What’s Wrong with the World

It seems that one of the chief problems with the securities markets lies in the explosion of types of securities. It would be one thing if there were a relatively untrammeled market in publicly listed stock: that's a simple commodity and folks generally understand what it represents and what owning it entails. Also, it's valued in a relatively straightforward way: profit per share. A company might lie about its profits, but it's harder to obfuscate the entire system.

But the same can't be said about more innovative securities. Nobody understands what default swaps, mortgage-backed securities, and such things really are. What do I actually own when I buy such a thing? The answer, if it is to have any content at all, must call upon a rather shocking sophistry. Furthermore, the trade in these instruments appears to create the illusion of wealth (a problem discussed here before) out of nothing.

I think a lot could be done by simply prohibiting the public purchase and sale of securities that reflect any interest other than ownership in a corporation. Combined with the long-extant fraud provisions of the Securities and Exchange Acts, that might suffice. And boy would it throw the system for a loop.

I might add that the private market in securities is an entirely different animal, one frequently marked by poor decisions, misfortune, and unscrupulous practices. But I don't see the private market as having been a key element in your point.

In general the desire to stack ever more layers of agency costs upon my desire to buy 100 shares of Costco, sell 100 shares of Wal-Mart, or trade in and out of preferred-like junior unsecured AIG debentures, reflects either mere anticapitalist animus or a vague sense that Something Must Be Done about something, because, well, um. Because the securities business, unlike other commercial endeavors, relies upon contract law? Because securities, at their root, are deviously complex and inherently require vast server farms and herds of math PhDs crowded into Midtown?

But this- reason 1- is simply not the case. There are still small companies that raise capital by going door to door, selling shares of capital stock in a business. There are still companies that are so small or so closely held that their shares trade "by appointment". There is no need for computers or regulators, and the agency costs that are charged upon such transactions feed not the beast of Wall Street but the growing regime of, apparently, regulation for regulation's sake, regulation so it'll look like Something Is Being Done.

The latter parts of Point 1, along with Pts 2 & 3, are a complaint about Bigness and its corollary, over-interconnectedness. I am not unsympathetic to the idea that we would be better off if we were a nation of shopkeepers, who still made a lot of the stuff we need for everyday living. But singling out "securities" misses the target, and "heaping on more regulations" is the wrong ammo. (I would look in the direction of shifting the regulatory regime away from "pro-bigness" (Under GOP or Dem supervision, the recently-reconstituted AT&T is almost certain to receive permission to buy t-Mobile under the pretext of increasing competition with the highly unlikely promise that there will be hirings rather than firings) to shrinkage. Perhaps, for instance, roll back the interstate banking regulations that allowed North Carolina National Bank to fatten up beyond morbid obesity into Bank of America's Too Big To Failness.)

At bottom this is just another manifestation of the old paradox, "quis custodet ipso custodes?" [who watches the watchers?].

Classically Group A and Group B watch each other for their mutual protection. But sooner or later Group A gets tired of constant vigilance and hires Group C to watch Group B on their behalf. This promptly makes Group C vulnerable to corruption from Group B, and thus the downward spiral begins.

I confess that humans being fallible and finite, I see no way to ever prevent this cycle, only to ride it out.

Paul, do you have a link to an article that talks in layman's language about investment banks and what it would mean to "force them into private ownership"? How would that goal and the means necessary to it intersect with David Brandt's very interesting comment, above?

Paul, do you have a link to an article that talks in layman's language about investment banks and what it would mean to "force them into private ownership"?

I assume he means that investment banks would be owned by a relatively small number of partners in the firm who would personally have lots of skin in the game and thus allegedly be more prudent and long-term oriented in their risk taking. See, for example, this article:

http://dealbook.nytimes.com/2008/08/20/a-partnership-solution-for-investment-banks/

Lydia, here's an excellent (and admirably accessible to laymen) article by Amar Bhide. The whole thing rewards a careful read, but here's a passage on public vs. private ownership:

After 1979 IPOs increased from about 140 to nearly 600 per year, a process culminating in the Internet bubble, when companies with no profits and tiny revenues famously went public. But it wasn’t just dotcoms. Investment banks such as Salomon Brothers, Morgan Stanley and Goldman Sachs that had flourished as private partnerships also secured listings. After centuries of having to worry about their own capital, bankers were free to play ‘heads we win, tails public stockholders lose.’ That became an important source of our current problems.

Here is another relevant passage:

Banks’ CEOs were not on top of things either. Freed of both stockholder and depositor restraints, banks (and their financial next of kin) became sprawling ‘Too Complex to Manage’ enterprises whose balance sheets and trading books were but wishful guesses. CEOs famously frolicked on golf courses and at bridge tournaments while their businesses imploded because they didn’t know any better. Moreover, turning a blind eye to reckless bets was not a bad policy for executives with limited personal downside. CEO Richard Fuld’s Lehman stock may now be worthless — but he gets to keep the $500 million he took out in previous years. Sandy Weil has laughed all the way away from Citibank, which he turned into a hodgepodge of investment banking, trading, retail brokerage, commercial banking and insurance. Hank Paulson sold $500 million of Goldman’s stock — at twice its current price, and without paying capital gains taxes — when he become treasury secretary in 2006. His predecessor at Goldman and Treasury, Robert Rubin, received $115 million according to the Wall Street Journal for providing direction and counsel at Citigroup while its stock lost 70 percent of its value.

This sort of recklessness is much harder to imagine in the old world of private investment banks, where all the capital being risked is held by partners with an immediate and undiluted interest in keeping an eye on things. (A good book to read to get a feel for the old system is Ron Chernow's House of Morgan.)

I assume he means that investment banks would be owned by a relatively small number of partners in the firm who would personally have lots of skin in the game and thus allegedly be more prudent and long-term oriented in their risk taking.

I would imagine that such a system would have the advantage of making it politically impossible to sponsor a bailout because it would literally be a redistribution of wealth from the public to (previously) rich people rather than a corporation.

I would imagine that such a system would have the advantage of making it politically impossible to sponsor a bailout because it would literally be a redistribution of wealth from the public to (previously) rich people rather than a corporation.

As the article I cited mentions, Drexel is a counterexample to the virtues of the private partnership structure. I would add that hedge funds like Long-Term Capital Management, while not necessarily private partnerships but whose investors are very well-heeled, are a counterexample to your claim that it would make it politically impossible to bail out a group of rich people. LTCM became too important a player to be allowed to fail.

Drexel is a counterexample to the virtues of the private partnership structure

Could you say a bit more about that?

Also, how would it even be possible to _force_ these things into private partnerships? What would that involve?

And what did the article you linked, Perseus, mean by saying that private partnerships are a "thing of the past," or something of that sort, as if it would be impossible to recreate them? (Perhaps this is actually true, though.)

David, could you expand upon what would be involved in this?

Perhaps, for instance, roll back the interstate banking regulations that allowed North Carolina National Bank to fatten up beyond morbid obesity into Bank of America's Too Big To Failness.

As Perseus well knows, LTCM was hardly bailed out as we have come to know bailouts. The banks saw their doom and were corralled into collective action by interest and cajolery from the government, but taxpayer capital was never staked. That's an important distinction. Moreover, LTCM was hardly spared the discipline of the market. Lots of those hotshots lost their shirts no less than their reputations. They picked up a lot of dimes, but the steamroller finally caught up to them. Nor is that all: the trades undertaken by Long-Term were admittedly very complex and arcane, but that was child's play compared to the computer-powered high-frequency wizardry of today, which so far from merely abstracting has fully disengaged the human element.

In any case, no commenter should take me as presenting private partnerships as some kind of perfect panacea. I possess no idealism about the old partnership. My primary motivation for recommending the policy is the firm belief that they do less harm than sprawling unaccountable public behemoths.

Lydia, the context of that article indicates strongly that the "thing of the past" remark concerns investment banks in particular. The last of those to go public was Goldman in 1999. There is, of course, still a huge proliferation of private investment firms with varying specialties. But the big ancient i-banks (those that haven't been swallowed up into other finance institutions) are all public corporations.

As for how this policy would be accomplished, I suppose it would entail a combination of carrots and sticks and would be characterized by a gradual repurchase or extinction of public shares. This process itself might have, alas, some of the apparent features of a bailout, since it would almost certainly require central bank and regulator cooperation.

Could you say a bit more about that?
Also, how would it even be possible to _force_ these things into private partnerships? What would that involve?
And what did the article you linked, Perseus, mean by saying that private partnerships are a "thing of the past," or something of that sort, as if it would be impossible to recreate them? (Perhaps this is actually true, though.)

Drexel's partnership structure facilitated control of the firm by a small group (principally Milken and Joseph) prone to legally dubious shenanigans and too dependent on speculative-grade ("junk") bonds. Partnerships are largely a thing of the past because they don't allow investment banks to increase their scale and management flexibility in the way that going public does.

The banks saw their doom and were corralled into collective action by interest and cajolery from the government, but taxpayer capital was never staked.

Not in the direct, TARP-like sense, but the FRBNY organized the bailout and the Federal Reserve lowered interest rates in direct response to the turmoil created, which is an indirect subsidy:

Although organizationally, the Federal Reserve’s roles are managed separately, all three functions responded to the LTCM problem or the related market turmoil. ...Further, in its role as a monetary policymaker, the Federal Reserve Board lowered interest rates at the end of September and again in October 1998 to help stabilize turbulent financial markets. ...Some industry officials said that FRBNY’s involvement in the rescue, however benign, would encourage large financial institutions to assume more risk, in the belief that the Federal Reserve would intervene on their behalf. [which is what the Fed ended up doing in 2008]

http://www.gao.gov/archive/2000/gg00067r.pdf

I'm well aware of the importance of the Long-Term crisis. I reckon it an indispensable step on the road from commercial republic to plutocracy. But the term "bailout" sometimes wants for the nuance necessary to examine all these matters properly.

Lack of nuance would seem to explain the misleading title. It is not "securities" that are different, but Wall Street's bankers, hedge funds, TBTF's socialization of losses.

Well, this problem is slowly being fixed by heavy-handed regulation, legislative finger-pointing, and general demonization. Goldman Sachs, its stock limping along at barely tangible book value, will need to get out from under its current commercial-bank charter in order to pay huge amounts to up-and-comers, stock options in a flat-to-down stock failing as incentive compensation; it will need to go private to speed the process of no longer being Hate Object du Jour- also less attractive to potential employees; and it would probably need little more than a large loan + equity stake from Warren Buffett to retire the stock currently in public hands.

Meanwhile, capital raising activities are very slow here. Groupon, a way for a poorer nation to clip coupons collectively, is the hot IPO of the day. Meanwhile, companies that make 'stuff' are going public not here in the US, but in London, Singapore, Toronto. Fewer companies seeking to raise capital = reduced demand for investment bankers in America.

At the same time, American companies not only are 'offshoring' their manufacturing, they're also offshoring themselves- GPS maker Garmin began in Kansas but is now Swiss, manufacturer Cooper Industries is now an Irish company, oil-industry companies like Ensco and Transocean are redomesticating to the UK and Switzerland, and so on. Capital- and capital's labor- goes where it's wanted. And, of course, as these companies seek capital to grow, they'll rely on commercial and investment bankers who are in other places than Wall Street, or America.

Question: will driving capital away from America return us to the days of Jimmy Stewart's building & loan in Bedford Falls, with Sheriff Andy, Opie and Aunt Bea around the corner?

(My bet is that in that direction lies what South African wags call ZimBobwe, sclerokleptocracy with wealth at the innermost-crony level, populist entitlement rhetoric, and the Little Red Hens mostly killed off or long since fled elsewhere.)

As for how this policy would be accomplished, I suppose it would entail a combination of carrots and sticks and would be characterized by a gradual repurchase or extinction of public shares. This process itself might have, alas, some of the apparent features of a bailout, since it would almost certainly require central bank and regulator cooperation.

Hmmm. So, engage *on purpose* in a process *now* which "has some of the apparent features of a bailout" presumably as a protective measure to try to prevent future, bigger bailouts?

I'm afraid that idea is not floating my boat.

It would be better to stop thinking of bailouts as some sort of law-like, automatic response to crisis generated by risky behavior. If we're going to get creative, why can't we get creative in finding ways to stop government from engaging in bailouts? Instead, we take bailouts as a given and get creative trying to find some ways to legislate against financiers' engaging in risky behavior.

I've probably said this before; I've certainly often thought it. What this whole approach to finance repeatedly reminds me of is a certain approach to health care. It goes like this: Accept as a given, set in stone in secula seculorum, that the government is going to be paying for some ginormous amount of American health care as a third-party payer. (Perhaps even _increase_ the extent to which this is going on.) Then, recognizing that this system is leading to rising costs, try to control the costs by direct rationing and top-down legislation, price-capping, etc.

Which also, by the way, doesn't work and just results in lots of other badness. I don't know enough about the finance side of the comparison to know in detail how it won't work and what other badness it will result in, though I appreciate David Brandt's remarks on the subject, which sound sensible to me. All on my own, I'd be guessing it won't, and it will.

Securities merit (from statesmen, we find out) "more careful scrutiny by regulation than other classes of trade or commerce", like ???

Slim Jims and licorice whips? Insurance? CDSs? futures? options? How about bonds, a market at least about 10 (20 maybe?) times the size of securities'? I mean sure, if the taxpayer will backstop all losses that threaten societal cohesion (or lower GDP), then, yeah, the statesmen who purport to act in his interest very well might need to lend careful scrutiny. Of course, smart money men will always and everywhere try to outfox the (usually less) smart g-men, in what already is and will ever be a never-ending game of cat and mouse. But wouldn't removing the taxpayer backstop would seem to nip the problem in the bud? Too big to fail would not merely be an impossibility, but an oxymoron.

But why securities merit greater scrutiny than, say, bonds, upon which a far greater amount of future expenditures (stored "wealth") depend, I'm not really clear on. Publicly traded companies are, in general, already quite transparent with their balance sheets and operations. Investor guidance is common, and most companies over the past few years in most quarters "beat the street" estimates.

I'm puzzled by Steve Nicoloso's comment. Surely bonds are a class of security, as are CDS, futures and options. Indeed, I far more interested in the importance, complexity and sophistication of debt securities than I am that of equity.

I'm puzzled by the picking of nits by someone whose misunderstandings are nearly as elementary. Buying a car is not regulated by the SEC, or Dodd-Frank, or the Volker Rule, yet it too is "supremely dependent on both an intricate structure of property and contract law and a stupendous architecture of technological sophistication". Why, horseless carriages are plumb fraught with technological doohickies to-day, yet car salesmen and car warranties are as oily and slippery as ever.

(Somebody Should Do Something.)

I must have profound insight into calculus, probabilistic modeling, and computer science to successfully buy a car? Wow, who knew. No wonder mine are old clunkers.

And I must have also missed the flood of MIT and Ivy League math excellence into the used car salesman business, to oil up those contracts.

Meanwhile, introducing "Jimmy Stewart's building & loan in Bedford Falls, with Sheriff Andy, Opie and Aunt Bea around the corner" with a sneer -- yes, what a blow for clarity the tiresome caricature is. What remarkable and penetrating objections you have raised, Mr. Brandt.

Aside from his sarcasm, I thought this comment of D.B.'s relevant and to the point:

Capital- and capital's labor- goes where it's wanted. And, of course, as these companies seek capital to grow, they'll rely on commercial and investment bankers who are in other places than Wall Street, or America.

There is a cost to these things. No solutions, only trade-offs and compromises, in the immortal words of Thomas Sowell.

Steve Nicoloso makes the point I have been making all along:

But wouldn't removing the taxpayer backstop would seem to nip the problem in the bud? Too big to fail would not merely be an impossibility, but an oxymoron.

Precisely. We _were_ talking about preventing future bailouts and even encouraging a sense of responsibility by way of real-world consequences, weren't we?

But, although I often start these conversations with the impression that that's what we're talking about, I don't usually end with that impression.

The thing is, Paul, I get a sense that if someone were to propose, say, a no bailouts Constitutional amendment (!), and if it had a snowball's chance of passing, you would be alarmed and wouldn't support it. So despite the fact that some of the motivation for your policy proposals is preventing _some_ bailouts and bailout-like government activities, others you favor and even want done pro-actively as a matter of policy! The picture I get of this is of government as the driver of a car with hands on the wheel, constantly making hand adjustments to the direction of the wheel. Government micromanaging, in other words.

Generally, my strong instinct is to think that such an approach will _not_ be a good idea, economically. That is, the (usually up-front) costs seem likely to outweigh the hoped-for benefits, even if those materialize, which they may well not.

Your propensity for seeing sneers, Mr Cella, is as overwrought as your dandified railings against something that you don't seem to understand enough to write clearly about. Thus your misadvertence to "the securities business", your curious insistence that contract law applies particularly to the misunderstood-thus-demonized securities, but negligibly to other, less magical commerce. Your vague wave at solutions- carrots, sticks, whatever- further indicates that you haven't got a handle on your subject. The purpose of my well-intended comments is not to sneer, except at your own sneerings, but to point an apparently undocile mind toward fewer misunderstandings of the material you apparently intended to expatiate upon.

I would be delighted to live in an America more like Mt Airy or Bedford Falls. I don't think OWS-style railing against the fact of a Goldman Sachs is particularly helpful in getting there, or anywhere other than contemporary Athens or Harare. I think that writers who are out of their depth should seek to learn from non-attaboy comments, or straightforwardly delete any which indicate that authorial expertise may be a little bit overblown in this case. Have a nice day.

Wow. This surprises me, as you, Paul, will understand. Doing a little googling, I found the following fascinating quotation, which seems pertinent to this post. It was published on-line in June of 2009. I cannot help wondering if the author has changed his mind or if his very interesting post does not mean what one would take it at face value to mean. I wonder if you have seen this quotation before, Paul. Here it is (emphasis added):

Another burden on private capital will come from the administration’s efforts to rein in the financial sector, to prevent the emergence of unhedged “systemic risk” of the kind that caused the financial collapse. To a large extent, though, such regulation is unnecessary, because global investors have already self-regulated. In the 2008 crisis, more private wealth was palpably destroyed for ultimately mysterious reasons than at any time outside of war in human history. The degree of leverage and the reliance on incomprehensible derivatives will strike future investors as terrifying anomalies from which to flee, not safe havens for easy profit toward which to flock. As a result, we now run a great risk of over-regulating finance and industry, in a classic case of closing the barn door after the horse has fled the stable.

The article is entitled "Wealth Creation Under Attack." The author is...

Francis Cianfrocca.

Lydia, the kind of no-bailouts principle you favor would necessarily entail a repeal of the Federal Reserve Act. As far as I can tell you are opposed to the policy of having a central bank as a lender of last resort, while I am not opposed it, and in fact think it is sound policy. That's always been a difference between us.

Also, as usual my own arguments should not be conflated with the unspecified and often unthinking agitation for massive regulation that Francis was reacting to. You'll find no endorsement of Dodd-Frank in my writings on the subject. I've written repeatedly of my deep suspicion of "comprehensive" legislation -- in immigration, health care or financial regulation.

At various times I have articulated specific reform proposals of my own -- the two most prominent being a restoration of something like Glass-Steagall (the firm separation of commercial and investment banking so that, among other benefits, federally-insured deposits cannot become the capital base for exotic securities trading) and the restoration of private partnerships as the dominant model for investment banking. I believe I expressed some tentative sympathy along the way for the so-called Volcker Rule, which IIRC was concerned with reining in proprietary trading. I believe I also endorsed the establishment of a clearinghouse or exchange for derivatives trading.

For Mr. Brandt's sake I'm going to presume mere ignorance and not stupidity has induced him to suppose that this post comprises the whole of my writing on the subject. The same ignorance is evident in the assumption that all I expect when writing on finance capitalism is "attaboy comments." The most cursory exposure to the three years of discussions here at W4 on these subjects would instantly show a very robust debate indeed, with the attaboy comments few and far between.

And silly me for thinking that the status of a used car sale in contract and property law is admirably clear, while the status of a synthetic collateralized debt obligation (i.e., a massive tranched security composed of revenue streams from CDS contracts) is anything but clear. And lest this "curious insistence" on the problems of contract law be thought too abstract and impractical, let's all keep in mind that it was precisely these sorts of synthetic securities, and all the brittle architecture surrounding them, that brought down AIG and sped along the vast socialization of private obligations in September of 2008.

I have never once asserted a claim of expertise. I've always advertised my status as a layman. I've always advertised my dependence on the expertise of others with more direct experience, and where possible highlighted my sources. In this very thread I linked to an essay by Amar Bhide; would Mr. Brandt like to show us where he went wrong in his critique of exotic securities trading? The charitable reader may even suppose that nothing I've ever proposed here was not vetted beforehand in private conversation with friends whose knowledge exceeds my own considerably. Perhaps if Mr. Brandt could point to specific misunderstandings and misadvertences, a fruitful discussion might ensue.

Paul, I'm sorry, but unless I'm just totally misunderstanding Francis's 2009 post (and perhaps I am, though it seems admirably clear), it's definitely going in a different direction from what we _repeatedly_ read by you on the subject, which is--I'm sorry, but this is just true--calls for more regulation of the financial sector. The main post here is just one case in point. Francis doesn't say, "Except for putting Glass-Steagall back in place, using a system of sticks and carrots to force investment banks back into private ownership, and enacting the Volcker rule, additional regulation of the financial sector to prevent systemic risk is unnecessary, because global investors have already self-regulated." That would, admit it, sound kind of weird. After all, these aren't (especially in conjunction) exactly tiny little things, and blaming the repeal of Glass-Steagall for the crisis and calling for its restoration has been absolutely a _hallmark_ of the entire school of thought that any ordinary layman would take his post to be criticizing!

Now, since you and Francis are close, and since he has been such a strong influence on your thinking in this area, it's entirely possible that you will be able to say with authority that he _does_ endorse, and has all along, all these regulatory additions that you endorse. In which case, I can only say that the conjunction of all of this is just another thing that helps explain why I find nailing down your position (not to mention his) so frustrating. It's not as though that 2009 piece sounds ambiguous. And in _Commentary_, no less.

Nor is that the only quotation I could have brought from the article. It reads almost like a free market manifesto. I nearly found myself cheering at its clear statements about keeping the government away from the people trying to create wealth.

An example of how confusing this gets: When I google Dodd-Frank and W4's URL, I do indeed, Paul, find you at least criticizing (in response to commentator Al) the idea that Dodd-Frank is a panacea. One might gather from those comments that you oppose it.

However, as you say, you expressed sympathy for the Volcker rule and say,

The banking lobby's reaction to some of Volcker's proprietary trading rules was evidence enough (in my judgment) of the corruption that confuses "free enterprise" with "usurious banking."

But when I, as a layman, googled "Volcker rule" I learned that, in fact, one version of it was _part_ of Dodd-Frank!

How's that for confusing? I suppose your response will be that you oppose some parts of Dodd-Frank and supported others, but the Volcker rule part of it was evidently one of the controversial ones, as seen in this link (which I posted in the earlier thread)--a link to an article which, to me (and as I commented then), doesn't sound "shrill" at all but merely like a reasonable side to a reasonable disagreement.

http://cei.org/op-eds-articles/repeal-dodd-frank%E2%80%99s-senseless-volcker-rule

And just before my above quotation from your comment on the Volcker rule, we find:

Granted those two reforms -- (1) that securities trading cannot be linked to commercial, that is, insured, banking; and (2) that investment banking must be returned to the old game of private partners' testing their money in the securities trade -- and I think great strides could be made. But I don't think it would be accomplished without extraordinarily shrill and sustained cries from the apologists for finance.

In other words, these are big deals, not little deals, and those "apologists for finance" would hate them.

Who could read that _Commentary_ article without thinking that, just maybe, he was reading an "apologist for finance"?

But, again, I'm willing to believe that that isn't what the article means about Cianfrocca. In that case, however, I'm as at sea as ever about where you guys are really coming from.

Here's Cianfrocca in 2010 on finance:

There’s got to be something important about the fact that, at least pre-crisis, the financial industry generated about 20% of the revenues of the S&P 500, but about 40% of its earnings. This industry is making way too much money. It’s like a parasitic tax, and I mean that literally. Just like government taxes, the finance tax puts you on the wrong side of the compound-interest equation, so you’re making less economic progress as time passes than you should.

Here he is from August of this year:

To my mind the public stock markets are not the real stock market. The real market is [private equity]. The public markets are where private investors go to dump their garbage after they’ve sucked the juice out of it. To a great extent, we don’t build great companies with public funding anymore in America. Certainly not like we once did. I think that’s an awful shame.

And if you’re an investor in the public stock markets, well, I feel for you.

I think that on net, the financial industry today is parasitic to the real economy, and I’ve felt that way for quite a lot of years. Nearly all the years I’ve been involved in finance, actually. If you know anything about the microstructure of derivatives markets (and maybe you do), you’re probably as disgusted as I am. And they’ve gotten measurably worse just in the past two years.

I think that investment firms need to be restructured such that the primary stakeholders (be they partners, MDs or shareholders) must be fully exposed to the downside as well as the upside.

I believe that the government can and MUST impose much stricter capital requirements on banks. In this, I’m in full agreement with the recent Tarullo proposals. If anything they don’t far enough. Certainly Basel III doesn’t go far enough. And the “con-cons” that people like Credit Suisse are talking about are too geeky to work right in a crisis, when you need them.

I think part of your confusion, Lydia, could be alleviated by recognizing a distinction between free enterprise and finance capitalism. This distinction is precisely the one I'm trying to highlight with my emphasis on the uniquely problematic character of modern securities markets. "The financial industry today is parasitic to the real economy": if this is true, it follows that the defender of free markets actually finds not a friend but an enemy in the financial industry.

Except, Paul, that 2009 article, at least the portion I quoted, is _about_ the financial industry and is _about_ the un-wisdom of trying to rein it in (thus, to mix metaphors, merely shutting the barn door after the horse has gotten out) by additional regulations.

And there's this (at the end--a rousing finish):

More generally, the United States under Barack Obama may be taking a hatchet to a pillar of the American social contract, which is that Americans should be free of encumbrance in their pursuit of private wealth. The pursuit of prosperity made America the most prosperous nation on earth.

Wow! The pursuit of prosperity is a good thing? How often do we hear that here at W4? Except from me and a few of our commentators, that is.

Or this,

Those who work to get rich are not doing so because they are seeking to provide enhanced tax receipts for the government, or to make it easier for government to do what elected officials and unelected bureaucrats think is best. They are, rather, fulfilling basic human desires—to excel, to succeed, to best the other person, to show the old man. Those desires provide the drive. The drive provides the wealth. The wealth provides the ancillary benefit for others. And the act of wealth creation itself creates opportunities for others.

Von Mises & co. couldn't have said it better. Can you say "a rising tide lifts all boats?" A phrase which is never in my recollection quoted or paraphrased here at W4 except to pillory it as simple-minded.

Or this,

A small handful of entrepreneurs become very wealthy through capital gains, by selling stock to the public or to other public companies. Yet another pathway to moderate wealth is through investing, or asset growth. In America today, much of the aggregate growth in economic productivity is ultimately captured in the valuation of the stock markets. (This includes growth accruing to American corporations through activities overseas.) Through investment activities, private individuals can and do participate in the increase of America’s prosperity as a whole.

Not a word _there_ about parasitism, nor anywhere else in the entire article. No way. The world of finance and investment, the world of the stock markets, is a good thing, a way for "private individuals" to "participate in the increase of America's prosperity as a whole."

It's just a whole different picture. The whole article is a whole different picture.

Probably just geared to the likely readers of _Commentary_, I suppose. Unfortunately. Sigh.

"The financial industry today is parasitic to the real economy": if this is true, it follows that the defender of free markets actually finds not a friend but an enemy in the financial industry.

How do you have a free market today without a complex financial industry?

"[I]f Mr. Brandt could point to specific misunderstandings and misadvertences, a fruitful discussion might ensue."

Dubitable. It's taken far too long parsing your post and comments to realize that by "securities" in your post title, the topic sentence of Reason 1, and elsewhere you mean securities in the ordinary sense only if you are, e.g., sneering at Mr Nicoloso; that by "securities" you mean a particular contemporary subset of a branch of modern financial engineering.

And that by "securities business" you mean not what most people think of as 'the securities industry' but that subset of the broader industry that is TBTF, TARP recipients, FDIC members; and not only that, but that subset of the above that deals in the sort of securities you mean when you use the word "securities".

And when you describe "contract law" as conducing to supremely plutocratic concentration, you don't mean that contract law is unimportant in buying a car, hammering out a custody agreement, or selling a house, but that these "securities" are so dire, or fell, or scary, plus they're computerized! that the rich get richer and the poor get poorer, and it's all because of bankers and lawyers. No, but I'm inferring all that, because you're clearly expecting those words not to convey what they usually do, and to convey a great deal of something else. "Securities" + "contract law" = plutocracy! ("Plutocracy"?)

I had thought this was the beginning, rabblerousing somewhat messily attired in the robes of a rhetor. Impassioned, certain, soaring, and meaningless if looked at critically.

Perhaps instead it is a conclusion, fist pounding the podium, the OWS kids on their feet, waving their fingers approvingly? Perhaps you've used these years of unread posts to train your audience to hear "dangerous plutocrat collateralized debt obligations" when you hiss the word "securitiessss" across the plaza? They picture Lloyd Blankfein noosed up, dangling from the old Buttonwood Tree when you cry "securities businessss"?

Yeah, I can see it as a weirdly stirring conclusion, depending on your delivery and the, uh, quality of your crowd. So I came late to the party, like John Cage not getting Glenn Branca. And I can't tell you just how trees desolated I am about that.

But as the first trumpet note, a call to action that might accidentally be heard by people who've been investing, and editing, for thirty years? Truly fails to convey what you mean, misleads- or makes you look ignorant- by misusing common investing vocabulary. Write it again, from the beginning. Change the title. Say what you mean, don't make your readers guess at what you do mean, don't mean, might mean. Redo the first sentence. Why "trade or commerce"? Trade and commerce generally serve as synonyms. Why "classes of"? Why does "other trades" not express whatever sense you want to convey?

If you write a paper that's thought its problems out a little more clearly, you'll probably find it a whole lot easier to list solutions that go beyond "carrot" and "stick".

I'm in a hurry, and did not get a chance to digest the discussion so far, but Mr. Cella's basic argument in this thread seems to be, in plain English:

Since the investment banks are regulated and it's created a mess, we need to regulate them.

Stated that way, I think it's pretty obvious what the trouble is with his thesis. The problem is, of course, that unless you think alpha male behavior and plutocratic interest are inherently wrong, everything Mr. Cella has said is wrong with the investment banking function is the product of over-regulation.

I'll be back later to see the rest of the discussion.

How do you have a free market today without a complex financial industry?

Perseus, in the many discussions Paul and I have had about regulation and free markets over the years, my understanding (and I hope I do not misrepresent) is that that, more often than not, is _his_ point. Thus, when I defend "the free market" or "capitalism," he points out repeatedly that I must deal with capitalism *as we actually have it* which he calls "finance capitalism," which is tightly bound up, evidently, with wrongful shenanigans of high finance and hence "plutocracy." The upshot is apparently that, as a rather old-fashioned and simple-minded libertarian-sympathetic (though not card-carrying) free market type, I should heartily support more regulation of the finance sector. I should oppose "finance capitalism," even if mainstream conservatives believe that it is anti-free market to do so.

How do you have a free market today without a complex financial industry?

You don't. But you can have a more healthy financial industry. You can have "investment firms ... restructured such that the primary stakeholders" are "fully exposed to the downside as well as the upside." You can have industrial corporations like AIG and GE that refrain from converting themselves into gigantic unregulated banks. You can have a financial industry where it is much less likely that a 300-man AIG office in London can write enough default swaps to rack up losses in excess of a large state's annual budget (losses eventually paid out with taxpayer capital). You can have a derivatives market less susceptible to reckless brinkmanship.

American business grew fairly steadily for two centuries without publicly-traded investment banks. The credit default swap was invented in the early 1990s. The intricacies of rocket-science bond arbitrage date from the 1980s. The evidence that these innovations in financial abstraction produced common benefit and prosperity is pretty scant.

The pursuit of prosperity is a good thing? How often do we hear that here at W4? Except from me and a few of our commentators, that is.

In the free trade thread I emphatically made prosperity my touchstone. It's precisely because I think a lot of what high finance engages in is false prosperity that I oppose it.

The upshot is apparently that, as a rather old-fashioned and simple-minded libertarian-sympathetic (though not card-carrying) free market type, I should heartily support more regulation of the finance sector.

The upshot is of course that you should support the right kind of regulation: regulation not for its own sake or the sake of just doing something, but regulation with a purpose -- namely, restoring a proper balance of commerce and finance. In 1950, finance accounted for some 10% of American business profits; by 2005 that number was 40%. It requires no great insight to discern that, three years later, finance was so indispensable to our national economy that it had to be bailed out.

The credit default swap was invented in the early 1990s. The intricacies of rocket-science bond arbitrage date from the 1980s. The evidence that these innovations in financial abstraction produced common benefit and prosperity is pretty scant.

We may not yet have a lot of empirical evidence about CDS, but they are a form of derivative, about which we do have substantial evidence that they are quite useful.

In the free trade thread I emphatically made prosperity my touchstone. It's precisely because I think a lot of what high finance engages in is false prosperity that I oppose it.

Truly, high finance creates false prosperity, but its actions merely reflect a strategic (and largely legal) optimum in the gambling casino created by artificially supressed interest rates. Allow interest rates to float to natural levels and bad investment will get squeezed out, at first by defaults, and finally by less often being made. Who is more immoral: the astute gambler, or the casino operator who uniformly punishes those who hold their chips, guarantees risk free winnings to their biggest clients (via QE)? Who then most deserves regulation?

There's definitely something to that. The ferocious chase for higher yield, in ever more complex and risky bond-like structures, was a major factor in the 2007-08 financial crisis.

Having taken valuable time away from writing calls on a failing American buggy-whip manufacturer via the machinations of an international bank to nose around a little more, I see that this piece reads so poorly because it is indeed an underedited cutdown from an earlier piece. The hammer and the nail are the same, of course; and as with every contemporary propounder I've come across who would wave the flag of Distributism! or of No Usury! I am always reminded of the second chapter of Orthodoxy.

Just for fun, I was examining the Evil Banker Plutocrats thesis via the current Forbes 400. Do you know, among the top twenty billionaires in the U.S., only three could be pilloried as financial capitalists? And that of those three, one- Buffett- was more a co-bailer-outer- if you must, a para-parasite- and another- Paulson- actually made his bones by taking the short end of the slice-and-dice mortgage thingies that cause anti-usurers to quake in their boots?

Among the top 100 richest gazillionaires, not even twenty are primarily Evil Financial Capitalists, pardon the redundancy. And that is with the definition stretched to include people who started equity mutual fund companies.

But there isn't anyone in the top echelon of Vile Plutocrats who stole his billions primarily by lending out money at interest, or by using, to allude to a trope, MIT PhD mathematicians to tranche up his loans-to-the-poor.

The mad doctors "all have exactly that combination we have noted: the combination of an expansive and exhaustive reason with a contracted common sense." Where are the usurious billionaires? Why cannot Forbes find them?