Finance Is Taking Over and Compromising the Real U.S. Economy
Look around a modern MBA department in any of the top universities around the world.
Since MBA stands for Master of Business Administration, the title implies that the purpose of the related academic program is to teach management. Instead, the overwhelming purpose of MBA programs nowadays is to inculcate finance.
This is a mistake that is killing the U.S. economy.
Finance is to the economy as engineering is to physics. That means it’s one of the various disciplines that apply principles of economics to help society function. And hopefully, to improve society.
Thus, finance is a tool. It’s one of many tools—including management, business, and even certain aspects of psychology—that help us measure economic performance.
But, finance, especially through the worldwide popularity of the MBA, has taken over the very discipline from which it stems.
It’s a phenomenon that has confused the roles that banks and other businesses are supposed to play. And it has contaminated Wall Street with an obsession over quarterly results.
When Something Is Odd in the Markets, It’s Probably Finance
When you notice weird things happening to stocks, things that business logic can’t explain, you can be sure that finance is to blame.
It’s finance that encourages companies to hold back on investments and double down on layoffs. Doing so rewards shareholders. This benefits Wall Street at the expense of Main Street.
Now, understand that finance does not cause any problems by itself. Finance is an essential tool, but it’s supposed to serve the economy. Instead, for some time—especially since the end of the 1980s—finance has enslaved the economy as a whole.
When a tool has taken over the wider project, it’s no longer the tool; it’s the master.
Finance, even the advanced kind that calls itself “financial innovation,” was intended to serve the wider U.S. economy. Rather, the reversal of roles has caused a distortion in the nature of capitalism itself.
Finance Has Hijacked the U.S. Economy
In other words, finance has sabotaged the very engine of economic growth.
Finance now competes against the real economy in the quest for resources. In basic terms, Main Street’s main challenge is not government or taxation; it’s Wall Street.
The problem starts right at the human resources component.
The companies that truly made America great in the 20th century—such as the Boeings, the IBMs, and even the Apples and Microsofts in the 1980s and 1990s—were able to attract the best and the brightest.
Wall Street has changed all this. Today, men and women who would have otherwise made fine engineers, physicists, medical doctors, biologists, managers, and leaders of people—making things and serving people—prefer to work on Wall Street.
And whom do they serve there? Are they looking out for you and their clients, making sure they secure the best possible outcome for your hard-earned savings?
Those who still believe this fairy tale may want to check back on the events of—and even more on the financial creativity that produced—the 2008 financial crisis.
The financial gurus who devised the algorithms that packaged junk-rated loans into high-value derivatives and options were peddling what polite conversationalists describe as “excrement.” And often it comes from a bovine supplier.
Why Are Ponzi Schemes Illegal But Not High-Risk Derivatives?
Thus, with all the scruple of a hyena, many would-be productive members of society thought nothing of using their skills for pure personal profit. They willingly conceived, created, and sold toxic waste—in the form of a financial “product.”
Is there any real difference between Bernie Madoff and the financial engineers who worked on the subprime derivatives assembly line?
The difference might only be that the subprime geniuses applied their talents and skills to a corporate product.
Recognized and fine names from the world of banking lent their approval to these products. And they were sold legally, through channels on the proverbial “up and up.”
More importantly, Madoff operated as an individual. Thus, he and a few members of his family could be taken down. The big banks, on the other hand, are “too big to fail.”
One or two big Wall Street firms did go down; Lehman Brothers and Bear Stearns no longer exist.
Yet, one of the biggest global symbols of the “finance versus real economy” battle, Goldman Sachs Group Inc (NYSE:GS), still enjoys its high pulpit over Wall Street.
Only in 2016 did Goldman Sachs admit it “may” have defrauded investors—like you, perhaps—in the 2008 financial crisis. (Source: “Goldman Sachs Finally Admits it Defrauded Investors During the Financial Crisis,” Fortune, April 11, 2016.)
Synthetic Finance: The Enemy of the Real U.S. Economy
The competition between finance and the real U.S. economy has become fierce. The subprime meltdown was merely the most spectacular failure of a phenomenon that began right around the time of the 2000 tech bubble. But it won’t be the last.
Out-of-control finance is driving the real U.S. economy under. In October 2008, even as the big banks groveled for bailouts from the very government (and taxpayers) they mocked, they never stopped practicing what some call “synthetic finance.”
The irony is that many used the term synthetic finance—or more commonly, synthetic position—to describe what is, in fact, a legal and accepted mechanism.
Mathematical Games and High Risk
A synthetic position or investment involves a blend of financial instruments, often options and other high-risk derivatives and securities.
They are sold to spread or diversify risk, yet they add and involve all kinds of complexities.
Thus, few holders of such investments understand what’s happening. And certainly, you would need the imagination of George Lucas to figure out how the real economy benefits from any of this.
The subprime derivatives at the heart of the 2008 crisis would make the cut for inclusion in the dubious category of synthetic finance.
Officially, the subprime derivatives had a fancy name: collateralized debt obligations (CDOs). They sound cool, even hip.
They were hypothetical mathematical propositions turned into even more hypothetical investment products. They had absolutely no link or attachment to a real economic situation.
The infamous CDOs that blew up in 2007 and 2008 were literally not even bets on how well a mortgage-based security might have performed. That alone would have warranted skepticism.
These derivatives went much further than that in detaching themselves from the real U.S. economy. They were bets on other bets, to put it simply.
More technically, these CDOs would pay off for their holders if a certain set of securities—based on cash assets—would default.
If you thought those days were over, think again. Similar products are back in fashion. (Source: “In a Blast From a Financial Crisis Past, Synthetic CDOs Are Back,” The Wall Street Journal, August 28, 2017.)
And, given the plans to deregulate Wall Street, as President Donald Trump has already started to do, we can expect more such products.
These will infect, or have already infected, Wall Street.
The Senate has already approved legislation that would effectively lift the Dodd-Frank Wall Street Reform and Consumer Protection Act restrictions and the Volcker Rule. The latter was intended to protect all American taxpayers. It prevents banks from making bold bets with federally backed or guaranteed funds.
In short, if you thought Wall Street had already become Las Vegas, you now have full confirmation.
Finance Is a Parasite
Finance has a life that’s independent of the real economy. It bets and counter-bets one financial tool against another, based on mathematical models that have little to do with anything.
In other words, very few Americans benefit. Those who do gain are also on Wall Street. American individuals and businesses, small and large, which still help the country run, get nothing in return.
Finance—detached from obligations to people and businesses—lives, works, and thrives for its own sake.
Those who engage in it have little better than Las Vegas odds to win. The risks are huge. But so are the gains when they come.
The result, as the International Monetary Fund (IMF) has pointed out, is that there’s an imbalance between the purely financial bets, made through synthetic products, and the investments in the real economy. The result is instability.
Bets on Bets
In a fairer world—and not even a utopia, just one with a minimal decency—financial investment and risks would hinge on investment and risks in the real economy. The derivatives and options would be based solely on the performance of related companies and stocks.
Today, they are based on bets over other bets, only slightly linked to the performance of companies.
In practical terms, the dominance of finance in everybody’s lives, whether we like it, has wiped out any gains that ordinary people would have obtained from quantitative easing.
The Federal Reserve has made cheap, low-interest money available for almost a decade. But many of the billions of dollars in interest saved did not help households increase consumption. The gains from high-risk funds even managed to pay much less tax than the paltry ones of the real economy.
It did not help the U.S. economy create real, full-time jobs either. People taking on debt did that.
Rather, the investment banks used the low-interest funds to continue their version of “business as usual.” That’s why ordinary Americans haven’t progressed economically over the past two decades.