Tuesday, December 16, 2008

Have We Forgotten the Purpose?

Please listen to this video of Bernard Madoff as you read this article. It’s 33 minutes long, but keep the $50 billion Ponzi scheme in mind as you listen to how and what their business did. I do not have the exact date this was recorded, but YouTube says it was approximately one year ago.

According to Madoff, markets are, “all about gaining an advantage over others in the market place.”

Oh really? See, I always thought that the purpose of the stock market was to provide working capital so that companies could buy the capacity to produce their product. How far away are we from that concept now?

The recent trend is that less and less of the real capital in the market place actually reaches businesses who then do something productive with it – in this country anyway. Today investors are placing large portions of their capital into derivatives… things like ETFs which generally are nothing but a derivative of the underlying real asset. For example, when you buy shares of SPY, your money is NOT providing any working capital to any company that produces anything real. Oh yes, you are providing your money to financial firms who ARE NOT producing anything real – they are producing large bonuses for themselves as they skim each and every transaction.

The same goes for any money “invested” in options and futures. As more and more money goes into “alternative vehicles,” less and less money goes into real production. The bubble blowing proponents will say, no, more overall money is available to those who need it… and I say bullshit. Derivatives of all kinds have taken us so far away from the purpose of the market place that we don’t even recognize that purpose any longer, kind of like Christmas!

The markets have been commercialized beyond recognition, yet proponents of the “new and better” marketplace will claim that derivatives “increase liquidity and lubrication” making the markets more efficient. Again, bull. What has happened is that more arms length debt/credit was created using very unrealistic underlying math. Simply put, credit money was created that served no purpose to society. It was mostly just misallocated. And since the vast majority of derivatives serve NO REAL purpose to society, they are, in fact, nothing more than legalized gambling. Bernie Madoff was nothing more than a bookie.

Those who claim that derivatives like Credit Default Swaps (CDS) provide necessary “insurance” so that firms may conduct their business should ask themselves why are businesses doing business with firms that they need to buy insurance to protect themselves from in the first place! Are they not doing their due diligence? And, if they do need insurance, why not buy legitimate insurance from a regulated insurer who is required to have real reserves? You see, CDS writers are unregulated and there is no requirement for them to posses any reserves at all. Thus I could start a business and sell a CDS contract “insuring” the manned rocket launch to Mars, but if it failed I certainly wouldn’t have the money to pay. Guess what? That’s exactly what happened – the writers of CDS, like AIG, do not have the money to pay. And our great leaders continue to shovel taxpayer funds to keep them propped up. Why?

We have forgotten what our markets are for, that’s why.

So, from my perspective it would be no sad day at all, the day that derivatives are outlawed and go away. Yes, my own paper flipping would go away, but that would be a fine day with me. I’d love to be able to put my money to work in a business that makes things that serves society. I simply can’t do that now; derivatives have made the marketplace far too risky for that!


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