The protest movement on Wall Street has a broad field of complaints against numerous targets that defy easy description. "We are the 99%" is the closest the movement comes to a unifying rallying cry. But broadly speaking one can generalize that the protests primarily focus on economic inequality caused by corporate greed and corruption, and the stranglehold of special interest lobbyists in Washington. Their rage is fueled by recent reports documenting the growing disparity between rich and poor, and ever-greater concentration of wealth in a small percentage of the mega-wealthy.
While those complaints ring true, the protestors are missing an even bigger point. They are complaining about the symptoms of the disease rather than the underlying pathology itself. A man who is pushed off a cliff may die of a heart attack on the way down, but the cause of death is not heart failure. Likewise, corporate greed may suck the lifeblood out of our financial system and drain the bank accounts of middle class America; and lobbyists may well control Washington, but those are secondary problems reflective of some deeper malady. Corporate greed is to economic inequality like that man's heart attack is to his tumble over the abyss.
So what then is the fundamental problem? The problem is that Wall Street is a grand lie built on a fraudulent foundation of quicksand. Wall Street is a casino rigged against investors sold false hope by unscrupulous companies sanctioned by government to deceive and bilk customers. Major stock exchanges are openly manipulated to favor large investment banks and brokerage houses at the expense of tax payers and individual investors. As the Wall Street protestors point out, the little guy missed out on the trillion dollar bailout offered to Wall Street's biggest banks and brokers. Your risk is privatized while their losses are socialized. Wall Street exists because society is eager to believe in financial miracles. The economic crises we now face, and the inequalities that result, were not only predictable, but as inevitable as the collapse of a house of cards in a strong wind. Unconvinced? Let's see what we know as fact.
We know that the trading system is inherently corrupt, weighted in favor of brokers who only make money by encouraging more trading. But something more sinister than just commission padding is involved. The SEC now alleges, for example, that Goldman Sachs deliberately misled gullible and trusting clients by selling them mortgage securities that Goldman Sachs was itself shorting. The media was full of wild and ridiculous analogies when this was first reported, but we can do better in three easy steps using the fictional auto company "GMS" as an example to explain the scam: 1) GMS built a car with fatal flaws intentionally integrated into the design so that the car would blow up a few blocks from the dealer lot; 2) GMS sold the car fraudulently to a faithful buyer as brand new, reliable, and long-lasting; 3) GMS had the car insured so that when the vehicle inevitable self-destructed after the sale GMS would earn a huge payout. GMS made money when selling the car and made money when the car exploded, which GMS knew it would because the car was designed specifically to do so. Only the buyer was hurt. He purchased an automobile from a dealer he trusted, confident in his choice, unaware that the car was rigged for a short life on the road and clueless that his investment was worthless. GMS created a double win by engineering a guaranteed loss for the duped client. Such behavior would be clearly illegal in car sales, not to mention highly unethical. But not on Wall Street.
We know that dubious ethical behavior is embedded into the fabric of Wall Street. In the case of Goldman Sachs, peddling rotten mortgage securities was not a first foray into problems selling short. The company paid a fine of $450,000 to settle SEC allegations (without admitting wrongdoing) for violating short-selling rules in 2008 through 2009. That trifling amount does not even constitute a hand slap and predictably, in the face of such miniscule fines, no lesson was learned.
We know that even giant Goldman Sachs is just a tiny drop in a vast sea of corruption, just the latest in an unbroken chain of malfeasance to make the news. Does the name Bernard Madoff or the amount of $50 billion ring a bell? Remember Kenneth Lay, Andrew Fastow, and Jeffrey Skilling of Enron? How about Dennis Kozlowski, Tyco's ex-chairman and chief executive? Remember WorldCom? That company had the fine distinction of perpetrating accounting fraud that led, at the time, to one of the largest bankruptcies in history. Let us not forget the Rite Aid executives who were accused of securities and accounting fraud that forced the drugstore chain to restate more than $1 billion in earnings. Executives at the company were charged with colluding in overstating Rite Aid's income in every quarter from May 1997 to May 1999, forcing the company to restate results by $1.6 billion, the largest restatement ever recorded at the time, according to the SEC. And who can forget the Adelphia Communications scandal? In that sordid case, the company inflated earnings to meet Wall Street's expectations, falsified operations statistics, and concealed blatant self-dealing by the founding family, the Rigas, who collected $3.1 billion in off-balance-sheet loans backed by Adelphia.
We know that six years ago Morgan Stanley, promoting a staid image of conservative trustworthiness, agreed to pay $50 million to settle federal charges that investors were never informed about compensation the company received for selling targeted mutual funds. Dick Strong of the Strong Funds admitted to skimming his investors to benefit himself. What was his punishment? Strong was allowed to sell his fund business for hundreds of millions of dollars.
We know that, in all, almost two dozen firms were implicated in scandal in 2004. Mutual fund firms agreed to fines totaling more than $2.6 billion in more than 100 settlements, almost none of which was returned to shareholders. The SEC settled with Putnam Investments, at the time the fifth largest mutual fund company, which allegedly had allowed a select group of portfolio managers and clients to flip mutual fund shares to profit from prices gone flat. Other mutual funds allowed the favored few to buy and sell shares in rapid-fire fashion. Oddly, this practice is actually legal, but harmful to innocent shareholders not lucky enough to be included in the game. You and I do not get to play. In a preview of the trillion dollar bailout five years later, wealthy clients were given special treatment. Perhaps most annoying, the practice that led to the mutual fund scandal in the first place was never addressed by regulators, even as the foundation was collapsing underneath them. Well-connected investors still had the chance to trade after the market has closed long after the scandal broke. Any effort to increase shareholder power was and is vigorously fought. A proposal that would force the SEC to give shareholders a greater voice in selecting board members was defeated in October 2004. Commissioner Harvey J. Goldschmid, an advocate of the proposal, said "The commission's inaction at this point has made it a safer world for a small minority of lazy, inefficient, grossly overpaid and wrongheaded CEOs." Nothing has changed since.
We know that other forms of favored trading are common as well, designed to benefit insiders. Fund shares, unlike stocks, are priced only once daily at their 4 p.m. closing price. That is true for you, but not for those favored clients who keep getting special bennies. Some funds allowed a few big clients to lock in the closing price after 4 p.m., letting them profit from late-breaking news. That is the ultimate insider trading. Sure, even companies have the presumption of innocence until proven guilty, but the list of firms tied to the 2004 mutual funds investigation was impressive, and included Janus, Strong, Bank of America's Nations Funds, Bank One's One Group funds, Alliance Capital, Prudential Securities, Fred Alger Management, Merrill Lynch, and Wilshire Associates.
Corruption is not a rare anomaly on Wall Street, but the norm, a constant thread throughout history, but we continue to pretend otherwise. How can anybody review this truncated list of fraud and abuse on Wall Street and dismiss corruption as the outlier? Yet almost everybody does.
Yet even those examples are not the most egregious. Warning signs in flashing neon could not be more obvious than corruption at Fannie Mae, accused of fleecing investors. The Justice Department opened a formal investigation in October 2004 following reports that the mortgage company might have manipulated its books to meet earnings targets. Sound familiar yet again? This is after Fannie tried to hinder an official investigation by refusing to provide relevant information.
What did we learn from these growing series of never-ending scandals? Absolutely nothing. Not one darn thing. Greedy and unscrupulous lenders are easy to blame, and rightfully so, but pinstripe suits are in fact minor players in the crisis. The proximate villains are government deregulators working in conjunction with commercial banks to create a grand Ponzi scheme of hiding risk. However, even obscene self-proclaimed masters of the universe and criminally compliant feds are not alone in their culpability.
And here is where I diverge from the protestors on Wall Street. We the American people, individual investors, families struggling to fund retirement accounts, bear responsibility for this crisis because we bought into the lie that Wall Street is real. As with religion and faith, people want to believe, and will therefore ignore obvious facts that contradict hopeful thinking about investment returns. The structural flaws of Wall Street are readily apparent to anybody who wishes to see the truth, but few do. Since the early 1930s, voices of reason have been sounding the alarm but investors gorging on hope refuse to listen, and the scam self-perpetuates.
Wall Street is an elaborate con never intended to work for individual investors. We as a society allowed this to happen by pretending we could have something for nothing, that we could create wealth with no risk, that we could invest with impunity no matter how weak the underlying fundamentals. We were had, but we let ourselves be taken on the false hopes of empty promises. We drank the Kook Aid. We believed that Wall Street was legitimate instead of a fantasy created by greed and fraud sanctioned by a compliant government.
We never questioned the ridiculous price of real estate. We seriously entertained insane ideas like the "end of the business cycle" touted by Wall Street gurus while the economy was inflating on an unsustainable bubble. We believed the economy would expand forever. Remember the effort under George Bush to privatize Social Security? We forgot the lessons of history from the 1920s and 1930s. We voted for politicians who are nothing but pigs at the trough.
You might reasonably claim after reading the above paragraphs that I am blaming the victim. But I am not. An analog will help here too. Let's say we all accept building codes that are designed to protect us from earthquake damage. We build our house according to code. A tremor hits and our house collapses. We are victims of the earthquake, unambiguously. But let's say we knew beforehand that the codes were developed fraudulently to benefit a few contractors, and a government willing to look the other way. We accepted the flawed building codes anyway because it made our construction costs lower. We are not then free of responsibility for the collapse of our home. I don't diminish the causative destruction of the earthquake, but much of the damage could have been avoided or minimized if we did not succumb to cutting corners. That is what has happened to us on Wall Street. We looked the other way for short-term gain at the cost of long-term economic growth and stability.
Yes brokers, bankers and investment houses criminally abused our trust while the government turned a blind eye. Many Wall Street CEOs should be in prison for what they've done and stripped of their ill-gotten gains. We were robbed; we are the victims of institutionalized fraud. But the fact is we trusted naively and hoped unrealistically. We accepted as fact what should have been questioned as fiction.
Occupy Wall Street protestors are rightfully mad even if their wrath is somewhat misdirected. On the other hand, the movement's core complaint of economic inequality resulting from a skewed playing field touches on a real political problem. Many Republicans pray at the altar of the free market, worship small government and view all forms of regulation as sinful. That dogmatic semi-religious approach to government has predictably led us to the edge of the abyss again and again. We have developed an American myth about the magical efficiency of market forces and have deified entrepreneurs. We have developed a growing disdain for government as an obstacle to progress. Neither is entirely true or false: capitalism is not wholly good; government is not entirely bad. Both the private sector and government are essential, and both are flawed. Wall Street is the worst example of such flaws. Our future lies in our ability to balance one against the other, extracting the best from both and minimizing the worst from each.
Wall Street is the product of a long trail of greed, crime and corruption. The market looks nothing like that envisioned by Adam Smith. We must see that Wall Street's inherent structural flaws and fraudulent foundation demand reasonable government regulation; we've seen what happens when those are relaxed. Protesting the consequences of greed is a start, but only a start.
Visit Jeff Schweitzer at his website.