HOW WALL STREET’S RENT-SEEKING VAMPIRE SQUID SUCKS ALL LIFE OUT OF THE ECONOMY L. Randall Wray UMKC
In economics there is the notion of economic rent—payment in excess of what is required to mobilize factors of production. For example, such rents accrue to those who have “cornered the market”—by artificially restricting supply of some resource, they are able to dictate usurious terms to buyers. We call them “rentiers”.
Here’s the point that is critical to understand: the rentier performs no useful function, and the economic rent can be eliminated without reducing the supply of the resources needed for production. This is why J.M. Keynes advocating “euthanizing” the rentier. As you know, “euthanasia” means “mercy killing”—you kill to reduce pain and suffering. Keynes was serious about this—his recommendation came in the final chapter of his great General Theory, as one of his two fundamental policy proposals. (For completeness, the other was a “somewhat comprehensive socialisation of investment”.
Advocacy of “mercy killing” does raise the question: in whose interest do we kill the rentiers? Obviously, it is not in the interest of the rentier class—they are perfectly happy to suck unnecessary economic rents that strangle the economy. Think of the idle class of feudal lords, whose sole purpose of existence was to consume what they did not earn. Nay, we euthanize them to release the entrepreneurial spirit of capitalism. As Adam Smith explained, the interests of the feudal lords were opposed to the interests of all other classes in society.
Today’s equivalent is Wall Street. It serves no interest other than its own. It adds economic rent to all economic activity in our society, sucking the lifeblood out of the economy. Wall Street is our rentier class. If you want to visualize today’s rentier, there is no better example than a Bob Rubin, a Hank Paulson, or a Jamie Dimon, each “wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money” (as Matt Taibbi put it).
As Wall Street’s grip tightened over the past four decades, economic growth stuttered. We first got the Great Stagflation, and then the serially bubblicious economy that inflated debt at the expense of jobs and incomes. The Vampire Squid financialized everything and buried all economic activity under mountains of debt: Developing nation debt; Junk Bond King Michael Milken and LBOs; Charles Keating and his Quintet of Crooked Senators (Hello, John McCain! Read the details of Keating’s attempt to put a contract on my colleague, Bill Black). And then it all really got fun with the Greenspan/Bernanke Duo’s stoking of Wall Street’s biggest bubble of all time—the US era of The Great Moderation that layered Americans under mortgage debt, home equity loans, credit card debt, student loan debt, health care debt, and car loans.
I’ve already written a lot about Wall Street’s financialization of everything—way beyond housing, to auto ownership, college education, “peasant insurance” (your employer takes out a bet that you’ll die earlier than your life insurance company thinks), and “death settlements” (anyone can place that same bet). Back in 2008 I wrote about how Wall Street had financialized commodities, creating the biggest commodities price boom in human history .
Beginning with the “reforms” of 1999 that unleashed financial markets—and especially US Pension Funds—Wall Street began funneling “Managed Money” to commodities markets. At first they were buying the real, physical, commodities and hiding them away in storage—much like the Hunt Brothers had done back in the 1980s trying to increase economic rents through the Big Squeeze on silver. The problem was that this drove up storage prices—all the storage facilities were full.
So Wall Street moved into futures markets—buying paper claims to commodities physicals that they had no plan to ever exercise. Essentially these were one-way bets that commodities prices would only go up. And indeed they did. Not surprising when you figure that total money under Wall Street’s management was orders of magnitude greater than the sum total of the global supply of most commodities (to be clear, some commodities markets are huge—soy, petrol, wheat, corn—but the dollar values of the rest are relatively small; remember that two relatively dim-witted offspring were able to corner the entire silver market at least for a while).
And so, as I argued in 2008, Wall Street managed to boost commodities prices by several standard deviations above the mean (these are those black swan sort of numbers—once in 10,000 years) to create the biggest and widest commodities bubble of all time.
And then a funny thing happened. Rep Stupak and Senator Lieberman started an investigation (helped by Mike Masters; I was also approached to look into the bubble—which led to my 2008 piece). US Pension Funds freaked out, realizing that if their members found out that the main driving force behind the explosion of gasoline prices was Pension Fund speculation in commodities futures there would be hell to pay. They pulled out one-third of their funds and oil prices fell from $150 to $50 a barrel practically overnight.
With the investigation undercut, managed money started to flow back into commodities and the speculative bubble was rebooted. Even Goldman estimated in 2011 that speculation accounts for a third of the price of a barrel of oil. (See the FT piece cited below.)
Never content with its piece of the pie, Wall Street got into the storage business. In a terrific (and all too rare) piece of reporting, the NYTimes has exposed the scam created by Goldman Sachs to corner the aluminum market. You’ve got to read this for yourself, but I’ll summarize the main point. Goldman bought Metro, a storage company in Detroit that handles a quarter of the market’s supply of aluminum. Before the Squid took control, Metro had 50,000 tons of aluminum in storage; under Goldman’s management that has increased to 1.5 million tons.
Based on that growth you might think the aluminum business is booming, right? Well, no. Producers who need aluminum cannot get it—it is all bottled up in Goldman’s warehouses. The typical wait to get an order filled by Goldman’s facilities has grown from six weeks to 16 months.
And here’s the kicker. Goldman doesn’t own an ounce of the aluminum—it merely stores it for the owners. When the owners demand their own aluminum, Goldman claims it cannot be found. This is like depositing your family jewels at the local bank, but when you go to retrieve them, the bank claims it has misplaced your safety deposit box. And so you wait for 16 months.
But it gets better than that, of course. The Squid charges the aluminum owners for the entire 16 months it takes to locate the metal bars—which are actually pretty hard to misplace since each weighs 1500 pounds and they are all stacked in nice neat rows.
Industry rules require that storage facilities must move a minimum amount of metal out of warehouse inventories—the idea is to stop speculators from simply hoarding them to drive prices up. So Goldman has its forklift drivers continually move the metal from one warehouse to another like very heavy but shiny hot potatoes. Ninety percent or more of the metal leaving a warehouse is destined for another of Goldman’s warehouses—not for the producers desperate to actually use aluminum for some productive purpose.
Goldman’s forklift drivers assured the NYTimes reporters that they could (of course) locate anyone’s metal “in a couple of hours, at most”. The 16 month delay is designed to increase Goldman’s economic rents—with the cost of storage added-on to the cost of aluminum destined for production. Thus, Goldman’s extra profits come at the expense of everyone else, which is the very definition of the rentier that Keynes wanted to euthanize.
Note that if you looked at Goldman’s warehousing “services” you’d conclude they are a miserable failure since they’ve increased wait times twenty-fold and greatly increased the cost. We normally think of “finance” as “greasing the mighty wheels of commerce”, but in Goldman’s case it captured the warehousing business to purposely gum up the works.
A Goldman spokesmodel disingenuously argued that Goldman’s warehouses neither own nor trade in the metals, as if to imply that it has no interest in, nor ability to corner the aluminum market. But, of course, that is the beauty of this particular scam. Unlike the Hunt Brothers, who got wiped out when they couldn’t meet margin calls when they tried to corner the silver market, Goldman corners the aluminum market without risking a dime of its own.
As always, though, Goldman screws you six ways to Sunday. Not only does Goldman get to collect all the rents generated by bottling up the aluminum in storage, it also gets even more rents from the inevitable rise of prices that result from its storage practices. That is because Goldman also runs one of the big commodity futures indexes, managing Pension Fund money that helped to drive the speculative bubble in commodities in the first place.
In the latest scam, Goldman has planned to team up with fellow Squids JP Morgan and Blackrock to corner the copper market. The SEC has decided to allow these three “banks” (I use the term loosely) to control 80% of the supply of copper.
You see, Wall Street does not do banking any more. There’s not enough economic rent in that. So over the past three decades they have pushed the nation’s regulators, like the SEC and the Fed, to allow them to stick their tentacles into every nook and cranny of our nation’s economy, creating and funneling economic rents that strangle the economic system. In case after case, the regulators take an exceedingly narrow view of their responsibility as they allow “financial” institutions to take control of our energy supply, our food supply, our water supply. This passage from the NYTimes article is particularly instructive: According to public documents in an application filed by JPMorgan Chase, the Fed said such arrangements would be approved only if they posed no risk to the banking system and could “reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests, or unsound banking practices.”
By controlling warehouses, pipelines and ports, banks gain valuable market intelligence, investment analysts say. That, in turn, can give them an edge when trading commodities. In the stock market, such an arrangement might be seen as a conflict of interest — or even insider trading. But in the commodities market, it is perfectly legal.
“Information is worth money in the trading world and in commodities, the only way you get it is by being in the physical market,” said Jason Schenker, president and chief economist at Prestige Economics in Austin, Tex. “So financial institutions that engage in commodities trading have a huge advantage because their ownership of physical assets gives them insight in physical flows of commodities.”
So the regulators will approve extension of the Squid’s tentacles so long as it does not increase risk to the Squid. Indeed, the regulators look to the advantages created for the Squid as it pokes its blood funnel into the real productive part of the economy—to suck information it can use to manipulate markets to its own advantage.
Which, of course, is exactly what Wall Street does, as it rigs all markets. From energy to LIBOR to Muni bond markets to credit default swap pricing and to currency exchanges. Every day, another scandal and arranged settlement hits the paper. Here’s the latest on President Obama’s “favorite banker”, Jamie Dimon and JP Morgan’s rigging of energy markets . Or here’s one on the rigging of CDS markets.
And here’s the classic Matt Taibbi piece, arguing Wall Street has rigged everything.
The FT also ran a good piece yesterday on Wall Street’s meddling in metals and other commodities. Barclay was fined $470 million for manipulating California’s energy market; JP Morgan is next in line for a big fine. Morgan has moved heavily into oil physicals, importing 31 Million barrels in the first quarter of 2013. Goldman and Morgan Stanley are in a class of their own with respect to outright ownership of power plants and oil tanks because they were allowed to buy these as investment banks, and got their special status grandfathered when they were handed bank charters to give them continued access to cheap funding via FDIC coverage.
However, Citigroup also got special privileges back in 2003 (Gee, I wonder if Bob Rubin greased that wheel?) when the Fed allowed the “bank” to buy physical commodities like oil, gas, and grains on the argument that these are “complementary” to their derivatives trading. Yes, indeed. In fact, since they’ve now placed derivative bets on everything, all markets are now “complementary” to their book.
The silliest justification for all this madness is that allowing “financial” institutions to get into the “real” sector, they gain access to “information” on markets. The argument goes like this: if I’m going to provide finance to fracking frackers, it is good for me to actually be in the fracking business because that way I get real world information about the fracking market.
By that logic, of course, there is no business that is not the business of Wall Street. Heck, if you are going to actually be the financier to drug runners, tax cheats, money launderers and terrorists, you ought to be allowed to directly get into drug running, tax cheating, money laundering, and terrorism!
Why separate the mobster’s banking from the mobster’s criminal enterprise? Combine them and let the synergies bloom.
Further, and this is the real point, you can greatly increase the economic rents if you allow a handful of Banksters to run every aspect of the economy to their own benefit. They’ll rig all the markets and reap all the rewards. Everything is rigged, as Taibbi argued. And we are screwed, as I’ve said.
The nation’s top financial cops will not stop this. The threat of Congressional investigations is not sufficient. As Keynes understood, there is only one way to stop Vampire Squid rentiers: Euthanize them by driving a stake through the heart of Wall Street.