Financial innovation is Wall Street's new 'soul sickness'

Date: Tuesday, November 10, 2009
Author: Paul B. Farrell, Marketwatch.com

Could our headline just as easily read: "Financial innovation: Wall Street's biggest con game?" How about: Rip-off? Joke? Oxymoron? Maybe "Wall Street's big lie?" Or something darker: "Financial innovation: Wall Street's deadliest sin, greatest evil, even soul-sickness?"

In fact, they all fit. Each reveals Wall Street's dark side: Why are they at war to keep financial innovation secret, hidden, without public transparency? And why is Wall Street spending millions on lobbyists to kill financial-regulation reforms? Why? Because Wall Street rakes in tens of billions of dollars annually from their financial innovations, gambling in the shadowy $670 trillion global derivatives market. And Wall Street does not want government, investors or competitors digging into their "financial weapons of mass destruction," as Buffett calls them.

Remember, financial innovation is just a Wall Street code word. Translated it simply means derivatives and other proprietary secrets like the high-frequency trading algorithms used by their quants. Yes, Wall Street wants you to believe that financial innovations also help Main Street, but that's just Wall Street lobbyist propaganda to mislead the public, regulators and legislators. Remember when Washington proposed standardized mortgages as a way to help consumers? Wall Street attacked, spending millions to kill it.

Wall Street has no interest in helping Main Street. Time magazine's Justin Fox, author of "The Myth of the Rational Market," said it best in his "Curious Capitalist" column. Most so-called financial innovations are "just new ways to fleece customers or hide risk, and all major financial crises have been associated with some financial innovation." Even credit-card innovations are used against customers as marketing tools to increase fees. The truth is: Wall Street's greed-driven financial innovations fuel our bubble/meltdown cycles in many ways.

Hard-core Reaganomics is back

Wall Street's obsession with unregulated financial innovation also signals a resurgence of Reaganomics, the conservative ideology that killed Glass-Steagall in 1999, created "too-big-to-fail" banks, and set the stage for the 2008 meltdown. That 60-year-old law protected Main Street by separating low-risk retail banking from high-risk investment banking gambling with high-octane financial innovations.

Former Fed Chairman Paul Volcker and Nobel-Prize-winning economist Joseph Stiglitz warn: We need a new Glass-Steagall to rein in Wall Street. Or prepare for a new meltdown. At a Senate hearing last summer financial-innovation pioneer Richard Bookstaber, author of "A Demon of Our Own Design: Markets, Hedge Funds & the Perils of Financial Innovation," said: "Derivatives are the weapon of choice for gaming the system." They are "vehicles for gambling ... side bets on the market."

Get it? Derivatives put all markets, investors and taxpayers at risk. These "side bets can pose risks that extend beyond the losses to the person making the bet," because they actually "change the behavior of the market." In short, financial innovations only serve the interests of Wall Street's insiders, not the public interest, not Main Street investors, not American taxpayers, and not retail banking customers. Without transparency and regulation reform, a new meltdown is guaranteed.

Unfortunately, Wall Street has no incentive to help the public good. Quite the opposite: They want to get very rich, very fast. And our laws encourage their greed. Bookstaber and other critics warn that Wall Street's goals are clear: Design financial innovations that evade securities laws, avoid taxes, minimize capital requirements, increase leverage, hide speculative risks, maximize short-term profits, and avoid stockholder disclosures. In short, Wall Street is back running the same con game that triggered the 2007-08 meltdown, which is why they've amassed a record bonus pool so fast. They have no conscience.

Historical evolution of a new 'American capitalism' mutation

Yes, Wall Street's behavior has the feel of a socio-pathological disorder and a strong hint of a secret conspiracy to defraud America, a cultural "soul sickness." Now visible: An emerging new mutant American capitalism. In fact, Matt Taibbi's description of Goldman Sachs fits the entire banking industry: a "giant vampire squid wrapped around the face of humanity." Look closely and see clear signs of immoral, even criminal, misconduct fueling Wall Street's obsession with unregulated financial innovation. To fully understand why, you need to see financial innovation in the broader, historical context of the emerging new American capitalism.

1. In the beginning, Adam Smith's 'Wealth of Nations'

"Every individual ... necessarily labours to render the annual revenue of the society as great as he can." But he "neither intends to promote the public interest, nor knows how much he is promoting it. ... he intends only his own gain ... led by an invisible hand to promote an end which was no part of his intention." The public good is collateral damage from the aggregate economic activities of greedy individuals all acting solely in their own narrow selfish interests. That's pure capitalism. Today the equation survives and thrives as the "efficient market hypothesis," where the collective behavior of 95 million irrational investors is assumed to create a totally rational capitalist stock market.

2. Greenspan and Ayn Rand, author of 'The Fountainhead' and 'Atlas Shrugged'

Rand was Greenspan's guru and mentor. For decades they had a profound impact on American capitalism. Rand was dogmatic: "When I say 'capitalism,' I mean a pure, uncontrolled, unregulated laissez-faire capitalism, with a separation of economics, in the same way and for the same reasons as a separation of state and church." Why? "Capitalism is the only system that can make freedom, individuality, and the pursuit of values possible in practice because capitalism demands the best of every man -- his rationality -- and rewards him accordingly. It leaves every man free to choose the work he likes, to specialize in it, to trade his product for the products of others, and to go as far on the road of achievement as his ability and ambition will carry him." Rand captured the conservative spirit of the emerging American capitalism, and through her disciple, both demanded total, unrestricted freedom for Wall Street.

3. Reaganomics and Milton Friedman's 'Capitalism and Freedom'

Reaganomics defined conservatism after 1981, grounded in Nobel Economist Milton Friedman's conviction that "the government solution to a problem is usually as bad as the problem." He hated FDR's New Deal and Keynesian economics, preaching hard-core Adam Smith capitalism. Naomi Klein, author of "Shock Doctrine: The Rise of Disaster Capitalism," summarized Friedman's "three trademark" principles of conservatism: "Privatization, government deregulation and deep cuts in social spending." That ideology gutted Glass-Steagall. And as Thomas Frank put it in "The Wrecking Crew: How Conservatives Rule:" "Innovations in governance" meant take "jobs away from career civil servants and hand them over to the big federal contractors." Reaganomics led to an Iraq war fought by more profit-hungry private mercenary contractors than committed volunteers. Ironically, it created bigger government.

4. New 'mutant' American capitalism must kill financial regulations

American capitalism generally, and Wall Street's mindset specifically, reflects the 234-year history from Adam Smith to Friedman, Reaganomics, Rand and Greenspan. Today however, it is resurfacing in a new disguise: Wall Street's blind obsession to kill all restrictions on financial innovations, whether in the SEC, FDIC, CFTC, or proposed Consumer Financial Protection Agency. Wall Street's cash got Obama elected, got their Trojan horses in his cabinet. Now their millions flow the opposite way, as their lobbyists sabotage Obama's financial-regulation reforms. And no matter who gets elected, Wall Street runs the game.

Wall Street's soul sickness feeds on mutant American capitalism

So tell us: Which headline did you pick? "Financial innovation: Wall Street's biggest con game?" Or maybe: Hoax? Rip-off? Scam? Joke? Oxymoron? Or was it Wall Street's biggest lie? Perhaps "Financial innovation: Wall Street's greatest evil?" Mortal sin? Soul sickness?

You think "soul sickness" is too heavy? Not really. Since the Enron scandals, critics have been warning that Wall Street has lost its moral compass. However, in the new mutant American capitalism, Wall Street doesn't need a moral compass. Get it? Ethics and morals are irrelevant in the emerging new American capitalism, the latest mutation of Adam Smith's capitalism.

That means Wall Street's blind "anything goes" obsession with financial innovation is totally consistent with the rules of the new American capitalism. Morals, ethics and the public good are irrelevant in the rules of Wall Street's new mutant American capitalism.

Wall Street's only restriction is to obey the 11th commandment: "Thou shalt not get caught." And when you compare the number of indictments from the 2008 meltdown to earlier ones during the Enron-era scandals and the S&L frauds (plus add in the $23.7 trillion debt those same "too-greedy-to-fail" crooks scammed from American taxpayers), you can easily see why Wall Street is clearly living within the rules they created for the new mutant American capitalism.

And that, folks, is why my final headline pick is: "Financial innovation: Wall Street's soul sickness." Why? Because this is a grave moral issue for all Americans, but Wall Street doesn't get it. Unfortunately, neither does Washington. Worse, neither do the American people, but that's what a cultural "soul sickness" does -- it blinds us to moral issues and leaves us wandering, lost, in the fog of Wall Street's self-destructive new mutant American capitalism.