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The Harm that Wall Street Causes



http://www.dfdpo.com/bypassing_the_harm_wall_street_causes.htm
We don’t need Wall Street anymore. We have all the tools we need to bypass the financial intermediaries and take charge of raising and investing money. Today’s technology allows the suppliers and users of capital to communicate directly with each other. Later sections of Bypassing Wall Street describe how those direct relationships are happening now and how they can be developed as an alternative to the Wall Street intermediaries.

It isn’t just that we have the ability to bypass Wall Street—that we should do it just because we can. We urgently need to free ourselves of the grip that Wall Street has over finance. The harm that Wall Street causes is intolerable. This chapter takes us into some of the most egregious penalties inflicted on us all by Wall Street. As Nobel laureate economist Joseph Stiglitz said in addressing his peers, the purpose of a financial system is "to manage risk and allocate capital at low transaction costs." What has Wall Street actually done? "They misallocated capital. They created risk. And they did it at enormous transaction costs." [http://economistonline.blogspot.com/2010/01/report-from-aea-meeting-part-i.html]

Wall Street Causes Our Economy to Crash

A few days after the Crash of 2008 began, Robert Samuelson wrote, “Greed and fear, which routinely govern financial markets, have seeded this global crisis. Just when it will end isn't clear. What is clear is that its origins lie in the ways that Wall Street -- the giant investment houses, brokerage firms, hedge funds and ‘private equity’ firms -- has changed since 1980.” [Robert J. Samuelson, “Wall Street’s Unraveling,” Washington Post, Wednesday, September 17, 2008; Page A19] Eric Hovde added at the same time, “Looking for someone to blame for the shambles in U.S. financial markets? As someone who owns both an investment bank and commercial banks, and also runs a hedge fund, I have sat front and center and watched as this mess unfolded. And in my view, there's no need to look beyond Wall Street -- and the halls of power in Washington. The former has created the nightmare by chasing obscene profits, and the latter have allowed it to spread by not practicing the oversight that is the federal government's responsibility.” [Eric D. Hovde, “Calling Out the Culprits Who Caused the Crisis,” Washington Post, Sunday, September 21, 2008; Page B01. See John Lanchester, I.O.U.: Why Everyone Owes Everyone and No One Can Pay, Simon & Schuster, 2010]

Of course, many factors contributed to the Panic of 2008, as well as the earlier panics that were triggered by Wall Street abuses. Some causation can be laid to crowd psychology and mass mania. [Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds, Richard Bentley, 1841, Farrar, Straus and Giroux, 1932] Classical economists since John Stuart Mill have applied this theory to economic bubbles, or manias, and the following panics and crashes. The theory is defined in a model developed by Hyman Minsky. It describes the cyclical flows of optimism and pessimism among investors and lenders. But the cycles, beginning with the mania, and followed by the panic and later crash, “start with a ‘displacement’ some exogenous shock to the macroeconomic system.” The result is that “the anticipated profit opportunities would improve in at least one important sector of the economy.” People “would borrow to take advantage of the increase in the anticipated profits.”

The Minsky model, with its "exogenous shock," certainly described what happened in the Panic of 2008. Wall Street created the “displacement” that came from the anticipated profit opportunities in real estate ownership and financing. The changes in the way real estate was financed, created by mortgage securities and credit default swaps, were a primary cause of the liquidity and credit crunch. [Markus K. Brunnermeier, "Deciphering the Liquidity and Credit Crunch 2007-08," [Journal of Economic Perspectives, Winter 2009, pages 77-100] In September 2008, when the mania suddenly stopped, we went into a panic and had the resulting crash. Wall Street was the instigator and the driving force behind that displacement. “By increasing leverage — that is, by making risky investments with borrowed money — banks could increase their short-term profits. And these short-term profits, in turn, were reflected in immense personal bonuses. If the concentration of risk in the banking sector increased the danger of a systemwide financial crisis, well, that wasn’t the bankers’ problem. [Paul Krugman, “Bubbles and the Banks,” The New York Times, January 7, 2010,

This wasn’t the first time Wall Street ruined our economy. There has been a repeated pattern of financial manipulation that created bubbles. When the bubbles burst, innocent people lost their lifes’ savings, their jobs and their homes. Since 1792, Wall Street has perpetrated the “Panics” that burst price and credit bubbles and led to recessions and depressions. In that first Panic, it was stock market insider trading that created the bubble. Discovery of the frauds burst the bubble, causing an economic decline. The government, in that first year of our Constitution, also set a pattern with token punishment and toothless reform. We were promised something different this time. “My job is to help the country take the long view — to make sure that not only are we getting out of this immediate fix, but we’re not repeating the same cycle of bubble and bust over and over again . . ..” [President Barack Obama, in an interview with columnists on Air Force One, reported by Bob Herbert, New York Times, February 16, 2009.]

In later Panics, it was generally more complex manipulation, selling newly created securities that made promises that couldn’t be met. The first players in those games would do spectacularly well, creating an urgent demand for more—the Minsky model “displacement.” Then some event would trigger discovery, followed by a collapse which brought down the entire economy. England has had the same consequences from games played by the City, its equivalent of Wall Street. This description of Britain’s South Sea Bubble of 1825 could as well apply to what happened with mortgage securities and derivatives nearly two centuries later: “Popular imitativeness will always, in a trading nation, seize hold of such successes, and drag a community too anxious for profits into an abyss from which extrication is difficult.” [Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds, 1841, reprinted by Farrar, Straus and Giroux, 1932]

One of the most damaging of Wall Street’s abuses came with the Panic of 1873, when Wall Street “had crafted complex financial instruments that promised a fixed return, though few understood the underlying object that was guaranteed to investors in case of default. (Answer: nothing).” When the bubble burst, “the stock market crashed in September, closing hundreds of banks over the next three years. The panic continued for more than four years in the United States and for nearly six years in Europe.” [Scott Reynolds Nelson, professor of history at the College of William and Mary “The Real Great Depression,” The Chronicle of Higher Education, October 17, 2008, http://chronicle.com/temp/reprint.php?id=477k3d8mh2wmtpc4b6h07p4hy9z83x18]
Another source of Panics was created in the 1890s, when Wall Street found a new line of business—mergers and acquisitions. In addition to the harm caused by eliminating competitors and creating industry monopolies, the takeover battles could lead to Panics. One war between investment banks, for control of the Northern Pacific Railroad, led directly to the Panic of 1901. Two Wall Street groups launched and reacted to raids, by placing orders for huge purchases of the railroad’s shares. As the stock price soared, short sellers sold heavily, betting that they would cover their short sales after the price dropped back down. Instead, Northern Pacific shares kept going up. As the short sellers were forced to sell other stocks to raise cash for covering their shorts, the rest of the market sank. Ron Chernow described the result as “the biggest market crash in a century,” with this New York Herald headline for May 9, 1901: "GIANTS OF WALL STREET, IN FIERCE BATTLE FOR MASTERY, PRECIPITATE CRASH THAT BRINGS RUIN TO HORDE OF PYGMIES." [Ron Chernow, The House of Morgan, Simon & Schuster, 1990, pages 92,93] According to Chris Farrell: “The takeover struggle for the northwestern rail is a convoluted tale of market manipulations, ruthless maneuvers, corners and shorts, soaring and plunging prices. . . . However, like so many struggles on Wall Street to this day, it was really a fight for power and dominance, of outsized ego and overheated rivalry.” [Chris Farrell, “Wall Street: Is It Good to Apologize for Greed?”, Business Week, November 22, 2009, www.businessweek.com/investor/content/nov2009/pi20091120_387385.htm?link_position=link19]

After each Panic, Wall Street has had its defenders. Following the Panic of 1907 came a book titled The Stock Exchange from Within, by William C. Van Antwerp, a self-described “busy stockbroker.” [William C. Van Antwerp, The Stock Exchange from Within, Doubleday, Page & Co., 1913, preface. The book was reprinted by Kessinger Publishing, LLC, 2006 and is available online at www.archive.org/stream/stockexchangefro00vana/stockexchangefro00vana_djvu.txt. Mr. Van Antwerp was also a collector of rare books and an alternate delegate to the 1936 Republican National Convention.] He first tells us who really caused the Panic: “We, as a people, have brought the disaster upon ourselves by reason of our indiscretions. We have lost our heads and entangled ourselves in a mesh of follies.” Then Mr. Van Antwerp goes on to explain that an individual will “not admit such reproaches, even in our communings with self. . . . He says Wall Street did it. His fathers said the same thing, and his children will follow suit.” [pages 186-187]

Besides, Mr. Van Antwerp wrote, panics are not really so bad. In fact, the recessions that follow do some necessary good chores: “Moreover, panics are rarely such unmitigated calamities as they are pictured by those who experience them. At least they serve to place automatic checks upon extravagance and inflation, restoring prices to proper levels and chastening the spirit of over-optimism.” [page 185 in the 1914 edition] A couple months after the Crash of 1929, which led to the Great Depression, Mr. Van Antwerp gave a speech to San Francisco’s Commonwealth Club: “In 1929, we merely suffered a case of nerves following a debauch. It is not to be expected that sound and conservative industry will be shaken this time.” He placed the blame for the Crash of 1929 squarely on the middle class: “This present panic had its roots back in 1917, when our masses found that they could invest money in bits of paper called Liberty Bonds. From investing to speculating was an easy step.” [http://vanantwerpfamily.wordpress.com. The role of "finance capital" in economic cycles is described by William Greider in One World, Ready or Not, Simon & Schuster, 1997, pages 227-258.]

In each of the Panics, there has been a particular player who took the game to its ultimate escalation, often getting out before the resulting collapse. Matt Taibbi laid out a chronicle of how just one Wall Street firm, Goldman Sachs, had caused five boom and bust cycles, beginning with the Crash of 1929. Taibbi claims that the firm’s investment trust, Goldman Sachs Trading Corporation, was a manipulation that collapsed and led to the Great Depression. Others were the tech bubble of the late 1990s, the oil price up and down, the housing price inflation/collapse and the federal bank bailout. He predicted the next would be the cap-and-trade game. [Matt Taibbi, “The Great American Bubble Machine: From Tech Stocks to high gas prices, Goldman Sachs has engineered every major market manipulation since the Great Depression--and they’re about to do it again,” Rolling Stone, July 9-23, 2009, page 52, available on SCRIBD at www.scribd.com/doc/16763183/TaibbiGoldmanSachs and scanned at http://zerohedge.blogspot.com/2009/06/goldman-sachs-engineering-every-major.html] One harm from the boom and bust cycles is the increase in frauds. "Swindling increases in economic booms because greed appears to grow more rapidly than wealth . . . Swindling also increases in times of financial distress . . . to avoid a financial disaster." [Charles Kindleberger and Robert Z. Aliber, Manias, Panics, and Crashes: A History of Financial Crises, John Wiley & Sons, Inc., Fifth Edition, 2005, page 189]

These Wall Street-caused panics bring their greatest harm to small businesses and their employees, America’s middle class. During the Great Recession started by Wall Street’s 2008 collapse, "Wall Street banks cut back small business lending by 9 percent, more than double their 4 percent cutback in overall lending." [Elizabeth Warren, interviewed by John Tozzi, Bloomberg Businessweek, June 28-July 4, 2010, page 46]. Job losses consistently were far greater for businesses with fewer than 50 employees than for larger employers. [For instance, see the ADP National Employment Report for September 2009, http://bizbox.slate.com/blog/FINAL_Release_September_09.pdf]

A more subtle but disruptive harm from Wall Street's monopoly over the movement of money for investment is its tendency to concentrate vast sums into a small segment of the economy. In 2011, for instance, Wall Street postponed doing IPOs and, instead, raised huge amounts of money from money managers for "private placements" of securities for Facebook, Twitter and other social media businesses. Those ventures spent much of the money hiring technical staff. The result was a shortage of these trained individuals and an increase in their compensation beyond the ability of smaller competitors to pay. [Pui-Wing Tam and Stu Woo, "Talent War Crunches Start-Ups," The Wall Street Journal, February 28, 2011, page B1] Another example is international: As Wall Street has globalized its business, it moves billions into a developing country and then suddenly takes it out. The resulting panics and recessions are left behind, to be worked out--or not--by the local government, the International Monetary Fund and World Bank, or by revolution.

...this is a very long read...
http://www.dfdpo.com/bypassing_the_harm_wall_street_causes.htm


The Harm that Wall Street Causes