Root of all evil… and financial corruption of markets

By Michael L. McManus

Over the years, we have seen various financial and legal investment schemes that have caused great losses to individuals, corporations and nations. Due to the global financial system, all nations must play and pay! These financial schemes have included phenomena such as junk bonds, insider trading, attacks on targeted currencies, and the newest of these devices, derivatives.

The scope has been enormous and devastating to many. Yet governments, regulatory agencies, banking systems and trading firms allow and even promulgate these tools of complex financial maneuvering. Why is this so? It is likely that we need a new “law” to explain their rise. Shall we call this the “law of false markets”? This law would be that it is easier to create bad money instruments than eradicate them once they are born and discovered.

Why are they bad? Junk bonds were the crafted brilliance of some financial marketers who became infamous in the 1980s. Michael Milken pleaded guilty to 92 separate counts of fraud for misusing and abusing junk bond quasi-markets mostly in the U.S. and Europe. They became so unbelievably speculative that they tempted the cleverest of Wall-Streeters to play and manipulate these markets. Ivan Boesky also made insider trading famous in the 1980s. The temptation continues right through until the market crash of 2008. Likewise, George Soros made the targeting of international currencies for manipulative purposes a new “tool” of the 1990s and beyond. Most of what was done was outside existing legal frameworks on a national or transnational basis.

But the most recent and amazing devices is the derivative market and its offshoots, one of the most notorious of which is the synthetic derivative market. These are highly complex trading markets not unlike large casino “bets” on the movement of stock prices even in a one day timeframe. Wall-Streeters used other people’s money (OPM) to make most bets. Some came crashing down.

Consider the fact that less than 50 percent of all people employed in investment services and banking and trading on Wall Street ever see the faces of their investors! To many of these highly educated people, everything is abstract and de-personalized. One is a big betting game. There is no oath of ethics that people are sworn to. That would be hard to implement.

But the root of this evil, surprisingly, is not the greed factor or the sheer desire for huge money, although that is a factor in this formula. In my own career, I experienced what I now call the root of all this evil, even before I knew what I was experiencing; a long time ago.

You see, I was one of the fortunate ones to qualify to attend the famous Wharton School of Finance and Commerce at the University of Pennsylvania. Wharton and its professors and especially its finance professors are among the best and brightest within the east coast financial intelligentsia. Along with Harvard, MIT, Columbia, and Yale, Wharton brought prestige and status to the industry. Its chief quality was its brilliance and its power of influence.

Now, in the typical capitalist system, everyone is taught that competition is one of the key success elements of financial and production markets. Through the seeking of competitive advantage, we see gradual improvements in everything we buy. There is a constant drive to be more competitive. This usually means that there is a competitor at every turn, and the job of a business is to somehow outsmart the competitor. Outsmart means to be cleverer in every respect, even to move with stealth and secrecy in trade wars or competition. To the victor go the spoils and in most cases it is perceived and experienced emotionally by traders as a zero-sum game. To win the market, we must even outsmart the market itself.

As we have this brilliance and training and we have the heritage of such profound educational institutions behind us, it is almost our professional duty to outperform our competitor.

When I was a struggling student at Wharton, I saw this all. There it was right before my eyes. Fellow students were so competitive that I often worried if I would survive. Faculty members, especially the finance professors, would dazzle us with their brilliance and cleverness. They would always be one or two steps ahead of the best students. That was their job and their heritage… to dazzle and impress and to craft things that would always be smart and keen. The game was to outsmart, in fact.

It is so subtle, yet so powerful. In this constant struggle for higher and higher sophistication, it became the sophistication, not the substance that mattered most. Engineers know this phenomenon well. They call it “creeping elegance.” Give a design engineer anything and he or she will make it one step more elegant! That is their job and their profession after all.

Yet outsmarting the customer and outsmarting the investor is where this all ended up. Yes, it became the root of the evil and led to a collapse and one of the largest financial crises ever back in 2008.

The subtle slide to outsmarting not only your competitor but also your customer leads all of us ultimately to bad outcomes. Financial markets and financial engineering play chaos as the hero, not order and dependability. It may be a long time before truth and dependability are the gold standard of finance, not outsmarting. No one likes a smart aleck, especially when you put your money and trust in their hands.

Michael L. McManus is a bi-monthly columnist for The Korea Times and Founder and President Emeritus of the California International Business University in San Diego. He is currently a guest professor at the Hankuk University of Foreign Studies (HUFS) in Seoul, and welcomes comment at mcmismism@aol.com.