Where Caveat Emptor Still Stalks the Land

I am not generally the dullest knife in the drawer, but when it comes to the subprime -- I mean credit, I mean whatever -- financial crisis, I often feel like one. I know a few facts, but can't put them together in a quite satisfactory way.

Fortunately, for my ego, I'm not alone. Few people seem to grok it all.

One that comes closest is the recent article The End of Wall Street's Boom by Michael Lewis, author of, among other books, 1990's Liar's Poker. I heartily recommend this for anyone wanting to better understand what went on at the heart of the storm.

If you believe there is something hopelessly twisted at the heart of the financial sector of the global economy, you'll find some support here. The most telling story Lewis relates, I think, is that of a dinner that Steve Eisman had with a fund manager:

His dinner companion in Las Vegas ran a fund of about $15 billion and managed C.D.O.'s backed by the BBB tranche of a mortgage bond, or as Eisman puts it, "the equivalent of three levels of dog shit lower than the original bonds."

[Eisman] had spent a lot of time digging around in the dog shit and knew that the default rates were already sufficient to wipe out this guy's entire portfolio. "God, you must be having a hard time," Eisman told his dinner companion.

"No," the guy said, "I've sold everything out."

In other words: "no problem, I've unloaded the toxic waste onto my customers. I'm doing fine, thanks for asking."

Let's be clear. If your grocer sold you toxic milk for your child, would they say "no problem, I unloaded it onto my customer?" How about your local pharmacist? Your auto dealer? Heck, if your local drug dealer sold you bad weed, wouldn't he at least be embarrassed?

Those other industries at least have the good taste to be ashamed. In this sector -- well, not so much.

There is a belief afoot in Finance Land, put well in the Financial Times by George Soros last January in a piece titled "Worst Financial Crisis in 60 Years Marks End of an Era."

Fundamentalists believe that markets tend towards equilibrium and the common interest is best served by allowing participants to pursue their self-interest.

As Soros points out, it's simply not true. The current crisis was caused by markets, and (sort of, so far) mitigated by governments. I learned in business school that the notion that competition leads to equilibrium is a bad economist's dream: the real point of competition is to bash the other guy's head in. Du-uh. The only reason it doesn't reach end game more often is regulation -- agencies, anti-trust laws, etc. which say "tilt" and "restart."

I've met all too many people educated in our "best" schools who have come to believe that selling toxic waste to customers is a legitimate part of a noble, even moral, endeavor called 'capitalism,' founded by Adam Smith, tweaked by Ayn Rand, and quasi-guaranteed in the Constitution. The customers? Caveat emptor. It's good for them. Culls the weak from the herd, don't you know. Doing my bit for capitalism and the American Way.

No, it's not. It is simply selling toxic waste to customers, and it is despicable under any code of behavior within 10 miles of the word "ethical." Poisoning a customer is like selling your mother to pay the rent, or stealing the life preservers from your children on a sinking boat. It is not even good capitalism, if you believe in simple loyalty economics.

Congratulating yourself for doing it is simply beyond the pale.

How many banks and hedge funds who sold Bernie Madoff's funds to their clients will offer to make good? To simply refund the commissions? Or -- a novel thought -- just apologize?

Nope. They'll just sue their own accounting firm, apparently, if Fairfield Greenwich Group is any example.

There's your caveat emptor at work, still stalking the land.

Follow Charles H. Green on Twitter: www.twitter.com/charleshgreen

Comments

[medicontheedge]

remember the guillotine???? these pigs are US.. we all grew up in the same era... what poison milk did these wankers drink? since THEY wrote the laws and enforce them,, the only thing WE can hope for is KARMA.

[DiogenesOfAlaska]

Two remarks, (1) on competition and equilibrium and (2) on caveat emptor.

(1) excessive bargaining power (as in: Cain and Abel) is what keeps markets from getting into or staying in equilibrium - among other things. This is a limitation of the range in which there is hope for the invisible hand to operate. Among other limitations.

On top of this there are situations where competition destroys wealth. Unleashing free-floating animalistic instincts has never been demonstrated - by anyone, not even Adam Smith - to lead to peaceful dinners under the family christmas tree.

(2) the problem is that for caveat emptor to work, there must be either clever constructions of contracts and a legal profession who understands those contracts and who is affordable or there must be a sufficiently high frequency of (small) transactions for reputational effects to kick in - as with the grocery selling foul apples as opposed to toxic baby milk. To appeal to caveat emptor in markets where deals have sizes of hundreds of millions, and a complexity that is not comprehensible in an affordable number of hours of a lawyer's work, the principle needs adjustment. Otherwise it's toothless.

These require no ethical commitment. The crisis is the result of foolish and imprudent actions - of everybody involved. And in my opinion this is crucial because it is this fact about the crisis which does in the ideology. It doesn't tell how to overcome the crisis, but it helps to make sure it doesn't repeat.