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The Wall Street Model: Unintelligent Design
Wall Street is collapsing not because of bad mortgage debt or lack of capital or over-leverage. Those are merely symptoms. Wall Street is collapsing because it deserves to collapse; it needs to collapse in order for America to survive. The economist Joseph Schumpeter called it creative destruction, a system where outdated models collapse to make room for new innovation.
Wall Street of the past decade never really had a business model as much as it had a business creed: greed is good; leveraged greed is even better.
The fact that Wall Street is collapsing is a given. How it survived as long as it did under its corrupted model is the question that will be debated in history books for the next generation.
For example, imagine a business model that bases remuneration to brokers on how much money they make for their Wall Street employer and not one dime for how well their customers’ portfolios perform. A Wall Street broker receives remuneration that rises from approximately 30 to 50 per cent of the gross commission based on their cumulative trading commissions with zero regard to how well the clients’ accounts have done. There is no acknowledged internal mechanism in any of the major Wall Street firms to gauge the overall success of the accounts the broker is managing.
The industry has been irreconcilably incentivized to corruption just as brokers have been socialized to silence. The reason we are seeing a stampede this week into U.S. Treasury securities is that much of this money belonged there in the first place, not in esoteric mortgage backed securities, junk bonds, commodity funds or annuities backed by AIG. Brokers put their clients “safe money” in these unsuitable investments because their Wall Street employer dangled a seductive financial inducement. A broker receives less than $1,000 in gross commissions (“gross” meaning before their firm takes their 50 to 70 per cent cut) on $100,000 of longer dated Treasuries. Putting that same $100,000 in a junk bond or mortgage-backed security or annuity could generate $3,000 or more. In other words, the financial incentive has created an artificial demand. And, as must inevitably happen, the true state of that demand is just now catching up with the true glut of supply.
What would be the incentive for Wall Street firms to offer higher commissions for some products over others? Because on top of their cut of the brokers commissions, they receive origination and syndication fees for the more esoteric investment products. These firms so despised the low-paying Treasuries that they replaced Treasuries with Freddie Mac and Fannie Mae paper in mutual funds bearing the name “U.S. Government Fund.” (This misleading practice and the fact that billions of dollars of public money resided in these misnamed funds has certainly played a role in the government’s decision to nationalize Freddie Mac and Fannie Mae.)
Then there is the insane model of bringing flim-flam new businesses to market. If we look at the people who are at the helm of today’s collapsing Wall Street, they have shifted in their chairs, but they are mostly the same conflicted individuals who brought America the NASDAQ bust that began in March 2000 and evaporated $7 trillion of American wealth. There is no longer any incentive on Wall Street to bring about initial public offerings of only companies that will stand the test of time and create new jobs and new markets to make America strong and globally competitive. There is only an incentive to collect the underwriting fee and cash out quickly on private equity stakes.
Next is the corrupted model of housing a trading desk for the firm inside the same company that is supposed to issue unbiased research to the public. For example, let’s say that XYZ Brokerage buys a big stake in ABC Company on its proprietary trading desk (the desk that trades for profits for the firm) on Wednesday afternoon. On Thursday afternoon, it could almost guarantee profits for itself by issuing a research report upgrading the stock. Conversely, it could short the stock on Wednesday and issue a negative report to drive down the price on Thursday, also guaranteeing itself a profit. Other than a fictional Chinese Wall, there is absolutely nothing to stop this type of public looting.
Now, ask yourself this. With the multitude of other ways that Wall Street has to make money, why are they allowed to have their own trading desk while simultaneously issuing conflicted research to the public. After the NASDAQ scandals that revealed Wall Street issuing biased research for personal profit, why weren’t proprietary trading desks and public research issuance shut down at these firms. There are plenty of boutique research firms to fill the void. The only conclusion to be drawn is what Europe is calling “regulatory capture” here in the U.S. That’s a phrase similar to what Nancy Pelosi was calling “crony capitalism” on Wednesday, September 17 before she decided to join the crony capitalists at a microphone on Thursday, September 18 to promise bipartisanship on the mother of all bailouts to Wall Street.
This unintelligent design business model would have cracked and imploded long ago but for one saving grace: it came with its own unintelligent design justice system called mandatory arbitration. Gloria Steinem once called mandatory arbitration “McJustice.” It’s really more like Burger King; Wall Street can have it their way. In a system designed by Wall Street’s own attorneys, arbitrators do not have to follow the law, or legal precedent, or write a reasoned decision, or pull arbitrators from a large unbiased pool as is done in jury selection. Industry insiders routinely serve over and over again. Had there been ongoing trials in open, public courtrooms, the magnitude of the leverage, worthless securities, and corrupted business model would have been exposed before it brought America to the financial brink.
That Wall Street and its Washington coterie are stilled embraced in regulatory capture and unintelligent design is most keenly evidenced by the recent merger of Merrill Lynch, the brokerage/investment firm, with Bank of America, the commercial bank and ongoing discussions to merge Morgan Stanley, the brokerage/investment firm with a commercial bank. (Memo to Enemy Combatants Against Taxpayers a/k/a Wall Street/Washington: this new model is the failed model of Citigroup. Why do you hate America?)
Make no mistake that what ever the dollar amount announced next week to funnel into an entity to buy bad debts from banks and Wall Street firms, it won’t be enough. It’s a Band-Aid on a malignant tumor. That tumor is Credit Default Swaps (CDS) with over $60 trillion now owed through secret contracts in an unregulated market created, financed and owned by the unintelligent design masters, Wall Street firms themselves. (See “How Wall Street Blew Itself Up,” CounterPunch, January 21, 2008.)
There is no sincere plan by this administration to help America or Americans. There is only a plan to slow the financial collapse until after the November elections by throwing a politically palatable amount of money at it and a plan to continue to blame it on a housing bust.
If we, the American people, allow this to happen, we’re enablers to the unintelligent design model. Before one more penny of our taxes are spent on this ruse, we must demand a seat at the table (I think Ralph Nader should occupy that seat) to discuss breaking up Wall Street, crushing this model, innovating a sensible model that serves the individual investor and deserving businesses, and promises our children a future of more than a banana republic.
PAM MARTENS worked on Wall Street for 21 years; she has no securities position, long or short, in any company mentioned in this article. She writes on public interest issues from New Hampshire. She can be reached at firstname.lastname@example.org