What Is the Function of Wall St.?
The global financial meltdown of 2008 – 2009 with its ongoing sequelae seems not to have definitively demonstrated the dangers of our continuing belief in the religion of “free markets” nor shaken, especially it seems in the Obama administration, our thrall with Wall St. and all things financial. We are seeing the combined effects of Wall St.’s funding of the Democrats and Republicans, the primacy of Wall St-ers in positions in government,1 and the tendency of the rest of us to want to beat the table and make wonderfully large profits (winnings). A deeper question here is what is the function and usefulness of gambling in the financial markets for our overall economy and society?
The recent revelations about the collapse of Lehman Brothers2 shed further light on how the profits of this bank were generated and then hidden through excessive leveraging, the use of specious financial products, and outright fraud in representing the state of the company to stockholders and other interested parties.
What is the role of Wall St. (and the rest of the global financial services industry) in the real economy, the one where people work to raise food, make things, and provide services that people actually use? On the surface, it would seem that Wall St. might be the source of fresh capital and loans to the economy. The sale of stock is the classic way in which companies raise new funds to drive growth. Banks make loans. Isn’t that what we expect banks to do? Take money in as deposits and then through bank wizardry multiply those deposits into a stream of loans bearing interest payments to companies, for profit and not, and to government, to generate economic activity. This type of activity by banks in total adds value to the whole economy. Though any one investment or loan may go belly up, enough succeed, and the total size of the economic pie grows.
Gambling and Wall St.
People being people, gambling is almost irresistible. Some find much to criticize about the various venues for legalized gambling. But, in sum, no gambling debt in Las Vegas, Atlantic City or elsewhere has done more than impoverish a family. Regrettable, though by common agreement and the lust for the taxes on this wagering, not an activity that will be banned by law. Keep in mind, gambling is by definition a zero sum game. Someone wins and someone looses. There can be no betting without counter-parties, fools willing to take on a wager. Gambling casinos and states take profits and taxes as the money flows from one party to another. But, the economy does not grow as a result of this activity. Money is just shifted from one person’s pocket to another.
Many Wall St. (and, needless to say, other financial markets) transactions are just gambling. Stock options are clearly gambling. Futures trading is gambling. In the current revelations of Wall St. gambling, new terms of art have come into common parlance. Synthetic Collaterialized Debt Obligation is the latest one I have learned. By all accounts these were hotly created just in order to sate the appetite for gambling when the supply of earlier chicanery (Collaterialized Debt Obligations) came into short supply.
Here is an interesting discussion of this on the 4/19/10 PBS Newshour.3 Pay attention to the differing language between the two commentators. Both do agree that this gambling was very widespread.
The SEC case against Goldman Sachs is bound up with allegations of fraud. Much focus has been put on the ethically sketchy behavior of various parties to these deals. Some commentators point out that it is one thing to believe that Goldman Sachs has breached their ethical duties, but a much more difficult task to prove in a court of law that they are guilty of an infraction of law.
Questions That Might Be Useful
I want to focus attention on more important questions. Why do we need this gambling in our financial services industry at all? Is this helping to make our, and the world’s, economy bigger and stronger? Does this gambling add value to the overall economic pie? Is all of this gambling distracting resources, financial and human, from producing growth? Do we want financiers to gamble with other people’s money in a way that can only move some of the money into the gambling casino’s pockets (transaction/deal fees) and, in the end, add nothing in lasting value? Do we think that it is worth the obvious risk to the overall economy to allow this gambling to probably destabilize the banking system again? Wouldn’t we be better off if all of those PhDs and MBAs now scheming to increase their gambling returns were employed elsewhere adding their talents to solving real problems, creating new and better products and services?
Defining gambling activities in financial services presents some interesting challenges. Perhaps a financial product whose value or payoff is dependent on the rise or fall of another product’s value could be defined to be gambling. Another idea is to require that more than 25% of the dollars (Euros, etc.) come from the pockets of the owners of the financial company proffering the gambling product. Bolstering that idea could be a requirement that these transaction could not be done on account or with borrowed money. A third is to tax financial gambling with a sliding scale. For the types of transactions where the wagering cycle is measured in minutes or even hours, place a small transaction tax, say 25% of the gains. Given the margins that are typical for these transactions, this would in fact be a significant tax rate. For wagers held for longer periods of time, the tax rate could be lower. Finally, all of these products should be sold only in an open marketplace. Financial gambling should only occur in officially sanctioned casinos, not in the back rooms of bars or Wall St. banks.
In the end, it would be great to work up a useful, direct definition of gambling and set up financial gambling casinos in the already existing gaming locations. Financial institutions who accepted deposits from individuals, corporations, and government entities would not be allowed to place wagers in these casinos. This would isolate those of us who do not wish to be held responsible for the outcomes of gambling from those who feel the need to wager. No more government bailouts, fewer financial bubbles and instability. Certainly there will be some financial products that might look like gambling that in fact serve a use in helping the economy to grow. We could establish regulatory processes within the SEC or Fed to vet these out. Over the longer term, the courts and Congress would come up with better tuned definitions of gambling. Those in the financial services industry who wanted to make money the old fashion way, through hard work and perseverance, could tend to their knitting. Much more boring, but better for the society as a whole.
- Obama did not invent this situation; Wall St-ers have held most of the important economic positions in the government for generations of presidencies. [↩]
- the frauds and collusion with their accounting firm Ernst & Young have been widely reported. All of this stimulated by a 2,200 page court appointed auditor’s report. Here is a link to one article from the NYTs, though the Financial Times is also very good on this matter. [↩]
- http://www.pbs.org/newshour/bb/business/jan-june10/goldmansachs_04-19.html [↩]