Wall Street Has a Gambling Problem (Excerpt)
Bulls make money. Bears make money. Pigs? They get slaughtered.
What is the definition of insanity? It's doing the same thing over and over and expecting a different result. By that standard, most of us are insane.
And, OTC derivative speculation is just such an act of insanity that in the end may bring down the American financial system and cause irreparable damage.
Almost every major economic disaster in American history has been due to irresponsible speculation in the financial marketplace. And, at no time in our history has speculation (stock swaps, venture capitalism, hedge funds) been more widespread, or more of a threat to our nation’s survival.
At the heart of our most recent economy crisis was the derivative speculation by the nation’s largest investment banks. Collectively these financial institutions (driven by greed) delivered the world to the edge of Armageddon.
By definition: A derivative instrument is a contract between two parties that specifies conditions (especially the dates, resulting values of the underlying variables, and notional amounts) under which payments are to be made between the parties involved.
In 1933 the Glass and Stegall Act was enacted, forcing a separation between commercial banking and investment banking. Apparently, lawmakers thought it unwise to continue to allow bankers to indulge in risky speculations with their depositor’s money. Not to mention that it was the bankers, dangerously borrowing on the margin, that had just caused the Great Depression.
But, before the ink was dry on the legislation, the banking community undertook plans to rewrite it. That is, failing in their bids to repeal it, they decided to try loosening the restrictions of the law. Mobilizing all the power at their disposal, they convened an army of wingtip warriors armed with Milton Friedman’s playbook to wage war against the Keynesians in the name of Adam Smith and all that was holy (laissez faire).
Enter Allen Greenspan, Chairman of the Federal Reserve and advocate of Free Market Capitalism, in 1993 declared the Glass and Steagall Act obsolete. Corporate banks like now defunct Lehman Brothers, J.P. Morgan, Chase, Goldman Sacks, Merrill Lynch, Bank of American, Citibank, Wells Fargo, and others waged a full-on campaign (employing the most influential lobbyist on Broad Street) to repeal the act.
One writer wrote: “After 12 attempts in 25 years, Congress finally repeals Glass-Steagall, rewarding financial companies for more than 20 years and $300 million worth of lobbying efforts. Supporters hail the change as the long-overdue demise of a Depression Era relic.”
The repeal kicked off a marathon of buyouts and mergers, large commercial banks gobbling up smaller investment houses; as well as, titans of Wall Street joining forces in order to better carve up the financial landscape.
By the mid-nineties, the banking elite seemed to have won over even their most diehard skeptics. The Dow Jones was reaching record highs (seemed like every week), helped by go-go stock and the tech boom. The rich got richer and even the middle class saw a modest and momentary uptick in their declining wages. America was once again the land of “milk and honey.”
Allen Greenspan, talking his cue from Ayn Rand the hyper-conservative political philosopher, was dubbed the “Wizard of Wall Street.” And, the three wise men and Wall Street insiders, Tim Geithner (Treasury Secretary), Larry Summers (Director of the Economic Council), and Robert Ruben( presidential economic advisor and later Treasury Secretary) had President Clinton’s full confidence, to put it mildly.
It was around this time that Brooksley Born (close friend of Hillary Clinton) was appointed Chair of the little knows agency, the Commodity Futures and Trade Commission(CFTC). Born was described by her peers as strong willed, yet responsible and accountable. Two traits not usually associated with lawyers.
Not long in office and she directed her staff to begin investigating CDO (Collateralized debt obligations) activity. Plainly put, CDO activity amounts to betting on whether a stock will do well or poorly. Evidently, she uncovered information which lead her believe that there was massive and systemic fraud going on. And, more importantly, CDOs, while yielding astronomical profits for investors, were posing a dangerous risk to the nation’s financial sector.
She was soon called on the carpet for her due diligence. She found herself before Allen Greenspan himself. And, while no one knows exactly what was said, it was clear that she was ordered to cease and desist her current investigations into fraudulent activity in the OTC derivatives markets.
Never mind that dark trades amounted to 27 trillion. Self-regulating, the black box trades or swaps weren’t required to record transactions and thus remained non-transparent. As a result, no one, not even Greenspan understood the threat that it posed to the global market’s equilibrium.
But, fortunately, Brooksley Born wouldn’t back off. This courageous little woman hung onto her convictions like a pit-bull laying claim to a hunk of steak.
I would like to say that this David of the fairer sex took her sling and slue the Goliath. She was even starting to gather believers when Proctor and Gamble filed a law suit against Banker’s Trust for swindling them out of millions in a derivative deal. Regrettable, the event only amounted to a speed bump as the banking elite mashed the pedal to the metal.
Pressure was brought to bear and Born was stripped of her power before Congress, but not her dignity nor her certainty about a market crash of crucial proportion in the foreseeable future. Her voice had been silence by those possessed by the blind will to money and power.
We didn’t have to wait long for her prediction to materialize. In 1998 LTCM (Long-Term Capital Management) controlled over $100 billion and had positions whose total worth was over 1 trillion. When the hedge fund neared default and approached financial collapse, as a result of its overextension, its spreadsheet revealed a systemic threat.
Turns out that the complexity (inverse trig functions) of the swaps deals were mindboggling, tethering LTCM to dozens of the world’s largest banks and funds. Naturally, Greenspan stepped in to bail out the fund and its rich creditors. Thus, a total meltdown of the U.S. economy was averted.
Now the warning signs were clear. But, doing something by way of regulation would interfere with the million dollar bonuses being doled out.
And, the band played on into the next decade. By 2007, the estimated amount of dark trades had reached 595 trillion. Yes, I said trillion.
After the tech bubble burst, the housing bubble proved to be the next cash cow. Sub-prime loans moved faster than a $5 hooker on coupon night and the big boys wanted a stake in the game.
So, billions in housing loans were bundled together into mortgage backed securities. Fannie Mae and Freddy Mac had been the leaders of the housing loan industry. However, when the two giants got embroiled in accounting scandals, they lost their dominance of the mortgage market.
Wall Street then stepped in, using petroleum-dollars and immerging markets monies, to finance the housing loan market. Stringent loan requirements were reduced and sub-prime loans increased mortgage volume. More mortgages, more money. Trillions in loans were handed out on the basis of a stated income (no proof required).
And, while the banking elite knew that the bubble would eventually burst, given the fact that the housing loans were given to people who should have never had them in the first place, they went right on doing business as usual. Most buyers never even understood the terms of the loan or the intricacy of adjustable interest rates.
I had just sold my house, and was renting a townhouse in Virginia during the insanity. I remember waves of different real estate agents knocking on my door daily, guaranteeing that they could put me in the house of my dreams, overnight. It sounded too good to be true.
The whole idea of creating money without creating anything of substance should have sounded too good to be true to America. But, the super banks and global funds continued buying and selling (short sales) the toxic paper. Investment banks continued to put their clients into these iffy securities while reaping huge commissions for themselves.
The formula was the same everywhere and it went something like this: Subprime Loans + Predatory Lending + Target Borrowers = Short Sales Foreclosures
But, it wasn’t just the rich; middle-class Americans were selling their home for five times what they paid for it just a couple of years ago. In a year you could double your money by “flipping” it. What could be more in keeping with the American Dream?
But, like in the children’s game of musical chairs, the music finally stopped and the crying began. There were so many corporations holding the valueless securities that lending institutions put a halt to all lending activity in a raw panic. The toxic assets were like landmines, cleverly hidden, with no one knowing there exact whereabouts.
By 2008, Hank Paulson, chairman of the Federal Reserve, was facing systemic collapse, a doomsday scenario unfolding before his eyes. I’m sure the phrase “domino effect” came to mind as one default lead to another and so on.
After gathering the banking elite together, they managed the largest transfer of wealth in the nation’s history. And, while it stopped the bleeding, the patient continued to suffer. Millions lost their, homes, pensions, and jobs. And, consequently, their dignity, self-respect, and some even their lives.
And, over a decade later, the suffering continues. I am a Barack Obama supporter, but his choice of financial advisors, Fed Chairman, and Secretary of the Treasury signaled that nothing was going to change. Perhaps, the economy was too weak, to anemic to survive major surgery.
Nonetheless, the fact of the matter remains that Wall Street still has a gambling problem. Even the long since retired “Wizard of Wall Street” admitted to Congress that he was mistaken. Deregulation of derivative was and is a clear and present danger.
Brooksley Born is an American hero, who sacrificed wealth and power in an effort to protect and defend the interest of the American people. Following her conscious, she spoke truth to power. Unfortunately, there are none so blind as those who will not see. She is and was a woman that can be trusted to do the right thing. Those who call themselves public servants could learn a lot from her.
But, there are other brave souls calling for an end to a climate where banks are too big to fail, an end to a self-regulated and secretive derivatives market, and for a start to the criminal prosecution of white collar criminals who rob to get rich.
The last time I looked fraud was a crime, so how did so many bankers, brokers, and managers avoid the federal pen. Instead of going to prison, many were awarded golden parachutes and multi-million dollar bonuses (paid for with tax payer’s money), leaving them laughing all the way to the bank. And, the joke is on us, the working class.
So, we are left with a ticking time bomb even after the bomb squad has left the scene.
What did they do in the last Gilded Age? They busted up monopolies; they reined in the oligarchs gone mad, they sent crocks to jail, and they passed tougher securities regulations.
But, instead of learning from the mistakes of the past, big business is calling for more deregulation as a cure-all for the nation’s economic woes.
Corporations are people, they claim. They’re the job providers, who must be allowed free reign.
They ignore the fact that it was these very same investment corporations that created the worst economic calamity since the Great Depression. And, in less than four years, they had managed, using their same old tactics, to convince million of Americans otherwise.
When President Obama called out Wall Street and offer up sweeping reforms, he was attacked by the Conservative and abandoned by his own party. It would seem that money talks and you know the rest. And, even before I could complete this rant, the OTC derivatives markets have grown by a billion dollar.
Professor Elizabeth Warren, now U.S. Senator points out: “It is a rigged game that benefits corporations.” Like Brooksley Born, Senator Warren has a warning for America. Derivatives are a house of cards. And, we damn sure better listen this time because we may not get another.
