Wall Street's Fraud and Illusion of Social Utility

On April 5 2016, someone posted a story on DailyKos assailing Senator Sanders’ claim that “the business model of Wall Street is fraud.” I was shocked to see the story had enough support to elevate it to the DK recommended list, despite these provably false statements:

...to say that the “business model of Wall Street” is fraud “to a significant degree” is completely irresponsible.  Do you know what else is part of their business model?  Helping enterprises raise capital in order to innovate and grow and provide goods and services to the economy.

On reflection, I realized that there are a lot of new people reading DailyKos who are—how to put this politely?—not completely aware of certain facts. Once or twice a year, Kos proudly notes how many more people are reading this site—which is great and certainly something to be proud of. But, it obviously means that we need to begin a new cycle of educating people about economics, banking, finance, Wall Street, and so on. The facts clearly show that Wall Street is NOT a net benefit to society, but a major reason why the United States continues to suffer poor economic performance for the bottom ninety percent of Americans.

The large graph above was compiled by the staff of the New York Times, and published on November 7, 2011. It is based on reports and other documents of the Securities and Exchange Commission going back to 1996. I like it because

1) it includes the specific law or regulation that has been violated;

2) it includes the names of the financial firms that committed violations—and the list include all the large Wall Street firms; and

3) the chart shows clearly that specific financial institutions have committed repeated, serial violations.

I would hope that just this graph alone would convince anyone of how stupid, ignorant, and/or deceitful it is to claim that Wall Street’s business model is not based on fraud. But the reality is that the graph captures only a very small part of the mendacity, deceit, fraud, and lawlessness that characterizes almost every aspect of Wall Street’s operations. Much of what I present below was initially presented in an excellent and exhaustive collection of links on WashingtonsBlog in May 2014: 6 Years After the Financial Crisis Hit, The Big Banks Are Still Committing Massive Crimes.

Oil market manipulated

In August 2008, Global Research’s F. William Engdahl, author of numerous books and article on the geopolitics of the oil industry, wrote that “As much as 60% of today’s crude oil price is pure speculation driven by large trader banks and hedge funds.”  Engdahl’s research is corroborated by former Director of the Division of Trading and Markets at the Commodity Futures Trading Commission (CFTC), Michael Greenberger.  Here is a collection of documents by Greenberger, including his testimony before the U.S. Senate Committee on Commerce, Science, and Transportation, and the U.S. House Energy and Commerce Subcommittee on Oversight and Investigations, both in June 2008. In May 2013, the European Commission began a major investigation after concluding that oil prices have been manipulated for many years. In April 2016, it was revealed that large banks in New York and London aided Unaoil in bribing governments worldwide to manipulate oil prices.

Other commodity markets manipulated

Big banks and government agencies have been conspiring to manipulate commodities prices since the 1990s—demonstrating that Wall Street’s capture of the regulators in government is not new at all:

In 1991, the CFTC started issuing exemption letters.  The first letter was written to J. Aron, a subsidiary of … Goldman Sachs.

Pretty soon, every major bank in the U.S. was given an exemption.

Congress didn’t know about the exemptions.  Indeed, the House Agricultural Commission – which oversees the CFTC – didn’t even find out about the exemptions until 6 years later … in 1997.

When a congressman on the Agricultural Commission asked the CFTC for a sample of one of the exemption letters, the CFTC official said he had to ask Goldman Sachs whether or not the CFTC could show a copy to Congress.  In other words, the banks were already running D.C. by the 90s.

Commodities speculation has exploded since the exemption letters were issues.
For example, in 2003, there was only $29 billion in speculative activity in the commodities markets.  By 2007-2008, there was over $300 billion in commodities speculation.

In July 2010, the British organization Global Justice Now issued its report The Great Hunger Lottery - How banking speculation causes food crises. In November 2013, Global Justice Now reported that just five banks made £2.2 billion (around $4 billion) from food speculation in 2010-2012. The five banks—Goldman Sachs, Barclays, Deutsche Bank, JP Morgan and Morgan Stanley—are the largest global banks involved in food commodity speculation. In its overview of the problem of bank speculation in food commodities, Global Justice Now estimated that

In the last six months of 2010 alone, more than 44 million people were driven into extreme poverty as a result of rising food prices. At the same time, banks and financial investors are making a killing. We estimate that Barclays makes up to £340 million a year from betting,

Big banks have reportedly also taken over important aspects of the physical economy – including uranium mining, petroleum products, aluminum, ownership and operation of airports, toll roads, ports, and electricity – to manipulate market prices.

Fraud in the US treasury bond market

Every day in America, news reports provide hourly summaries of the latest indicators of the USA stock market, such as the Dow Jones Industrials Index, or the Standard and Poors 500 index. But the stock market is actually one of the smallest of the financial markets. In terms of capitalization (the market value of the face amount of all stocks or bonds) the USA bond market is nearly twice as large: the total capitalization of the USA stock market is $21 trillion; while the bond market is $37 trillion. In terms of daily trading, the USA Treasury bond market is three times or more larger than the stock market.

In September 2015, Bloomberg reported that the auctions that underpin the USA Treasury bond market have been rigged for years, according to a 115-page lawsuit filed in Manhattan federal court on behalf of a number of pension funds by Quinn Emmanuel Urquhart & Sullivan LLP and other law firms against the 22 primary dealers who serve as the backbone of Treasury trading—including Citigroup Global Markets Inc., Credit Suisse Securities (USA), Goldman Sachs, JP Morgan Chase, Morgan Stanley, UBS Securities, and Wells Fargo Securities. According to the Bloomberg article, the plaintiffs have based their case on data  which indicates that more than two-thirds of a certain type of Treasury auction have been rigged to favor the primary dealers.

Fraud in world’s foreign exchange (currency) markets

Here I think it essential to supply historical background, because today, only about a third of Americans now living were alive at a time when there was no speculative foreign exchange trading at all. Foreign exchange trading or forex is trading of one nation’s currency for another’s, such as trading U.S. dollars for Japanese yen, or Swiss francs for Swedish krona. From the end of World War Two, until the early 1970s, forex was strictly related to one of four things:

1) actual foreign trade of goods or services between countries;

2) the need of people traveling out of country to change the currency of their home country into the currency of the country they were traveling to;

3) payments between governments, such as payments by the U.S. government to other governments for “basing rights” for U.S. military installations in those countries, or payment of aid to and from countries, such as the former Soviet Union to Cuba; and

4) illicit cross-border movement of things such as narcotics, weapons, human slaves, and covert intelligence operations.

In 1960, for example, there was $47 billion in forex conducted in the USA, an almost exact one-to-one match to the $25.9 billion in exports plus $22.4 billion in imports of goods and services.
In the nearly three decades from 1945 to 1971, the exchange rates of currencies were rather strictly controlled under the August 1945 Bretton Woods agreements between 44 Allied nations. These nations’ currencies were set in narrow band of values in relation to the USA dollar, and the USA dollar in turn was valued at 35 to one ounce of gold (one ounce of gold equaled $35). But on August 15, 1971, President Richard Nixon announced what amounted to the end of the Bretton Woods system: the suspension of the convertibility of dollars into gold. This ended the post-World War 2 era of fixed exchange rates.

It is the world’s single most momentous decision of government economic and financial policy in the entire post-war period, up until today. Nixon’s decision meant that exchange rates could float, or rapidly shift in relative value, entirely independent of any action by any government. This allowed massive, and I mean massive, amounts of speculative forex trading. In 2001, for example, while there was $1.94 trillion in total imports and exports of goods and services, there was $254 billion in forex trading every day. That works out to $60.96 trillion for the entire year. (See the 2001 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity by the Bank for International Settlements.) In other words, there was over 30 times more forex trading than there was actual trade in goods and services—a very far cry from the near one-to-one ratio of 1960.

But the big banks of Wall Street, the City of London, and other world money centers were not content with this huge new bonanza. Rigging any market they’re involved in appears to now be instinctual. In December 2013, Bloomberg reported that Secret Currency Traders’ Club Devised Biggest Market’s Rates:

...regulators from Bern to Washington are examining evidence first reported by Bloomberg News in June that a small group of senior traders at big banks had something else on their screens: details of each other’s client orders. Sharing that information may have helped dealers at firms, including JPMorgan Chase & Co., Citigroup Inc., UBS AG and Barclays Plc, manipulate prices to maximize their own profits, according to five people with knowledge of the probes.

Just under a year later (November 12, 2014, Reuters reported that regulators had imposed $4.3 billion in fines on major banks after an initial investigation. The banks fined were: HSBC Holdings Plc, Royal Bank of Scotland Group Plc, JPMorgan Chase & Co, Citigroup Inc, UBS AG and Bank of America Corp. In May 2015, Citigroup, JPMorgan Chase, Barclays and Royal Bank of Scotland pleaded guilty to manipulating currency markets, and agreed to pay a $7.5 billion dollar fine. According to the New York Time’s report, the

scandal...unfolded nearly every day for five years. The crimes described on Wednesday also painted the portrait of something more systemic: a Wall Street culture that enabled many big banks to break the law even after years of regulatory black marks after the crisis.“If you aint cheating, you aint trying,” one trader at Barclays wrote in an online chat room where prosecutors say the price-fixing scheme was hatched.

Interest rates manipulated since 1991

The first thing that should be noted is that—like forex—only about a third of Americans today have lived during a time when interest rates were very strictly controlled by government regulation and intervention. A July 2009 report by the Center for Economic and Policy Research, A Short History of Financial Deregulation in the United States (pdf file), provides a brief but excellent review of these issues: the two sections on the shredding of usury laws and interest rate regulations is less than four pages long. The two key events were:

1) The 1978 U.S. Supreme Court ruling in Marquette National Bank v. First of Omaha Service Corp., which held that nationally-chartered banks lending across state lines were governed by the laws and regulations of the state in which they were incorporated, not the states in which they lent money to customers. This initiated a “race to the bottom” of financial firms, especially those offering credit cards, relocating or creating subsidiary headquarter in the states with the most industry-friendly regulation.

2) The passage and signing into law in 1980 of the Depository Institutions Deregulation and Monetary Control Act, which began the complete elimination of all regulatory caps on interest rates.

(See also Kevin Phillips, American Theocracy: The Peril and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century (2006), pages 290-291, for three paragraphs succinctly listing 10 major landmarks in financial deregulation; and  Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (2010), Chapter 3, “Wall Street Rising.”)

Today, the largest fraud in terms of sheer size is the rigging of LIBOR—the London Interbank Offered Rate, which is used as a baseline in financial derivative contracts amounting to over $800 trillion. That is slightly more than 10 times the size of the entire world economy. Experts have stressed that the LIBOR fraud was both the largest insider trading scandal and the largest financial scam in world history. On 27 July 2012, the Financial Times published an article by a former trader who stated that manipulating LIBOR has been common since at least 1991. Among the biggest losers in the rigging of LIBOR were state and local governments which lost an estimated $10 billion.  Even though a RBS subsidiary in Japan and a handful of other banks have been fined for interest rate manipulation, the BBC reported in February 2013 that LIBOR is still being manipulated.

(Again, to stress the point that there once was a time, before many of you were born, when financial markets were tightly regulated: LIBOR was not conceived until October 1984, and unveiled about two years later. See also Federal Reserve Bank of New York, LIBOR: Origins, Economics, Crisis, Scandal and Reform (pdf, March 2014).

In May 2015, USA Securities and Exchange Commissioner Kara M. Stein publicly released her strong dissent from a recent SEC decision to “allow Deutsche Bank to maintain its well-known seasoned issuer (“WKSI”) status, which would have been automatically revoked as a result of its criminal misconduct” in the rigging of LIBOR:

Deutsche Bank’s illegal conduct involved nearly a decade of lying, cheating, and stealing. This criminal conduct was pervasive and widespread, involving dozens of employees from Deutsche Bank offices including New York, Frankfurt, Tokyo, and London. Deutsche Bank’s traders engaged in a brazen scheme to defraud Deutsche Bank’s counterparties and the worldwide financial marketplace by secretly manipulating LIBOR. The conduct is appalling. It was a complete criminal fraud upon the worldwide marketplace…. Numerous Deutsche Bank derivatives traders communicated their desire to manipulate LIBOR to Deutsche Bank pool and money market derivatives traders, causing the pool and money market derivatives traders to submit false and misleading LIBOR contributions. These derivatives traders would then enter into derivatives transactions tied to LIBOR with unsuspecting counterparties who were unaware of Deutsche Bank’s criminal manipulation of LIBOR going on behind the scenes. These counterparties included universities, charitable organizations, and other financial institutions.

Everything Can Be Manipulated through High-Frequency Trading

Traders with high-tech computers can manipulate stocks, bonds, options, currencies and commodities, and anything else traded on financial markets by using computer trading programs which direct buy and sell orders in just thousandths of a second.  Goldman Sachs has admitted that its computer trading programs can be used to manipulate any market. In March 2013, a Dutch company unveiled a new microwave network in Europe solely dedicated to HFT. The company’s 13 microwave towers cut the time it takes to transmit orders between London and Frankfurt by 4.43 milliseconds, or about 50 percent compared to cross-channel cable. Anyone looking at this process from the outside knows instinctively that buying a company’s stock or bond, or whatever, then selling it less than a second later, has absolutely nothing to do with the actual business performance and prospects of that company, or with supplying that company with financing.

On January 31, 2016, Business Insider reported:

Officials at the Australian Securities and Investment Commission have described the possible impact of HFT as “sometimes manipulative or illegal”, but “often predatory”.
In Australia HFT has made significant inroads into the market. In 2015 it accounted for nearly one-third of all equity market trades, a level similar to Canada, the European Union, and Japan.

ASIC estimates that HFTs in Australia are collectively earning an not inconsequential $100 million to $180 million annually.

Manipulating Numerous Markets In Myriad Ways

The June 2013 post on Washington’s blog ended with a cascade of links showing that every single financial market is massively rigged and rife with fraud:

The big banks and other giants manipulate numerous markets in myriad ways, for example:

• Engaging in mafia-style big-rigging fraud against local governments. See this, this and this

• Shaving money off of virtually every pension transaction they handled over the course of decades, stealing collectively billions of dollars from pensions worldwide. Details here, here, here, here, here, here, here, here, here, here, here and here

• Charging “storage fees” to store gold bullion … without even buying or storing any gold . And raiding allocated gold accounts

• Cheating homeowners by gaming laws meant to protect people from unfair foreclosure

• Pushing investments which they knew were terrible, and then betting against the same investments to make money for themselves. See this, this, this, this and this

• Engaging in unlawful “frontrunning” to manipulate markets. See this, this, this, this, this and this

• Engaging in unlawful “Wash Trades” to manipulate asset prices. See this, this and this

• Otherwise manipulating markets. And see this

• Participating in various Ponzi schemes

• Charging veterans unlawful mortgage fees

• Cooking their books (and see this)

• Bribing and bullying ratings agencies to inflate ratings on their risky investments
• The U.S. Federal Energy Regulatory Commission says that JP Morgan has massively manipulated energy markets in California and the Midwest, obtaining tens of millions of dollars in overpayments from grid operators between September 2010 and June 2011.

The Biggest Fraud: Getting You to Believe Wall Street Has a Socially Useful Role

From Debunking the Great Myth of the Financial Markets, which I posted in May 2009,

Suggestions to solve the financial crises by basically shutting down most of Wall Street are always shouted down by howls of "How are companies going to raise money?" or "How are people going to invest in companies?"

Well, take a good, long look at this graph, which shows the percentage of capital expenditures by U.S. non-financial companies that was raised in U.S. financial markets from 1952 to 2006. 

Financial markets provide less than zero percent of the funding for capital expenditures by non-financial companies (NFCs). “Less than zero percent” means the financial markets are taking money OUT of non-financial companies, exactly the opposite of the myth that Wall Street provides financing to companies in the rest of the economy.

Wall Street simply is not doing what most people think it's doing. Nor what most people think it should be doing. Wall Street is not even doing what it says it is doing. Wall Street is pushing a big myth that its services are essential to the functioning of the rest of the economy. But the truth as, as this graph shows, Wall Street does not -- and has not for a very long time -- serve the function of allocating credit in the economy….

...the fact that the financial markets contribute so little to the most crucial operations of non-financial companies is just the beginning of the story. The financialization of the economy has had severe effects on the goals and objectives of NFCs (non-financial companies), not just their operations and capital expenditures. What has really happened is that while the size of financial markets and types of financial instruments and transactions have increased, non-financial companies have been forced to abandon the long-term planning and goals of industrial capitalism, and instead adopt the short-term perspective and "quick buck" goals of the financial markets.

John Bogle, founder of the world’s largest group of mutual funds, the Vanguard Group, has written an entire book on the subject, entitled, The Clash of the Cultures: Investment vs. Speculation. Bogle has calculated that the financial system destroys $500 billion in value every year. Put another way, in less polite words: the financial system extracts $500 billion in loot from the rest of the economy every year.
A few weeks ago, there was an interesting interview with Rana Foroohar, author of  Makers and Takers: The Rise of Finance and The Fall of American Business. Foroohar chronicles the rise of the financial industry and its destructive impact on the global economy.

But only 15 percent of all the money flowing through financial institutions today ends up in businesses. The rest of it is staying within the closed loop of the market itself. It’s being traded.

In June 2012, I posted Neo-liberalism, De-capitalization/De-industrialization, and the Res Publica on Naked Capitalism, examining the evidence that this process of financialization and the dominance of Wall Street has resulted in the United States economy becoming less capital intense—in other words, less capitalistic—and less entrepreneurial.

For example, fixed investment by manufacturing companies as a percent of GDP has fallen to less than half what it was during the 1950s through 1970s. In December 2011, Steve Roth posted Capital in the American Economy Since 1930: Kuznets Revisited, and reported that he had found:

The most notable and consistent postwar trend is the decline in net investment, even while gross investment remained mostly flat with slight decline, and capital consumption increased slightly. Those two small trends compound to result in the quite large (35%) decline in net investment as a percent of GDP from the 50s to the 00s.

This de-capitalization and de-industrialization of the U.S. economy is often attributed to globalization and the pressures of foreign trade, but I think this argument is largely a diversion from the role Wall Street and the financial system have played in looting America’s industrial base and working force. And make no mistake: the stagnation of USA wages for the past four decades is directly tied to the financialization of the economy. As former AFL-CIO economist Thomas Palley explained in The Debt Delusion in February 2008 (before the collapse of Bear Sterns laid bare the rot within the financial system):

America’s economic contradictions are part of a new business cycle that has emerged since 1980. The business cycles of Presidents Ronald Reagan, George H.W. Bush, Bill Clinton, and George W. Bush share strong similarities and are different from pre-1980 cycles. The similarities are large trade deficits, manufacturing job loss, asset price inflation, rising debt-to-income ratios, and detachment of wages from productivity growth. The new cycle rests on financial booms and cheap imports. Financial booms provide collateral that supports debt-financed spending. Borrowing is also supported by an easing of credit standards and new financial products that increase leverage and widen the range of assets that can be borrowed against. Cheap imports ameliorate the effects of wage stagnation.

This structure contrasts with the pre-1980 business cycle, which rested on wage growth tied to productivity growth and full employment. Wage growth, rather than borrowing and financial booms, fueled demand growth. That encouraged investment spending, which in turn drove productivity gains and output growth.

Palley’s overall schema of the shift from an economy based on rising wages and increased productivity, to one based on inflation of assets and increased debt, is another way of describing how the U.S. economy is being made less capital intense, or de-capitalized. If a corporate raider or “private equity partner” is able to gain control of an industrial company for $1 billion, and is able to break it apart and sell it piecemeal for $1.2 billion, the nation’s capital intensity has NOT been increased. The stock of capital did NOT increase by $200 million, contrary to all the numbers on all the financial statements dutifully reported by the dupes of the financial press. And this is an extremely simple example. Reality is more often characterized by complex financial arrangements that, when boiled down, amount to asset stripping and outright de-capitalization through imposing debt. These are not new tactics: Donald Bartlett James Stewart detailed this financial piracy in a nine-part series originally published by the Philadelphia Inquirer in October 1991, which was published as the book America: What Went Wrong?.

I want to end by quoting again from the recommended story on DailyKos in April 2016:

...to say that the “business model of Wall Street” is fraud “to a significant degree” is completely irresponsible.  Do you know what else is part of their business model?  Helping enterprises raise capital in order to innovate and grow and provide goods and services to the economy.

And ask people: how is it possible that so many people who consider themselves part of the fact-based liberal community, can be so wrong?