I’ve been watching the Occupy Wall Street protests like everyone else, and like many at least I’ve noted that they are long in interest and short in details. There’s a tendency for the media to attribute this to superficiality; hey these people have no agenda they’re just troublemakers. I think it’s more than that. People are angry about Wall Street but they aren’t specific about their complaints because the process is just too complicated for the average person to understand.
While I make no claim to be an expert on the Street, I’ve been involved with it for over a decade and have even been for a time a partner in a hedge fund. So while I don’t claim to speak for the movement, I think I may understand a bit of the substance in their claims of greed and fraud. I propose to share them here, and if you’re offended by semi-political comment, read no further!
The first truth of the situation is that we ARE in a class war, and we’ve been that way since the industrial revolution. It’s an inevitable fact about our economy, and pretty much everyone else’s too. Manufacturing or production or whatever you call it transforms things that aren’t particularly valuable or useful (raw materials) into things that are both valuable and useful. That means that they offer a significant opportunity for PROFIT.
The giants of American industry, like Carnegie, Rockefeller, and Ford recognized that by contributing capital to build plants and facilities, they could turn dirt (or ore, at least) into gold, and they did. Of course, they needed to have labor to do this, and the more that labor cost as a component of the production transformation, the lower the profit was. Thus, capital and labor are natural adversaries, and since labor is a majority of voters, the battle is hard for capital to win, at least directly. That’s why we’ve seen “offshoring” of jobs; labor costs are lower.
The second truth of our situation is that the desire to grow wealth is insatiable; call that “greed” or just a manifestation of the classic American goal of creating a better life as you will. The point is that growing wealth by building plants and creating production is a long and risky process, and so “capital” decided to look for another route. The strategy it’s been trying for probably nearly 100 years is the “bubble”.
Bubbles are situations where the monetary value of something escalates faster than the objective value. You can create them in a lot of ways, but what they all come down to is what could be called LEVERAGE. You get leverage by using borrowed money to buy stocks, which gave us the 1929 crash. You get it by over-hyping tech to drive up the price/earnings ratio of shares beyond any reasonable value, which gave us the 1999 NASDAQ bubble/bust. You also get it by playing financial derivatives.
Which brings us to Truth Three. Derivatives are financial instruments that disconnect the stuff you invest in from the assets they represent, so that in some cases there’s no real “asset” at all. When you buy “futures” you buy the right to buy or sell a stock at a given price, not the stock itself. You pay less for the futures than for the stock, but the value of the futures moves with the value of the stock, and so you get an accelerated gain or loss. When you buy a credit default swap, you buy insurance on a bond, a debt. In the 2008 economic crash, CDSs were almost certainly written in enormous quantities, perhaps many times on debt that the buyer didn’t even own. We also bundled mortgage debt into packages whose content was largely invisible. So we created a house of cards on financial instruments that didn’t represent anything, and so whose value was whatever the markets cared to determine.
Derivatives are not easily regulated. People who “sell a stock short” are supposed to be borrowing shares, selling them in the expectation the stock will go down, then buying them back to “cover”, pocketing the profit if the shares do fall. That at least keeps short sales connected to the real shares, but for years now people have sold “naked shorts” meaning they’ve not bothered to borrow the shares at all. How’s that for leverage! We don’t really know how much of this happens because there’s no easy way to track it, and with some derivatives there’s no public exchange or records of trading.
Now, for the fourth truth. The stock markets are largely driven by firms who specialize in stock trading, not by “investors”. These firms use high-performance network connections to exchanges to buy and sell huge blocks of shares, and to buy and sell derivatives based on bundles of stock (just like we had them based on bundles of junk mortgages!). What moves the stock market is the TRADES, so when stocks go up and down that reflects not the sentiment of those who OWN the shares but those who TRADE them. High-frequency trading and derivatives can create massive movement in shares, like the “flash crash” earlier this year and the sudden upswing of stocks more recently. All the volatility you see in the market is exacerbated by derivative trading, and it scares hell out of the average investor.
And guess what? The “average investor” is forbidden by law to participate in a lot of this. Unless you’re an “expert investor” under US securities laws, you can’t trade in most of these instruments and you can’t invest your money in funds that do. So you sit with your 401k and watch the value fluctuate because of trades designed to create massive leverage-based profits for a group you’re not allowed to join. Even the funds you invest in may be battered by the derivative trades, so you’re not safe anywhere. You may have a problem being truly or optimally profitable because you’re in a system you’re not really ever PART of.
The system might also have cost you your job. We have lost jobs in the US because capital is leaving, or trying to leave, the historical bargain with labor. In part, it’s jumping onto the bandwagon of derivative-based growth in wealth. A virtual financial instrument that’s not tied to reality doesn’t create products, and thus doesn’t create production. In part, it’s simply moving labor to places with lower cost. We offshore jobs because it creates more profit. Free trade helps countries who have something to trade; to the extent that we become a service economy we become necessarily a net importer because we aren’t producing stuff here. We may have cheaper goods here, but we have cheaper jobs, fewer jobs. They weren’t stolen by China, they were given away by companies to boost profits by lowering labor costs. And we’re creating fewer new jobs because we’re not investing in production, but in derivatives and “social networking” and things that generate a big return for capital but produce little or nothing in production, and so produce no good high-value manufacturing jobs. Why are VCs not investing in the “next Cisco” or the “next Apple” but instead in the “next Facebook”? Because it’s higher profit at lower risk.
So there’s my take. Capital, meaning finance, meaning Wall Street, is optimizing its own profit at the expense of our economy overall. Why do Fed numbers show that “wealth” is growing so much faster than GDP? How can the country be worth more than it’s producing in total? It’s the “virtual economy”. Why is the wealth of the top tier increasing and that of the four lower quintiles of income changing by essentially nothing in real spending power over the last twenty years? Because they’re not part of the system that’s winning.
Occupy Wall Street has in my view a reason for anger, whether the individuals in the movement understand the reasons or not. They have a reason to be unhappy with both parties, because both parties are complicit in the problem; money finances campaigns and wins elections. But if they don’t want to become the American version of “Arab Spring” that topples governments but can’t govern when they win, the movement will need to look at the root causes of the Wall Street problem and pressure politicians to take effective steps to fix them. Otherwise, we’re going to have more bubbles and more uncertainty in the future. That’s not good for anyone, even the Street. Parasites that kill their host are not successful.