Financialism Unwrapped with A 1% Candidate For The 1%

Much has been made of the Greg Smith Op-Ed concerning Goldman Sachs, especially in regard to his contention that the investment house maintains a “toxic and destructive” culture.   Goldman Sachs responded:

“In a company of our size, it is not shocking that some people could feel disgruntled. But that does not and should not represent our firm of more than 30,000 people. … While I expect you find the words you read today foreign from your own day-to-day experiences, we wanted to remind you what we, as a firm – individually and collectively – think about Goldman Sachs and our client-driven culture. [politico]

No denial in this part of the statement that Goldman Sachs employees referred to clients as “muppets.”  Gold Sachs continues:

“Anyone who feels otherwise has available to him or her a mechanism for anonymously expressing their concerns. We are not aware that the writer of the opinion piece expressed misgivings through this avenue, however, if an individual expresses issues, we examine them carefully and we will be doing so in this case.” [politico]

No denial herein either about the firms attitude towards its core ‘values’ and clients, as described by Smith:

“What are three quick ways to become a leader? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.” [NYT]

Politico published a summary of liberal and progressive reactions to Smith’s Op-Ed, but offered little real analysis.    Even a cursory analysis should remind readers to ask a deeper question:

What is the effect of the Goldman Sachs (and other investment house) culture on the promotion of American capitalism?

The “answer” to the negative publicity concerning the financial sector is not merely to hire a new public relations chief, but to satisfy the American public that the investment sector is playing its appropriate role in our economy.  That role should be to channel capital (money) from areas of surplus to areas of shortage.   This is previously tilled territory — but the transferring of capital from investors to industries is supposed to be what the financial sector is all about.   The traditional role is NOT to funnel money into the investment house itself to be churned into more profits in the Wall Street Casino, but to facilitate investment in a productive economy.

A secondary question asks how can public policy improve the performance of the financial sector, which now includes a burgeoning number of hedge funds, private equity managers, and hybrid bank holding company/investment banking operations, so as to further the traditional function of the financial sector in our capitalist economy?

Financialism says: Deregulate the markets and let the money transfer where it will, and if the capital simply serves to support the creation of yet more structured financial products with three letter acronyms — so be it.

Capitalism says: A free market requires the redistribution of capital from areas of surplus (investors) to areas of shortage (manufacturing companies, wholesalers, transportation companies, retail businesses, home owners…)  Funds that are simply swirled around in the Wall Street spin cycle from one investment house to another do not perform this vital function.  In short, the financial sector cannot call itself the “circulatory system” of American capitalism if the money is only circulating around Wall Street.

Financialism says: Any regulatory oversight which costs any investment firm money is an “onerous” burden on the financial sector, and is “anti-business” in that the benefits of regulation do not outweigh the costs of compliance.

Capitalism says:  A free market must also be a fair market, and if investors are to make truly free investments they must be able to calculate not only the price of an investment but also its value.   Some “deals” in the not so recent past have been so opaque that investors could see the price of an equity or bond, but were flummoxed by any notion of what the value might be. It’s time for an example.

In February 2007 Lehman Brothers stock was selling for $86.18 per share, giving it a market capitalization of $60 billion.  [Investopedia] What was less readily apparent was that Lehman’s leverage ratio was 31:1.  Even less publicized were the leverage ratios of other investment houses;  Bear Stearns at 34:1, Morgan Stanley at 33:1, Goldman Sachs at 26:1.  Thus in February 2007  it was possible to know the price of Lehman Brothers stock, but harder to calculate the actual value of the investment and interpret the implications of the leverage ratios.

Financialism says: The regulations imposed by Sarbanes-Oxley and Dodd-Frank are too complicated.

Capitalism says:  We can’t determine value if we ignore the function of information in the transactions.  The following explanation is probably as concise as it gets:

“In a fully free market system, prices act to allocate resources by indicating where they will be most effectively and efficiently used. Prices perform this function by bringing together information about the value of goods and services being produced and the exchange ratios that these goods and services have relative to each other.” [ClemsonInstitute] (emphasis added)

Now, if the products being sold by financial institutions are complicated, does it not stand to reason that the regulations requiring transparency, or the oversight related to restraining the activities involved in trading “illiquid, opaque products with a three-letter acronyms,” will also be complicated?

How, for example, does one draft a simple rule for insuring that something like a CDO squared — “A special purpose vehicle (SPV) with securitization payments in the form of tranches. A collateralized debt obligation squared (CDO-squared) is backed by a pool of collateralized debt obligation (CDO) tranches,” — doesn’t abuse the clients or customers without addressing the complexity of the products themselves?”

Politics and Financialism

The 2012 election campaigns are giving us a very clear view of the way capitalism is perceived by at least one of the candidates, Gov. Mitt Romney. Romney is taking a text-book Financialist stance, to the point of declaring that his main GOP rival former Pennsylvania Senator Rick Santorum is an “economic lightweight.” [ChiTrib]

What would former Governor Romney do, as an “economic heavyweight?” First, he would seek the repeal of the Sarbanes-Oxley Act, passed in the wake of the Enron Debacle, and the meltdown of WorldCom and Adelphia.  [WSJ] When former President George W. Bush signed the bill into law in 2002 the idea was “to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws.”  The  shareholders certainly did need some protection.  Enron shareholders lost approximately $63,101,519,000.  [USAT] MCI estimated WorldCom losses at $74 billion. [BaltSun] The collapse of Adelphia piled on more billions. [Variety]

It’s important to note that while the passage of Sarbanes-Oxley had salutary effects on the overall economy, its provisions were primarily focused on protecting shareholders — the investors, the people and organizations who BOUGHT shares in publicly traded corporations.  [Pepperdine]  These people and institutions may be called “buyers,” “muppets” and “elephants,” by the Financialists, but they represent an absolutely crucial investment factor in any traditional financial transaction.  Without investors (shareholders) there can be no transference of funds (capital) from areas of surplus to areas of shortage.

Secondly, Mr. Romney would repeal the Dodd-Frank Act.  [WaPo]  The Dodd-Frank Act was passed in the wake of the Mortgage Meltdown of 2008.  The bill took on a complicated mix of issues related to the Housing Bubble and the securitized assets (many of which were politely called “toxic”) on which it was based.  Improvements were made in regard to the roles of rating agencies, executive compensation, shareholder protection, hedging disclosures, securitization retention, whistle-blower protection, strengthening SEC oversight, private fund adviser regulation, regulation of over the counter derivatives, financial stability, requiring plans for Orderly Liquidation, and a reorganization of financial regulators.  [See more here]

The objections from the financial sector can be a summarized as (1) It’s too complicated. (And CDO-Cubed’s aren’t?)  (2) It’s too expensive.  (And, how much did our economy lose in the Housing Bubble collapse?) and (3) With all these new rules we are experiencing “uncertainty,” and that makes us less willing to lend money. (This sounds rather like a bit of unsubtle extortion — relax the rules or we won’t release the money?)

Again, it’s important to note that repealing Dodd-Frank will do NOTHING to protect consumers, shareholders, buyers, “muppets,” or “elephants.”  The only group that might benefit from the repeal of the Act are — no surprise — the Financialists who would very much like to return to the heady days of the Housing Bubble and generate revenue and bonuses in their Financial Sector.

Little wonder Governor Romney is a favorite among the Wall Street Casino Crowd.  His interests are their interests.  His opinions are their opinions.  His is NOT the world of consumers, shareholders, buyers, “muppets,” and “elephants.”

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