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Financial Innovation vs Financial Fraud: A Reggie Middleton Rant
I was reading a post by George Washington over at ZeroHedge that actually spurred the following rant. An excerpt reads:
The Telegraph notes:
The former US Federal Reserve chairman told an audience that included some of the world's most senior financiers that their industry's "single most important" contribution in the last 25 years has been automatic telling machines, which he said had at least proved "useful".
Echoing FSA chairman Lord Turner's comments that banks are "socially useless", Mr Volcker told delegates who had been discussing how to rebuild the financial system to "wake up". He said credit default swaps and collateralised debt obligations had taken the economy "right to the brink of disaster" and added that the economy had grown at "greater rates of speed" during the 1960s without such products.
When one stunned audience member suggested that Mr Volcker did not really mean bond markets and securitisations had contributed "nothing at all", he replied: "You can innovate as much as you like, but do it within a structure that doesn't put the whole economy at risk."
He said he agreed with George Soros, the billionaire investor, who said investment banks must stick to serving clients and "proprietary trading should be pushed out of investment banks and to hedge funds where they belong".
It is not just George Soros.
Nassim Nicholas Taleb has repeatedly said that speculation should be limited to hedge funds, and that banks should solely engage in traditional depository functions, and - because of their power to create credit - be treated as public utilities.
Many other top economists and financial experts have said that financial innovation is harmful, and have called for reimposing Glass-Steagall and for separating traditional banking from investment banking.
What got me started was the use, and misuse, of the term "innovation".
It is not financial innovation that must be curtailed. Innovation, in and of itself, is a very good thing. The issue currently at hand is that it was not financial innovation that got us into this mess. It was fraud! Financial engineers attempted to create methods of circumventing regulations, laws, prudent risk management, common sense and mean market returns. For instance, taking $100 million of junk status mortgages and creating $300 million of so-called AAA exposure out of it (MBS, CDO's, CDO cubed, credit lines supporting CDO's, CDS protecting the CDO exposure. etc. - all from a simple mortgage that no one thought would be paid in the first place). That is not innovation, that is called LYING! It was thinly veiled fraud. This lying, in turn, was labeled "innovation", which it absolutely was not, and the moniker has been carried on in the media ever since.
Innovation is the personal computer! Innovation is the smart phone! Innovation is mapping the human genome! Innovation can be found in stem cell research! Innovation is discovering new ways of human learning and social interaction. All of these examples of innovation make society more productive, and more efficient. It harms none but those who would be relegated to the annals of obscelence anyway. But CDOs and credit defaults swaps as innovation!!! I'm afraid not. I bitched about this as far back as two years ago in "Welcome to the World of Dr. FrankenFinance!" There are forms of finance that are innovative, but they have nothing to do with the current malarky.
Then we have "the Great Global Macro Experiment", in which today's central bankers can be likened to mad scientists. The reflexive relationship between private sector bankers' (the Frankenstein monster's) faux "innovations" and their public sector "mad scientist" (Dr. Frnakenstein) counterparts will destroy the developed economies as we know them unless this ridiculous boom/bust cycle is put to an end. The quickest and most efficient way to do that is to let overpriced bubble assets deflate in due course and have the markets reflate them naturally based on fundamental values and stable macroeconomic conditions - and NOT through artificial (hence unsustainable, causing another boom/bust cycle) boosting of risky asset prices and synthetic suppressing of market rates in order to stimulate unsustainable demand that would have been there in a sustainable fashion in the first place if risky asset prices were allowed to deflate.
Yes, I know it's a run-on sentence, but why stop when I'm amped. I also know why the mad scientist central bankers will not let the Frankenstien assets properly correct. If they do, then it will throw the existing oligarchy off of their perch. I have dedicated several posts to this socio-economic stratification dilemma that is known as class conflict. See "You've Been Bamboozled, Hoodwinked and Lied To! Here's the Proof. What Are You Going to Do About It?" for an example of exactly what I mean. That is why the media preached "the world is coming to an end" in 2008. Read my blog. I predicted the series of events that led up to the meltdown quite accurately, and publicly (look here for the proof). Take it from someone who demonstrated that they saw what was going on well in advance. THE world was definitely not coming to an end. THEIR world was coming to an end. MY world was just experiencing a much needed, albeit a very serious, and well telegraphed correction, in the form of a near depression that would have wiped out most of the unproductive financial and (dare I utter it) intellectual capital to make room for the stuff that would move us into the next phase of productivity for the new millenium.
The "mad scientists" have prevented that cleaning of the house, and here we are now - most likely about to hit that depression-like correction anyway, and having wasted trillions of dollars of taxpayer financial capital in an attempt to save an unproductive oligarchy to which I do not belong.
keep speaking truth, reggie, the world desperately needs you.
Please look at this...
A little switch and bate here. All derivatives must be included in the reform otherwise we will continue to bail out the dealers, parties. Enough... The people who pay for the bailouts, us, should be protected.
"Colin Peterson (D-MN), Chairman of the House Committee on Agriculture, along with Barney Frank, has added an amendment to the OTC Bill (opens large pdf). There are two relevant sentences for reformers from the long document. The first is on page 32:
(49) SWAP EXECUTION FACILITY.—The term ‘swap execution facility’ means a person or entity that facilitates the execution or trading of swaps between two persons through any means of interstate commerce, but which is not a designated contract market, including any electronic trade execution or voice brokerage facility.
This replaces other language in the original bill (opens even larger pdf), on page 546:
SEC. 5h. SWAP EXECUTION FACILITIES.
(a) REGISTRATION.—
(1) INGENERAL.—
(A) No person may operate a swap execution facility unless the facility is registered under this section.
(B) The term ‘swap execution facility’ means an entity that facilitates the execution of swaps between two persons through any means of interstate commerce but which is not a designated contract market.
So notice any differences? First the definition of a swap execution facility has been expanded to include “a person” (different from the “or entity”). It’s also expanded to an “or trading” definition, and includes voice brokerage firms. So now we are moving from the definition of something that is a platform for swaps to be traded on to instead something that simply helps swaps get traded. This could, quite simply, be a telephone over which two people trade a derivative (with one person declaring himself to be the exchange?). Instead of changing the way business is done for reform it looks like it redefines reform as the way things are currently done, and just calls it a victory.
Now on page 89 of the amendment:
(2) RULES FOR TRADING THROUGH THE FACILITY.—Not later than 1 year after the date of the enactment of the Derivative Markets transparency and Accountability Act of 2009, the Commission shall adopt rules to allow a swap to be traded through the facilities of a designated contract market or a swap execution facility. Such rules shall permit an intermediary, acting as principal or agent, to enter into or execute a swap, notwithstanding section 2(k), if the swap is executed, reported, recorded, or confirmed in accordance with the rules of the designated contract market or swap execution facility.
The second sentence here allows an intermediary to execute a swap, ignoring the section 2(k) which is the meat of the reform, as long as the swap is recorded somewhere. Now we already have, from above, that a swap execution facility can be something other than the exchange. This is a rule that guts the regulation right out the door, and for no apparent benefit to reform. Many of these alternative swap facilities will be owned by the banks, so it won’t necessarily force the price transparency that has been promised. To trust regulators to simply do the right thing is naive at best when the ability to follow fixed rules is available.
From what I’m hearing, it is possible Frank doesn’t even know that this language, once in the bill as an amendment but removed, has snuck back into his reform legislation. Things are moving very quickly on the hill right now, and this is scheduled to be wrapped up by tomorrow. However this new language runs counter to the reforms Frank has promised to deliver to the American people. Either this language needs to be clarified before the bill is complete, or removed entirely."
http://baselinescenario.com/2009/12/09/how-to-kill-otc-derivatives-refor...
copy/paste the tickets on Bloomberg, redact the actors...now how's that for transparency?!
Reggie,
That was one of the best rants I have read in a long, long time, these words absolutely speak to me and for me.
A small team mapped the entire human epigenome which has enormous downstream implications for human health. Excellent scientists, their research underpins regenerative medicine, cancer treatment and an understanding of human development.
Their mean income is about 40k.
Meanwhile another small team blew up the entire derivatives market with enormous downstream implications for the global economy. Complete frauds, their products didn't work as claimed, the stole money by the trillions and they squandered bright minds on creation of useless snake-oil.
Their mean income is about 400k.
What kind of fucked up world do we live in?
Reggie, great rant. I enjoy reading your posts in general as it is apparent you and your group do your due diligence. Unfortunately, since the U.S. has almost no industrial base and, therefore, is reduced to fraud as it principal export, it looks like "financial innovation" is here to stay until the entire, sordid, rotting carcass collapses under its own weight.
Reggie is all meat and potato's--wasn't a rant Reg--just the truth.
Rusty keep-em coming-alkibonds what a hoot-ah crap now thats gonna be on the next local ballot-time for another Knob Creek and its only 7:00am.
Financial innovation is bankers finding clever new ways to extract their clients' money before they wise up to it, but it is also used by politicians to pay for the promises they can't afford.
colonic irrigation required,
appointments available soon.
I don't know I kind of think the CDS market is kind of innovative.
They created an accepted financial instrument where both the buyer and seller are committing fraud right at the outset.
They have now achieved........Maximum Efficiency
AndyC
Perhaps it's not versus, but rather a term I've been using- the fraudancial sector.
Reggie - Excellent!
"That is not innovation, that is called LYING! It was thinly veiled fraud. This lying, in turn, was labeled "innovation", which it absolutely was not, and the moniker has been carried on in the media ever since."
BINGO! Hit the nail on the head!
If there is any justice in this world, in 2010 we will see the Shock-and-Awe prosecutions of hundreds of fraudsters on Wall Street, the mortgage loan sharks, the rating agencies, the TBTF banks, and their aiders and abetters at the Fed, Treasury, SEC, and Congress.
If you wouldn't choose a much simpler lifestyle, over complete corruption, at the top of a tyrranical empire, you are part of the brainwashed problem. It only gets worse from here. these cretins, are not redeemable. they are not just infected, they are the infection.
I take the end of the world more seriously. If the current political/financial elites were swept away or thinned significantly there is nothing and nobody to replace them. There is no organized political force with an organized set of principals to step in. There are no followers, except the Tea Party crowd who do whatever a set of entertainers tell them to do and think.
So while I do not say we were better off keeping the game going but that the world would have ended for more than the 10% more in America who will now be poor. Most would have been far poorer and still may be and the process would not or will not be pretty. A certain degree of anrachy or authoritarian control might ensue, or both.
There is no easy cure or rather the easy one has been chosen. We muddle along. Injustice and grand theft from the top exists in all systems. It isn't like America is some kind of hell after all. Especially for people who frequent this site or ones like it.
Be careful what you wish for because it's hard to say who might be gone after if the big change comes.
That is utter nonsense. The US Constitution and the laws on the books are the backbone of the country, not the personalities currently in office.
And, for the record, it is not the Tea Party crowd that follows entertainers; there would be noone to listen to. The entertainers are all (save Bruce Willis) still licking at the anus of the great BHO.
Why do people assume that everyone that reads this site is rich?
Unfortunately many of us cant apply the lever up and skim till you bust up and get bailed trading strategy that is so profitable down on Wall Street
We have been told that we are SETF
Small Enough To Fail
AndyC
reggie... first i want to thank you for all the time you devote to us with your research. second... the only event that " will throw the existing oligarchy off of their perch " will be the second coming of christ. that will happen much sooner than people think.
Why do you use a nude woman for your avatar?
she isn't nude. why do you have a bag on your head?
it's comforting to know mr. volker agreed with mr. soros, another miserable s.o.b. who aided the nazis. nice.
he is a nazi.
Most excellent rant, Reggie.
innovation is the code word for "information asymetry" hence outsize profits. wolfgang munchau pointed out the same thing in yeaterdays ft. that there is no evidence financial innovation is good for the economy or produces any benefit besides extra profits
Heidi is the proprietor of a bar in Detroit . She realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar. To solve this problem, she comes up with new marketing plan that allows her customers to drink now, but pay later.
She keeps track of the drinks consumed on a ledger (thereby
granting the customers loans).
Word gets around about Heidi's "drink now, pay
later" marketing strategy and, as a result, increasing numbers of customers
flood into Heidi's bar. Soon she has the largest sales volume for
any bar in Detroit .
By providing her customers freedom from immediate
payment demands, Heidi gets no resistance when, at regular intervals, she
substantially increases her prices for wine and beer, the
most consumed beverages. Consequently, Heidi's gross sales
volume increases massively.
A young and dynamic vice-president at the local bank
recognizes that these customer debts constitute valuable future assets and
increases Heidi's borrowing limit. He sees no reason for any
undue concern, since he has the debts of the unemployed alcoholics
as collateral.
At the bank's corporate headquarters, expert traders
transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS.
These securities are then bundled and traded on international
security markets. Naive investors don't really understand that
the securities being sold to them as AAA secured bonds are really the
debts of unemployed alcoholics.
Nevertheless, the bond prices continuously climb, and the
securities soon become the hottest-selling items for some of the
nation's leading brokerage houses.
One day, even though the bond prices are still climbing, a
new risk manager (who did not go to college or university and spent
most of his time skiing ;-) ) at the original local bank
decides that the time has come to
demand payment on the debts incurred by the drinkers at
Heidi's bar. He so informs Heidi.
Heidi then demands payment from her alcoholic patrons, but
being unemployed alcoholics they cannot pay back their drinking
debts. Since, Heidi cannot fulfill her loan obligations she is
forced into bankruptcy. The bar closes and she and her eleven employees lose
their jobs.
Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in
price by 90%.
The collapsed bond asset value destroys the bank's
liquidity and prevents it from issuing new loans, thus freezing credit
and economic activity in that community.
The suppliers of Heidi's bar had granted her generous
payment extensions and had invested their firms' pension funds
in the various BOND securities. They find they are now faced with having
to write off her bad debt and with losing over 90% of the presumed
value of the bonds. Their retirees can no longer afford to retire.
Her wine supplier also claims bankruptcy,
closing the doors on a family business that had endured for three
generations. Her beer supplier is taken over by a competitor, who
immediately closes the local plant and lays off 150 workers, moving
those jobs to their plants in Mexico and China.
Fortunately though, the bank, the brokerage houses and
their respective executives are saved and bailed out by a
multi-billion dollar no-strings attached cash infusion from the
Government. The funds required for this bailout are obtained by new taxes
levied on employed, middle-class, non-drinkers.
This help clear things up?
That clears up the Capital Markets syndication and placement, but all the while and most especially now, the lion's share of money is made by dealers and brokers trading this paper, which makes an occasional pit-stop at an institution which can mark them to a model or get them covered in an off-balance sheet vehicle because they are TBTF, when in fact it is we who are Too Duped To Succeed TDTS
"At the bank's corporate headquarters, expert traders
transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS.
These securities are then bundled and traded on international
security markets. Naive investors don't really understand that
the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics."
Excellent post Rusty
Can I assume that.............
After transforming the loans into securities and selling them to Pension Funds, Charitable Trusts, College Endowment Funds, Widows and Orphans Funds and the like, the experts down at the bank wisely shorted these very same securities in the marketplace knowing that they would prove to be virtually worthless?
Why, this is genius! Citibank would jump on this bandwagon in a second.
Nicely said Reggie. Keep pushing and thank you very much.
Amen, sir. The words people are throwing around these days are making things look pretty ugly for those of us that believe in freedom (which carries with it an inherent tenet that those that infringe on the freedoms of others are punished severely)...
On a slightly OT rant: It's the same as congress making new laws to fix existing laws that simply lie unenforced. The solution is not a new law, it is to enforce the existing one. But how can these morons in Washington demand the staff/salary/pomp and circumstance/pensions/healthcare/etc. etc. etc., if their fraud (that most of what they do is damaging; they add little if any value) was known by the masses.
Speaking of GS, er Geroge Soros, Financial Alchemy...