Tag Archives: speculation

Let’s Save Capitalism

Adam Smith If we want to do something big why not craft a nationwide campaign to save capitalism?  Basic, dictionary definition capitalism:

“ (noun) an economic system in which investment in and ownership of the means of production, distribution, and exchange of wealth is made and maintained chiefly by private individuals or corporations, especially as contrasted to cooperatively or state-owned means of wealth.” [Dict.com]

Let’s declare, right out front, that capitalism is NOT a political system.  It does, however, require a political apparatus and infrastructure to maintain our economic institutions.   Let’s assume that Adam Smith was correct, that monarchical controlled monopolies and charters were counter-productive.  Indeed, Adam Smith was quite vehement on the subject of monopolies. He was particularly opposed to those guild members, shop keepers, and manufacturers who conspired to operate in the Wretched Spirit of Monopoly.”  [Kurz pdf]  He’d seen the results of  conglomerates such as the East India companies of Great Britain and the Netherlands – and he disapproved.   That critique hasn’t prevented the monopolists from mangling the message by adding a bit of  Mandeville here, adding a touch of Samuelson there; marinated in the toxic and sophomoric economics of Rand,  and devising a philosophy to justify unadulterated greed.

The problem for the Justification of Greed crowd is that at some point in the economic process someone has to buy something.  At least in the real world, someone must manufacture a product using primary products (minerals, timber, etc.) and then must transport the products to distributors (secondary) markets, so that ultimately a consumer will purchase the product at a price determined by the balance of supply and demand.  This, at its simplest, is pure capitalism.  We need more of it.

In America’s bifurcated economic system the financial sector, which once primarily facilitated the investment in the manufacturing, distribution, and selling of goods and services, has taken it upon itself to function for its own benefit – one all too often at odds with the Main Street economy it was meant to serve.

The financialists [Forbes]  discovered the gold to be mined from mountains of debt, and sought profit from the debt, the service of the debts, the trading of debt, the manufacturing of securitized assets based on debts, and they turned Adam Smith on his head:

“Adam Smith never espoused the beliefs that control our capitalist system today, that the only purpose of a business is to create shareholder value and that the unfettered market will effectively regulate itself. These two views have been widely adopted, without empirical foundation, by many influential financial and political policy-makers. They have been used to justify systemic deregulation and a maniacal focus on generating short-term earnings that are not necessarily real economic earnings.” [Forbes]

And, they’ve held sway for almost the last three decades:

“Over the last 25 years American capitalism has become financialism, which is primarily transactional, unrestrained greed. Financialism embraces the view that the only purpose of business is to create shareholder value, measured primarily by short-term results. The dominance of short-termism is evidenced by the magnitude of institutional stock “renting” for terms of 12 months or less, the volume of high-speed, high-frequency algorithmic short-term trading, the short average tenures of chief executive officers and the dominance of executive compensation tied solely to short-term results.” [Forbes]

In short, ‘faster and more volatile’ has replaced ‘visionary and more rational’ in our economic system.  And the politicians in place are either wedded to this financialism and actively abetting it, or they are such close allies that the differentiation is difficult to discern. Or to put it in harsher terms: The politicians are selling out the long term benefits of American capitalism for the benefit of short-term financialism.  What’s been the result?

“When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first,” said Piketty, “capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based.” [Piketty, Farrell]

We might simplify this statement by saying: When the financialists take over the field from the capitalists the economic inequalities they create unleash havoc on our real economy and our national values.  Who warned us about this?  None other than the patron saint of financialists – Adam Smith:

“The disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect persons of poor and mean condition is the great and most universal cause of the corruption of our moral sentiments.” [Piketty, Farrell

Smith wasn’t quite finished with the Greedy:

“The great source of both the misery and disorders of human life, seems to arise from over-rating the difference between one permanent situation and another. Avarice over-rates the difference between poverty and riches: ambition, that between a private and a public station: vain-glory, that between obscurity and extensive reputation. The person under the influence of any of those extravagant passions, is not only miserable in his actual situation, but is often disposed to disturb the peace of society, in order to arrive at that which he so foolishly admires.” [Smith; Theory of Moral Sentiments]

So, what have we done for the past 25 years?  We de-regulated the avaricious, we praised the vain-glorious, and we rewarded those harboring these “extravagant passions” with riches beyond their dreams.  Then we declared it “good,” and “American” and the culmination of “Free Enterprise,” when in fact the effect was to “disturb the peace of society,”  and create such income inequality that it is difficult to sustain the basic capitalism we say we admire.

Politicians need to make their positions clear: Do you support American capitalism or do you support Financialism?  If the former, you are deserving of our praise and votes. If the latter, you need to be out of any office of influence until you understand that you are destroying the very system you purport to value above all else.

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Word Salad Shooting At The Volcker Rule

The Big Banks don’t like the Volcker Rule.   For reference, and so we’re all talking about the real thing, here’s the little culprit: The Volcker Rule “separates investment banking, private equity and proprietary trading (hedge fund) sections of financial institutions from their consumer lending arms. Banks are not allowed to simultaneously enter into an advisory and creditor role with clients, such as with private equity firms. The Volcker rule aims to minimize conflicts of interest between banks and their clients through separating the various types of business practices financial institutions engage in.”  [investopedia]


We can simplify this further.  A bank, insured by the FDIC, may not combine their proprietary trading activities with their consumer lending ones.   And, why do we need the Volcker Rule?

“The Volcker Rule seeks to keep activities essential to banking within a safety net, while excluding other, riskier, activities from this safety net. There are a variety of special regulations, and protections, banks get, ranging from federal deposit insurance (known as FDIC) to access to the Federal Reserve’s discount borrowing window, designed to keep the system working through panics. Banks currently engage in a wide variety of non-banking activities with safety net protection. For example, they speculate in currencies and run hedge funds and proprietary trading desks for their own benefit. These activities made the financial crisis worse; one estimate has the major Wall Street firms suffering $230 billion dollars in prop trading losses a year into the crisis. And right now, these activities are subsidized by access to the banking safety net.”  [Nation]

So, the message to the Big Banks is relatively clear:  Your consumer lending activities on behalf of your clients are covered by the “safety net” (FDIC coverage or access to the Fed’s discount window) BUT your hedge funds and proprietary trading desks aren’t.

Slicing and Dicing

Opponents of the implementation of the Volcker Rule make some basic points, all of which deserve more scrutiny.  (1) They argue that the rule making process is creating “uncertainty” because we don’t know what the final rules will be.  The word “tautology” comes to mind because this argument circles back on itself nicely, as in ‘ we can’t make rules because while we’re drafting the rules we don’t know what the rules are.’  If we applied this argument to any other phase of life there would never have been any rules.

Here is an example of the tautological thinking:

“Since neither the banks nor the regulators have any idea what the final regulations will say, they will have no idea what constitutes good faith efforts to comply. Because of the continuing confusion and its effects on the financial system, Congress should immediately begin a serious re-examination of the Volcker Rule’s likely effect both in this country and abroad and repeal it as quickly as possible.”  [Heritage]

Why bother to “seriously re-examine” the rule if the initial purpose is to quickly repeal it?  Imagine for a moment waiting for Moses to return from the mountain.  If our moral judgments aligned with the Uncertainty Proponents we’d not necessarily know that we shouldn’t dispatch each other because we’d have to know in advance if the Almighty intended to incorporate justifiable homicides or excusable homicides, manslaughters or negligent homicides, within the proscription of killing each other — and, further, we couldn’t have a Rule until all of these nuances had been properly phrased and found to be acceptable to all the stakeholders.

(2) A more cogent argument against devising regulations pertaining to the Volcker Rule asks:  How do specific short term banking services apply to the separation of traditional banking and modern client services?   At this point we get into the “liquidity” swamp.

Suppose the executives of SlamBang Corp. want to purchase some stocks for the purpose of generating some revenue for the firm by going to its banker and asking the bank to make the purchase, hold on to the stocks, and if the price of the stocks goes up then selling the stocks, and returning the proceeds of the sale to the SlamBang Corp?  (Less, of course, the fees, commissions, etc. for the bank)  Would this be a violation of the Volcker Rule?

Now we’ve waded into the edges of the Liquidity Swamp, liquidity being “The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity. Assets that can be easily bought or sold are known as liquid assets.”   And, our next step takes us into “leverage.”

Leverage means the extent to which a company is operating on borrowed money.   The good news is that if the company isn’t too far in debt it will be financially stable and lenders will want to make loans to it for a variety of very legitimate purposes.  The bad news is that if it’s as underwater as a Sand State homeowner with a NINJA loan it will be bankrupt, and no one will want to lend the corporation another nickel.  (Think Lehman Brothers)

Life can get messy if and when the SlamBang Corp. gets its revenue from making something tangible AND from making speculative bets in the equities markets — with borrowed money (like asking the bank to hold on to the “stuff” it bought until the price goes up.)  The more the SlamBang Corp. is leveraged — borrowing money to make money — the riskier the entire proposition.  Where will our SlamBang Corp. go to borrow more money to make more money?

Bankers, having set up sizable trading desks, or having once been one big trading desk (Goldman Sachs), were only too happy to transform themselves into bank holding companies for the benefit of their very own social safety net (FDIC coverage, Fed Discount Window, etc.) when they were collapsing like Macy’s Thanksgiving Day Parade balloons in a shooting gallery — now that they have returned to profitability they aren’t the least bit interested in returning to “core banking activities,” and divesting themselves of the revenue generating proprietary trading functions.

Re-enter the financial officers of the SlamBang Corp.  into the lobby of the Big Bank.  Under the terms of the Volcker Rule the Big Bank may not act BOTH as their adviser AND their creditor.  What Big Bank fears at this point is that SlamBang Inc. will take its “speculation in liquid assets for the purpose of leveraging its position” elsewhere, to a private equity or hedge fund for example.

It’s important to notice at this point that SlamBang Corp. isn’t hurt by the Rule, it can easily send its business to an alternative source of credit or financial services — it’s the Big Bank that wants a fork in every plate on the table.    Advocates of Big Bank say:

“The situation becomes even more confused if the bank serves as a “market maker” for a security. A market maker plays a vital role in ensuring the efficient running of financial markets by both buying and selling that security so that others can be assured of buying and selling opportunities, an activity that requires the bank to own a certain inventory of the security.” [Heritage]

Translation:   Banks are now market-makers and market-makers have to own securities in order to be market-makers.   The problem for our economic system is that when the “markets” are made by the banks, and those “markets” are extraordinarily speculative, AND the Big Banks expect the FDIC or the Fed to rescue them if the speculation goes south — then how best can we sustain the traditional functions of our financial sector in a capitalist system without allowing the Big Banks to put us all in jeopardy?

The Volcker Rule.

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