply rings with respectability. It’s what those other people do, those pillars of the community. It’s what we should do. Save and invest. We all know this is the prudent thing, the responsible thing to do. It’s the way to get ahead, to build a future for ourselves and our families, to move beyond living paycheck to paycheck. We’ve been told this since our youth and the media extols the virtues of those who do. Not only do they do well for themselves; they build enterprises that provide jobs and new inventions and needed products and services for others. That’s the American Way. It built our country’s prosperity. Solid, respectable, responsible, important, trustworthy, and vital – those are some of the virtues attributed to investors. And those who truly invest deserve such admiration. But most Wall Street transactions are not investment; they’re speculation, gambling, and even theft. And not just recently; it’s been that way for a long time. It is built into the structure and nature of such markets and the eternal quest to make more money quickly by doing and risking less.
Think about it. Where do the proceeds from these Wall Street transactions go? When I ask my students where the money from stock trading goes, over half of them say that it goes to the companies whose shares are being traded. If that were true, it would be investment. But they’re wrong; the money does not go to the companies. And most of you likely guessed wrong as well. The difference is that my students are college seniors pursuing degrees in business.
So where does the money go? Let’s continue with corporate stock as an example. Almost all of the proceeds from publicly traded stock go from the buyer to the seller, with percentages going to brokers, financial managers, analysts, rating agencies, and insurers such as AIG. Beyond the Initial Public Offering (IPO) [more on that later], none of it goes to the company except on the rare occasion when the company raises additional capital by selling off a portion of its retained corporate stock.
Wall Street and all other financial markets are places where people can place bets on how well certain stocks will perform, particularly in terms of their value. Will the share price go up or will it fall? Unfortunately, this has very little to do with how the company is performing. It has to do with expectations about the prices of shares and these are often affected by irrational and emotional reactions from reading too much into “signs” about the economy, from putting to much faith in CNBC “experts,” and from giving too much credence to internet rumors. Most participants in the market make money by buying shares cheap and selling them high – and their bets are mostly about that. Few make money by investing in companies and providing funds that are used to make products and to produce jobs. Less and less of the money in the market is in it for the long haul.
This description is of course an oversimplification. There are many kinds of financial transactions in such markets and some of them provide more money to companies than do others. I will address these transactions in greater detail later in this chapter. For the most part, however, a majority of these transactions end up draining money from the productive economy, not providing money for it. Perhaps it should not, therefore, be called investment.
So what sustains the myth that these Wall Street financial transactions stimulate the economy? What sustains the myth that by cutting taxes for the wealthy, more money will flow into these markets leading to economic growth which results in job creation? For the most part, it is repetition. If certain slogans are said again and again, they start to be perceived as maxims, assumed to be true even when they are not. A few public relations professionals and political consultants have specialized in creating sound bites and slogans that can be used this way for political advantage. They simply make up some phrases that fit a particular ideology, test them in focus groups for emotional response, and then sell the “winners” to the political party that hired them. For the last thirty years, variations of this “investment” myth have been packaged and sold.
In this particular case, the packaged myth also caught on because it was once true that buying stock in a company provided the capital needed for operations and growth. It was true when such shares were bought and sold by people who knew each other, before the large impersonal public markets which I refer to collectively as Wall Street existed. It still is true when people start a small business or buy into one or invest in start-up ventures. But beyond the IPO when shares are offered on the open market, share trading is in effect the selling and buying of pieces of paper that function as demands for payment from the company either in the form of dividends or increased share prices, not an infusion of money into it. And most share traders do not care how the companies get the money to pay them. In fact, most shareholders do not even know which company’s shares they own. They simply participate in financial funds managed by specialists who make all the choices. Such “ownership” is anything but responsible.
NEXT PORTION to be posted this weekend - WALL STREET MYTH -
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CHANGING AMERICA’S MIND - An introduction
Beliefs about Business, Economics and Citizenship that are Destroying Our Country
Over the next several weeks, I will be sharing draft chapters from my forthcoming book with you and other selected friends. I will be publishing them on my blog, Common Sense & Economic Nonsense (you will find the link below). This is a work in progress. Your comments and suggestions will be appreciated.
The title of my new book is:
CHANGING AMERICA’S MIND
Beliefs about Business, Economics and Citizenship that are Destroying Our Country
As a consultant who has worked with numerous major corporations and small businesses, an adjunct professor in management, and a citizen active in my community, I’m writing about several widely held myths and views that I believe are destroying our country. It is my hope to cause us all to think about these concepts and to search for new ones that lead to a better future.
If you can squeeze out a few minutes, I think you will find the material thought-provoking and entertaining.
Larry
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