``Popular opinion ascribes all these evils to the capitalistic system. As a remedy for the undesirable effects of interventionism they ask for still more interventionism. They blame capitalism for the effects of the actions of governments which pursue an anti-capitalistic policy.” Ludwig von Mises, Interventionism an Economic analysis
Adding more arbitrary laws or “regulations”, which are usually founded upon noble goals, have been used as the main pretext for expanding political power by the incumbents.
This unfortunately is what people refuse to see yet has been a critical cause of much of today’s ills.
For the political economy, regulations can unilaterally skew the distribution of power from the ruled to the ruler. If there is such a thing as “income or wealth” inequality, the obverse side is the “political inequality”.
Professor Lawrence White[1] on the difference of rule of law and rule of men, ``The contrast between the rule of law and the rule of men is sometimes traced still further back to Plato’s dialogue entitled Laws. In that work the Athenian Stranger declares that a city will enjoy safety and other benefits of the gods where the law “is despot over the rulers, and the rulers are slaves of the law”. In other words, government officials are to be the servants and not the masters of society. The rule of law is vitally important because it allows a society to combine freedom, justice, and a thriving economic order.”
When government officials elect to end up as “masters of society”, one of the main acts to attain such goals is to deliberately trample upon with laws of the land to allow laws to work to their favor.
In short, despots legitimize their power grab by coercively instituting their own set of laws. The Philippines is no stranger to this as seen through former President Ferdinand Marcos’ proclamation 1081, ``Marcos ruled by military power through martial law, altered the 1935 Constitution of the Philippines in the subsequent year, made himself both Head of State as President and Head of Government as Prime Minister, manipulated elections and the political arena in the Philippines, and had his political party--Kilusang Bagong Lipunan (KBL) (English: New Society Movement) control the unicameral legislative branch of government called the "Batasang Pambansa". All these allowed Marcos to remain in power and to plunder.[2]”
And since the manipulation of laws tends to rearrange the political economic order according to the whims of those in power by restraining civil liberties and economic freedom, ergo, the benefits or privileges will be partial to those within the ambit of the administration.
Said differently instead of having resources distributed through the marketplace, resources will be allocated politically in accordance to the order of importance as seen by the authorities. Nevertheless when the concentration of power is left to a few to decide, then price signals will be distorted and that lobbying, favouritism, corruption and cronyism will be her common feature.
The Phony War Against The “Cockroaches”
So what has these to do with the current state of the markets?
Alot.
The emergence of proposed regulatory reforms by the Obama administration for Wall Street comes timely with the US SEC-Goldman Sachs brouhaha.
Aside from the noteworthy coincidence[3], the US markets appears to be validating our view by ignoring the impact of the US SEC-Goldman tiff (see figure 1).
Figure 1: Political Act Slowly Unraveling
In contrast to the camp that sees the Goldman controversy as an issue of fraud, by looking at the incentives that drives the actions of political authorities, we have argued otherwise[4].
Besides, it is not within our ambit to comment on juridical merits of any legal case and neither are those who claim that it is about ‘fraud’. Commenting on the legal aspects based on news accounts signifies nothing but “trial by publicity”.
If Goldman had been truly a “cockroach”, then there must be other cockroaches too from which the sudden apostasy of the Obama administration must mean a total “war on cockroaches”.
And true enough, we find that Goldman’s practice hasn’t been isolated but an industry practice especially among the TOO BIG TO FAIL institutions.
According to the New York Times[5], ``Many banks on Wall Street and in Europe were even bigger players in the types of complex investment deals that Goldman is now defending. Merrill Lynch was at the top of the heap, assembling $16.8 billion worth between 2005 and 2008, according to a new report by Credit Suisse.
``UBS put together $15.8 billion worth of similar products, according to the Credit Suisse estimates, while JPMorgan Chase and Citigroup each created more than $9 billion worth. Goldman Sachs was a comparatively small issuer, at $2.2 billion.”
Yet if one looks at the market, except for Goldman Sachs (GS), the SPDR Financial Select Sector (XLF) [where JP Morgan, Citigroup, Merrill and GS is 24.3% of index weighting] and the S&P Bank Index (BIX) has simply shrugged off any “contagion” against a so-called “war on cockroaches”.
Noticeably, the broad based US markets as shown by the S&P 500 (SPX), which includes the Dow Industrials, the Nasdaq and the mid cap Russell 2000 all went to a bullish rampage by breaking to the upside as of Friday’s close.
Oddly too that the so-called aggrieved party in the controversial case was also reported as practicing the same allegedly skulduggery employed by Goldman, this from John Carney[6],
``It was a piece of regulatory arbitrage: In essence, IKB was investing in complex mortgage bonds without having to set aside regulatory capital or report the increase in risky assets to its regulators or auditors.”
``In short order, Rhineland became one of the biggest buyers of the complex investment products puked out by the likes of Lippman at Deutsche Bank, JP Morgan Chase—and Goldman. One banker told Euroweek that IKB—through Rhineland and similar tactics—had become one of the five or six largest investors in Europe. Thus, Goldman found them a willing buyer for the junk piled into Abacus” (underscore mine)
Take note of the word: regulatory arbitrage.(as we will be using this later)
More Dirty Dancing Politics
As the days go by, more and more Goldman-Washington ties are being uncovered.
In contrast to common knowledge that the Democratic Party has been less affiliated with Wall Street, this is turning out to be untrue, according to the Politico, ``The Democratic Party is closer to corporate America — and to Wall Street in particular — than many Democrats would care to admit.” A chart from the New York Times can be seen here.
Moreover, we discovered that there are five former employees of Goldman currently employed in the Obama administration. This perhaps reveals the extent of connection between the two supposed rivals.
In addition, the timing of Friday’s government lawsuit likewise coincided with SEC’s report about its “failure to investigate alleged fraudster R. Allen Stanford”[7]. This may seem like an effort to possibly dampen media’s impact from regulatory failure by exposing a much bigger news. Apparently this succeeded.
And speaking of regulatory competence, one cannot help but guffaw at news reports where 33 SEC employees, including high ranking officials, spent much time during the crisis in porno browsing!
According to the NY Daily News[8], ``The shocking findings include Securities and Exchange Commission senior staffers using government computers to browse for booty and an accountant who tried to access the raunchy sites 16,000 times in one month.”
Perhaps, Madoff, Standford and Goldman people were trying to arbitrage falling markets with “porno” finance-whatever that means. This resonates clearly of the quality of the bureaucratic mindset.
Moreover, there have been pressures for Goldman to amicably settle with the SEC even if “they’re right on the merits of the case”[9].
And surprisingly, President Obama despite earlier reports to verbally assail Wall Street turned up with a conciliatory voice at a recent speech ``Ultimately, there is no dividing line between Main Street and Wall Street,” Obama said in his speech at Cooper Union, about two miles from the financial district. “We will rise or we will fall together as one nation.”[10]
We read a popular American blogger offer a bet against anyone who thinks Goldman will win the suit. Apparently this perspective is looking at the wrong issue.
Goldman can lose a case and still win the war. In the game of chess, this is called sacrifice or even queen sacrifice. Yet in a staged or scripted dispute, like in wrestling, one party’s loss is just a part of drama to fulfil other goals. A real life example of a staged battle is the US-Spanish “Battle of Manila”[11].
History As Guide To Future Actions
Let us put the issue in historical context.
Rightly or wrongly banks and financial institutions have been in the public “hot seat” from nearly time immemorial[12]. But in contrast to having reduced power from financial reforms, the banking system had even acquired more political clout in spite of these. The Federal Reserve was even stealthily hatched amidst scepticism over the banking industry.
Here is G. Edward Griffin’s speech[13], Author of The Creature from Jekyll Island, on the inception of the Federal Reserve (all bold highlights mine),
``Why not? why the secrecy? what's the big deal about a group of bankers getting together in private and talking about banking or even banking legislation. And the answer is provided by Vanderlip [Frank Vanderlip president of the National City Bank of New York] himself in the same article. He said: "If it were to be exposed publicly that our particular group had gotten together and written a banking bill, that bill would have no chance whatever of passage by Congress." Why not? Because the purpose of the bill was to break the grip of the money trust and it was written by the money trust. And had that fact been known at the get-go, we would never have had a Federal Reserve System because as Vanderlip said it would have had no chance of passage at all by Congress. So it was essential to keep that whole thing a secret as it has remained a secret even to this day. Not exactly a secret that you couldn't discover because anybody can go to the library and dig this out, but it is certainly not taught in textbooks. We don't know any of this in the official literature from the Federal Reserve System because that was like asking the fox to build the henhouse and install the security system.
``That was the reason for the secrecy at the meeting. Now we know something very important about the Federal Reserve that we didn't know before, but there's much more to it than that. Consider the composition of this group. Here we had the Morgans, the Rockefellers, Kuhn, Loeb & Company, the Rothschilds and the Warburgs. Anything strange about that mixture? These were competitors. These were the major competitors in the field of investment and banking in those days; these were the giants. Prior to this period they were beating their heads against each other, blood all over the battlefield fighting for dominance in the financial markets of the world. Not only in New York but London, Paris and everywhere. And here they are sitting around a table coming to an agreement of some kind. What's going on here? We need to ask a few questions.
``This is extremely significant because it happened precisely at that point in American history where business was undergoing a major and fundamental change in ideology. Prior to this point, American business had been operating under the principles of private enterprise--free enterprise competition is what made American great, what caused it to surpass all of the other nations of the world. Once we had achieved that pinnacle of performance, however, this was the point in history where the shift was going away from competition toward monopoly. This has been described in many textbooks as the dawning of the era of the cartel and this was what was happening. For the fifteen year period prior to the meeting on Jekyll Island, the very investment groups about which we are speaking were coming together more and more and engaging in joint ventures rather than competing with each other. The meeting on Jekyll Island was merely the culmination of that trend where they came together completely and decided not to compete--they formed a cartel.”
In other words, the trend towards consolidation of the industry via “financial reforms” has empowered more cartelization than less. And today’s proposed financial reform bill will enhance and not reduce such relationship in contrast to opinion of the reform advocates.
John Paulson And The Survivorship Bias
I’d like to show the relevance of hedge fund manager John Paulson’s reputation during the latest boom-bust cycle (see figure 2).
Figure 2: Google Trend/Wall Street Journal: John Paulson’s Popularity
As we have earlier argued, the SEC-Goldman dispute is a fait accompli argument (Wall Street seems to agree[14]).
That’s because Mr. Paulson, among the 12,400 hedge funds as reported by Hedgefund.net during the 3rd quarter of 2007, only shot to fame in early 2008 (left window) after profits in his fund skyrocketed (in mid 2007) which left the field biting his dust (right window).
In most of 2007, John Paulson, like Manny Pacquiao in the early 90s, was relatively an unknown figure (Mr. Paulson has hardly been searched by anyone)! This means that counterparties when appraised of Mr. Paulson’s participation in early 2007 would have simply ignored him as he was just one among the many “mediocre” aspiring hedge fund managers.
This also reveals that many people tend to read and value information based on today’s account and not during the time when the controversial transactions was developed. This cognitive error is known as the survivorship bias, or the ``the logical error of concentrating on the people or things that "survived" some process and ignoring those that didn't[15].”
[1] White, Lawrence Avoiding and Resolving Financial Crises: The Rule of Law or The Rule of Central Bankers?
[2] Wikipedia.org, Proclamation No. 1081
[3] Norris, Floyd, Fortunate Timing Seals a Deal
[4] See Why The US SEC-Goldman Sachs Hoopla Is Likely A Charade
[5] New York Times, Questions for Banks That Put Together Deals
[6] Carney John, Goldman’s Dirty Customers, The Daily Beast
[7] Wall Street Journal, The SEC's Impeccable Timing The Goldman suit helped to hide the IG report on the Stanford debacle.
[8] NY Daily News; While economy crumbled, top financial watchdogs at SEC surfed for porn on Internet: memo
[9] Bloomberg, Goldman Sachs Should Cut Losses in SEC Standoff, Lawyers Say
[10] Bloomberg, Obama Challenges Financial Industry to Join Regulatory Overhaul
[11] Wikipedia.org, The Battle of Manila (1898)
[12]see Quote of the Day on Wall Street: After Nearly A Century, Hardly Any Change
[13] Bigeye.com; A Talk by G. Edward Griffin Author of The Creature from Jekyll Island
[14] See SEC-Goldman Sachs Row: The Rising Populist Tide Against Big Government
[15] Wikipedia.org, survivorship bias
