Those of us who love the free market–sign me up!–have a lot to learn about the difference between free market capitalism and crony capitalism. If we think Wall Street is on the side of free market capitalism, maybe we have another think coming.
One book which helps us begin to sort out what is really going on in the big Wall Street firms, and in our national government, is The Big Short: Inside the Doomsday Machine. This was a #1 bestseller in about 2010 or 2011. The author is the gifted Michael Lewis. He takes a topic which is extremely difficult to understand, and teaches us enough so that we get the gist of what is going on, even if we don’t come close to a deep knowledge. If we get only the gist, I don’t think we need to feel too bad. Wall Street itself, with all its very intelligent people, didn’t understand what it was doing.
Selling “short” is paying money out to bet that the market will go down. If the market goes down, one wins one’s bet. If, however, the market goes higher, one loses one’s investment. What happened was that in the early 2000s, many companies were selling home mortgages to people who really did not have good credit or even good jobs. The people were often signed up with “teaser” loans–a low interest rate for two years, after which the interest went dramatically higher. This was certain or almost certain to lead to default in a high percentage of cases.
Many mortgage loans were bundled together in bonds. The bonds were then sold as very low risk financial entities. They might be less than prime mortgages–hence the name subprime–but strength in numbers indicated that they were still very low risk. But they weren’t low risk at all. They were high risk. The big name ratings agencies (Moody’s, Standard & Poor’s) were asleep at the switch–or worse. So people and institutions were buying bonds they thought were solid investments, when they were the exact opposite.
The Big Short tells the story of several people who, independent of one another, figured out that the bonds were rotten investments, and were likely to go to zero in value within a couple years. They were all shocked by what they were finding out. They doubted their own senses. Surely they were missing something? The more research they did, however, the more it seemed that their instinct was correct–these bonds were toxic.
All of these people, again independent of one another, found a way to short the bond market. In some cases a new type of financial instrument had to be created. They placed their bets. If they were wrong, they would lose a lot. But if they were right, they would make millions. There was no guarantee they were right. Time would tell.
We know what happened. They were right. The bonds went to zero. The short bet paid off millions to the people who had discovered the idiocy of the bonds and had backed their hunch with serious money. This could have meant the end of many Wall Street firms. But our essentially fascist national government stepped in to rescue the Wall Street firms with taxpayer money. We, the rubes, were fleeced again.
Reading about all this is fascinating. At times it can make your blood boil at the evil involved, by both the Wall Street people and by our national government. But we need to know. We need to stop being rubes. Facing reality about our rubishness (to coin a word), would be a good start.
A brilliant movie entitled “The Big Short” was made in 2015. Warning: it is R rated for pervasive language and some sexuality/nudity, so it is not for everyone. The book does not give us sexuality/nudity, but it also gives us vulgar language. Read and/or watch at your own discretion. The movie follows the book in spirit if not in complete detail. It is brilliantly paced, acted, and directed. The movie also does a superb job of exposing the evil at the core of our system. Both are warnings to us rubes: wake up or keep on being fleeced. The choice is ours.
Here are a few quotes from the book.
“Howie Hubler lost more money than any single trader in the history of Wall Street–and yet he was permitted to keep the tens of millions of dollars he had made. The CEOs of every major Wall Street firm were also on the wrong end of the gamble. All of them, without exception, either ran their public corporations into bankruptcy or were saved from bankruptcy by the United States government. They all got rich, too.
What are the odds that people will make smart decisions about money if they don’t need to make smart decisions–if they can get rich making dumb decisions? The incentives on Wall Street were all wrong; they’re still all wrong.” (pp. 256-257)
“Thus was born TARP, which stood for Troubled Asset Relief Program. Once handed the money, [U.S. Treasury Secretary Henry] Paulson abandoned his promised strategy and instead essentially began giving away billions of dollars to Citigroup, Morgan Stanley, Goldman Sachs, and a few others unnaturally selected for survival. For instance, the $13 billion AIG owed to Goldman Sachs, as a result of its bet on subprime mortgage loans, was paid off in full by the U.S. government: 100 cents on the dollar. These fantastic handouts–plus the implicit government guarantee that came with them–not only prevented Wall Street firms from failing but spared them from recognizing the losses in their subprime mortgage portfolios.” (pp. 260-261)
“The world’s most powerful and most highly paid financiers had been entirely discredited; without government intervention every single one of them would have lost his job; and yet those same financiers were using the government to enrich themselves.” (p. 262)
One topic touched on briefly is how the move from privately held partnerships to public corporations was a factor in the irresponsible behavior of Wall Street firms. Whether corporations are biblical, or an escape from personal responsibility, is a subject for another day. The following quote includes one censored word; this is a family blog.
‘The main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders. “When things go wrong it’s their problem,” he [John Gutfreund, former leader at Salomon Brothers] said–and obviously not theirs alone. When the Wall Street investment bank screwed up badly enough, its risks became the problem of the United States government. “It’s laissez-faire until you get in deep s***,” he said, with a half chuckle.’ (pp. 263-264)
The solution to our financial and political problems are not to pass seventy or seven hundred laws which supposedly are going to make cheating impossible. The solution is I think twofold. 1/We really do need to face the fact that we are rubes, and that we can and should stop being rubes. The Big Short, by Michael Lewis, makes an admirable contribution in teaching us that we are rubes but that we don’t need to be. 2/More fundamentally, as individuals we need to develop a profound personal integrity, an integrity which wants not only not to cheat anyone, but also to protect the property of others–on sort of a cosmic scale. If we do that, the scumbags on Wall Street, and the scumbags running our government, will eventually be replaced by honorable people. It may take a long time, but if we never start, it will never take place at all.
I am short Wall Street, and short the U.S. government. I think my bet will pay off eventually. I will probably be long dead, but that’s fine. Lots of generations of people are coming after me.