The Stock Market Crash Reveals the Rot at the Core of Our Economic System

Matthew Cunningham-Cook February 13, 2018

Traders work on the floor moments before the morning bell at the New York Stock Exchange November 21, 2008 in New York City. (Photo by Mario Tama/Getty Images)

We just saw the steep­est stock mar­ket decline in six and half years, and the largest one-day point decline in the his­to­ry of the Dow Jones Indus­tri­al Aver­age. Last week saw the worst week on Wall Street in two years. The pre­cip­i­tous fall fol­lows the recent so-called Trump ral­ly,” where stock mar­ket val­ues inched to their high­est lev­el since World War II.

While this down­turn may not spell an imme­di­ate cri­sis for cap­i­tal­ism, it does fur­ther reveal the rot at the core of the sys­tem. The largest finan­cial firms can prof­it from sud­den fluc­tu­a­tions in the mar­ket — while ordi­nary investors such as those with pen­sion funds and 401(k)s are left hold­ing the bag. This volatil­i­ty in the mar­ket has allowed for more Wall Street ticks to suck at the hog of the rough­ly $27 tril­lion in retire­ment assets held by Americans.

There are a few prin­ci­ples that guide how traders and spec­u­la­tors on Wall Street oper­ate: Buy low and sell high. Liq­uid­i­ty in the mar­ket gen­er­ates prof­its. And use infor­ma­tion to your advan­tage. With­in this frame­work, a small group of pow­er­ful banks dom­i­nates Wall Street trad­ing, includ­ing JP Mor­gan, Gold­man Sachs and Bank of Amer­i­ca Mer­rill Lynch.

Many of these pow­er­ful finan­cial insti­tu­tions have been bet­ting that volatil­i­ty will rise. The Wall Street Jour­nal report­ed in April that banks would sud­den­ly be sit­ting on huge prof­its from their volatil­i­ty insur­ance” were volatil­i­ty to increase. Low volatil­i­ty in the stock mar­ket has hurt the rev­enue of trad­ing desks such as those at Gold­man Sachs by reduc­ing oppor­tu­ni­ties to exploit spreads in prices. The largest banks have dis­cre­tionary con­trol over hun­dreds of bil­lions of dol­lars in assets that, through selec­tive buy­ing and sell­ing, can cre­ate added volatil­i­ty in the market.

Gold­man, in par­tic­u­lar, has a long his­to­ry of ben­e­fit­ing hand­some­ly from ris­es in volatil­i­ty. Dur­ing the 2008 finan­cial cri­sis, Goldman’s for­mer Chair­man Hank Paul­son served as Trea­sury Sec­re­tary while anoth­er for­mer Chair­man, Stephen Fried­man, served as head of the New York Fed — Goldman’s pri­ma­ry reg­u­la­tor. Goldman’s for­mer chief lob­by­ist in Lon­don, Joshua Bolten, was White House chief of staff, and anoth­er Gold­man vet, Neel Kashkari, was a top deputy to Paulson.

At the end of 2006, Gold­man began to short the res­i­den­tial mort­gage-backed secu­ri­ties mar­ket (RMBS). The even­tu­al col­lapse of RMBS helped trig­ger the finan­cial cri­sis in 2008.

Near­ly every bank with expo­sure to the col­lapse in the RMBS mar­ket was either bailed out by the gov­ern­ment or put into an order­ly receiver­ship. The lone excep­tion was the invest­ment bank that was like­ly the most exposed to the sub­prime mar­ket, Lehman Broth­ers. Lehman’s Chap­ter 11 bank­rupt­cy fil­ing meant that there would be no aid from the gov­ern­ment, and investors hold­ing Lehman RMBS could expect to get just pen­nies on the dollar.

Every oth­er major bank was deemed by Paul­son, Fried­man, Bolten and Kashkari to be Too Big To Fail because of the mort­gage cri­sis, except for Lehman, whose col­lapse would trig­ger mas­sive prof­its for Gold­man. While the pen­sion funds that had pur­chased Lehman secu­ri­ties lost bil­lions, Gold­man made out swimmingly.

Then there’s LIBOR, or the Lon­don Inter­bank Offered Rate, which was tied to the val­ue of $800 tril­lion in secu­ri­ties world­wide. In 2012, near­ly all of the world’s major banks were found to have manip­u­lat­ed LIBOR by arti­fi­cial­ly dis­tort­ing the data they sub­mit­ted to set the rate. Andrew Lo, a pro­fes­sor of finance at MIT, said in 2012 that the scan­dal dwarfs by orders of mag­ni­tude any finan­cial scam in the his­to­ry of markets.”

These gam­bits demon­strate how con­cen­trat­ed pow­er in finan­cial mar­kets allows for the largest insti­tu­tions to manip­u­late these mar­kets for their ben­e­fit. And under Pres­i­dent Trump, even the most basic lev­els of secu­ri­ties law enforce­ment have decreased dra­mat­i­cal­ly. Law360 report­ed in Novem­ber 2017 that enforce­ment activ­i­ty had plunged” since the Trump admin­is­tra­tion began.

In Jan­u­ary, Trump installed Robert Khuza­mi, a for­mer Deutsche Bank gen­er­al coun­sel, as the num­ber-two U.S. Attor­ney for the South­ern Dis­trict of New York, which com­mon­ly leads secu­ri­ties pros­e­cu­tions with the Secu­ri­ties and Exchange Com­mis­sion. And Gold­man alum Steven Mnuchin is cur­rent­ly serv­ing as U.S. trea­sury sec­re­tary. This reg­u­la­to­ry roll­back, over­seen by indi­vid­u­als with strong ties to the finan­cial indus­try, allows bad actors in the mar­ket to ensure that they can oper­ate unscathed.

When the mar­kets fall pre­cip­i­tous­ly, as recent­ly hap­pened, it’s gen­er­al­ly not the invis­i­ble hand” at work. Every bet has a win­ner and a los­er, and in the casi­no of Wall Street, the house always wins. The up-and-down jumps of the mar­ket ben­e­fit those with inside or priv­i­leged infor­ma­tion. And on the oth­er side are the mil­lions of ordi­nary investors with lit­tle under­stand­ing of the intri­ca­cies of how the mar­ket actu­al­ly works, and with lit­tle con­trol over how their wealth is actu­al­ly invested.

In July, Simon Der­rick of BNY Mel­lon com­plained to CNBC that the lack of volatil­i­ty leads to a lack of trad­ing prof­its.” And the Wall Street Jour­nal report­ed Tues­day in an arti­cle enti­tled Banks Cheer Return of Wild Mar­kets” that banks have blamed placid mar­kets for lack­lus­ter returns in their big trad­ing oper­a­tions” but that they’re cheer­ing the big mar­ket swings, see­ing hope for a boost in fees that dropped off a cliff last year.” The paper also quot­ed a financier say­ing “[a]nything that brings back volatil­i­ty would be good.”

Besides the big banks, anoth­er promi­nent ben­e­fi­cia­ry of the rise in volatil­i­ty is bil­lion­aire Vin­cent Viola’s Vir­tu Finan­cial, a high-fre­quen­cy trad­ing firm that han­dles 20 per­cent of all equi­ty trades in the U.S. stock mar­ket every day — that saw its prof­its plum­met along­side the reduc­tion of volatil­i­ty in the mar­kets. After this past week, Vir­tu now rides high” with its share price jump­ing 40 per­cent in two days. Vio­la, the founder and Chair­man Emer­i­tus” of Vir­tu, has sig­nif­i­cant ties to Don­ald Trump, who briefly nom­i­nat­ed Vio­la as Sec­re­tary of the Army in 2017.

While it’s impos­si­ble to prove that the lev­el of manip­u­la­tion that occurred with LIBOR and the 2008 finan­cial cri­sis is hap­pen­ing now, there is motive and oppor­tu­ni­ty: Wall Street’s largest trad­ing desks were neg­a­tive­ly hit by low volatil­i­ty, and the same banks and hedge funds have con­trol over hun­dreds of bil­lions of dol­lars that can influ­ence price swings in the mar­kets. And for their bets on price swings in a volatile mar­ket to pay off, Wall Street has to have some­one on the oth­er side of that bet: the dumb mon­ey of pen­sion, 401(k)s, and mutu­al funds. The rise of high-fre­quen­cy trad­ing firms like Vir­tu come at the expense of every­one else.

So what needs to hap­pen to pro­tect these ordi­nary investors from such fluc­tu­a­tions? In a Feb­ru­ary In These Times cov­er sto­ry, Liza Feath­er­stone and Doug Hen­wood lay out one smart solu­tion — a mas­sive expan­sion of Social Secu­ri­ty so that peo­ple aren’t depen­dent on deeply cor­rod­ed mar­kets for their sav­ings and retirement.

Anoth­er good idea would be to elim­i­nate the tax exemp­tion for munic­i­pal bonds, and com­pelling pen­sion funds to invest in munic­i­pal bonds instead of Wall Street. This would end a huge tax shel­ter for the rich, while return­ing pub­lic pen­sion funds to the invest­ment strate­gies that worked well for them through the end of the 1960s.

A revived Glass-Stea­gall Act to sep­a­rate com­mer­cial and invest­ment bank­ing would also help to stamp out mar­ket manip­u­la­tion by rein­ing in the pow­er of banks like Gold­man and JP Mor­gan. But for these things to hap­pen, there needs to be a more adver­sar­i­al pub­lic atti­tude towards high finance. The stock mar­ket isn’t guid­ed by an invis­i­ble hand: There are real peo­ple behind it and prof­it­ing from it — and it isn’t you.

Matthew Cun­ning­ham-Cook is a labor researcher and writer liv­ing in Prince George’s Coun­ty, Mary­land. You can con­tact him at m.cunninghamcook [at] gmail​.com.
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