“Take the rapid trading by the computer geniuses with the computer algorithms. Those people have all the social utility of a bunch of rats admitted to a granary.” -Charles Munger., Vice Chairman of Berkshire Hathaway
Much has been said and written about the connection between the repeal of Glass-Steagall and the economic crash of 2008, but it is overly simplistic to focus on that one GOP legislative genuflection to their almighty “free market.” Three Republican Senators, Gramm, Leach and Bliley, pushed the repeal through a Congress with GOP control in both houses and, yes, Bill Clinton signed it, but as I have said before on this site, that was only a necessary condition for the housing bubble built on securitized mortgages that brought down the whole economy, not the actual cause.
It was the Bush administration’s wholesale deregulation of the financial industry that in fact caused the crash. It was that across the board “small government” policy of deregulation that in fact allowed Wall Street to crash the economy again, for the second time in an eighty year span, based on nothing but “free market” ideology. After 9/11, Bush had almost all of the FBI’s financial crimes unit reassigned to national security, leaving only a skeleton crew to keep an eye on the scammers in pinstripes, and his tax cuts in 2001 and 2003 led to defunding the SEC and other federal agencies that oversee the financial markets.
Warren Buffet, at a CNBC interview on May 7, 2012, laid it out most succinctly by saying that banking is and should be a profitable business, but here in the U.S. they issue loans guaranteed by the federal government, i.e. the FDIC, and that leads to an extreme laxity of market discipline. The Wall Street banks, in pursuit of profits without regard to anything as humane or patriotic as the general welfare of the American people, will do anything they can get away with to make a quick buck, no matter how risky, because they know they will get bailed out.
Buffet then says, because the federal government backs and insures the banking industry, through the FDIC: “Government has to decide what banks can do –and where the limits are.” Who else can or will set any rational limits on the otherwise unchecked greed of the “free market” capitalist? Some of them, like Buffett, would or would like to exercise some restraint, but that is futile where the bad money in a completely open “free" capitalist market always drives out the good by promising greater returns in the short run.
Thus, the abuses in the financial industry between 2000 and 2008 were both deep and widespread. The repeal of Glass Steagall allowed the big investment banks to get back into the mortgage business, but unlike the traditional commercial banks on Main Street, they did not have to retain ownership of the mortgages for thirty years or so, nor did they intend to do so. Instead, with virtually no regulatory oversight under the Bush administration, they simply kept writing mortgages with good loans, risky loans and really bad loans -it made no difference to them because they were able to bundle and securitize the loans, selling them as an investment “product” called collateralized debt obligations, to the public, colleges, unions, public and private retirement plans as well as individual investors.
They were able to sell many thousands of such mortgage backed CDOs, inevitably creating a housing bubble where the selling price of a house on which a loan was based had far outpaced the actual value. They did this, again, with absolutely no governmental oversight, after they got the ratings agencies like Moody’s and S& P to rubber stamp their shaky CDO’s with AAA ratings. They were able to do that because the banks pay the agencies to rate their financial “products,” so in order to keep the business coming they didn’t need to be told how to rate them.
There were no federal or state regulations to check that blatant conflict of interest at the ratings agencies. There is at least one instance where an analyst became concerned about a CDO he was told to give an AAA rating and actually asked his supervisor if he could review the mortgages in the file. He was told, in substance, “we don’t want to know what’s in there, and that's the way the ratings agencies worked across the board. .
That is how unregulated capitalism always works, whatever the industry and whatever the issue, from product safety, to pollution, to financial fraud. There is no “invisible hand” that guides unregulated capitalism to achieve the greatest possible good, and if you believe in that 19th century metaphor from David Ricardo, you might as well believe in Thomas Nast’s cartoon of Santa Claus coming down from the North Pole with lots of toys for all the good little girls and boys.
Warren Buffet’s colleague, Charles Munger, was asked about what was wrong on today’s underregulated Wall Street, even after Dodd Frank, and he brought up the high volume rapid fire trading in securities based on computer algorithms that follow market trends. In the old days, when Wall Street investment banks actually served a useful social function by providing money for a wide variety of manufacturing and service industries, they employed skilled and experienced analysts who actually looked at the companies’ seeking investment funds, their business plans, their operational costs, their marketing strategies, and investment decisions were made on that basis with the issuance of paper stock certificates.
Today, the high-frequency traders look only at abstract algorithms to make short term investment decisions, to buy, sell, buy, sell, with absolutely no benefit to anyone or anything but the Wall Street investment banks’ short term profits. That kind of investment creates no jobs, produces no useful products and delivers no useful services. That is what Charles Munger means when he says that those traders have as much social utility as rats in a granary. It’s not just the fact that the rats are eating too much of our grain, they also foul what’s left with their droppings.