Wednesday, September 7, 2011

Stocks, Bonds, and Honesty

The other day I called up my friend Larry and caught him in the middle of some on-line stock trading. “Actually, trading options,” he said, “And I’ve been doing pretty well.”

Seeing what shape the economy has been in, I expressed surprise. He spent the next 40 minutes or so explaining what ‘options’ were, and how they differed from ‘futures’, how both of them related to the stock market and investment companies, and so on. At the end of his explanation I was still mostly in the dark, but one pattern emerged clearly.

“It’s gambling!” I said, amazed. “The stock market is just a legal gambling casino, where people bet on, uh… other people’s perceptions of… the value of… percentages of… ownership of… companies that do real work! You know, that sounds downright sinful.”

“Bingo!” he laughed. “All investment – including banks – is gambling, but very few people realize it. That’s why our economy’s in its present mess.” He then went off into a ten-minute rant about how the government should never have bailed out the ‘stupid’ banks who made the same mistake that caused the 1929 Crash: treating loans, debts and mortgages as if they were real property, which they aren’t. “It should let those fools collapse,” he said, “And let the smaller, smarter banks pick up the pieces. The only problem with that is ‘transparency’: letting people know exactly what their assets are really worth. Anything else loses people’s confidence in their value. Those fool banks’ own secrecy has lowered the value of their assets.”

“…Because,” I realized, “It lowers people’s perceptions of the value of… Wow! Then if those banks had been totally honest, stated publicly everything they were doing, where every penny of their money was going, then everybody would have known what they were worth…”

“And their value couldn’t have gotten inflated, and subsequently deflated,” he finished the thought. “Besides, their investors would have seen when and where they made bad decisions, and would have called them on it. That’s precisely how and why the smaller, smarter banks have survived – to pick up the pieces, as they’re doing now.”

“And as you’re doing with your ‘options’,” I guessed. “So Ben Franklin was right; honesty really is the best policy.”

“Bingo!” he laughed again, and then sailed off into another rant about how, in the 19th century – before the Federal Reserve had even been dreamed of, before there was any FDIC ‘oversight’ or ‘insurance’ for banks, when America’s currency was entirely solid – the value of our money actually increased; what $1.00 would buy in 1800 could be bought for $.80 in 1900. Nobody really trusted banks then, but subjected them to constant scrutiny; the banks with the most obvious ‘transparency’ drew the most investors, and those that were secretive soon failed. “Truth can be a deadly weapon,” he finished.

But I was struck by another thought. During that same 19th century America, with its childlike belief in honesty, became one of the richest countries in the world. But there are plenty of countries – societies, cultures – in the world (I name no names) which hold that truth is a ‘precious jewel’: much too precious to be given away for free; no, it must be sold to the highest bidder, and even then it’s acceptable to cheat the buyer if you can. These same cultures – some of them millennia old – may have some incredibly wealthy individuals, but the majority of their people are dirt poor and always have been. Even the benefits of modern industry – most of it given outright to those societies by countries like America – haven’t made much difference. Could their very attitude toward honesty be the cause?

Why not? When you assume that everyone you deal with will lie and cheat you if he can, you respond by lying and cheating in turn; otherwise, the other guy will take you for a gullible fool, easily robbed, and he really will rob you blind. This makes any kind of transaction as slow and cautious as a hand-off between illegal drug-dealers – which is not the way to create a fast-moving, flexible, elaborate and sturdy economy. Those dishonest cultures have long histories of producing wily merchants and a multitude of thieves, and of playing economic warfare with their trade-partners – which usually ends in ruin. This is why these third-world countries have remained notoriously corrupt and poor, despite America’s and Europe’s best efforts to help them.

This is why I’m suspicious of people who insist that America must become more “global in outlook” and adopt a policy of “realpolitik”. They’re as good as saying that we must adopt an attitude of constant cynicism, lying and cheating: that we should become as corrupt as the nations we’re dealing with, or else let ourselves be robbed blind.

No, that way lies disaster. History and economics show us that we have to stick rigidly to our principles, uphold honesty and simply not deal with cultures that refuse to do the same, regardless of what tempting profits they may offer us in the short run. In the long run, honesty – transparency, as Larry called it – is what will save us.

Franklin, who hobnobbed with the courts of Europe and was quite familiar with “realpolitik”, knew whereof he spoke.



Anonymous said...

Amen, sister, sing it again.

I think you'd like David Brin's blog and his book "The Transparent Society" and his opinions of reciprocal accountability.

Ori Pomerantz said...

Where is the like button?

There was once a superstitious people, living on the western edge of the civilized world. They could be very violent when provoked, but they normally tried to keep their promises. They ended up conquering the world, and giving the western world the longest known period of mostly peace.

I'm talking, of course, about the Romans - but the parallels are pretty strong.

Antongarou said...

You're making the mistake of thinking about "the banks" as some nebulous individual entities. they aren't: the problem lies in the way that bank(and other) executives, which are individual entities, are compensated- the only metric that they're compensated by is short-term profit, and that's a pretty good incentive to maximize said profits while hoping that the collapse will happen on the next guy's watch. Especially if you believe in "too big to fail".

As to the banks collapsing...if these guys collapsed they would take a nice chunk of the global economy and most of the US economy with them. Something on the 25-50% of the US population would have probably lost a nice chunk of their savings exactly at the time they could least afford to lose them. Net probable result?A global depression that would have made the 30's look like a nice vacationing spot.

I do think that the US government would have been better advised to buy them outright, take them apart leisurely, and sell the pieces- IIRC that option wasn't even on the table. What I'm wondering about is why we saw no increase of regulation to stop such things happening again(which, barring total change in corporate culture is the only available measure).

Last Knight said...

I've always been a big fan of "trust but verify" myself. I don't assume that you're lying to me, or that you're mistaken in your portrayal of the facts, but neither do I act on what you tell me alone. In return, I strive to be honest and honorable in my dealings with others, but expect them to verify as well.

Leslie Fish said...

Hi, Grrl. Haven't had a chance yet, but will definitely look.

Hi, Ori. Heheheheh, yes, I've seen those parallels before. I also noted that, as it shifted from a republic into an empire and that empire grew bigger, it became more and more lumbered with bureaucracy -- which ultimately dragged it down.

Hi, Anton. Yeah, let the govt. buy them up and shake the trash out! If the govt. bought up all those foreclosed houses that the banks and mortgage companies are holding back to keep the prices up, and sold them for exactly what remains on their mortgages, we'd have no more homeless in America. Likewise I agree that we need a total change in our "corporate culture" -- perhaps by abolishing corporate law completely. Now I've seen some honest and responsible banks (such as the Cattleman's), but they're all small and outside the tacit alliance of banks like B. of A. and Chase. They'd survive if the dinosaurs died all at once.

--Leslie <;)))><

Leslie Fish said...

Hi, Knight. Agreed, "trust but verify". Also called "always check the story out". Americans have trusted, like children, to our institutions entirely too much -- and let them get away with outrageous lies as a result. We're going to have to learn to Check The Story Out much more often.

--Leslie <;)))><

Antongarou said...

Leslie, "corporate culture" is exactly what it says on the label. It has little, if anything, to do with regulations and a lot to do with the way executives are taught what's acceptable and what isn't by their peers, and what the stockholders are looking for from them(maximization of short-term profits, currently). Like any subculture, changing it without looking rather long for the right pressure point is something between "hard" and "impossible": deregulation will just remove some current pressures that are stopping its standards from causing more toxic damage. The current corporate culture(i.e. internal reward system+standards) rewards sub-clinical sociopathic behavior in top executives: it is expected that they lie, back-stab each other etc. but as long as they maximized short term profit, no matter at whose expense, everything's fine.

PS.One of the possible ways to make sure such behavior doesn't get encouraged is to make companies pay income tax on their profits, which encourages them to invest more in th company assets rather then running everything on barest minimum so they can send more profit to the stockholders.

Anonymous said...

Where did this idea of "short term profits" come from? I'm really getting tired of people using it without being able to provide examples or even explain what the businesses were supposed to do instead.

The issue is not short term vs long term profits, it's the fact that they are profiting at all. The government tried to regulate them into acting more like a charity than a bank. Then the banks change so they can make money off loosing money, and everyone complains that they shouldn't do that. Tough.

Does anyone really think the smartest business minds go into government? No, they go into a business where they get paid. The idea that government can outsmart the bankers is absurd.

Aya Katz said...

Whoever that person with the really long name consisting of random letters and numbers was, he has a point. But why does he have to hide behind such a funny name?

Honesty is good. But regulating the banks so that they have to give loans to people who are bad credit risks is not good. Government interference in commerce inevitably leads to convoluted practices by those regulated.

That said, all business is a bit of a gamble, even farming. If you grow food to feed yourself and your family, then you don't care how valuable your crops seem to others. The moment you start growing for resale, what other people think your crops are worth becomes more important than anything else. Supply and demand dictates commodity prices, not just the stock market. Growing a cash crop is gambling that there won't be an oversupply of that particular commodity that year.

Antongarou said...

What are executives rewarded on today?The company's performance during the last quarter, or at best year. How are they rewarded?With money or direct equivalent thereof. A good way to start changing the reward system would be to make the bonuses "mature" only several years after they have been given and make them dependent on the company's performance in the meantime, for example, so that executives will have incentives to look into middle-long term rather then solely on the short term.

Anonymous said...

That weird name was me, and I have no clue what's up with that.

As far as executive pay. The people determining it aren't as stupid as everyone seems to think they are. They care about the long term viability of a business. Most of them probably have most of their wealth tied up in the business. But if things look like it's all going down hill, they will take what they can before the business gets bought out. Or as happens now days, they get a bailout from the government.

If I remember right, it used to be that executives were rewarded with company stock (which improved in the long term), but government got upset with that for some reason. It doesn't matter how the bonuses are worked, someone will be upset by it.

Leslie Fish said...

Hi, Garou. Actually, what I had in mind is something more radical; abolish the laws that create "corporations" in the first place. If all businesses had to be "companies" or "partnerships" (probably the easiest thing for a former corporation to turn into) they'd be a lot more vulnerable to the wrath of their consumers -- and neighbors. They wouldn't have "responsibility to our stockholders" for an excuse anymore, and they'd damn-well have to think seriously about the long term.

--Leslie <;)))><

Aya Katz said...

Leslie, amen to that!

Peter G said...

Getting rid of corporations would probably be worse than the ill it's supposed to cure.

An easy example from my recent Hazwoper class. The US is very lucky it was a big corporation like BP that had the Deep Horizon oil spill. They have the assets to pay for the clean up. A small company, or a couple hundred families owning the rig, would have been totally wiped out while still not having close to the money needed to pay for it.