Closing the Wall Street Casino

The Elephant In The Room: Guest columnist and well-known economist Peter Morici shares some thought-provoking business insights in this great analysis of why kids are going to school to get degrees and no one is making things.

I recently received a superb business article from Roger Sustar, the owner and president of Fredon Corporation (Mentor, OH), a manufacturer of precision machined parts and assemblies. The War on Crime Revs Up on Wall Street was written by well-known economist Peter Morici, a professor in the Robert H. Smith School of Business at the University of Maryland. As Roger describes it, this article provides “a great analysis of why kids are going to school to get degrees and no one is making things.” See what you think.

THE WAR ON CRIME REVS UP ON WALL STREET
These days the Justice Department and the Securities and Exchange Commission are investigating Wall Street with tactics, such as wire taps, usually reserved for professional criminals and terrorists. Apparently those agencies recognize what the Treasury and Federal Reserve simply won’t admit: insider trading, robo foreclosures and peddling dodgy securities to unsuspecting investors are good old fashioned fraud. Like the corruption tolerated by Third World autocrats, those practices handicap American capitalism in global competition and undermine prosperity.

With subpoenas for executives at Treasury’s favorite son, Goldman Sachs, and Senate investigations into rogue trader SAC Capital advisors, legal pursuit is scaling up to a 1930s Hollywood gangland saga. And America’s most privileged are in the crosshairs. That’s sad, but not bad, because more than a decade of sharp practices and multi-million dollar bonuses on Wall Street have turned the stock market into a sucker’s bet for Main Street investors and handicapped American growth in the bargain.

Punitive settlements and convictions resulting from investigations into insider trading at Galleon and SAC, shoddy mortgage foreclosure practices at Bank of America, and the shady marketing of mortgage-backed securities at Goldman Sachs would ultimately curb cynical behavior and ever bigger paydays on Wall Street –  and improve returns for stock investors. Just as importantly, it would redirect American capital and talent toward more productive, job-creating purposes.

Think about it. In February 1998, the S&P 500 first closed above 1000. Since then, corporate profits are up about 210 percent, but equities less than 35 percent. Corporate profits rose 6 percent annually, but investing in stocks paid a disappointing 2.3 percent a year. Buying stocks doesn’t seem to pay because too much of the profits created by innovators with ordinary investors capital is captured by hedge funds, Wall Street trading desks, private equity houses and aggressive M&A shops, then paid to Wall Street executives and traders.

In the drive for ever bigger compensation packages, Wall Street’s best and brightest violate boundaries of ethical behavior and the law. Not all of our problems can be laid on Wall Street’s steps, but its culture of entitlement and sharp practices impose enormous burdens. Huge Wall Street incomes, juiced by duping investors, deprives pension funds and ordinary investors of the returns they are due on their stocks.

The absence of significant appreciation in equities for more than a decade means that many retirees dependent on IRAs and other defined contributions vehicles can no longer live comfortably, and many baby boomers who have been pushed into such pension vehicles cannot retire. Their money may be working hard, but only for Wall Street titans and not for them. It is sound public policy to encourage workers to save for retirement instead of relying on the promise of a defined benefit pension from an employer that may ultimately disappear, but contribution-defined pensions simply cannot work without a stock market that generates returns that follow the growth of corporate profits.

Americans expect carnivals and casinos to be stacked against them – gambling is entertainment and losses are expected – but capital markets are where the nation’s savings are supposed to be put to best uses, drive growth and create opportunities for the next generation.

These days, too much money and talent are directed into financial engineering efforts to design the next complex derivative. Not enough is going into physics and real engineering, such as designing electric cars, new materials, and products and services that will define U.S. global competitive success and prosperity for the next 25 years. The carnival culture on Wall Street is attracting too many young people to business schools to study economics and finance instead of pursuing physics and engineering. That’s why the best business schools are overwhelmed with applicants from Connecticut and California, while engineering colleges depend on students from China and Asia, who will then return home to compete with American businesses.

Increasingly, venture capital and stock investors are looking abroad for the best returns. This deprives small and moderate-sized U.S. companies of capital needed to expand and invest in new ideas and create jobs.

The Wall Street casino has misdirected what capital is invested in the U.S. During the boom of the last decade, America overinvested in housing and underinvested in industry by persuading investors to purchase bonds that funded “creative mortgages” for folks who could not then afford and are now losing 4000 sq ft homes, and to otherwise prosperous Americans to foolishly purchase second and third homes as investments against future appreciation. All proved to be poor bets and sewed robo the foreclosure scandal.

As the mortgage meltdown continues, consider how much more competitive the U.S. economy would be today – and how many more good paying jobs Americans would have – had all of those homes never been built and all of that money been redirected and invested in new technologies and expanding sound enterprises. Prosecuting Wall Street will do a lot to curb abusive practices and excessive compensation, make stocks and IRAs sensible investments, redirect capital and talent into productive purposes, and get the American growth machine back on track for our children and grandchildren. – Peter Morici

I believe Professor Morici has addressed an elephant in the room that the business community has chosen to ignore under a false pretense of capitalism for far too long.