Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

18 May 2010

Coming Unglued

[For an update on May 20, 2010, click here.]

Remember Doug Adams’ Hitchhiker’s Guide to the Galaxy? In it, an advanced species programs a monstrous computer to calculate the answer to “life, the universe and everything.” After an eon or so or continuous computing, it spits out the result: “42.”

Adams’ masterpiece was the first attempt to combine humor and science fiction. Yet oddly enough it got the right answer, within about two percent. Today the real answer to life, the economy and everything is forty-one, not forty-two.

What’s forty-one? That’s the percentage of all US business profits that our financial sector reached, for the first time, this decade.

You read that right. Now think about it. Up to two-fifths of all profit in the entire US economy now come from lending or manipulating money or proxies for money like stocks, bonds, futures and derivatives. Only 59% comes from productive enterprise like growing food, making clothes or shoes, building houses, or assembling cars, planes or computers.

When our species first made the transition from shells and beads to precious metals like gold and silver, money was supposed to be a medium of exchange, a facilitator of trade in things with real value. Now up to two-fifths of profit come from working with the shells and beads.

It is as if 41% of workers in a factory got paid for sitting and fondling their machines. But even that analogy is too tame. As we all know, the money fondlers get paid much better than most of us. If profits are riches (which they are!), then we Americans collectively bestow a big share of our national riches on money fondlers. Shades of Silas Marner!

What do those people do to deserve that level of remuneration? Well, some of them lend money to businesses that do real things. But as well all know from reading the news, that’s not the part of finance that makes big bucks. What makes big bucks falls under two headings: swindling and gambling.

The public and our legal system are slowly waking up to the swindling. I don’t know how you define swindling, but here’s how I define it. Swindling is knowingly selling something at a higher price because the buyer has a misconception or insufficient knowledge to evaluate the sale. It’s taking advantage of what you know that the buyer doesn’t. A classic example is selling a used car for a higher price because the buyer doesn’t see a hidden defect.

Let’s take a few recent examples. You buy health insurance with a pre-existing-condition exclusion. You read the brochure, and it convinces you the insurance company will be there if you get sick. But you’ve had a few visits to the doctors and a few medical tests over the last few years. You don’t know that, if you get sick, the insurance company will go over all those visits and tests with a fine-toothed comb, looking for any hint of a pre-existing condition as an excuse for refusing to insure your illness. This particular swindle will soon be history, courtesy of our President, but a whole lot of people called him a socialist or Nazi for ending it.

Closer to our financial meltdown is Goldman, Sachs’ alleged derivative swindle. The firm created unregulated and horrendously complex financial instruments whose values ultimately depended on the success of thousands of individual home mortgages. It invited people to bet that those values would stay constant or go up. That sounds like a mere gamble. But the SEC says Goldman didn’t tell buyers that someone betting on the other side had designed the derivatives to go down. If the SEC can prove its case, that’s a swindle.

Goldman is hardly alone. As lawyers and regulators dig through the huge mass of records of our financial near-collapse, a striking picture is emerging. The erstwhile pillars of our financial sector―names like Bank of America, Bear Stearns, Citigroup, Merrill Lynch, Morgan Stanley, etc.―stand accused of swindling, or creditors or aquirers trying to feed off their carcasses claim that these firms themselves were swindled.

So far, these claims are mostly unproven allegations. But so much smoke without fire would flout history, human nature, and common sense. The picture that regulators and lawyers are painting is of a dog-swindle-dog financial culture, devil take the hindmost. And the devil almost did, until we taxpayers bailed them out.

The gambling is much, much easier to see. Why? Because that’s what firms accused of swindling fall back on. Remember Goldman’s public defense in the SEC suit? Stripped to its essence, it was: we weren’t swindling; we were running a gambling parlor. We got A to bet that housing would survive; we got B to bet that sub-prime mortgages would tank. What’s wrong with that? Isn’t gambling as American as Las Vegas and apple pie?

Now look at the stock markets lately. Once in a while, a stock will move because something real happens in a firm’s business. Boeing’s stock falls when its Dreamliner schedule gets delayed yet again, or when engineering speed bumps are publicly reported. Apple’s stock goes up when its much-hyped iPad comes out, and again when a million sell in a few weeks.

But most of the increasingly volatile market fluctuations have absolutely nothing to do with the merits or accomplishments of individual businesses. They are “bets” on the general economy or a sector of it. They are gambles.

Greece, with an economy 2% of ours, gets a cold. The whole world sneezes, and the markets tank. The EU comes up with a trillion dollar bailout, and the indices fly up, overshoot, and oscillate. People gamble on the volcano in Iceland. They gamble on the BP oil spill. They gamble on the weather, the pace of global warming, and political reaction to it. They gamble on the outcome of patent disputes that not even the lawyers trying them dare to call in advance.

In all these things, the line between gambling and swindling is a thin one. The SEC says it’s swindling to sell a bet to B designed by A to go south. But is it swindling for a currency trader to make a bet based on decades of experience and mainframes full of historical and current data, and to sell the other side to a rube who’s read about currency trading in Money magazine? That may depend on the eye of the beholder.

Whether you call it gambling or swindling, we’re not done yet. Whatever you call it, it’s coming at us faster, bigger and fiercer. Because now the gamblers and swindlers needn’t act personally. They can program computers to do their gambling and swindling for them. And with (so far) lax regulation, they can hook those computers together in automated “markets,” which can “trade” millions of times per second. We can all now gamble on financial instruments at the speed of light.

Anyone who’s ever dealt with a gambling addiction knows what to expect. Before real reform occurs, things have to come really unglued.

The first shudder of our ship coming unglued was the “flash crash” of May 6. In a mere hour, the Dow index dropped about 1,000 points, and then recovered a bit. Some stocks lost 90% of their values during the hour-long crash.

It’s now nearly two weeks later. As the Wall Street Journal reported today, “SEC staffers are combing through thousands of trades” during the crash, by hand, so far without a clue as to what caused it.

When I read that, I laughed out loud. The average day on Wall Street sees billions of transactions. A billion is a million thousands. So if it took two weeks to get this far, it will likely take 500,000 weeks to get to the bottom of things. Our descendants will have an answer in the year 11,625.

The public, the traders and the regulators have no mental conception of the speed of computers, the amount of data they can handle, and the rapidity with which things can go awry. And the gamblers don’t brook any interference with their computerized gaming. When the SEC sued Goldman, the markets went down. Today, when the clueless regulators seriously proposed “circuit breakers” and the Germans imposed limitations on short sales and other gambling in the financial industry only, the Dow lost 115 points.

Free-market fundamentalists have teamed up with the gamblers and swindlers. “Let the markets go!” they scream. “Markets are never wrong; limiting them is. Let the game roll on!”

In this uncertain climate, when gaming and swindling have reached as high as 41% of national business returns, it is no wonder that women stand against the tide virtually alone. Evolution has given them the sad duty of feeding the kids when men with grandiose schemes come home empty-handed, or don’t come home at all.

Today, women like Congressional Oversight Panel Chair Elizabeth Warren, SEC Chair Mary Schapiro, and FDIC chief Sheila Bear are all that stands between us and our computerized, unregulated financial system coming totally unglued. Only if they stand firmly in the doorway, pointing out the way to Gamblers Anonymous and its twelve-step program, do we have a prayer of bringing our financial sector’s huge and wildly fluctuating share of our national business profit back to productive use.

Update (5/20/10): Today the Senate passed a financial reform bill. Two of the four Republican Senators voting for it were women, namely, Maine’s two female senators, Susan Collins and Olympia Snowe. (The other two were men, Scott Brown of Massachusetts and Chuck Grassley of Iowa.) The number of women in this tiny group of enlightened Republicans is way out of proportion to the number of female senators, let alone Republican female senators.

I think this is no accident. Women seem to get the fact that a national economy like Las Vegas is not sustainable. Men seem to fall for their gambling’ buddies braggadocio, the line that we need all the gamblers and swindlers lest they go offshore and enrich other nations. I say let them go (if anyone else really wants them), and let a bigger chunk of that 41% of profits go to people building our Dreamliners, iPads, windmills, solar cells, nuclear power plants, and Chevy Volts.

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