Finance Superstars Talk About the Massive Fraud in Our Economic System
Last Wednesday, I attended a conference initiated by the Roosevelt Institute on the financial mess, called Make Markets Be Markets. The conference's speakers included people with experience on Wall Street, the banking industry, government and academia; Nobel Prize-winning economist Joe Stiglitz, Elizabeth Warren, and other luminaries who have offered an alternative and reformist narrative to our recent financial crisis. At two and half hours, it was relatively short, giving each speaker the opportunity to make their points and providing a sharp focus. One underlying theme of the event was fraud, the great elephant in the room, that neither the press or our government officials acknowledge, though it is a fundamental element to the financial crisis and its solutions.
Joe Stiglitz started the conference and stated how reducing transparency and hiding information was an essential element to the crisis. Stiglitz concluded, "Innovation was regulator and tax arbitrage." Wall Street and the banks deliberately added opacity and complexity to confuse clients and consumers. Elizabeth Warren pointed out, “complexity made a lot of profits," for example, she showed how the average credit card contract in 1980 was one page, today it is thirty.
This opacity and complexity helped make the financial industry predatory against their clients and customers. Not only did government regulatory agencies fail in stopping this confidence game of historical magnitude, but so did markets. NYU's Lawrence White pointed out the credit agencies such as Moody's and S&P, whose role is to provide independent analysis, essentially became co-conspirators as their business model changed from being paid by investors to being paid by the Wall Street issuers, making it against their interests to issue dour ratings on investments.
The only truly rigorous aspect of economics is accounting. It's no surprise that as the banks and Wall Street sought opacity and confusion through complexity, their greatest target would be the accounting system. There were various elements of "accounting innovation", but the largest, most notorious, and completely incredulous was the practice of "off balance sheet" accounting. One of the greatest elements of this off-book accounting was secularization—simply, the practice of taking existing debt, be it mortgages, student loans, or even credit card debt, bundling it together, then selling it as a completely different product. Financial analyst Josh Rosner, who called the Fannie and Freddie accounting scandal in 2001 and the housing peak in 2005 stated:
"Poorly developed and opaque securitization markets drove excess liquidity and irresponsible lending and borrowing...securitization markets too often operate in a "Wild West" environment where the rules are more often opaque than clear, standards vary, and useful and timely disclosures of the performance of loan level collateral is hard to come by. Asymmetry of information, between buyer and seller is the standard."
While Mr. Rosner pointed to the problems of securitization, Frank Partnoy, a finance and legal expert, went after the greatest scam, the derivatives markets. Mr Partnoy pointed out there is currently $600 trillion in derivative positions on a global economy of $60 trillion. Derivatives are another off-balance sheet innovation, in which speculators may take pure gambling positions, allowing them to take positions on matters in which they have no stake. It was in paying-off derivatives that a $185 billion of tax-payer money flowed through AIG. Today, then New York Fed head Timothy Geithner, Treasury Secretary Hank Paulson, and Fed Chair Ben Bernanke all claim they didn't authorize this payout, the check seemingly magically sent.
To make his point even clearer, Mr. Partnoy put up Citi's official balance sheet, saying it was a "fictional balance sheet", representative of an industry in which financial innovation made the most basic accounting, the one thing which can offer real insight into a company's health, just another part of an elaborate scam.
Michael Greenberger of the University of Maryland made the important point that most of what we all call financial innovation is simply the resurrection of many old practices, outlawed in the 1930s, now dressed in new garb. He pointed specifically to the 1936 Commodities Exchange Act as representative of all New Deal financial reform. It insured transparency, open exchanges, anti-fraud, and anti-manipulation. He contrasted this to the 2000 Commodities Futures Modernization Act which gave modern derivatives and open field. Greenberger noted the Act was supported vigorously by then Fed Chair Alan Greenspan, SEC Chairman Arthur Levitt, and Treasury Secretary Larry Summers. The law turned derivative markets into history's largest casino and its proponents knew exactly what was coming and preempted state gaming laws, thus derivative gambling could be completely unfettered.
Rob Johnson of the Roosevelt Institute was the last speaker and talked about the final arbitrage, which is "too big to fail." It is the arbitrage of the republic by looters who have created a system so rife with fraud that it brought down the American economy, throwing millions out of work, paying the very perpetrators trillions of dollars and counting. These very same people bought and sold our elected officials so often in the past several decades, that today DC might very well be deemed the one functional market. You actually get what you pay for.