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 State after state repealed or loosened their typical limit of 9% in an effort to keep their banks competitive.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:
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Games Boys Play
Larry
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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).”
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Games Boys Play
Larry
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