Extortion, Capture, Looting, Propaganda. Our Modern Finance Industry.

First, let’s get something very clearly understood:  More than three years after the Great Recession, all of our major banks, as well as the major banks in Europe, remain insolvent.  From Yves Smith’s brilliant book, Econned, How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.

“Andrew Haldane, the Executive Director for Financial Stability at the Bank of England, concluded that it was impossible for the financial services industry to pay for the damage it wrought in the global debacle.  The lowest plausible estimate of the total costs that he could come up with, amortized over 20 years, still resulted in a first year’s bill that exceeded the total market capitalization of the biggest banks.”

It took 40 years to unwind a regulatory structure that was the envy of the world.  That regulatory discipline allowed America to become the world’s greatest manufacturer.  Common sense regulations,  forged in the heat of the Great Depression and responsible for a long period of economic growth widely shared by the majority of citizens, were systematically dismantled.

As the dismantling progressed the nation’s financial industry grew in size and profitability.  Once only 8% of the economy, it soared to 25%.   In terms of total corporate profits, finance grabbed more than 40% of profits.  At the core of this expansion were a new class of financial ‘innovations’ called derivatives.  Layered over traditional financial instruments like bonds, stocks, insurance contracts, commodity futures and related options, these derivatives exponentially increased the amount of money going into finance and, for all intents and purposes, dramatically under-priced risk.  Derivatives had the nefarious effect of funding debt that was hugely under-priced, causing trillions of dollars in ‘bets’ to be made on all aspects of finance.

It wasn’t just in housing mortgages either.  This surge in under-priced debt went everywhere:  Student loans, car loans, merger and acquisition funding, sovereign debt, insurance contracts–everywhere–you name the financial function and this explosion of liquidity drove down interest rates to the point where those rates couldn’t come close to covering repayment problems or other risks.

The only solution is structural change that reduces the size and interconnectedness of the major actors.  Given the fact that these ‘major actors’ provide the primary funding for political campaigns, including millions of dollars in political advertising aimed at influencing the public’s understanding and perception of events, efforts to make structural changes face huge political hurdles.

  • Shrink the use of derivatives, most specifically so-called credit default swaps (CDS).  These instruments are pure bets on insurance contracts.  They avoid the ‘insurable interest’ rule of insurance (you can’t pay for insurance on your neighbor’s house, for one obvious example, because you have an incentive to burn it down!) and have no legitimate economic purpose other than being a fee generating machine for the financial services industry.   These derivatives still exist and are still exempt from regulation, believe it or not.  They are so pervasive inside bank balance sheets, an outright ban is probably not wise.  Regulating them, however, will end the cowboy type of behaviour common with their use.  Regulating them will increase their cost, in other words, and limit their use.  This will also restore more accurate risk assessment.
  • Limit guarantees to critically important banking and capital market activities by installing a modified version of the Great Depression era, Glass Steagall legislation.  Commercial banks would be limited to making traditional loans and using plain vanilla hedges.  They could also engage in pure fee businesses such as those of being custodians or trustees.  Any use of CDS derivatives would be limited to regulated CDS insurance subsidiaries.  Investment banks would become more strictly regulated although their traditional functions would remain unchanged: Underwriting and distributing equities and bonds and market making; CDS activity limited to regulated insurance subsidiaries; mergers and acquisitions; asset management providing the asset manager does not rely in any way on funding from the investment bank.  Proprietary trading and the trading and sale of over the counter (OTC) derivatives would be prohibited, however.  Lending to hedge funds, save against specific positions on conservative terms, would be barred, as would warehouse facilities and bridge loans.
  • Tighten other regulations to close gaps and extend liability to responsible parties.  These regulations should not be rules-based, but principles-based, a.k.a. ‘if it walks like a duck and quacks like a duck, it’s probably a duck.’  A low tolerance policy towards ‘innovation’ designed to evade standards would be more effective than any attempts to craft airtight regulations.
  • Restore secondary liability.  In 1994 the US Supreme Court disallowed suits against advisors like accountants and lawyers aiding and abetting frauds.  In criminal law the guy who drives the getaway vehicle is an accessory, why isn’t an accounting firm who prepared misleading financial statements an accessory to fraud?
  • Increase the budgets of regulators.  More auditors are needed who can sniff out that something is not right.  The claim that everyone who knows the inner workings will be in the private sector and won’t want to be a regulator is specious.  There are many examples of experienced private market actors who decide to become regulators.  Sometimes for, God forbid, altruistic reasons!   The enforcement team would need to attract only a few of these experienced individuals to make a great difference.
  • ‘Free market’ mania, quoted from Econned:  “Powerful business interests, largely captive regulators and officials, and a lapdog media took up this amorphous, malleable idea and made it a Trojan horse for a three-decades long campaign to tear down the rules that constrained the finance sector.  The result has been a massive transfer of wealth, with its centerpiece the greatest theft from the public purse in history.  This campaign has been far too consistent and calculated to brand it with the traditional label, ‘spin.’  This manipulation of public perception can only be called propaganda.  Only  when we, the public, are able to call the underlying realities by their proper names–extortion, capture, looting, propaganda–can we begin to root them out.”

Beezer here.  Econned is the best book I’ve read so far, and I’ve read many, that explains in terms the average person can understand just how we got into this mess–and explain how we might be able to extricate ourselves without burning the whole house downIn our opinion the last bullet is obviously the most important.  The public has to be better informed in order to understand that what we have now is decidedly not capitalism and the markets we have now are decidedly not ‘free.’   The first job is to take on the propaganda machine.  It’s giving the public a Potemkin Village version of reality.  What we need is reality.

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One Response to “Extortion, Capture, Looting, Propaganda. Our Modern Finance Industry.”

  1. M. Gainsbrough Says:

    Hi, just wanted to know I’ve really been enjoying your blog, especially the last couple posts. Keep up the good work, friend!

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