Wall Street’s New Millennium Transformation from Partner to Predator
The first 13 years of the 21st century was marked by gross financial speculation and mismanagement which resulted in: an unparalleled loss of wealth, drove the Great Recession of 2009, and lead to a severe deterioration in the competitiveness of key American Industries. The question that Americans now face is whether we have learned anything from these events or will this period be regarded by our grandchildren as “the good old days”?
Global Economics Matters
The first decade of the new millennium witnessed the transformation of Wall Street from a partner with American Industry to a nearly omnipotent, parasitic, self-absorbed predator, which showed little concern for investors, our economy, and our country. American corporations and their employees were increasingly viewed as nothing more than the chips in the daily poker game that Wall Street played with the American economy.
The bull market, which took the Dow from 800 in 1982 to over 11,000, peaked during March 2000 in a buying frenzy that catapulted the value of even speculative “penny stocks” into triple digits. Mutual funds reported year-over-year triple digit percentage gains and “To the moon, Baby!” was the sacred mantra of many equity traders.
However, the decade that began with the Dow hitting new highs saw the speculative bubble begin to burst a few months into 2000. The collapse of the equity markets was then followed by Enron’s illegal manipulation of the energy markets which further undermined our economy.
The final, near fatal blow in Wall Street’s assault on our national wealth and stability came via the issuance of collateralized debt obligations (CDOs). The widespread sale of CDOs by such firms as Goldman Sachs, which was simultaneously betting on the decline in the value of these securities, a strategy known as shorting, while marketing these securities as good investments to AIG and many mega banks, teamed with excessive speculation in the housing market to push our economy into the Great Recession of 2009. Standard and Poor’s rating service estimated the total bank losses on CDOs approached $500 billion by 2009. This loss along with the reduction in real estate and equity values resulted in an unprecedented loss of national wealth during the first decade of the new millennium.
I believe the banking institutions are more dangerous to our liberties than standing armies. Thomas Jefferson
Like stacked dominoes collapsing on each other, these events caused many “too-big-to-fail” financial institutions such as AIG and several Mega Banks to falter. Despite the public outcry, most were readily bailed out by Congress via the $700 billion TARP funding bill, billions of which went to Goldman Sachs which bought credit default swaps as insurance against a decline in the credit worthiness of AIG and others who bought Goldman’s questionable CDOs. Some members of the same Congress then fumed and publicly pontificated when the automakers came knocking on their doors for a much smaller “handout” designed to save a larger number of jobs and another key industry.
Beside speculation, two other factors contributing to this fiasco were the dismantling of key legislation aimed at protecting the integrity of our financial system such as the Glass Steagall Act, which separated commercial banking from investment banking and the sheer incompetence and indifference of our regulatory agencies.
During the prior decade, the SEC concentrated on such “market Mavens” as Martha Stewart and Mark Cuban while ignoring repeated warnings as early as 2000 about Bernie Madoff. While Madoff and a few others were sacrificed to quell the angry masses, most of the firms involved were merely hit with fines that while large in magnitude were small compared with the revenues derived from their misdeeds.
TARP pay Czar, Ken Feinberg, scolded 17 banks for handing out $1.6 billion in excess executive pay, but he refused to force the bank executives to return any of the money. Just a handful of individuals have gone to jail and the $550 million fine levied on Goldman Sachs for its role in the CDO market fraud amounted to less than 3% of the firm’s 2010 profits.
Despite these events, the prior decade was “the best of times” for some Wall Street investment bankers and traders.
Despite an FBI warning to Congress in 2004 about mortgage fraud, investment banks such as Goldman Sachs and Morgan Stanley continued to market CDOs, with Goldman’s sales alone reaching a total of $40 billion for 2006 and 2007. Even after the collapse of the CDO market, the top five U.S. commercial banks, including JPMorgan, Chase, Goldman Sachs, and Bank of America, were still actively trading unregulated derivative contracts, similar to CDOs.
Just months after receiving billions in TARP funding, several financial firms reported obscene profits. Devoid of competition from the defunct Lehman Brothers and Bear Stearns, Goldman Sachs and the other “survivors” benefited from the secondary stock offerings they orchestrated for members of the financial industry that were decimated by their investments in real estate and CDOs. Even Niccolo Machiavelli would have blushed!
While holding hat in one hand for TARP funds, the financial industry and their powerful lobbyists then gave $25 million to key members of Congress along with a stern lecture to maintain a hands-off approach to their business.
With over 347,000 mergers, LBOs, and acquisitions made during the first decade of the new millennium, deal making, which often eliminates jobs, also reached unprecedented levels. While only an estimated 30% of these deals actually met the forecasts of the bankers and management that touted them, it still didn’t deter almost $27 trillion, twice the U.S. Economy, in deal related expenditures over the prior decade. Just 10% of that total would pay for health care reform, a doubling of total U.S. R&D expenditures, and employ 10 million Americans for the next 5 years.
Replacing investment, short-term, speculative trading became the god that Wall Street and the Major Exchanges worshipped. Since the mid-1970s, the average daily trading volume on the New York Stock Exchange has swelled by a factor of 25. Any trading scheme or new security that generated volume was deamed a good one, even if it was speculative, predatory, encouraged questionable practices such as naked shorting, or neutered long term investment strategies.
High-frequency computer trading, which has produced two near market meltdowns, now accounts for more than half of the trading volume on a daily basis. Many Wall Street leaders, such as Charles Schwab, founder of Charles Schwab Corporation, believe high frequency trading is gaming the market and one of the primary reasons public investment in stocks has tumbled from 67% in 2002 to 52%.
Hedge funds, which can both buy and short stocks, grew exponentially in popularity and some worked together in wolf packs to systematically drive the share prices of such stalwarts of the American economy as Alcoa, Applied Materials, Bank of America, Citibank, Dell, Ford, General Electric, General Motors, and Motorola all into single digits during the market free fall of 2009.
The public outcry over the financial malfeasance of the prior decade did finally pressure Congress and the regulatory agencies into taking action.
This began when Congress enacted the Dodd-Frank Wall Street “reform bill” in 2010. However, as soon as the ink was dry on the paper, powerful lobbying groups converged on the capital to neuter the legislation. More recent efforts to require banks to sharply raise their capital levels to offset their growing portfolios of high risk investments have made little headway in the Senate. Even the reinstatement of the uptick rule on short sales, which prevented the “gang bang shorting” of stocks by hedge fund trading cartels, never got out of committee.
In a recent briefing, Senator Elizabeth Warren lamented the growing power of Wall Street’s largest banks: “The four largest banks are now 30% larger than they were just five years ago and they continue to engage in dangerous practices”. Warren and John McCain are urging a new Glass-Steagall Act to separate traditional bank activities such as home loans from high risk investment banking business such as trading derivatives like CDOs. Yet, many who support the idea believe the big banks with the aid of their “champions” in Congress will be able to effectively neuter such legislation, even if passed.
Incredibly and at long last, the Securities and Exchange Commission is now considering requiring those who involved in misdeeds to admit guilt in proven cases of financial fraud versus its prior standard practice of just fining the firms without requiring them to even admit guilt.
Despite the financial scandals of the past decade and stepped up prosecution, little has really changed in what Senator McCain so aptly described as the Casino known as Wall Street.
Over the past three years, the Securities and Exchange Commission has filed more insider trading actions than in any prior three year period including successful actions against two hedge fund giants, Galleon and SAC.
The recent financial misdeeds did not just stop at insider trading. Barclays has admitted rigging the Libor, a key interbank lending rate. At least a dozen other banks are now being probed by regulators in the rate rigging scam.
The long waited Facebook IPO was marred by mismanagement and the leak of damaging inside information to select institutional investors just prior to the offering, after which the stock plunged.
Europe’s leading bank, HBSC will pay the largest penalty ever imposed on a bank, $1.9 billion, to settle claims it was involved in money laundering for Mexican drug cartels. Another British bank, Standard Chartered PLC, signed an agreement with New York regulators to pay a $340 million fine to settle a money laundering investigation involving Iran.
Following in Enron’s footsteps, the major investment banks extended their trading “expertise” to other markets such as energy. J.P. Morgan is close to a roughly $410 million settlement of Federal Energy Regulatory Commission (FERC) allegations that the company manipulated energy markets in California and the Midwest. The pact isn’t expected to even result in sanctions, let alone jail time, for the primary traders targeted by the FERC probe.
So while robbing an inner city liquor store or grocery often results in hard time, the biggest inconvenience many Wall Streeters face for massive financial fraud is to have their names mentioned in the news and missing a date or two with their supermodel girlfriends due to legal depositions.
In essence, Wall Street has become nothing more than a wealth transfer machine, taking the equity that companies and its employees work so hard to create and via deceptive and often illegal means transferring this wealth to a select few.
We have met the enemy and they is us. Pogo
The first 13 years of the 21st century was marked by gross financial speculation and mismanagement which resulted in: an unparalleled loss of wealth, drove the Great Recession of 2009, and lead to a severe deterioration in the competitiveness of key American Industries. The question that Americans now face is whether we have learned anything from these events or will this period be regarded by our grandchildren as “the good old days”?
Also see The Late, Great American Middle Class
Those who fail to learn from history are doomed to repeat it—Winston Churchill
Future Highlights…
- The Late, Great American Middle Class
- Rising Interest Rates
About the Author, Mark Miller
a member of Peace
Mark spent 25 years in technology research and management positions at NASA, 3M, Seagate, and Control Data and 13 years as a senior sell side equity Analyst. He was a lead optical design engineer on NASA’s COBE Mission that measured Big Bang Radiation. COBE lead scientists John Mather at NASA Goddard & UC Berkeley’s George Smoot were awarded the Noble Prize in Physics for COBE results.
Mark has published 40 technical articles, holds 7 patents, and received 5 University invites to lecture on technical research. He has been selected 3 times in the Wall Street Journal’s “Best on the Street” annual survey of 2,000 sell side equity Analysts which recognizes performance of their stock picks, #1 in Computer Peripherals recommendations in 2006.
In 2011, Mark was ranked #1 in Thomson/Starmine ratings for stock picks in the Electronic and Electrical Equipment Segment and is currently ranked #1 for stock recommendations in the Computer Peripheral segment.
Equity research recognized in articles by Wall Street Journal, Investors Business Daily, numerous newspapers and Internet blogs.