Wednesday, September 7, 2011


We hear it all the time. Don't interfere with the marketplace. Deregulate. Get the government out of the market. Unfettered competition leads to the best possible outcome for everyone because people rationally pursuing profit will enhance both productivity and quality in the marketplace. Like an "invisible hand" the needs of society would be met. In the end consumers get better products. Producers get more money. Workers earn better wages. Everyone wins.

At least this was the message many believe that Adam Smith, the intellectual godfather of capitalism, told us in The Wealth of Nations (1776). It's this belief system that has fed the free market and deregulation push we've seen over the past 30 years. It's what's pushing us today. Unfortunately, much of what Adam Smith wrote was often misrepresented and taken out of context by many of his followers, including Milton Friedman. It's one of the reasons I wrote The Myth of the Free Market.

To be sure, Adam Smith argued that the state should stay out of the marketplace. But not because market players should be free to do what they wanted. Rather Smith believed that government should stay out of the market because it usually intervened on behalf of monopoly and privilege. Smith's message was that we shouldn't allow market players run herd over the rest of us.

Many of today's market players have no clue about any of this. And it shows. In fact, contrary to popular belief, market players today ignore - or don't recognize - how they have been pushing and benefiting from the very visible hand of government subsidies and supports, which Adam Smith feared would happen. Check it out:

A SERIES OF MARKET BAILOUTS: Talk about a lack of accountability. One of the cornerstones of a competitive market system is the idea that there would be retribution for stupid decision making. You would go bankrupt and/or lose your business. Guess what? Increasingly, for Wall Street's biggest players, it's simply not happening. Anyone who argues otherwise is either clueless or on crack.

Here's a short list of the bailouts Americans have yawned at or supported since Ronald Reagan's "free market" revolution began in 1980:
* Wall Street / Mexico in 1982.
* Continental Illinois in 1984.
* The Discount Window intervention to save floundering banks in the late 1980s.
* Market support after the October 1987 crash.
* The Savings & Loan debacle of 1989-1992.
* Intervention to save the Bank of New England and Citibank.
* The 1994-1995 Wall Street / Mexico rescue.
* The Asian Currency rescue in the late 1990s.
* The Fed-organized LTCM bailout.
Impressive, ain't it? But know one thing. This list is incomplete.

In virtually every case above we were told, in one way or another, by the Chicken Little's of the financial world (and Washington) that bailouts and subsidies were necessary or else "prosperity in our time" could end. Markets would collapse, and middle class Americans would be hurt. So we propped up the stupidity with bailouts, rather than "let the market work." We were saved.

Then 2008 came along. Oops.

Perhaps the greatest guaranteed money flood in human history. It all began when Alan Greenspan became chair of the Federal Reserve (1987-2006). Instead of letting market players pay for their market stupidity, Greenspan made the decision to push money into Wall Street - the Greenspan Put - every time they created a mess of things. And he did it by making money available at a cheap price (and he said he wasn't a Keynesian ...).

Coupled with deregulation, this fed market appetites for bigger and bigger market bets (it didn't matter to Greenspan that the vast majority of trading is not done by humans buying and selling a few hundred shares, but by computers and high frequency traders dealing in ever more complex instruments).

Accountability flies out the door when The House backs your bets in Vegas. So it is with Wall Street (though, to be fair, Vegas doesn't do what Washington does). The Greenspan Put has been continued under Ben Bernanke with QE I, QE II, and what we can expect to be QE III (yes, it's coming).

FAVORABLE LEGISLATION / MARKET INTERVENTIONS: If markets are logical, and market players are rational, why do free marketeers need the very visible hand of government for this ...

You're not smart enough so ... The 401k was created in 1978 by Congress to encourage workers to invest in the market (by allowing employees to defer paying taxes on income they invest). The rules impose strict penalties for early withdrawal (why penalties if market players are rational?). The end result is that by enticing investors with tax breaks our financial markets have been given an artificial boost, which is good for portfolio and wealth managers who get paid based on fees and volume managed. Don't believe me? Check out what's happened to market activity and volume traded since the 401k and other "invisible hand" of the market tools were invented by Congress ...

- The Helmet Laws for brokers ... NYSE circuit breaks, which stop trading, are designed to maintain confidence when markets tank. Then we allow market players to suspend redemption's (not allowing clients to sell their investments) in order to stabilize markets in panic. Both make a travesty of market logic and the code of rationality that we're told dominates the market. It rewards gambling and stupidity by telling brokers "we'll control the panic, even if your incompetence starts it."

- The "socialize the losses" law (deduction) ... If you sell a stock at a loss you can deduct it (as a "capital loss") from your tax bill. Nice.

- The "carry it forward" tax law (deduction) ... Stock losses can be carried forward for tax purposes. Specifically, a banking stock that collapse can be used to offset gains from more successful ventures, or even a portion of your everyday income. So much for taking it on the chin when you make a stupid investment decision.

There are many more of these legislative and political gifts. The point is that it's hard to argue that the millionaire wunderkinds on Wall Street are rugged individualists going it alone in a jungle-like market environment when we look at all the government created, and taxpayer funded, market supports that are out there.

In fact, in many ways Wall Street has become a walled off, protected, ward of the state.

Still, today there are plenty of market players who are dumb and arrogant enough to believe they're actually market gurus, slaying market dragons. In reality, monkeys picking stocks randomly could have made money in this state subsidized market environment (and they have the tests to prove it).

At the end of the day, Wall Street and their financial mandarins are the beneficiaries of a massive legislative and regulatory group hug given by Washington over the past 25-30 years.

Get government off my back? What a joke. Worse, market players don't even know it.

- Mark

UPDATE: Here's an excellent article (9/26/11) explaining ETFs, or exchange-traded funds. It's written by Money Mornings Shah Gilani. ETFs are complex derivative products, which fit into the "complex instruments" noted above.

1 comment:

Me said...

Start with a book.... Upton Sinclair I believe? The Jungle