For The Love Of Money: Financialists vs. Capitalism

One common theme reiterated in the Tea Party world is that liberals “think wealth is evil.”  [TPN] There’s rarely any evidence — even anecdotal — supplied with this allegation, it’s merely accepted as an article of conservative faith.  But no, the Biblical reference doesn’t say “money is the root of all evil,” it actually says in 1 Timothy 6:10, “For the desire of money is the root of all evils; which some coveting have erred from the faith, and have entangled themselves in many sorrows.”  First, you desire money above all else (materialism) then you covet it to the extent you distort your own values, then you get “entangled” in a host of problems — most of your own making.  Thus, wealth isn’t evil, even great wealth isn’t evil, unless: Materialism begets (a fine old Biblical word) a distortion or destruction of core values.

Unfortunately, what we’ve been destroying is our own system of Free Market Capitalism, “An economic system in which the means of production and distribution are privately or corporately owned and development is proportionate to the accumulation and reinvestment of profits gained in a free market. ” [Dictionary]

The “accumulation and reinvestment of profits gained” is essential feature of the system.  Wealth is accumulated and reinvested which fuels economic growth.  There’s absolutely nothing wrong with that — IF the reinvestment is attached to “development.”

If we accept the veracity of the mini-sermon above, and the standard dictionary description of capitalism, then our economic system should work to allow the accumulation of wealth and to facilitate its distribution in such a way as to enhance the development (growth) of our own economy.  This is where the financial sector should take the stage.

The Basics: Surplus to Shortage

The most basic explanation of the financial sector’s function is to “channel funds from economic units with surplus funds to those that have a shortage of funds.” [NiEco.pdf]  The three basic economic units are consumers, businesses, and government.  The financial markets should, for example, allow households to accumulate wealth which can be used to purchase shares of a company that is selling equities in order to expand its operations.  If the cycle is working properly the investor-household risks its funds because there is the potential for earning more from the return on the investment.  The explanation implies the “development” function, i.e. that the surplus funds will be applied towards some business activity which is intended to expand or maintain the company operations.

OK, we got all this in high school Economics, or perhaps in Econ 101 — so, what’s the problem?  Let’s return to our mini-sermon for part of the answer.  Coveting money (profit) for its own sake distorts the entire operation.  If the money (profits) aren’t reinvested in the economy in productive ways which channel the surplus to the areas of shortage, then capitalism doesn’t work.

Surplus to Surplus

What happens when the financial sector places more value on the accumulation of profits than on the essential surplus to shortage channeling function in a capitalist system?  We get the Wall Street Casino.

The New York Times provided this description:

“The Securities and Exchange Commission has accused Goldman of defrauding clients by selling them a complex instrument without telling them it was designed so another client could bet against it. Testifying before the Senate subcommittee on investigations, Goldman executives denied withholding information. They insisted there was nothing wrong with selling mortgage-backed products while placing bets against them.  They called it “risk management.” Most people call it stacking the deck.”

The obvious point is that Goldman Sachs was engaged in betting against its own clients, but there is a more subtle point included in this statement:  Goldman Sachs was not channeling funds from surplus to shortage, but from profit to profit.  Goldman Sachs sold mortgage backed securities (and made a profit) and then hedged its own profit by betting against its own sales.  While there may be nothing presently illegal about this conduct there is also little to connect it to the fundamental function of channeling funds from surplus to shortage.

The capitalist system worked when mortgage bankers lent money to home owners who needed the funds to purchase homes (surplus to shortage), and it was working when the lenders sold the mortgages into the secondary markets (freeing up and accumulating capital so more mortgages could be sold), but the system was endangered when the mortgage backed securities were repackaged in such an artificial and unnecessarily complex way that financial institutions were  making money by in-house gambling on the success of the transactions — not securing a profit in the “real economic world.”

Playing with money in the shadow world of the Wall Street Casino worked, until it didn’t.  “The financial crisis was man-made and avoidable. Regulators and credit-rating companies blew it. Banks and homeowners borrowed too much. Companies such as AIG and Lehman Brothers had horrible governance. Ethics and accountability broke down.”  [Bloomberg] This is what happens when the core function of the financial markets (channeling surplus to shortage) breaks down, i.e. when the financial sector focuses altogether too much attention on “making markets” which involve bankers selling paper to other bankers on which the bankers bet.  What fueled the mania?

Fall Out With No Shelter

In a word: Financialism.  “…it encourages the proliferation of transactions that have no direct connection with the real economy. Funds that should be devoted to lending to businesses, homebuyers or consumers, are instead diverted into endless arcane zero sum games, with pernicious results. ” [Armistead] Translation: Funds that should be moving from areas of surplus to shortage are instead moving among and between financiers purely to make a profit, with no connection to the real world. For all intents and purposes, financialism is the accumulation of wealth for the purpose of minimizing risk in order to accumulate more wealth.

Those who sneer at the expression “re-distribution of wealth” are conveniently ignoring the fundamental precept of Free Market Capitalism which requires the financial sector to facilitate the re-distribution  of wealth from surplus to shortage in the form of investment.   Cheerleaders for the radical right who denounce financial regulations and financial regulation reform are in essence asserting that it is perfectly acceptable in a Free Market Capitalist system for one group to accumulate as much wealth as possible without engaging in the real economy.

Worse still, the sector which is supposed to provide the essential re-distribution of wealth in the real economy is the one most enamored of moving funds from surplus to surplus in the Fantasy Economy without performing its core function in a Free Market Capitalist system.  Rationalizing this activity requires some astonishing levels of distortion.

Looking back once again at the statement by Bank of America CEO Monynihan we can see the ultimate expression of Financialism:  “I have an inherent duty as a CEO of a publicly owned company to get a return for my shareholders,” Moynihan said in an interview with CNBC’s Larry Kudlow at the Washington Ideas Forum.” [Politico]

His “ultimate duty” is a return for investors?  Not providing the best banking services to our customers?  Not providing the most efficient banking services  to stimulate economic growth in the communities we serve?  Not providing the customers with financial products that will serve their economic needs  even if these are marginally profitable for the bank?  In Moynihan’s  Financialist world shareholders trump customers, short term profits trump long term economic investment, and short term corporate value trumps real economic growth.

Ed Hess (Forbes) explains why Moynihan’s perspective is a fantasy as contrasted to the reality of our economic lives:

“The fact is that there is no empirical basis for financialism’s underlying fundamental principles–that a corporation has no obligation to society other than to maximize short-term value for its shareholders, and that the capital markets should be their own sole regulators.”

The Debris Field

When transactions are currency for their own sake, when “markets are made” solely for the purpose of short term returns, and the ethics of finance are so distorted that short term profitability is an end in itself, all manner of unfortunate results may ensue.

We’ve read the headlines: “Wisconsin school districts slammed by Wall Street.” [CNN] Five Wisconsin school districts were sold financial products that could end up costing them $200 million. “SEC charges Stifel Nicolaus executive with defrauding 5 Wisconsin school districts” [OnWallSt]  “5 Wisconsin School Districts and 3 Ill-fated Securities” [NYT]  “RBC to pay $30.4 million to settle SEC charges on Wisconsin CDO sales.” [WSJ]  “Jefferson County (AL) approves deal with creditors,” “Jefferson’s crisis erupted in early 2008 when investors dumped floating-rate bonds used to refinance its fixed-rate sewer debt after companies that insured them lost their top credit ratings because of investments in subprime mortgages.” [Bloomberg]

The sad examples of the Wisconsin school districts and Jefferson County, Alabama illustrate the debris field created by rampant Financialism, but they are not the only consequences.

Pressure to reduce labor costs:  If short term profits demanded by Financialists are paramount, then corporations are more likely to be expanded by mergers and acquisitions than by investment in production capacity.  M&A activities  often eliminate more jobs than they create.

Short term profitability assumes the reduction of labor costs, and the obvious way to trim expenses is to lay off employees.  In the 1990s Financialists became entranced by the “7% rule” — according to which if a company laid off employees its stock price would increase by 7%.  The “rule” has been thoroughly debunked, but pressure to reduce labor costs as a way to secure a favorable report from stock analysts continues. [NewYorker, 2007]

The pressure to reduce labor costs also impacts wages and has done in such a way as to create wage stagnation, with the resulting decrease in consumer spending capacity. In the real economy workers are consumers and consumers are workers. [Reich] In the fantasy economy of the Financialists yield is the only thing that matters.

Pressure reducing corporate stability:  The average shelf life of a CEO in this over-heated Financialist driven economy is about six years.  A half dozen seasons on the job does not encourage institutional memory, institutional stability, or long range planning.  Tying compensation to short term profitability reduces interest in long range, core function based, business leadership.  The good news is that many  successful corporations haven’t fallen for the Financialist siren song, but too many have — and too many are in the financial sector.  [Forbes]

Saving Capitalism

It is not the accumulation of wealth that leaves a debris field of broken American dreams.  However, the short term profit dominated deformation of our Free Market Capitalist system is predicated on a denial of both theological and economic verities:  The Financialist’s love of money (short term profits) causes us to err in our faith in Free Market Capitalism, and to entangle ourselves in many sorrows.

*H/T Karoli for illustration from LynnUnitedforChange

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