Dangerous Games with Extreme Money

EXTREME MONEY: The Masters of the Universe and the Cult of Risk .
by Satyajit Das,
Penguin,514pp.
Reviewed: 17 September 2011

Money is the way we measure exchange of goods and services. Finance is the tactics and technologies for directing the circulation of money, for any purpose. Economics is the study of production, exchange and consumption of goods and services. This book delivers a horrifying picture of how Extreme Money (under-regulated, manipulative finance) has corrupted both the world of money and the world of academic and government economics.

Masters of the Universe is the label proudly worn by a large class of financial operators in Wall Street, London and their equivalents, including Australians. They build, operate and protect a financial system based upon fake valuation of assets, fake transactions, and fake profits, which may turn other people’s real savings into real losses, while the Masters pocket stupendous fees and “performance” bonuses for themselves.

The Cult of Risk is a little more arcane. The principle of risk lies at the heart of investment capitalism. In normal use, risk means the chance of profit or loss that is undertaken by anybody lending to, or investing in, another person or business. The higher the risk of loss to the investor, the higher should be the rate of return or of interest due to that investor. Calculation of risk is rarely perfect, but the formula is expected to benefit of both parties, so long as they share similar understanding and information about the risk that is being traded.

Ordinary consumers make risk decisions each time we decide on the level of insurance we want to purchase, or whether to put our savings in cash, bonds, equities or real estate. Rarely do we understand the extent to which our personal risks can be manipulated by the financial Masters of the Universe, essentially to their own private benefit. Risk is abstracted, repackaged and traded by the financiers, using derivatives and hedging techniques, to the point that neither buyer nor seller really knows the risk (and therefore the value) of the instruments being transacted. Ultimately, buyers exchange cash for false expectations of security. The smarter financiers take their bonuses in cash.

Satyajit Das has decades of professional experience as a risk analyst, first with a major Australian bank, then as an independent risk consultant. He has participated in the wheeling and dealing, bluff and counter-bluff, puffery and debacle of the financiers’ world of risk trading. The Cult of Risk is the separation of debt and risk-trading from the real world of the economy.

Das exposes the shambles of a system characterized by bogus and failed economic market theory, a shamelessly rapacious finance industry, and a broad failure by governments to protect either their citizens or their productive industries from a finance industry driven by the most perverse incentives.

He traces the many steps downwards toward the Global Financial Crisis and its continuing aftershocks. Financial institutions can effectively multiply their operating cash by issuing credit – essentially, printing their own money. Credit has brought many benefits to economies, but also multiplied the amount of financial risk that circulates and proliferates with no ultimate backing in real assets.

Real money comes from customers’ deposits and from shareholders’ funds, but the amount of credit extended by banks to their customers is eight times the amount of real money in circulation. With the label of “securitization”, bundles of risk-laden debt (such as sub-prime mortgages and credit-card debts) are repackaged and sold on as if they were secure assets, with no way for the buyer to understand the risk they are buying.

Banking deregulation has allowed banks to speculate with their depositors’ and shareholders’ funds, often disastrously. Financiers have been allowed to award themselves bonuses for speculative contracts at the time they are written, rather than when they are completed. They speculate in the financial risks born by real people and businesses, but for the most part can avoid any risk to their own gross remuneration. This is a clear example of moral hazard.

The Chicago School of Economics was espoused and funded enthusiastically from Wall Street, and has garnered several Nobel Prizes for economic theories that, when put into practice by financial institutions, have proved shallow and disastrous. The fundamental flawed has been failure to account for the greed, fear and ignorance that drive human behaviour in the real world.

Alan Greenspan, long-time Chairman of the US Federal Reserve, is castigated at length for his ideological commitment to Ayn Rand individualism, which blinded him to all evidence of failure in deregulationist neo-liberal finance policy. A whole generation of politically-favoured economists were essentially fundamentalists, who dismissed both contrary interpretations and inconvenient facts that did not suit their ideology.

The Masters of the Universe exploited these flawed policies to make personal billions from useless or destructive market manipulations, and the global economy is still paying for that. Behind the financiers’ marble façade is a flimsy wooden shack riddled with termites.

The book is packed with facts, case studies and incidents to support its basic polemic. Das writes colorfully, in short punchy sections, and countless memorable aphorisms – though I sometimes wondered whether less might have been more. If you don’t follow all the technicalities, you will still find a highly readable, though appalling, narrative.

The GFC has focussed short-term political attention on these issues, but that attention was too often lacking during the bull-markets and decades of growth. When house prices and the stockmarket appear to be rising, who dares to be a spoilsport? Even now we see finance journalists describing house-price inflation as “performance”.

New technologies, from the pocket calculator to the Internet and computerised split-second trading, accelerated the scale and velocity of financial circulation ultimately far beyond the capacity of human reaction. They have thus removed the customer or private investor ever further from the ability to know the true value of the risks they are undertaking. Das quotes widely from ancient historians, industry insiders and even post-modern cultural critics to show that underlying issues of trust, governance and human market behaviour are as old as history and as present as the sun. Don’t believe anyone who says, “It’s different this time”.

On the principle of Buyer Beware, do we suckers deserve sympathy? Das describes a world of finance in which the sellers play with loaded dice and the buyers, however wary, may never understand the product they are being sold. That is what economists call “market failure”, and the trigger for regulatory intervention.

Ultimately, the challenge is not to the buyers and sellers in the market, but to the credibility of governments. Today, Australian banks are fiercely resisting the introduction of strengthened prudential requirements that have been adopted by the global Basel Committee on Banking Supervision. While financiers in Wall Street, London and Sydney resume their well-resourced rent-seeking campaigns, governments in all the capitalist democracies face a significant crisis of public confidence in their ability to manage their economies.

Politicians, please read this book.

Richard Thwaites lives mainly on superannuation and modest investments, hoping to escape the attentions of financial predators.