I was an accountant (used to work for PWC). I am now an independent investor/trader trading for my own account to make a living (I do not trade with other people's money, only mine).
In crude terms I am for all intents and purposes an economic "parasite", in that I make my living by buying and selling pieces of paper, without producing anything of value. A more "charitable" argument might say that I am oil in the economic machine. Personally I would argue the former is closer to the truth.
Given my background, and how I make my living, I thought a brief review of what is needed in financial reform might be in order. After all I think it might help to have one parasite telling you how the other parasites are screwing with you.
This (from today's Goldman e-mail revelations) is parasitical, not acting as an intermediary.
As homeowners were falling behind on their subprime mortgages, wreaking havoc for investors that owned slices of their mortgages in securities peddled by Wall Street, Goldman Sachs was "well positioned," according to internal company emails from top executives.
The firm had "the big short," declared chief financial officer David Viniar -- Goldman Sachs was making money off the souring of the very securities it had peddled to the market.
In simple terms, the finance industry exists to do one thing - bringing together those with money with those in need of money. It exists because both those with and without money are willing to pay "something" for being hooked up with the other side .
Banking should be pretty boring. You take in deposits and lend out money. By charging more for money that you lend out than what you pay for money you take in you can earn a "spread" to cover your operating costs and make a profit as well.
The important question for society is this - how much is a fair return for providing this intermediary function?
The problem we have, and probably the main reason behind the financial crisis is simple. Instead of remaining an intermediary function the finance industry became for want of a better word, a casino, with the finance industry taking a bigger and bigger share of the bets being placed.
In 1976 a number of banks were added to the S&P500. At that time the financial services industry made up only about 6% of the S&P. By the middle of 2007 the financial services industry (remember, supposedly an intermediary industry) made up 21% of the S&P500. Even a non accountant can tell you that if the intermediary is 21% of the business, something is quite likely wrong.
Think of it this way. Think of a farmer's market where local farmer's sell their products, and pay the owner of the market a fee to have a stand at the market. You have a nice pleasant market with fresh produce and low prices that attracts lots of customers.
Now imagine that the owners of the market look at all these customers and think ... "$$$". So they start opening up some carnival games (or renting out stands to those that do), you know the ones where you almost never win anything, and even some slot machines. This brings in even more people as it becomes "the" place to be on Saturday morning.
Soon the demand for stalls is going up. The owners up the rent, and the farmers that can afford to stay up their prices to cover their higher costs. Some farmers even go back to selling at the food terminal to middlemen who then sell at the market. What had been a simple low cost market has now become a big business.
Something similar happened in finance. Instead of being content to make money on the simple "spread" the business went in two directions:
- Fee based: Banks started realizing that charging small fees on everything soon added up. Whether it was transaction fees, or overdraft fees, or money management fees, or ... they tried to get a cut out of everything going through their hands.
- Transaction volume: The second follows from the first. Not only do you want to have fees, you want to have lots of fees and you get that by having lots and lots of transactions.
Let's look at a few examples:
a) Mergers and acquisitions: Financial industry companies are always on the lookout for potential deals. Why? Because they make great fees by "creating" these deals. You have this continuous push to do deals, not because it makes business sense, but because it makes money for the deal makers.
b) Retirement accounts: If someone is managing your money chances are they are making a fee, whether you know it or not, and more importantly, whether you are making money or not. Think of how many people sit there selling mutual funds and the like so that they can build up their fee income.
c) Trading: We now have high frequency trading which churns huge numbers of shares for minor changes in price, but adds up to big profits.
Then there is Goldman Sachs:
As parasite number one there can be no better example than Goldman Sachs. Just look at how much money they make from "trading" on their own account (remember this is what they take out of the system for being an intermediary). In 2009 they had 131 trading days where they made at least $100 million in net trading revenues (up from 90 in 2008, 88 in 2007, 49 in 2006, 18 in 2005 and 14 in 2004) . Think about that - $100 million + per day - sucked out of the market in gains. I for one am at a loss to explain how that could by any stretch of the imagination be called "god's work".
Fixing the system:
We will know that the system has been fixed when the finance industry goes back to being about 5-10% of the S&P500, back to where it gets compensated for acting as an intermediary, and not for running a bigger casino backstopped by the taxpayer.
In simple terms we want to a) make banking boring again (financial engineering is not a legitimate form of making "stuff"), b) get rid of weapons of mass financial destruction, and c) reduce the fees being sucked out of the system. to this end here are a few basic things....
- Institute the Volker rule. If you are a bank, no proprietary trading for you. If you want to gamble/trade go start a hedge fund. And NO it is not that hard to say what is and what is not proprietary trading.
- Force derivatives onto an exchange, with transparency. In this way two things will happen. We will know where the risk lies and the 6 "banks" that run the current monopoly in the dark will no longer be able to make the kind of profits that they now do.
- Shine light on high frequency trading and dark pools, via far more detailed reporting. Both of these are ways in which the "banks" can siphon off profits without anyone really being aware of how much they are making.
- Eliminate naked credit default swaps (equivalent to the buying of fire insurance on your neighbor's house when you think an arsonist is in town) and synthetic CDOs. There is no problem wanting to hedge ... but you have to have something to hedge. No more naked shorting either. This would have eliminated the type of transaction that Goldman is now in hot water over (a form of transaction that actually fueled the reckless lending behind the housing bubble).
- Bring back more restrictive mortgage rules. Something like a minimum 10% down and a 25 year amortization. No more alphabet soup mortgages. Would this hurt the housing/mortgage business? Initially yes, but eventually you would have a more stable housing market with fewer booms followed by the inevitable busts. You would also eventually have more affordable housing for all (but maybe not as profitable for some).
- Mark to market accounting. Even at this stage we have no idea how "sound" the banks actually are because they have been allowed to hide their losses (by marking to make believe - basically saying their assets are worth whatever they say they are). Ultimately the financial crisis will not end until excess debt is purged from the system, and a lot of that bad debt is still being hidden and not addressed. The first step is in being clear just how much there is out there.
Caveat:
Let's be honest here. Speculators can play a positive role in price discovery, but ... we can not have markets where about the only players there are speculators trading between themselves waiting for the first sucker (i.e. actual user/supplier of the good in question) to come along to be raped.
Boiled down to its essence my argument is simple. There may have been some benefits from financial "innovation" (although Volker comments - "I wish somebody would give me some shred of evidence linking financial innovation with a benefit to the economy."), but there is NO WAY that these benefits have been commensurate with the costs.
We need to put handcuffs on the bankers (to keep banking boring) and we need to reduce the leeching of the financial squids on the broader economy. This will mean job losses in finance. This will mean the bright folks may have to work in the broader economy and not just in financial engineering. And, this will ultimately mean a business with much lower profits and much lower bonuses.
Finally this can not just be about banking, without also being about debt (what ultimately fuels the finance business). Changes have to be made to the debt culture, to the idea of buy now, pay tomorrow (or never). There must be a return to fiscal sanity and living within ones means.
Me:
I have been living off of my trading for more than 10 years. I have not made enough to retire, but I have made enough to live a relatively simple, but comfortable life. I am though I think about to pack it in and head back to the work world ... and that is how it should be for the parasites like us, except that I am going back to work not because the markets can't be used to make a living, but because the vampire squid and the other "banks" have become so good at sucking the corpse dry that there is nothing left for anyone else, especially the average investor. These squids are slowly but surely killing their host, a market now rigged to provide profits for the squids but only crumbs for investors.