Your essay The Collapse of Our Corrupt, Predatory, Pathological Financial System Is Necessary and Positive was entirely correct about risk. But let me come at this from a different angle – namely fraud.
Finance skims a percentage off the real economy. Some part of the skim is legitimate reward for capital allocation – a necessary part of a capitalist system and part of what makes it more efficient than a command economy. But some part of the skim is fraud.
Where are we now? Let’s look at the sources of skim:
First there are the more legitimate skim sources – interest payments, management fees, IPO fees, M&A fees, trade commissions.
Then there are the less legitimate bank sources: penalty credit card interest rates, late fees, usage fees, over-the-limit fees, late payment fees, bounced check fees, low balance fees. And the capital markets sources – front-running, insider trading, account churning, manipulation of the news cycle, the captive analyst “ratings game”, trading against your own client’s order book, forex trades which are marked at the day high or low irrespective of when the trade took place, market manipulations at options expiration, stuffing your managed client accounts full of dubious IPOs and new issues that your organization is earning fees from originating.
Bucket shops and ponzi schemes take it even a step further – no actual financial activity takes place. Its simply robbery.
And now we add the new stuff: credit default swaps without margin, fraudulent loan origination, sliced & diced mortgages, mark to myth accounting, foreclosure halts to avoid realizing losses, extend & pretend, quote stuffing, HFT trading activity that boils down to denial of service attacks on exchange computers causing delays in pricing information, highly complex derivatives sold to unsuspecting but optimistic public servants, too big to fail status providing cheap backup in the event of trouble, and increased organizational size that facilitate cartel-like control over government and regulators.
But if that’s not enough, there is the structure itself: they aren’t doing this with saved capital, but rather with freshly printed and/or borrowed capital. Its all done with 12:1 leverage at a minimum. So only 8.3% of the gambling (optimistically anyway) is actual capital – saved surplus. And if Basel II says it’s risk-free, well there’s no need for reserves at all. It is just manufactured money, which effectively mean each bet is diluting the actual savings of real people. And if the bet goes bad, the Fed will ride to the rescue with low-cost money. But usually the bet goes well, because ordinarily the number of sources of fraud today is so HUGE, its practically impossible not to succeed.
Unless of course they get too greedy. Or the debt levels rise so high that large numbers of borrowers default. And guess where we are.
The financial system is supposed to allocate capital and take a modest skim as reward for helping society to be efficient. When they are doing this, they provide a net benefit to society because it’s a win-win proposition. They are making society more efficient, and they thus earn their percentage.
However, and this is the key point: fraud provides no net benefit to society.