October 13, 2008


Margareta Pagano and Simon Evans, Independent, UK - The market is worth more than $516 trillion, roughly 10 times the value of the entire world's output: it's been called the "ticking time-bomb".

It's a market in which the lead protagonists - typically aggressive, highly educated, and now wealthy young men - have flourished in the derivatives boom. But it's a market that is set to come to a crashing halt - the Great Unwind has begun. . .

The complex and opaque derivatives markets in which these hedge funds played has been dubbed the world's biggest black hole because they operate outside of the grasp of governments, tax inspectors and regulators. They operate in a parallel, shadow world to the rest of the banking system. They are private contracts between two companies or institutions which can't be controlled or properly assessed. In themselves derivative contracts are not dangerous, but if one of them should go wrong - the bad 2 per cent as it's been called - then it is the domino effect which could be so enormous and scary.

Most markets have something behind them. Central banks require reserves - something that backs up the transaction. But derivatives don't have anything - because they are not real money, but paper money. It is also impossible to establish their worth - the $516 trillion number is actually only a notional one. . .

Little-known Democratic senator Byron Dorgan from North Dakota was one of the most vociferous refuseniks, telling his supposedly more savvy New York peers of the dangers. "If you want to gamble, go to Las Vegas. If you want to trade in derivatives, God bless you," he said. He was ignored.

Warren Buffett, the American investment guru, dubbed them "financial weapons of mass destruction", but for the once-great-and-good of Wall Street they were the currency that enabled banks, hedge funds and other speculators to make billions.

Anything that carries a price can spawn a derivatives market. They are financial contracts sold to pass on risk to others. The credit or bond derivatives market is one such example. It is thought that speculation in this area alone is worth more than $56 trillion, although that probably underestimates the true figure since lax regulation has seen the market explode over the past two years.

At the core of this market is the credit derivative swap, effectively an insurance policy against the default in the interest payment on a corporate bond. One doesn't even need to own the bond itself. It is like Joe Public buying an insurance policy on someone else's house and pocketing the full value if it burns down. . .

As markets slid into crisis, and banks and corporations began to default on bond payments, many of these policies have proved worthless.

Emilio Botin, the chairman of Santander, the Spanish bank that has enjoyed phenomenal success during the credit crunch, once said: "I never invest in something I don't understand." A wise man, you may think.

Sam Smith, Progressive Review, May 2008 - America was just a decade past the last major war it would ever win. The length of the average work week was down significantly from the 1930s but real income had been soaring and would continue do so through the 1970s. We had a positive trade balance and the share of total income gained by the top 1% of the country was only around 8%, down from 24% in the 1930s.

As Jermie D. Cullip describes it:

"From 1950 to 1959, the total number of females employed increased by 18%. The standard of living during the fifties also steadily rose. Most people expected to own a car and a house, and believed that life for their children would be even better. . . The number of college students doubled. Getting a college education was no longer for the rich or elite.

"The decade of the fifties was a decade of major breakthroughs in technology. James Watson and Francis Crick won the Nobel Prize for decoding the molecular structure of DNA. Tuberculosis had all but disappeared, and Jonas Salk's vaccine was wiping out polio in the United States. . .

"Over the decade the housing supply increased 27 percent . . . Growth in the economy also led to increasing popularity of other financial intermediaries. Life insurance companies flourished for the first half of the decade and a large number of new private firms entered the market to absorb the excesses of personal savings. Savings and Loan Association holdings of mortgage loans during the decade clearly demonstrate the boom in construction at this time. In 1950 $13.6 billion was held rising to $60.1 billion in 1960. Another important growth in the 1950s capital markets was in pension funds. This industry grew from $11 billion in 1950 to $44 billion in 1960.

"By mid- 1955, the country had pulled out of the previous year's recession and gross national product was growing at a rate of 7.6 percent. The boom was so great that the budget for 1956 predicted a surplus of $4.1 billion. With the surges in production and the economy, the 1950s is often recognized as the decade that eliminated poverty for the great majority of Americans. Over the decade, GNP per capita almost doubled and the public welfare reacted accordingly as the cost of living index rose by just 1 percent and unemployment dropped to 4.1 percent'"
All in all not a bad decade to be in if you were running a business. So much so, in fact, that some began griping about it all in books like The Organization Man and plays like Death of a Salesman.

But here is the truly amazing part - given all we have been taught in recent years: America did it all as its universities turned out less than 5,000 MBAs a year.

By 2005 these schools graduated 142,000 MBAs. In the other words, in the 1950s it would take two centuries to produce a million MBAs. By 2005, with huge trade and budget deficits, a disappearing auto industry, the most costly and disastrous war since the mid 19th century, a growing gap between rich and poor, a constantly projected inability to care for our ill or elderly and a pessimism repeatedly confirmed in polls, we could produce a million MBAs in only seven years.

There are plenty of worthy arguments to be made correlating the rise of business school culture with the decline of the our economy. For example, in the period that corporate culture has been in ascendance - roughly since the Reagan years - wages of lower income workers have declined, the ratio of executive to worker pay has soared, the real value of the minimum wage has fallen by almost a third, total hours worked has increased, percent of jobs with pensions has dropped, our balance of payments has become increasingly negative, the top 1% is back to getting 21% of all income and the age at which one receives Social Security has increased.

A few years back I put it this way: "A cursory examination of American business suggests that its major product is wasted energy. Compute all the energy loss created by corporate lawyers, Washington lobbyists, marketing consultants, CEO benefits, advertising agencies, leadership seminars, human resource supervisors, strategic planners and industry conventions and it is amazing that this country has any manufacturing base at all. We have created an economy based not on actually doing anything, but on facilitating, supervising, planning, managing, analyzing, tax advising, marketing, consulting or defending in court what might be done if we had time to do it. The few remaining truly productive companies become immediate targets for another entropic activity, the leveraged buyout." And this was all before the rise of the killer hedge fund. . .

THE CORPORATE CURSE: How business culture dragged America down with it.



At October 16, 2008 2:25 AM, Anonymous Anonymous said...

there were at least seven previous comments here.
what has happened to them?


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