Fear and Looting in America: Innovation or Casino Capitalism?

Every time someone calls for new financial regulations, Wall Street hoists the bloody flag of financial innovation: "If you regulate us, you will stifle innovation!" Every time I hear this, my blood pressure spikes because I know it's a lie but I can't really prove it. We now know for certainty that Wall Street's latest and greatest innovations, like synthetic collateralized debt obligations, have been a disaster. They increased systemic risk while piling up lavish profits for Wall Street traders. And they contributed absolutely nothing to the real economy. I'm now a card carrying Luddite.

"Not so," I'm told by financial pundits. Wall Street's fantasy finance does help the real economy by dispersing risk, reducing capital costs and by making more capital available for investment in tangible goods and services. Those innovations, insiders say, means there will be more plants, equipment, R&D, and infrastructure throughout the country. Even National Public Radio reporters who have boldly investigated Wall Street scams succumb to this mythology. Here's how NPR's Adam Davidson put it during an interview about toxic derivatives that milked five Wisconsin school districts for nearly $200 million:

"Over the last thirty years, there have been a series of financial innovations that have just been plain good. They have allowed city governments, local governments, to get money more cheaply, which means more hospitals, more schools, betters sewers, you know, just basic good public services, and that whole system may be permanently broken by this crisis."

I love his reporting, but I found myself screaming at the radio: "Prove it! Show me some evidence!" I keep hoping that someone will look at the facts instead of assuming fantasy finance is real.

Well, finally someone did. Hallelujah! Adam S. Posen and Marc Hinterschweiger reviewed the data and discovered that the dramatic rise in derivative financial products over the last several years did not lead to new capital formation. Furthermore, they found that the new products were traded among financial institutions and not within the real economy at all. As they put it: "There only seems to be a weak link, if any, between the growth of the newest complex -- and now proven dangerous if not toxic -- financial products and real corporate investment."

In short, these innovations had nothing to do with real economic growth. They were new casino games -- a series of financial bets that made Wall Street filthy rich... at our expense. For a while they helped local government get money more cheaply. But now they've cost those same governments tens of millions. That's gambling, not sound finance.

So how do we stop the proliferation of what Ben Bernanke called "exotic and opaque" financial instruments? Most government officials believe that careful regulations can tame the excesses without driving Wall Street overseas or stifling productive innovations. George Soros offers a more drastic solution. He wants to ban any derivative product that the average public official can't understand.

Now that's a financial innovation with promise.

Les Leopold is the author of The Looting of America: How Wall Street's Game of Fantasy Finance Destroyed Our Jobs, Pensions and Prosperity, and What We Can Do About It. (Chelsea Green Publishing, June 2009)

 

Follow Les Leopold on Twitter: www.twitter.com/les_leopold

Comments

[marinara]

very good writing. bravo.

[when-the-whip-comes-down]

I believe that plebianswillrevolt has the right concept. I feel that there is a new systemic tolerance concerning conflicts of interest. When Gerald Ford pardoned Rumsfeld and Cheny after Watergate, that set the stage for the military industrial complex to have unprecedented political influence over our government and media. Reagons starwars project was a good indicator. When the supreme court appointed the rethugs to power in 2000, that allowed the script for Bill Kristolls Plan for a New American Century to take effect. What we are seeing now is further evidence of the wholesale privatization of our government assets. When our government is taken private, the government no longer has the interest in serving its constituents, it becomes the profit generating apparatus of the individuals who control it.

[watchTVgetSTUPID]

Here is Innovation to create jobs

New career profession ... HOUSE STRIPPER

A house stripper removes all possible components that can be sold as used parts or scrap metal. This includes
copper wiring,
whole air conditioners,
aluminum wiring,
all plumbing fixtures in the kitchen and bathroom inluding stainless steel sinks & toilets & and bathtubs,
circuit boxes,
Doors
Windows & their frames
Floor joists, rafters, 2 by 4s, plywood, etc


The HOUSE STRIPPER bids $5,000 given to the home owner in return for everything he can remove and sell. I also see a specialist Carpenter House stripper. An unemployed construction worker will come in and remove all possible lumber and pay the home owner 10% of the new price. The capitalistic self starting carpenter will then sell it as used lumber on craigs list for 30% new price.

Very little is left of the house. Even the bricks, septic tank, ventelation, siding, underground sprinkler system, patio blocks, landscaping plants, might be worth recycling.

Finally the homeowner will sell truckloads of dirt and just leave a big hole in the ground

This is what the corrupt Wall Street CEOs are doing to their companies. If the Banksters lose everything in their forclosures, then they may become more open to working with the families instead of kicking them to the curb.

[PhilipTaylor]

Good Model of Capitalism:

Models of Capitalism­=formulate­d to resistant elite manipulati­on+injusti­ce+foster tranquility
Reward Individuals for Income Appreciati­on=Profits­+Public Good are proper model of capitalism
Where are True Reformers=­Intellectu­al honesty demands redesign of Corporations
Redesign of Corporatio­ns=facilit­ate broad populace participation fairly+sustainably in profitability

Truly fair system=leaders drawn from new soil=People without obligations to WS but knowledgeable

Warren+Kru­gman+Stigl­itz and others with extensive knowledge

[swisskabab]

NPR Puhleeze ... NPR is just a propganda machine for Obama' and Wall St. policies. I regret
supporting and contributing to Obama's presidency.

NPR is in bed with Wall St. I stopped listening to NPR .

[Ancona]

It absolutely infuriates me that We the People are being held financially accountable for these gambling debts, which are being made through various conduits to the very banks who caused this mess in the first place.

It is my opinion that the United States Government should not pay any of these swaps at face value. At the very outside, the companies who placed the swaps should be paid no more than the original cost of the premium [read: bet]. There is no reason for these banks to profit off of the backs of the American People because they want to collect a bet.

In fact, I think that credit default swaps must be declared illegal because their existence makes it too easy for huge firms with "program trading" to naked short a smaller competitor out of business by crashing the value of their stock. I further believe that it is high time we started some earnest inquiries into who did what, and when did they do it. These investigations should start at the top and work their way down through the ranks.

I want blood.

[mikefina]

Do you think people who continue to live in NOLA should be paid for future flood insurance claims. What about Californians who buy eathquake protection--knowing that they live in a fault area? Shouldn't we just tear up those contracts? CDS's are integral to hedging risk on mortgage securities.

If you want to regulate them, fine. But unless you are contemptuos of all dubious-value investments (like the insurance products I listed), please rethink your position.

PS You won't get blood. Stop your silliness.

[Les Leopold - Huffpost Blogger]

There's an important difference between a CDS and an insurance policy. A CDS is called a CDS precisely so that it can escape strigent insurance regulations. You can't just write out insurance to protect a home against floods. And you can't take out fire insurance on someone else's home. But using a CDS, tens of thousands of people can bet that your house will burn down. There are no rules about having a tangible insterest, or having adequate reserves..­..which was precisely what Wall Street intended.

[inteljournal]

They want a bailout...­....But they dont want to be regulated

It doesnt add up!

[Soulsurfer]

The finance industry has learned what other large, parasitical industries have......­........co­ntrol of the media message is vital in sustaining the con. Feeding "reporters" phony lines about societal benefits and faux outrage at the slightest hint of governmental oversight is on the first page of their playbook. A large contingent of lobbyists and pliable public representatives complete the picture. Self enrichment is the only goal, society as a whole be damned.

[dsws]

"There only seems to be a weak link, if any, between the growth of the newest complex -- and now proven dangerous if not toxic -- financial products and real corporate investment­."

Way to cherry-pick the criterion. Yep, the ones that were bogus all along didn't do much good.

Stifling innovation is to be avoided, all else equal, even in financial dealings. On the other hand, there's no reason to let fear of stifling innovation stand in the way of otherwise-­reasonable regulation of the financial system. As I understand it, that's more or less the mainstream view among economists. It's not a serious problem. There are plenty of serious problems to be solved in designing good financial regulation, but this isn't one of them. Any screaming from either side is just noise.

[noaxe397]

I recently read in Fortune magazine where a couple of lawyers have started an index fund that invests in the outcome of lawsuits. No, I swear, it's true. If you invest in the winning party you get a share of the judgement. There are markets for investing in the weather. This is, truly, casino capitalism. The idea that these investments make more capital available for real growth is like saying cutting taxes increases revenue to the government.
Simply stated, ALL exotic investments, that is, those that do not create something physically or intellectually tangible should be outlawed, as should short selling. Capitalism is about creating growth. Short selling bets on failure.

[mikefina]

If it invests in this narrow a band of company's that you describe--it is NOT an index fund. As of this evening, there is no official grievance index, with which an index fund might track.

Sorry to quibble, but terms of art/definitions are important.

There may or may not be funds which track any number of things, but they are not INDEX funds.

[taikan]

This is not an index fund. However, it is a form of investment. In return for getting a percentage share of any recovery, investors contribute funds (capital) to pay the expenses of litigation that the plaintiff(s) otherwise could not afford. The investor takes the risk of losing all or a part of his/her investment if the litigation is not successful or the judgment is not large enough. The plaintiff(s), on the other hand, are relieved in full or in part from the burden of having to finance the litigation and pay the costs of discovery, motion practice, etc., which can easily run into the millions for significant litigation.

[noaxe397]

Thank you, gentlemen, for the correction. However, what about the point that these types of investments do nothing for the overall economy. They concentrate money in the hands of a few. Now, that is not an intrinsically bad thing, at least at one time it wasn't. Like, when I had a defined pension plan so I knew I would not be destitute when I retired or have to work until I died. However, today, with so many working people using the capital markets for their retirement, there must be hyper regulation, even if it results in lower returns on individual investements, lower profits, etc., (although, one does not necessarily follow the other, as the last 8 years has proven) because now the casino capitalists are not only risking THEIR money (which is their right, they've earned it) but their market manipulations ( or mischief) risk MY money that I need for retirement. Of course there is risk in all investments, but I have no fear investing my money in IBM, ATT, Exxon, etc because these companies are real, they deal in tangible stuff, they are transparent, their growth creates jobs and their products improve society overall and I will realize a decent, steady rate of return.

Want an ownership society? Then watch how I am willing to protect what I own. And be careful.

[mikefina]

Regulate away, but if the standard is what the average Public Official can understand, we are doomed?

The same people that leave Congress to lead Fannie and Freddie are at the top of the Public Official food chain and the STILL don't understand what they themselves did!

So, by all means, regulate, investigate, aggrevate--but don't put the class dunce into a role as evaluator of core curriculum.

[DiogenesOfAlaska]

"If you regulate us, you will stifle innovation!" - sorry for raising your blood-pressure, but the way to approach this is to develop immunity against the phrase.

It's a lie indeed. But the reason is simple: regulation doesn't stifle innovation at all.

If regulation is understood properly it doesn't impose anything a bank or institution wouldn't do by itself if it indeed acted in its own fully enlightened self-interest.

The problem is: there is no such thing as the fully enlightened self-interest of a financial institution, contrary to what Greenspan may have thought (or may have pretended to think).

That's because the owners aren't those who profit from the reckless risk-taking. AIG did terribly foolish things and should have been closed down by their owners and their own board. Why did this not happen? Because those who profit are not the same as those who pay. Not even before the bailout. Certainly not after the bailout.

There is zero case against regulation. The innovation story is a fairy tale. If an instrument does create sustainable wealth, and does enhance intermediation demonstrably, there is no point in regulating it away.

Yes indeed regulation would be redundant - if financial institutions were up to the level of sophistication they claim to be - but aren't.

[allthings]

I am all for securitized mortgage instruments to spread risk around as long as they are designed to do that and not just concentrate profit.

However I draw the line at investment instruments that are essentially bets on bets on bets.

[Merlin7]

Strange country we live in. Steal a loaf of bread and you're likely to do jail time. But if you lose most of the life savings of millions of people, the government will reward you with big bonuses and prop up your business with a huge amount of tax dollars paid by the very people you victimized in the first place! And then our federal officials will add insult to injury by doing next to nothing to change laws and rules to ensure the same thing doesn't happen again. I guess "crime" is a relative term.

[watchTVgetSTUPID]

French Revolution was motivated by this attitude. The law in all its majestic equality makes it a crime for both the rich and the poor to sleep under a bridge or to steal a loaf of bread.


Guess thats why the leaders eliminated our rights and push massive prison systems.