Few would argue that our economic system is in need of an overhaul, what with income and wealth inequality beyond levels thought possible in an enlightened world, national debts and mortgage defaults at bursting points, corporate lobbyists and tax evasion realigning the needs of everyday workers, and a near global financial meltdown that almost destroyed the world banking system still steaming. But one wonders how anything can change when governments refuse to reign in the big boys playing games with the economy.
A once-staid banking industry (with its 3-6-3 rule: borrow at 3%, lend at 6%, on the golf course by 3 pm) has been transformed into a high-stakes poker game, what Scott Patterson called in his sobering book The Quants about math wizards and markets, “hot-rod hedge funds fuelled by leverage, derivatives and young traders willing to risk it all to make their fortunes.” Prior to the near meltdown, the quants were given free rein to make money any way possible, trading CDOs and CMOs (over-the-counter supposedly correlated sliced-up debt products meant to securitize risk) and CDSs (arbitraged insurance that plays long and short positions at the same time), all without regulation. In fact, regulation was discouraged.
With the introduction of credit default swaps – worth more than $60 trillion or almost the entire world GDP before the cracks began to appear – the financial system didn’t stand a chance as greed got greedier, including trumped-up trading profits for a financial industry more interested in its bottom line than in serving clients. Five years on, five banks now control 90% of a more than $700-trillion derivatives market (JPMorgan Chase, Citigroup, Bank of America, Morgan Stanley, and Goldman Sachs). What was once a pastoral Norman Rockwell painting is now one big Jackson Pollock mess.
But can we trace the meltdown to its real causes, at least to try and stop future dominoes of destruction from falling? How about the Gramm-Leach-Blily Act replacing the Depression-era Glass-Steagall Act and the 1956 Bank Holding Company Act. In one scrawl of President Bill Clinton’s pen, investment banks were again allowed to invest ordinary people’s savings at ever-greater margins. The date was November 11, 1999. A year later, Clinton signed into law the Commodities Futures Modernization Act, effectively excluding derivatives from being classified as gambling. Or the Securities and Exchange Commission in 2004 loosening the amount of money a bank must keep in reserve, which freed banks to expand their subprime lending spree. Or Federal Reserve Chairman Alan Greenspan nixing the idea of controls on derivatives. A Wall Street recipe for disaster. Sadly, after almost 14,000 pages of Dodd-Frank, and a not-yet-implemented Volcker Rule, little has changed.
The stock market is still the biggest casino going, in which many of the best mathematical minds continue to ply their correlations and trend analysis formulae, creating newer and more sophisticated black box moneymaking machines, reaping billions to assert their talent (or curb their demons) – all on the backs of credit or in some cases the perception of credit. “Money, it’s a gas,” but how far do we have to fall before we put people back into the equation?
The cooked-up complexities in today’s markets are still susceptible to the viral nature of positive feedback loops. Just as Patterson noted about the origins of the 2007 liquidity crisis: “when the slightest bit of volatility hit in early 2007, the whole edifice fell apart.” The system was pushed well beyond its limits, destroying livelihoods and long-established norms from the prior FDR New Deal era that had, among other things, created the modern American middle class. In the process, income inequality has risen as high today as in the 1920s.
We all lose whenever government errs on the side of Wall Street versus Main Street, self-interest versus community. What is more, few understand the levers being pulled to manipulate the money machines. So-called “quantitative easing” is supposedly saving the system today, the latest and greatest of Keynesian fixes, where the Fed buys bonds to prop up the market and monetizes American debt, but in effect expands inequality – injecting liquidity into money funds to help those who make money from money, yet not giving aid to those with homes or small businesses – not to mention playing havoc with currency markets in countries previously deemed worthy of such “easing.”
To be sure, the situation is more complicated than George Bailey’s, who so devotedly and stoically stood by his fellow man in the perennial Frank Capra Christmas favourite It’s a Wonderful Life, encouraging all to share in the fruits of community labour, a movie everyone understands is – at its core – about fairness. Do the basic tenants of fairness no longer apply?
To those who think private industry, private regulations, and private markets know best how to serve innovation and growth, how can a market know best if price is its only measure, and is so often manipulated? When price is king, greed becomes greedier, especially when viewed only as ups and downs in a stock index or good and bad numbers in a spreadsheet. High-frequency machine trades now account for over 70% of all trades. In the multi-trillion-dollar, foreign exchange markets (a.k.a. forex or FX) over $4 trillion is traded round the clock daily (Sundays excluded). Once upon a time foreign exchanges helped companies with international supply chains weather currency fluctuations; now they serve the coffers of high-wealth individuals.
Is it time to include a tax or commission on assets held for less than a specified time to curb high-frequency trading, which has nothing to do with investing in a company? Is it time to regulate derivatives, which are essentially high-end games of chance? Is it time to remove tax-avoidance schemes, which serve only to fuel speculation and expand inequality? Other more radical changes will be needed if the lever-pulling fails to correct our latest Bubble Economy such as limits to income and ownership, anathema to the American way of life.
Capitalism is not a license to act only for profit. Its first great proponent, Adam Smith, said as much: “Consumption is the sole end and purpose of production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer.” Smith understood that the inherent flaw in real capitalism was that there could be no profits. But we do not have real capitalism. We have a capitalism stacked in favour of those in finance. Is it really any wonder that the finance industry is expanding at the expense of industry when the bankers are calling all the shots?
Do we want better HDTV or better health care? Next generation drone warfare or flood defences? Bigger bank accounts for the money men or more jobs for the rest of us? We have to find a way to promote investment in people first, not profits. Capitalism 2.0 – the choice is ours.
JOHN K. WHITE, an adjunct lecturer in the School of Physics, University College Dublin, and author of Do The Math!: On Growth, Greed, and Strategic Thinking (Sage, 2013). Do The Math! is also available in a Kindle edition. He can be reached at: firstname.lastname@example.org.