There is a difference between Capitalists and Financialists, and rarely do we get a clearer example of this differentiation than in the Chicago Tribune’s interview with Citadel’s Kenneth Griffin.
Capitalism is an economic system in which private capital is channeled from areas of surplus to areas of shortage by the financial sector, for the purpose of the expansion, innovation, and development of our production, distribution, and exchange of goods and services.
“Financialism is an economic system where the primary activity consists of creating and manipulating financial instruments.[...] when financialism sets in, financial instruments become progressively further removed from their role in supporting commerce in the real world and develop a life of their own, a weird shadow dimension, a hall of mirrors, a distorted alternate reality that intersects and reacts with the real economy in unpredictable and destructive ways. [...] Derivatives have a lot to do with it. Leverage and the abuse of easy credit are contributing causes. The shadow banking system is a symptom.” [Seeking Alpha]
Q. There’s some people who will see a lot of irony in that given the speculation that takes place in the financial industry.
A. I think there’s a huge difference. Gambling is entertainment. We have great destinations for that, like Las Vegas. Just not in Chicago. Financial markets, what one often refers to as speculation, is really the force by which we move capital to the best and highest use. Investors who find the best businesses to put their money behind are rewarded for their research. It’s not the prettiest way you can ever imagine to allocate capital. But if you look across the entire world, it’s the best way we know to allocate capital.
First, because Poker is an entertaining pastime doesn’t mean there aren’t some people who take the game seriously enough to become professional players. Nor do we conveniently re-define the employment of professional athletes merely because the games they play are also enjoyed by children. Speculation is speculation whether done by Saturday Night or professional players.
Secondly, let’s look at the core statement: “Financial markets, what one often refers to as speculation, is really the force by which we move capital to the best and highest use. Investors who find the best businesses to put their money behind are rewarded for their research.”
What “highest and best use?” Is the highest and best use of our capital funds the investment in expanded factories, new equipment, or in the results of research and development? Or, in shadow financial sector bets on CDOs? Speculative trading in derivatives? The trading of derivatives based on synthetic CDOs?
Investors who do their homework should be rewarded with better returns. However, how is an investor to know if the investment banker hasn’t placed “a bet” against his or her position? It’s been done before, famously by Goldman Sachs.
Investors also have to be able to evaluate the financial products they are encouraged to purchase. What was the value of a share of Lehman Brothers before their collapse? We knew the price but not the value. What was the value of the two hedge funds run by Bear Stearns prior to the credit debacle? Again, the “market” told us the prices attributed to these firms, but nothing about their real value. We’re still trying to figure out the actual value of those infamous toxic assets bankers loaded onto their books before 2008.
How do we reward “research” when we have a plethora of information about the prices for various investments, but we can’t know the actual values because these might be skewed by the “reflexive, distorted reality,” brought on by the use and abuse of leveraging and derivatives?
Is this the best way to allocate capital? Obviously not. Not if this analysis by Asian bankers is any indication: “The value of global financial assets including stocks, bonds and currencies probably fell by more than $50 trillion in 2008, equivalent to a year of world gross domestic product, according to an Asian Development Bank report.” [Bloomberg] If a system in which losing $50 trillion worth of global financial assets in one year is a distinct possibility, then we’re quite evidently a long way from “the best way to allocate capital.”
“But at the same time, the government being involved in picking winners and losers invariably leads to a loss of economic freedom and encourages corruption. Solyndra is the poster-child of that. The backers of that entity gave a lot of money to the Obama administration. Was it $500 million (they lost)? A half billion dollars unaccounted for, for all intents and purposes. It’s gone.”
Really? By Mr. Griffin’s lights the United States of America would never have given the go-ahead to the transcontinental railroad? Was giving land to the Union and Central Pacific Railroad companies “picking winners and losers?” How about the decision by the New York State Legislature to back the financing of the Erie Canal? For the one example ultra-financialists love to cite (Solyndra) we can name several government sponsored or backed innovations and developments which are the poster children for economic success. As noted in a previous post, WE developed a national rail system, WE funded microwave research, WE pioneered systems to de-ice aircraft, WE funded an interstate highway system, and WE funded the research for the radial tires we use to drive on it.
A financialist isn’t concerned with the development of actual firms that produce, distribute, or exchange goods and services EXCEPT insofar as those firms are objects of the financialist’s research into the value of their stock prices. Or, into the value of their corporate indebtedness which may or may not make the company a target for mergers and acquisitions. Inventing, manufacturing, and selling aircraft de-icing equipment…not so much.
“Q. So do you or don’t you think the public should know if you’re giving this money?
A. My public policy hat says transparency is valuable. On the flip side, this is a very sad moment in my lifetime. This is the first time class warfare has really been embraced as a political tool. Because we are looking at an administration that has embraced class warfare as being politically expedient, I do worry about the publicity that comes with being willing to both with my dollars and, more importantly, with my voice to stand for what I believe in.
As government gets bigger every single day, how does my willingness to stand up for what I believe is right become eclipsed by my dependency on institutions that are ultimately controlled by the government? Remember I live in financial services, and every bank in the United States is really under the thumb of the government in a way it’s never been before. And that’s really worrisome to me, as someone who’s willing to say, ‘Wait, we need to step back and try to push government outside the realm of every dimension of our lives.'”
Class warfare, a political tool? Please. Warren Buffett described class warfare and famously noted that his class was winning it. “There’s class warfare, all right,” Mr. Buffett said, “but it’s my class, the rich class, that’s making war, and we’re winning.” [NYT] The follow graph confirms Mr. Buffett’s observation:
And, what says “winning” more than cutting the rungs from the social ladder out from under those who might follow? Cuts to higher education? Cuts to public school education? Cuts to programs to keep families out of abject poverty such that their children have an opportunity to advance? Cuts to programs that facilitate the health and well being of our citizen/consumers? Slashing the safety nets of Medicare and Social Security which give the ladder a firm foundation?
As the “government gets bigger every day?” Does Mr. Griffin mean an increase in the number of federal employees? If he does then he is mistaken by 273,000. ” By the end of 2010, the United States STILL has less employees on the books than we did back in 1980 even though the population has grown from 226,545,805 to approximately 330,000,000 in 2010.” [Quinnell]
Perhaps what is worrying our Financialist Mr. Griffin and his cohorts is the part in which there is more oversight of the banking sector. Now, why would the American people expect more accountability and oversight of a financial sector which lost $50 TRILLION IN GLOBAL WEALTH IN ONE YEAR?
The Financialists would have us forget that most of the housing bubble was inflated by PRIVATE sector banking, greedy for more loans to warehouse, sliced and dice into CDOs, and thence bet upon. Bankers, during the housing bubble, behaved more like teens in need of a curfew than adults in charge of transferring capital in a complex economy.
Returning to the Oracle of Omaha to explain how this happened:
“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.”
And, they don’t think they need adult supervision? Supervision “takes away their freedom?” Can anyone else recall this fundamentally adolescent complaint echoing through millions of American households? The usual response is something like: When you earn our trust you’ll have more freedom. Perhaps the Financialists would be better off if they worked as hard earning back our trust as they do financing candidates who will let them stay out as late as they want with their pumpkins and mice?
Example Four: Mr. Griffin explains we drove home prices too high, and there was a big bubble (we figured that out already) and he didn’t mention Wall Street, so the interviewer asked:
Q. So you don’t think Wall Street played a role?
A. I didn’t say that. The biggest role: Fannie (Mae) and Freddie (Mac). Look at the issue of economic freedom that I spoke to earlier. The GSEs provided more fuel to the housing bubble than any other entity in the world. And by the way, they had their own dedicated regulator. And, by the way, we’re all going to pick up the tab of several hundred billion to a trillion dollars in cleaning up the losses at Fannie and Freddie. The primary source of fuel to that bubble was policies that came out of Washington. And, by the way, why were Fannie and Freddie so above reproach for all those years? They put so much money into local congressional seats in one way or another. No congressman wanted to touch them.
Unfortunately, Mr. Griffin has “slipped the surly bonds of Earth,” and flown off into his own alternate reality at this point. It’s possible to conclude that the Financialist Word Salad offered above reflects the discomfort Financialists have with the actual origins of all the money that flowed into the subprime mortgage market during the bubble. McClatchy newspapers clarified:
Scroll down the list above — do you find Fanny and Freddie there? Of course not, those two GSE’s are in the secondary mortgage market, and they were pummeled by shareholders into lowering their underwriting standards because the Wall Street maw couldn’t be filled during Cinderella’s Black Swan Ball with enough “stuff” to churn into those bright shiny CDOs and related derivatives without lowering standards — and so they did. “But, but, but, Officer, I’m out after curfew because my parents gave me an excuse?“
Example Five: Mr. Griffin continues –
Wall Street had a role in this. The development of mortgage-securitization technology, like every other form of technology, had both good and negative attributes. The biggest negative attribute is that we failed to encourage the end lender of money to be as disciplined as we should have been. And (the rating agencies) didn’t call it right. But I’ll leave you with a thought on this. It’s very hard to know you’re in a bubble until it’s gone. The housing bubble hit a lot of people. The dot-com bubble hit a lot of people. And until it burst — and you look back and go, ‘What were we thinking?’ — it’s often really hard to know you’re in a bubble.
Discipline broke down among lenders. Discipline broke down among mortgage brokers. And discipline broke down among consumers.
This would be a lovely excuse (“Gee Whiz Officer We Didn’t Know What Time It Was…”) except that there were people trying desperately to tell you that things weren’t going well, and the Financialists at Cinderella’s Black Swan Ball didn’t want to listen.
Brooksley Born tried to get the reins on runaway derivatives trading which was beginning to worry her in the 1990s:
“In the late 1990s she was advocating more transparency and regulation of financial derivatives. In 1998, leading the CFTC, she declared that the unregulated contracts could “pose grave dangers to our economy.”
But derivatives turned out to be the precursor ingredient to the financial explosion a decade later. Without derivatives, a multitrillion-dollar market, the simple collapse of the subprime mortgage market wouldn’t have been so dire.
Born was also known as being stubborn. But she ran up against then Fed chairman Alan Greenspan, Clinton Treasury secretary Robert Rubin and assistant Treasury secretary Larry Summers. The three men ultimately prevailed on Congress to stop her and limit regulation over derivatives.” [McClatchy]
Susan Bies, a member of the Federal Reserve’s Board warned bankers very specifically in 2006 that the economy might not be able to absorb the shock when the bubble burst:
“The growing ingenuity in the mortgage sector is making me more nervous as we go forward in this cycle, rather than comforted that we have learned a lesson. Some of the models the banks are using clearly were built in times of falling interest rates and rising housing prices. It is not clear what may happen when either of those trends turns around.” [McClatchy]
And, of course we should include Sheila Bair of the FDIC:
She first became concerned about housing in 2001 as an official at the Treasury Department.
Bair, a native of Independence, Kan., became chairwoman of the FDIC in June 2006 and was soon warning about subprime mortgages. She said she “started hearing that lending standards had deteriorated in subprime. So we started looking into it.”
She apparently was the only actual bank regulator to raise alarms.
Again, she was essentially ignored. [McClatchy]
Strike Three. These three women weren’t the only ones raising flags and trying to get the “out after curfew at Cinderella’s Black Swan Ball” Financialists to pay attention to the ticking clock. Economists Paul Krugman, Dean Baker, and Nouriel Roubini predicted problems. Investment manager Peter Schiff saw problems in the offing. Financial strategist Med Jones came very close to the final picture. [EconPred] To say “No one saw it coming” is as self serving a claim as it is specious.
These five examples of Financialism at play in Mr. Griffin’s interview should be sufficient to convince the sentient among us that the Financialists are (1) intent upon placing the blame for their mismanagement of the economy during the housing bubble on anyone but themselves — those pesky borrowers, those GSE’s, ANYONE but themselves; (2) focused not on the transfer of capital into the production, distribution, and exchange of goods and services BUT into the shadow banking world of profitable derivatives and perhaps even more derivatives of the derivatives; (3) certain that if “the government” (that would be the people of the United States of America) would just let them go back to their party as if nothing had happened everything will be AOK and hunky-dory.
Finally, they appear to be quite convinced that anyone who questions their judgment, influence, and power (after we’ve had such a lovely $50 trillion example of what happens when they are allowed to play without adult supervision) is preaching Class Warfare.
And, this is what Financialists sound like.