How trillions of dumb dollars found a home
By
Bill Bonner Nov 28, 2008
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A defence of the City and other desperadoes
Who's to blame for the worldwide financial meltdown, a crisis that has so far wiped out a notional $30trn dollars – give or take a trillion or so? "Lax central bankers... reckless investment bankers... the hubristic quants," says Niall Ferguson, writing in Vanity Fair. "Regulate them" is the universal cry. "Tax them," say the politicians. "Hang them," say investors.
Here on the back page, we take the part of the underdog – the downtrodden and the despised. Who fits that description now? Who gets less respect than smokers? Who is in a lower caste than hewers of wood and drawers of water? We're talking, of course, about workers in the City. So today, we take their part, because no one else will.
First, let us look at the charges:
They skinned millions of investors – with their outrageous bonuses, spreads, fees, incentive shares, performance charges, salaries, and 'profits' – leaving the financial industry severely under-capitalised... and unprotected. Guilty as charged.
They ginned up 'securities' that no one really understood and sold them to unsuspecting investors, including colleges, pension funds and municipal governments. Er... guilty again.
They put the whole financial world in a spin – churning positions back and forth between each other in order to collect commissions... leveraging... flipping... stripping assets... securitising... derivatising... making wild bets based on flim-flam mathematics.... No point in going on about it... guilty.
Yes, the financial hotshots did all these things. And more. They sold the world on 'finance', rather than making and selling things. Then, it was off to the races. Everybody wanted to bet. Perfecta, place bets, odds-on... double or nothing. Of course, investors would have been better off at the race track. The track takes about 20%. In the financial races, the City took 50%-80% of all the profits.
Before 1987, only about one of every ten dollars of corporate profits made its way to the financial industry – in payment for arranging financing, banking and other services. By the end of the bubble years, the cost of 'finance' had grown to more than three out of every $10. Total profits in America reached about $6trn last year; about $2trn was Wall Street's share.
What happened to this money? Other industries use profits to build factories and create jobs. But rather than even save the capital, the financial industry paid it out in bonuses – as much as $10trn during the whole bubble period. Now the sector finds itself a few trillion short, it looks to government for succour.
But the City's critics have missed the point. Yes, the financial industry exaggerates. But so does the whole financial world. Both coming and going. It's madness on the way up; madness on the way down. Investors pay too much for 'finance' when the going is good. And then, when the going isn't so good, they regret it. This regret doesn't mean the system is in need of repair; instead, it means it is working.
Besides, the financial industry was just doing what it always does – separating fools from their money. What was extraordinary about the bubble years was that there were so many of them. There is always smart money in a marketplace – and dumb money. But in 2007 there were trillions of particularly stupid dollars roaming the marketplace, looking for trouble. What other kind of money would pay Alan Fishman $19m for three weeks work helping Washington Mutual go bust?
Whence cometh this dumb money? And here we find our more worthy villains. For here we find the theoreticians, the ideologues – and the regulators themselves, who now offer to save capitalism from itself. Here is where we find the bogus statistics, the claptrap theories and the swindle science. "Six Nobel prizes were handed out to people whose work was nothing but BS," says Nassim Taleb, author of The Black Swan. "They convinced the financial world that it had nothing to fear."
All the BS followed from two errors. First, that economic man had a brain but not a heart. He was supposed to always act logically and never emotionally. But there's the rub, right there; they had the wrong guy. Second, that you could predict future price movements simply by looking at those of the recent past. If the geniuses had looked back to the fall of Rome, they would have seen property prices in decline for 1,000 years. If they had looked back 700 or even 100 years - they would have seen wars, plagues, famines, bankruptcies, hyperinflation, crashes, and depressions galore. Instead, they looked back only a few years and found nothing not to like.
If they had just looked back 10 years, says Taleb, they would have seen that their "value at risk" models didn't work. They were put to the test in the Long Term Capital Management crisis. Things that their models said wouldn't happen in a trillion years happened in 1998. In the real world, Taleb explains, things are stable for a long time. Then, they blow up. That's when all the theories and regulators prove worthless. These blow ups are inevitable, but unpredictable... and too rare to be modeled or predicted statistically. "And they are almost always much worse than you expect."
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