Monday, March 30, 2009

My Manhattan Project

by Michael Osinski - March 29th, 2009 - New York Magazine

The first collateralized mortgage obligation, or CMO, was created in 1983 by First Boston and Salomon Brothers, but it would be years before computer technology advanced sufficiently to allow the practice to become widespread. Massive databases were required to track every mortgage in the country. You needed models to create the intricate network of bonds based on the homeowners’ payments, models to predict prepayment rates, and models to predict defaults. You needed the Internet to sail these bonds back and forth across the world, massaging their content to fit an investor’s needs at a moment’s notice. Add to all this the complacency, greed, entitlement, and callous stupidity that characterized banks in post-2001 America, and you have a recipe for disaster.

This is an excellent article to read if you want to understand how separated from serving free enterprise and capitalism Wall Street has become. The greatest threat to human freedom has become the delusion that Wall Street IS capitalism or free enterprise, due to the hatred for the corruption of Wall Street that has become a part of the culture of liberals. Libertarians and conservatives should despise Wall Street with even greater virulence since it is a more of an afront to our values than it is to the socialists of the left.

In actuality, Wall Street has as much to do with capitalism as fraud has to do with banking. Just because someone puts the money they defrauded someone out of in a bank, does not mean that the banker is guilty of fraud. Just because scam artists and charlatans sell financial instruments that represent a business, does not mean they are a part of free enterprise or capitalism.

The process by which CMO (Collateralized Mortgage Obligations) and CDS (Credit Default Swaps) were used to con people into paying too much money for these pieces of paper, does not make it business. Business is the creation of products that people use. Tangible items. The relationship of financial instruments to the underlying asset or obligation must be clear. In these instruments they are not.

Though capitalism is awkward without a financial industry like banking, it is still possible. It is done with barter. That financial instruments make it easier to conduct the barter process, removing the necessity of taking delivery of cumbersome things like cows or coats when they are simply intermediary transactions, does not mean that the financial instruments represent actual business. They are a process to facilitate business. Unfortunately that distinction has been lost to many, even many who work on Wall Street.

As you read this article it becomes clear. The writer sees what he did as capitalism, and he has lost respect for capitalism as a result. It was never capitalism. It was always a corruption of the financial process of facilitating capitalism.

There are three different types of financial firms that facilitate various aspects of capitalism. These are banks, insurance and security firms. The transactions they facilitate are not complex just because they are abstract. Whenever any one of these organizations start creating complex processes to pervert the transactions they are charged with for the purpose of increasing their fees, it is not capitalism. It is fraud.

I am still frustrated by the huge number of supposedly smart people in our nation who do not understand the difference between capitalism and financial entities. Money is an abstract creation. Because it is susceptible to fraud, government usually takes over and creates a currency to facilitate both capitalism ... and the payment of taxes and fees that government needs. That it works for either type of transaction, does not make it capitalism. Therein lies the confusion.

Capitalism is aided by the creation of honest and responsible entities that; handle a sound currency; smooth disruptions to the business cycle caused by risks such as fire, flood, etc.; and allow for sharing in the creation or sale of a business in parts. When these three disparate financial functions are merged into a single entity, it is always followed by the perversion of their duties and financial collapse. Go back to the great depression and you find the merged and conflicting financial duties from failing to separate these functions was a major contributing factor to the sysstemic collapse.

You have to ask then why we removed those reasonable restrictions in the late 90s and went back to the merged financial firm model that failed before? I also wonder how much we can blame these monolithic financial firms for the creation of the complex instruments which are at the heart of our current crisis? With the corruption of Wall Street (as currently practiced in the crony capitalism model of big government partnering with monoplies to extort profits), why are libertarians and conservatives unable to shed their outdated belief that Wall Street means capitalism?


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