Archive for February 17th, 2010

When Matt Taibbi published his Rolling Stone piece about Goldman Sachs, a number of people accused him of being sensationalist and even misleading about Goldman’s influence and malfeasance. The enduring image from that story was the Vampire Squid, a giant and blood-sucking creature that will seek (and succeed at) profitting off of pretty much anything. The continuous flow of news stories about outsized profits from a range of activities have seemed to vindicate Taibbi. Of course, there is some value in more measured academics taking on Goldman and Wall Street in general, so here’s Randy Wray:

Forget the bonuses…And, yes, they are blowing the black hole of financial insolvency bigger day by day even as they thumb their noses at Washington…But what is even more disturbing is that Wall Street is still maniacally creating risk, inventing new ways to bet on the death of “peasants”, economies, and nations…

A Wall Streeter buys the life insurance policies of individuals with terminal illnesses, packages them into securities, and profits when the underlying collateral dies…Now we learn that firms continue to carry life insurance on former employees, hoping they will die untimely deaths so that the firm can collect…Death is the new profit center, packaged and sold by Wall Street insurers…

Second, there is of course Greece. Goldman Sachs sold them financial products to disguise their budget deficits. Of course, Goldman argues that it was doing nothing unusual—it has been creating complex products to hide risk for decades…Goldman gets huge fees, but of course the risks always come back to bite its suckers…We don’t know whether Goldman has placed its own bets on the death of Greece—nor is it clear what role Goldman has played in whipping up hysteria about the likelihood of default, but the bank is almost certainly benefiting by the booming business in default “insurance”…it looks like the European Union, which is launching a major audit, just might banish the bank from dealing in government debt…

Finally, according to a report, Citi is going to launch a new derivative that will allow gamblers to bet directly on financial crises…The CLX products are supposed to hedge the liquidity risk of a spike of funding costs. The problem, of course, is exactly the one faced by those who had bought CDS “insurance” from AIG: counterparty risk…Only the government can cover unlimited losses. Hence, only the chosen few “too big to fail” sellers of this kind of insurance will be able to play the game. That is, folks like Goldman, J.P. Morgan, Citi, and Bank of America. And guess who will get stuck with the bill when the whole scheme crashes? You betcha, it will be the Treasury…

And that is what this whole Wall Street house of cards boils down to: risky bets, private profits, socialized losses. Worse, yet, it misaligns interests so that Wall Street profits are higher if there is economic and social instability…Until Wall Street is constrained and downsized, it will continue on its path of death and destruction.

In spite of all the happy talk about the end of the recession and the successful resolution of the financial crisis, things are much worse today than they were two years ago…Be prepared for another global crisis by summer. And also get ready for another Washington bail-out…

So here’s the best policy. Unwind the $23 trillion committed by the Treasury and the Fed. Let the market operate. It wants to close down all the “too big to fail” institutions. The market is right—these institutions are not necessary, indeed, they represent the biggest problem facing the financial sector…it makes far more sense to allow default to wipe out the bets, and then work to save the productive activity, jobs, and income.

I know that Wall Street’s protectorate, led by Geithner, Rubin, and Summers, will claim that failure of the behemoths will create an economic disaster. But that is not true. All real economic fall-out can be contained and the economy will emerge much healthier. Replace Wall Street’s life support with support for mainstreet…True recovery would begin immediately, and we’d be out of the mess by summer.

Wray’s plan sounds great, but it’s obviously pie-in-the-sky politically. If Wray is right about an impending double-dip, though, then perhaps a second window for real financial reform will be opened. The problem is that with Geithner calling the shots, it seems inevitable that “risk management” will continue to carry the day on Wall Street, while unbounded uncertainty, systemic risk, and overleverage lurk in the shadows. 

Wray’s article is a reminder of the lengths to which banks will go to seek profit, the destruction they will leave in their wake, and how far we are from reining this process in. Capital has gone wild, and unless reform addresses the inner workings and profit motives of the vampire squid, and aligns them with the whole country’s economic interests, we will find ourselves back here not only in six months, but also in six years.


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