Economics is not a science.
At best, it's an ideology.
And, at times, a very dangerous one.
— Satyajit Das (1957), The End of Ponzi Prosperity, Big Ideas, ABC Radio National, 23 May 2012.
Jay Gould (1836 – 92) [Financier]:
[The trick is to hire] one half of the working class to kill the other half.
(March 1841)
Kenneth Galbraith (1908 – 2006):
The salary of the chief executive of the large corporation is not a market award for achievement.
It is frequently in the nature of a warm personal gesture by the individual to himself.
(Robert Monks & Nell Minow, Corporate Governance, John Wiley, 2008, p 311)
[Indeed, apart] from the universities … the art of genteel and elaborately concealed idleness may well reach its highest development in the upper executive reaches of the modern corporation.
(The Affluent Society, 4th Edition, Penguin, 1984, p 96)
James Kunstler (1948) [17 October 2005]:
The mortgage industry, a mutant monster organism of lapsed lending standards and arrant grift on a grand scale, is going to implode like a death star under the weight of these nonperforming loans and drag every tradeable instrument known to man into the quantum vacuum of finance that it creates.
(p 203)
The Wizard
[Alan Greenspan was] The Wizard, the man behind the curtain, who mumbled in ways that people couldn't understand, but appeared to be controlling absolutely everything.
— David Wessel (1954), The Warning, PBS Frontline, 2009.
Alan Greenspan (1926):
When I agreed to accept the nomination as chairman of [President Reagan's] Council of Economic Advisors, I knew I would have to pledge to uphold … the laws of land, many of which I thought were wrong. …
[Nonetheless,] I had long since decided to engage in efforts to advance free-market capitalism as an insider, rather than as a critical pamphleteer.
(The Age of Turbulence, 17 September 2007)
What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk:(Robert Manne, Is Neoliberalism Finished?, Goodbye To All That?, Black Inc, 2010, p 27)
- from those who shouldn't be taking it;
- to those who are willing to, and are capable of doing so.
[Government] regulation cannot substitute for individual integrity …
[The] first and most effective line of defense against fraud and insolvency is counterparties' surveillance …
(Satyajit Das, Extreme Money, p 279-80, emphasis added)
Bernie Madoff (1938):
[In] today's regulatory environment, it's virtually impossible to violate [the] rules …
[This] is something the public doesn't really understand: … it's impossible … for a violation to go undetected — certainly not for a considerable period of time.
(The Future of the Stock Market, Philoctetes, 20 October 2007).
Satyajit Das (1957):
Generally these people are influenced by one of two novels …One is a childish fantasy that often engenders a lifelong obsession with its unbelievable heroes; leading to an emotionally stunted, socially crippled adulthood, unable to deal with the real world.
- Tolkien's Lord of the Rings, [or]
- Ayn Rand's, Atlas Shrugged.
The other, of course, involves orcs.
(The End of Ponzi Prosperity, Big Ideas, ABC Radio National, 23 May 2012)
(Alex Gibney, Enron - The Smartest Guys In The Room, 2005)
(Michael Kirk, The Warning, PBS Frontline, 2009)
Joe Nocera (1952) [Journalist, The New York Times]:
[Alan Greenspan said to Brooksley Born,] something to the effect, that:[We're] never going to agree on fraud. …
You probably think that there should be rules against it. …
I think the market will figure it out … and take care of the fraudsters.
Michael Greenberger [Director, CFTC, 1997-9]:
Greenspan didn't believe that fraud was something that needed to be enforced …
(Michael Kirk, The Warning, PBS Frontline, 2009)
Commentator:
Alan Greenspan was mistaken …
Creditors can be just prone to greed as the latest wizard of Wall Street [and] they are often the last to understand the risks that would ordinarily help fear counterbalance greed.
(Peter Temple, Hedge Funds: The Courtesans of Capitalism, John Wiley & Sons, 2001, p 282)
Anne Manne:
After a lifetime proselytising on behalf of the "producers" and denouncing anyone needing government assistance as "parasites," when [Ayn Rand] became old and sick, she discovered that even a best-selling author could not afford health care in the neoliberal US.
She [reluctantly] availed herself of Medicare and ended her life on what she had [most] despised — Social Security.
(The Age of Entitlement: How Wealth Breeds Narcissism, The Guardian, 7 July 2014)
John Galbraith (1908 – 2006):
[Economic] insecurity is something that is cherished only for others.
(The Affluent Society, 4th Edition, Penguin, 1984, p 90)
Alan Greenspan: Champion of Deregulation
[Like his mentor Ayn Rand, Alan Greenspan] purged dissenters with Stalinist efficiency …
Time and again, [he] ensured that proposals for regulation of the financial system were stillborn.
[In 1998,] Brooksley Born, the head of the Commodity Futures Trading Commission (CFTC) … proposed
- regulation,
- greater disclosure and
- more reserves against losses.
A furious Greenspan, together with Treasury secretary Robert Rubin, deputy Treasury secretary Larry Summers, and SEC chairman Arthur Levitt, launched an extraordinary attack against regulation of derivatives and personally on Born. …
Greenspan told Born that she did not understand what she was doing …
Regulation would:
- reduce market efficiency,
- create uncertainty, and
- reduce standards of living.
Regulation would cause a flight of capital from America, reducing its financial influence.
(p 300)
When Born [persevered,] Greenspan, Rubin and Levitt used their influence in Congress to stall the proposals. …
After Born departed in 1999, Greenspan, Summers (now Treasury secretary), and Levitt [stripped the CFTC] of much of its powers over derivatives.
Later Rubin and Summers argued that they had actually favored regulating derivative but [that] the system and public opinion [had] militated against it.
(p 301, emphasis added)
(Satyajit Das, Extreme Money: Masters of the Universe and the Cult of Risk, FT Press, 2011)
[Senator Phil Gramm, chairman of] the Senate Banking Committee, [also ignored Born's] warnings, crafting a deregulatory bill made to order for Enron and Koch, called the Commodity Futures Modernization Act.
Despite Born’s warning, the Clinton administration embraced the exemptions too, swayed by Wall Street pressure.
In the mid-1990s, [Phil's wife, Wendy Gramm] became the head of Mercatus’s Regulatory Studies Program [at George Mason University …]
There, she pushed Congress to support what came to be known as the Enron Loophole, exempting the type of energy derivatives from which Enron profited from regulatory oversight.
Both Enron and Koch Industries, which also was a major trader of derivatives, lobbied desperately for the loophole.
Koch [argued that] there was no need for government policing because corporations’ concern for their reputations would cause them to self-regulate.
(p 154)
(Jane Mayer, Dark Money, Doubleday, 2016)
[Wendy Gramm was Director of the CFTC under Ronald Reagan from 1988 to 1993.]
[After] resigned from the CFTC and [she] took a seat on the Enron Board of Directors and served on its Audit Committee. …
[After Enron collapsed, Gramm and other directors] agreed to a $168 million settlement in a suit led by the University of California.
As part of that settlement, the directors agreed to collectively pay $13 million to settle claims of insider trading.
(Wikipedia, 2 July 2017)
George W Bush (1946):
I love Ken Lay …
When I’m president, I plan to run the government like a CEO runs a country.
[And] Ken Lay and Enron are a model of how I’ll do that.
(2000)
Kevin Phillips [Former Republican Strategist]:
[The alliance between the Bush family and Ken Lay had] no precedent.
[It was] the most important major relationship [between] a presidential family and a single corporation in American history.
Peter Singer (1946):
Following the Enron scandal, [George W Bush] pledged to increase enforcement against corporate rip-offs, but his 2003 budget actually reduced funds for such enforcement by $209 million.
(The President of Good and Evil, 2004, p 257)
Kenneth Lay (1942 – 2006):
Enron is a company that deals with everyone with absolute integrity …
Jeffrey Skilling (1953):
We are the good guys, we are on the side of angels.
(The Financial Crisis, The 2000's, Episode 5, CNN, 2018)
[If] we had anything to do with [the Californian electricity crisis,] then we are the stupidest people in the world.
(Alex Gibney, Enron: The Smartest Guys in the Room, 2005)
Dan Whitcomb:
Jeffrey Skilling … has been released from federal custody [after serving 12 years in prison for] 19 counts of conspiracy, securities fraud, insider trading and lying to auditors. …
In 2013, a federal judge reduced his 24-year prison term to 14 years, accepting an agreement … to end years of appeals.
Under the deal, more than $40 million of Skilling’s fortune … was to be distributed to victims …
(Former Enron CEO Jeffrey Skilling released from federal custody, Reuters, 21 February 2019)
Alex Gibney (1953):
[Enron's video on demand] technology did not work, and the deal with Blockbuster soon collapsed.
But with the magic of mark to market [accounting,] Enron used future projections to book $53 million in earnings on a deal that didn't make a penny. …
[As the illusion of profitability started to slip] executives started selling their stock. …
[And Enron moved on to announce] its latest plan: to trade weather …
[In 2001, shortly before Enron collapsed,] Lou Pai flew away from Enron with $250 million …
[The] divisions he left behind lost a total of nearly $1 billion …
[Lou invested his winnings in real estate, becoming] the second largest land owner in Colorado …
[He was never charged with wrongdoing.]
20,000 employees lost their jobs and medical insurance.
Average severance pay: $4,500.
Employees lost $1.2 billion in retirement funds.
Retirees lost $2 billion in pension funds.
Enron's top executives cashed in $116 million in stock [on top of bonuses totaling $55 million.]
(Enron: The Smartest Guys in the Room, 2005)
Contents
Alan Greenspan: The Wizard
The Masters of Mankind
The Cult of Risk
Debt Slavery
One Shitty Deal
(LIBOR^2 × 1/LIBOR) − (LIBOR^4 × LIBOR^−3) = ?
Inside Job
Satyajit Das (1957)
Retired derivatives consultant.
- Consuming our future, Big Ideas, ABC Radio National, 9 March 2017.
- Update on global markets, Late Night Live, ABC Radio National, 18 May 2015.
- Extreme Money: Masters of the Universe and the Cult of Risk, FT Press, 2011.
Risk transfer encourages people to take more risk and to shift risks to those least able to understand and bear them.
There is a strong correlation between the complexity of an instrument, its remoteness from the real economy, and its likelihood to spread contagion.
(p 206)
Rather than using derivative to manage risks, dealers structured transactions to- create risks,
- disguise true values,
- delay competition, and
- prevent clients from unbundling products.
(p 235)
Some hedge fund managers are exceptionally skilful.
Soros, Tudor Jones, and James Simons … have outstanding records.
(p 243)
Adjusted properly for leverage, liquidity risk, model errors, and complexity, most hedge funds return, at best, the same as or frequently less than traditional investments.
(p 247, emphasis added)
In 2008, hedge fund returns averaged negative 20 percent. …
Hedge fund investments fell by around $600 billion.
Over 3,300 hedge funds out of 8,000 ceased operations.
(p 255)Oligarchy — government by a powerful, dominant class with deep-vested interests.
Extreme money created a powerful coalition of financiers, business interests, regulators, and politicians that increasingly dominated the economy.
This oligarchy set the agenda, and set policies, which benefited them and their constituencies.
Similar backgrounds, education, and interests, especially a common cognitive view of the world, shaped the oligarchy.
(p 263)
The new liquidity factory or market-based credit was based on financial alchemy.
[By 2006, securitization] and derivatives … provided around 79% of total liquidity [— traditional money making up the remaining 21 percent.]
- Around 38% of global money was in the form of securitization, around $82 trillion (146% of global GDP).
- Around 41% was in the form of derivative contracts, around $215 trillion (384% of global GDP).
Banks moved assets off-balance sheet into the opaque, unregulated shadow banking system.
The shadow banks depended on short-term debt from professional money markets to fund long-term illiquid assets.
Borrowing against the value of the assets, they were vulnerable to falls in their price. …
The liquidity factory increased debt to levels without historical [precedent.]
The tsunami of debt fueled [investment drove] price increases in equity, property, infrastructure, and commodities [creating asset bubbles].
(p 269, emphasis added)
Securitization and derivatives were supposed to deliver a safer financial system. …
Complex chains of transaction allowed risk and debt to move from a place where it was observable to places where it was hidden and unregulated.
Trading linked market [players] in networks of relationship and interdependence.
Bear Stearns was linked to 5,000 parties via 750,000 contracts.
Lehman Brothers had more than a million contracts with a notional value of $40 trillion, including more than $5 trillion in credit default swaps alone.
(p 270)
[Individual Collateralized Debt Obligations Squared] transactions re-securitizing [Mortgage Backed Securities] could involve 93,750,000 mortgages and 1,125,000,300 pages of documentation.
(p 272)
In the United Kingdom, the total size of banks reached more than 4 times the country's GDP [by 2008].
[RBS (formally the Royal bank of Scotland) alone] was larger than the UK's GDP of 1.5 trillion pounds. …
As its financial sector grew, UK manufacturing fell from more than 30% in 1970 to 11% of the economy in 2009.
[By 1978, 4.3 million manufacturing workers had lost their jobs, and] the UK ranked below North Korea in terms of number of patents granted. …
[In Australia, bank profits have tripled] in the last 10 years.
Compensation levels rose sharply …
In 2006 and 2007, Wall Street bonuses totalled [$67.3 billion.]
Financiers [reaped] large economic rents — excess earnings above the amount required to ensure adequate supply of goods or service.
Free markets and competition should reduce economic rents.
(p 276)
But the structure of financial markets, especially the lack of transparency … combined with information and skill asymmetries between banks and customers created [irresistible] opportunities. …
When fund management fees were reduced by migration to low-cost index tracking funds, investment managers tempted investors into new high margin products, structured investments, [and] private equity and hedge funds, with the promise of high returns.
Simple derivatives were repackaged into complicated and opaque exotic structures to increase profit margins.
High rewards encouraged the best and brightest to sign up, helping create newer more complex products.
(p 277)
Moody's Investor Services (Moody's) [17% owned by Warren Buffett's investment company], Standard & Poors (S&P), and Fitch controlled 95% of the ratings market. …
Originally investors paid subscription fees for ratings information.
Today, 90% of revenues are from issuers [of securities. …]
In 2007, Moody's revenues from rating structured securities were $900 million [—] far in excess of fees from rating government, municipal and corporate bonds. …
(p 282)
[In] June 2010 Buffett testified before the Financial Crisis Inquiry Commission … that he knew little about the rating process other than its profit margins. …
He did not acknowledge any failure or complicity of the agencies in creating the bubble. …
(p 325)
[In 2000, senior] rating agency staff [were pulling] seven-digit salaries …
Protecting investors gave way to maximizing revenues. …
In 1994 the agencies failed to anticipate the collapse of the Orange Country from derivative trading losses.
Insufficient disclosure was the reason offered.
In 1997, they failed to predict the [Asian financial collapse,] blaming insufficient disclosure and lack of informational transparency.
After Enron and WorldCom went bankrupt, they argued insufficient disclosure and fraud.
In 2007, Moody's upgraded three major Icelandic banks to [AAA.]
[All] three banks collapsed in 2008.
Unimpeded by insufficient disclosure, lack of informational transparency, fraud, and improper accounting, traders anticipated these defaults, marking down bond prices well before rating downgrades.
Rating structured securities [involved] statistical models [which mapped] complex securities [onto] historical patterns of default on normal bonds.
(p 283, emphasis added)
Defaults on [investment grade] BBB CDOs were around ten times that for equivalent conventional securities.
In 2010, Donald Mackenzie of the University of Edinburgh compared … actual defaults of mortgage backed securities [with typical model] predictions …- [For] AAA rated securities, the actual defaults were more than 12 times the model predictions.
- [For AA, A and BBB,] actual defaults were anywhere from 75 to 300 times higher than … model estimates.
(p 284)
[In their defense,] the agencies claimed their ratings were opinions, protected under the US constitution as free speech.
(p 285)
In 2006, food and oil prices [spiked:]- Wheat rose by 80%,
- maize by 90%,
- rice by 320%, and
- oil prices doubled. …
The price rises triggered greater buying as investors who tracked specific indices had to purchase more.
Higher prices encouraged producers and traders of the actual commodity to hoard, betting on further price rises, creating supply shortages with potentially catastrophic human consequences. …
Financial investment and speculative activity rather than … supply and demand increasingly determined food prices.
(p 334)
[In 2010,] the policies of the US government and the US Federal Reserve [contributed to another surge in food prices.]
By flooding the financial system with money, in an attempt to restore growth, they reduced the value of the US dollar.
As most commodities are priced and traded in dollars [sellers were forced] to increase prices to maintain the purchasing power of their commodities.
The weaker US dollar … also reduced the faith of investors in paper money, driving increased investment in hard commodities with real value and ready use.
((p 335)
[On] April 20 2007 … Treasury Secretary [and former Goldman Sachs CEO] Henry Paulson [declared that] the US economy was "robust" and "very healthy," and the "the housing market is at or near the bottom." …
In July 2007, Bear Stearns injected $1.6 billion into one of its hedge funds. …
(p 338)
In March 2008, JP Morgan purchased Bear Stearns for a price lower than that paid by the LA Galaxy for … David Beckham.
In September 2008, Fannie Mae and Freddie Mac were nationalized [and] Lehman Brothers filed for bankruptcy protection in the world's largest corporate failure …
[Days] later the US government took a majority stake in AIG to stave off failure.
(p 339)
[In 2008, the US,] UK and Europe committed $14 trillion, 25% of global GDP, [to bailout packages and stimulus measures —] $7,000 for every man, woman and child.
Paulson believed the package would not be needed …
Bungled initiatives followed half-baked ideas.
Finally, the US [and other governments were] forced to take significant stakes in major banks, guaranteeing debt and deposits …
In every crisis policy makers argue that people's life savings and pension entitlements are at risk if the system is not bailed out.
No one asks who put them at risk in the first place.
Bankers' excuses are of someone, having murdered their parents, seeking clemency on the grounds that he is an orphan. …
Having unknowingly underwritten a system allowing banks to generate vast private profits, ordinary men and women were forced to bear the cost of bailing out banks.
(p 342)
In the United States, more than 8 million jobs were lost …
Global trade volumes decreased 12% …
As exports fell, 20 million Chinese workers … were thrown out of work.
(p 343)
By late 2008, a tenth of the vessels that transport the world's trade were idle. …
Chrysler was bought out by Fiat.
Bailed out by the government, GM … filed for a prepackaged bankruptcy …
The Irish banking system collapsed under the weight of bad loans …
(p 344)
Ireland spent more than 30% of its GDP to bailout its banks.
[Public] debt rose from the low 25% … to more than 100% of GDP. …
The downturn exposed … problems of corruption and close associations between business people, bankers and politicians. …
Iceland's government took over the largest banks as they collapsed with debts equal to about 12 times the total economy.
In attempt to protect British depositors, the UK used 2001 antiterrorism laws to freeze the British assets of a failing Icelandic bank.
Iceland was listed alongside Al Qaeda, Sudan, and North Korea.
(p 345)
The problems in Europe masked the bigger problem — US government debt, growing at $1 trillion a year. …
US national debt approached 100% of GDP. …
In 2009 [the US] owed its creditors $13.4 trillion …
(p 357)
There are similarities between the financial system, irreversible climate change, and shortages of vital resources like oil, food, and water.
In each case, society borrowed from the future, shifting problems to generations to come.
In the end, you literally devour the future until eventually the future devours you.
(p 361)
[The] complicity of ordinary people is difficult to ignore.
Many were investors, directly or indirectly through retirement schemes, who turned a blind eye to excess.
Investors ignored generous pay packets for bankers while the bankers made [making] investors richer …
Home owners did not complain when their properties rose in value.
(p 365)
In October 2010, the fees paid to lawyers, advisers, and managers involved in the bankruptcy of Lehman Brothers reaches more than [a billion dollars.]
Partners command $1,000 an hour; junior associates … $500 an hour.
One law firm charges $150,000 to compile bills and time records.
Expenses include $263,000 for a few weeks' photocopying, thousands for business class air travel [including $2.54 for gum at the airport], five-star hotels, and charges for limos waiting for meetings to finish. …
The fees include [$1.5 million] to monitor the fees paid.
(p 370)
[Niall Ferguson,] the world's first and only celebrity economic historian … reportedly charges around $100,000 per speech, earning $5 million a year …
(p 374)
[Semiotics is] a branch of linguistics that studies signs and symbols. …
In post-modernity, the meta level eventually dominates the primary level [from which it emanates.]
The cotton-candy money of financial alchemy dominates ordinary money.
This leads to circularity and self-reference — value becomes driven by itself, prices become a function of what you can borrow against the collateral, driving up value feeding on itself.
Instruments designed to manage risk create new risks.
Hedging of risks by individual participants creates risks for the system. …
[Institutions essentially trade] with themselves.
They undertake transactions … price them and book fictitious earnings …
The true function of money as a [medium] of exchange, a store of buying power, and a measure of value is corrupted.
(p 375)
[By 2010, renumeration] in the financial sector [had returned] to pre-crisis levels.
(p 379) - Debt Slavery, Keiser Report, October 2011.
All bankers are capitalists when they're making money.
The moment they lose money they become socialists and line up [for their taxpayer funded bailouts] along with everybody else …
The key to understanding [the Black-Scholes formula] and the whole option pricing framework, is that:We now understand risk.
So banks, and everybody else, get into the idea that we understand risk, we know exactly what it is, and we can lay it off and hedge it.
More importantly, we can now dynamically hedge it.
And that 'insight' about risk created this cult that we actually got rid of uncertainty, we could make things certain.
And everything in finance was driven by more and more debt, because if you don't have uncertainty, you can take on more debt, because the problem of paying it back goes away to some degree. …
Everyone has conspiracy theories.
Everyone assumes that in a dark room somewhere, people plotted this out to the last tee.
It wasn't.
It was accidental.
A whole series of things fell into line. …
While these developments in risk were going on [there was also the problem of growing] income inequality.
People were getting poorer.
So what did we do when people got poorer?
We democratized credit and said:Hey, you want that car?
[There] is a social element to this.
You may not earn enough, but we'll lend you the money. …
Its about slavery.
Because you can make people slaves in different ways.
One is, once you get them to borrow, and they owe you money, they become slaves as well. …
So this bunch of people, financiers now, were propelled into the center stage of all of this where they controlled the entire process — purely accidentally.
But the one thing about financiers is that they're smart.
When they see something which has advantages — they take advantage of it — so they propel themselves into the centerpiece. …
[In] the 1970s we had stagflation.
Keynesian mixed economy wasn't working.
So people said:What can we try?
Nobody knows whether it actually worked or not.
Let's try a bit of deregulation.
… Ronald Reagan is the beatified person on the far right except [everyone forgets that] he ran the biggest deficits up to that point in time …
[By contrast, Bill Clinton] ran the most right-of-center financial policies known to mankind.
[Political] ideology became unhinged because nobody really knew what to do.
And the financiers said:Hey, efficient markets and we are the answer!
So they were able to [concentrate political, economic and financial power in their own hands —] which we now know has backfired. …
There's nothing wrong with debt, per se.
Debt assumes a couple of very important things.
Firstly, what you bought with it produces income.
So … you have the income to pay back the interest and the principle.
[And secondly, that] whatever you bought keeps its value.
[But if the asset is a house and its value starts to fall — then you have a problem. …]
[The Ponzi scheme has now become the government's.]
Because the government … took over the debt from the private [banking] sector because they had to … when the banking system became literally insolvent.
[So now there is] a concerted effort by the central banks to keep interest rate low …
For instance, take Japan, 200% [gross] debt to GDP …
If you push interest rates from 1% to 3% Japan basically goes out the back door quicker than you can blink. …
[You've] got to break the finance-government complex …
Same as the defence-industrial complex from the 50s — you've got to break that.
{You've got to … make sure banks can't influence politicians in the way that they do.}
Which [means] you've got to change campaign finance [and cut out all] the heavily financed lobbying which … weakens all the legislation. …
[And you want a Federal Reserve board] which makes decisions purely on the economics of the case, not on the politics of the case. …
[Alan Greenspan's] constituency was always the bankers.
From '87 onwards, every time the banks had a problem he cut interest rates.
He flooded the system with money.
And that created this huge debt burden, to a large degree. - Financial derivatives, their rise and rise, Rear Vision, ABC Radio National, 7 July 2010.
Senator Carl Levin quizzing Goldman Sachs executive Daniel Sparks:
$600-million of Timberwolf securities was what you sold.
Look what your sales team was saying about Timberwolf:Boy, that Timberwolf was one shitty deal.
Come on, Mr Sparks, should Goldman Sachs be trying to sell a shitty deal? …
Satyajit Das:
[Transactions] like Abacus and Timberwolf, which are at the heart of allegations of breaches of securities codes in the United States by Goldman Sachs.
[They] combined the two technologies, the [Credit Default Swap] and the [Collateralized Debt Obligations] to create bets on whether people were going to default on their loans.
[They] were taking a view that the US mortgage market and US housing prices would fall, and cause losses.
But the investors … were investing because they obviously had an opposite view.
Kathy Gollan:
The investors who bought into the CDO Timberwolf, thought they were investing in a triple-A product with an attractive rate of return, based on income from mortgage holders.
But CDOs are very good at hiding risk and hidden within Timberwolf's complex structure were huge levels of risk.
And in fact Timberwolf lost 80% of its values within five months, when the housing market collapsed and mortgage holders defaulted. …
Satyajit Das:
[We] need to decide whether we can allow these [financial] instruments to [exist for] reducing uncertainty and risk … rather than manufacturing risk and speculating. …
[There] are things we can do … standardising the contracts, making them easier to understand and … putting them onto Exchanges where there's greater transparency …
[But of] course you will hear of the howls of protest from the financial industry from here to Mars.
Would you like to know more? - Chronicle of a Loss Foretold, Excerpt Part 1, Traders, Guns and Money, FT-Prentice Hall, 2006.
[The client, OCM,] now owed the dealer $600 million on which it was committed to pay a fixed rate for the remaining life of the transaction — three years.
OCM had originally borrowed rupiah 1,200,000 million (rupiah 2,000 multiplied by $600 million). …
The loss was larger [than] the total capital of the company. …
[However, the] mirth at the dealer must have given way to concern.
It was not over OCM’s fate.
It was over the risk that OCM may not be able to pay the amounts owed to the dealer.
The traders had already taken the profits on the transaction upfront (under a quaint practice called mark-to-market accounting).
Sadly, the investment bank’s unenlightened management did not let traders take their share of profits in the first year.
Some of the profits were suspended and would only be recognized over three years.
If the transaction was terminated and OCM failed to pay, then these profits would be written back.
The traders would lose out.
It was imperative that OCM be placed on life support at least for the time it took the traders to receive their share of the large profits [— 30% was the rumored profit split …]
[So, the] traders negotiated a new trade …
It reached a new plane of creativity.
Under the transaction, the offending transaction was canceled at no cost to OCM.
In its place was a new swap.
The new transaction was for $600 million.
Under the swap, for the next three years, OCM would pay a fixed dollar amount.
The amount was $4 million a month [8% annualized].
In return the dealer would pay OCM an amount calculated according to a complicated formula:
Maximum of [0; NP × {7 × [(LIBOR^2 × 1/LIBOR) − (LIBOR^4 × LIBOR^−3)]} × days in the month / 360]
Where
NP = $600 million
The financial engineering was dazzling. …
LIBOR = 6 month Dollar LIBOR rates
The complex equation, if you did the algebra, always equaled zero.
The dealer would never pay OCM anything [while] OCM would be paying the dealer $4 million each month for three years.
[But wait!
There was more:]
There was an “extension” option.
The dealer could, at its sole [discretion], extend the transaction at maturity by an additional three years.
This option was repeated every three years.
The maximum maturity was 30 years.Is this customary for a transaction of this ilk?
[The accounting partner] inquired.
I had responded in the negative.
I had never seen one before.
It’s sole purpose appears to be to disguise the fact that the dealer will keep extending the transaction until it finally terminates at the end of 30 years.
[I said.]
OCM will pay back its loss on the terminated swap together with interest in monthly payments over 30 years.Interesting, [it's] just a disguised loan.
[He concluded.]
The Masters of Mankind
All for ourselves, and nothing for anyone else, seems, in every age, to have been the vile maxim of the Masters of Mankind.
— Adam Smith (1723 – 90), The Wealth of Nations, 1779.
Empty words like governance and oversight masked a lack of adult supervision of business and markets.
[It was management by neglect: a business culture that] presided over increasing debt, greater leverage, higher risk, lower capital, and accounting fudges.
(p 290)
[In 2006, the] average weekly wage of investment bankers was $8,367, compared to $841 for all private sector jobs.
(p 313, emphasis added)
In Fairfield County, Connecticut, where many hedge funds were based, the average pay was $23,846 a week.
{[In 2007, the] leading 20 hedge fund and private equity managers earned … $12.6 million a week [— equivalent to] the $29,500 average annual income in the US in just over 8 minutes [or] the President's salary (around $400,000 per year) in less than 2 hours.}
[The] combined remuneration at the five major Wall Street investment banks alone exceeded the world's total foreign aid budget [for 2007] of $850 billion. …
… CEO of Macquarie Bank Allan Moss … earned $35.5 million in a single year …
(p 314)
Larry Summers believed that the market allowed skilled talent to capture their fair share of returns, consistent with productivity and contribution to economic outcomes.
Between government jobs, Summers earned $5 million at hedge fund DE Shaw & Co, playing down his role a mere part-time job. …
Large bonuses were based on high profits, the product of excessive risk and leverage.
Some of the earnings were imaginary, based on mark-to-market accounting, not true cash profit. …
In 2006 [Dow Kim, head of Merrill Lynch's] fixed income business, including mortgages, received a bonus $35 million on top of his salary of $350,000. …
Merrill ultimately lost vast sums when the basis of the profits, mortgage investments, fell sharply in value. …
(p 315, emphasis added)
Merrill was taken over by [Bank of America,] after a short and troubled period with John Thain at the helm. …
(p 201)
[Thain, distinguished himself by spending] $1.2 million redecorating his office [as] Merrill slipped closer to insolvency.
(p 330)
Joining CitiGroup after his term as Treasury secretary, Robert Rubin was paid $20 million a year as a non-executive board member with poorly defined duties.
During the tenure of Rubin and CEO Chuck Prince, Citi lost over $50 billion and its market value fell by more than $60 billion, ultimately requiring a government bailout.
(p 315)
[Prince,] a lawyer appointed to deal with regulatory problems, lacked the requisite risk skills. …
Prince's nickname was "one Buck Chuck," a reference to the fact that Citi's stock price barely moved $1 under his leadership.
Losses on mortgages drove Citi's stock price perilously close to the one-buck figure as the bank struggled to survive.
(p 201)
[On leaving Citi, Prince] was paid an exit bonus of $12.5 million, additional to $68 million already received in stock and options, a $1.7 million annual pension, as well [as] an office, car, and driver for up to 5 years.
Prince signed a 5 year noncompete agreement.
Citi may have benefited more by allowing their former CEO to manage a competitor, give the results of his tenure at the bank.
(p 315)
The top five executives of Bear Stearns and Lehman [Brothers] pocketed cash bonuses exceeding $300 million and $150 million respectively (in 2009 US dollars) [even though] the earnings on which the remuneration was based were reversed in 2008 …
(p 316)
… Lehman's Richard Fuld and Bear Stearns' James Cayne, took nearly 2 decades to become multimillionaires and finally billionaires. …
[By contrast,] Brian Hunter, responsible for energy trading at hedge fund Amaranth before it imploded, earned between $75 million and $100 million [in one year,] ranking him a middling 29th highest paid in his profession [for 2005.]
Several hedge fund managers routinely earn $1 billion each year.
(p 318)
[Remarkably, Richard Fuld] did not use a computer and did not have the ability to open attachments on his BlackBerry.
(p 290)
In 1994 Warren Buffett tried to stop bonus payments until Salomon Brothers' profitability returned to satisfactory levels.
Buffet was forced to abandon the proposal when many senior staff left, joining competitors.
(p 319)
In 2009, Lloyd Blankfein, chairman of Goldman Sachs … who earned $54 million for a year's work just before the crisis, remained unapologetic about the firm's behavior.
In [an Orwellian] piece of of historical revisionism … Goldman Sachs claimed that it never needed government assistance and would have survived the crisis without it.
(p 364)
(Satyajit Das, Extreme Money: Masters of the Universe and the Cult of Risk, FT Press, 2011)
John Keynes (1883 – 1946)
[In the future, the] love of money as a possession — as distinguished from the love of money as a means to the enjoyments and realities of life — will be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease. …
The pace at which we can reach our destination of economic bliss will be governed by four things:
- our power to control population,
- our determination to avoid wars and civil dissensions,
- our willingness to entrust to science the direction of those matters which are properly the concern of science,
- the rate of accumulation as fixed by the margin between our production and our consumption;
(Economic Possibilities for our Grandchildren, 1930)
[The] ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood.
Indeed, the world is ruled by little else.
Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.
(p 383)
There is no clear evidence from experience, that the investment policy which is socially advantageous, coincides with that which is most profitable.
(p 140)
(The General Theory of Employment, Interest and Money, 1936)
Robert Skidelsky (1939)
From the start 'scientific' economics had been strongly normative.
By increasing understanding of 'economic laws' it hoped to shift actual economic arrangements towards the competitive ideal which would maximise the creation of wealth; hence the strong association between nineteenth-century economics and the policy of laissez-faire.
Adam Smith and his followers were chiefly preoccupied with the failures of government.
Their idea was that government should keep law and order, and get out of economic life.
By the last quarter of the nineteenth century the mood had changed.
- The failures of laissez-faire were palpable;
- the competence and the integrity of governments were much improved; [and]
- the growth of democracy had increased the pressure on the state to 'solve' or at least [mitigate] social problems.
[The Age of Collectivism had] dawned.
Feeding the growth of collectivism was
- the growth of the social sciences, and
- the parallel emergence of an activist intelligentsia, claiming a right of direction, vacated by the aristocracy and the clergy, by virtue of superior intellectual ability and expert knowledge of society.
The central claim which emerged from the confluence of these two tendencies was that society was a machine whose working could be improved by deliberate action, with unintended side-effects being equally amenable to correction and control, much as a mechanic fine-tunes an engine.
It was the vision … that we can make of our lives and world the world what we wish.
(p 456)
(John Maynard Keynes (1883-1946): Economist, Philosopher, Statesman, One Volume Edition, Penguin, 2003)
