What's Really Bankrupt
The Wall Street Model: Unintelligent Design
By PAM MARTENS
21/09/08 "Counterpunch" -- Wall Street is collapsing not because
of bad mortgage debt or lack of capital or over-leverage. Those
are merely symptoms. Wall Street is collapsing because it
deserves to collapse; it needs to collapse in order for America
to survive. The economist Joseph Schumpeter called it creative
destruction, a system where outdated models collapse to make
room for new innovation.
Wall Street of the past decade never really had a business model
as much as it had a business creed: greed is good; leveraged
greed is even better.
The fact that Wall Street is collapsing is a given. How it
survived as long as it did under its corrupted model is the
question that will be debated in history books for the next
generation.
For example, imagine a business model that bases remuneration to
brokers on how much money they make for their Wall Street
employer and not one dime for how well their customers’
portfolios perform. A Wall Street broker receives remuneration
that rises from approximately 30 to 50 per cent of the gross
commission based on their cumulative trading commissions with
zero regard to how well the clients’ accounts have done. There
is no acknowledged internal mechanism in any of the major Wall
Street firms to gauge the overall success of the accounts the
broker is managing.
The industry has been irreconcilably incentivized to corruption
just as brokers have been socialized to silence. The reason we
are seeing a stampede this week into U.S. Treasury securities is
that much of this money belonged there in the first place, not
in esoteric mortgage backed securities, junk bonds, commodity
funds or annuities backed by AIG. Brokers put their clients
“safe money” in these unsuitable investments because their Wall
Street employer dangled a seductive financial inducement. A
broker receives less than $1,000 in gross commissions (“gross”
meaning before their firm takes their 50 to 70 per cent cut) on
$100,000 of longer dated Treasuries. Putting that same $100,000
in a junk bond or mortgage-backed security or annuity could
generate $3,000 or more. In other words, the financial incentive
has created an artificial demand. And, as must inevitably
happen, the true state of that demand is just now catching up
with the true glut of supply.
What would be the incentive for Wall Street firms to offer
higher commissions for some products over others? Because on top
of their cut of the brokers commissions, they receive
origination and syndication fees for the more esoteric
investment products. These firms so despised the low-paying
Treasuries that they replaced Treasuries with Freddie Mac and
Fannie Mae paper in mutual funds bearing the name “U.S.
Government Fund.” (This misleading practice and the fact that
billions of dollars of public money resided in these misnamed
funds has certainly played a role in the government’s decision
to nationalize Freddie Mac and Fannie Mae.)
Then there is the insane model of bringing flim-flam new
businesses to market. If we look at the people who are at the
helm of today’s collapsing Wall Street, they have shifted in
their chairs, but they are mostly the same conflicted
individuals who brought America the NASDAQ bust that began in
March 2000 and evaporated $7 trillion of American wealth. There
is no longer any incentive on Wall Street to bring about initial
public offerings of only companies that will stand the test of
time and create new jobs and new markets to make America strong
and globally competitive. There is only an incentive to collect
the underwriting fee and cash out quickly on private equity
stakes.
Next is the corrupted model of housing a trading desk for the
firm inside the same company that is supposed to issue unbiased
research to the public. For example, let’s say that XYZ
Brokerage buys a big stake in ABC Company on its proprietary
trading desk (the desk that trades for profits for the firm) on
Wednesday afternoon. On Thursday afternoon, it could almost
guarantee profits for itself by issuing a research report
upgrading the stock. Conversely, it could short the stock on
Wednesday and issue a negative report to drive down the price on
Thursday, also guaranteeing itself a profit. Other than a
fictional Chinese Wall, there is absolutely nothing to stop this
type of public looting.
Now, ask yourself this. With the multitude of other ways that
Wall Street has to make money, why are they allowed to have
their own trading desk while simultaneously issuing conflicted
research to the public. After the NASDAQ scandals that revealed
Wall Street issuing biased research for personal profit, why
weren’t proprietary trading desks and public research issuance
shut down at these firms. There are plenty of boutique research
firms to fill the void. The only conclusion to be drawn is what
Europe is calling “regulatory capture” here in the U.S. That’s a
phrase similar to what Nancy Pelosi was calling “crony
capitalism” on Wednesday, September 17 before she decided to
join the crony capitalists at a microphone on Thursday,
September 18 to promise bipartisanship on the mother of all
bailouts to Wall Street.
This unintelligent design business model would have cracked and
imploded long ago but for one saving grace: it came with its own
unintelligent design justice system called mandatory
arbitration. Gloria Steinem once called mandatory arbitration “McJustice.”
It’s really more like Burger King; Wall Street can have it their
way. In a system designed by Wall Street’s own attorneys,
arbitrators do not have to follow the law, or legal precedent,
or write a reasoned decision, or pull arbitrators from a large
unbiased pool as is done in jury selection. Industry insiders
routinely serve over and over again. Had there been ongoing
trials in open, public courtrooms, the magnitude of the
leverage, worthless securities, and corrupted business model
would have been exposed before it brought America to the
financial brink.
That Wall Street and its Washington coterie are stilled embraced
in regulatory capture and unintelligent design is most keenly
evidenced by the recent merger of Merrill Lynch, the
brokerage/investment firm, with Bank of America, the commercial
bank and ongoing discussions to merge Morgan Stanley, the
brokerage/investment firm with a commercial bank. (Memo to Enemy
Combatants Against Taxpayers a/k/a Wall Street/Washington: this
new model is the failed model of Citigroup. Why do you hate
America?)
Make no mistake that what ever the dollar amount announced next
week to funnel into an entity to buy bad debts from banks and
Wall Street firms, it won’t be enough. It’s a Band-Aid on a
malignant tumor. That tumor is Credit Default Swaps (CDS) with
over $60 trillion now owed through secret contracts in an
unregulated market created, financed and owned by the
unintelligent design masters, Wall Street firms themselves. (See
“How Wall Street Blew Itself Up,” CounterPunch, January 21,
2008.)
There is no sincere plan by this administration to help America
or Americans. There is only a plan to slow the financial
collapse until after the November elections by throwing a
politically palatable amount of money at it and a plan to
continue to blame it on a housing bust.
If we, the American people, allow this to happen, we’re enablers
to the unintelligent design model. Before one more penny of our
taxes are spent on this ruse, we must demand a seat at the table
(I think Ralph Nader should occupy that seat) to discuss
breaking up Wall Street, crushing this model, innovating a
sensible model that serves the individual investor and deserving
businesses, and promises our children a future of more than a
banana republic.
Pam Martens worked on Wall Street for 21 years; she has no
securities position, long or short, in any company mentioned in
this article. She writes on public interest issues from New
Hampshire. She can be reached at
pamk741@aol.com Click on
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