written 24 May 2020
published 31 May 2020
I enjoy reading histories of financial disasters. Money is a powerful concept, a socially agreed upon symbol of value, allowing greater versatility in trade than the limits of straight barter. But being only concept, it is inherently divorced from experiential reality. For instance, if you are dying of thirst, water will save you. That is the real value of water, independent of how much money you have. Money could buy you water, if water is available, at a price you can afford, and the seller is willing, but money itself will not quench your thirst because it is only concept. Because the value of money is disconnected from reality, there are no intrinsic limits on how the value is assigned, opening the door for corruption and distortion. The most persistent distortion is the constant drive for increased return on investment decoupled from any change in reality.
"Enron: The Smartest Guys In The Room": McLean and Elkind (2003). Enron Energy Services began in 1985 by providing energy, but grew to become a powerhouse trading energy stocks. The key to their success was an accounting trick called "mark to market", which allowed them to claim all the future profits from a project in the fiscal quarter the deal was initiated, without ever being adjusted by subsequent reality. That this is legal points up the disconnect between concept and reality. To cover growing losses, offshore shell companies were created to warehouse the bad debt, keeping it off Enron's published balance sheet. This subterfuge helped Enron appear profitable and some people made millions. With the stock price growing every quarter, Wall Street loved Enron, and it was named the "most admired" corporation by Fortune magazine for six years in a row. Reality eventually prevailed and the dot-com crash revealed the sham. By November 2001 the stock had dropped to zero, wiping out billions in "shareholder value". All but a few lost everything, and a couple of people even went to jail.
"The Big Short": Lewis (2010). In the 1990's, driven by desire for increased returns, the mortgage industry began pooling thousands of home loans into financial products, which were sliced up into portions with varying risks and return rates, which were then sold to investors. This was very profitable, and therefore popular, and the pool of good mortgages was soon repackaged and sold. Then banks started using more questionable loans to satisfy continued investment demand.
The market expanded to the point where mortgage originators didn't even pretend to verify that a borrower could afford repayment. Bad loans were immediately sold up the financial food chain, and became "someone else's problem". Many loans were written with very low "teaser" interest rates, allowing anyone to qualify, which reset to higher rates several years later. When that began to happen in 2007-8, the housing mortgage market collapsed and whole regions went into default. The financial products based on these garbage loans had been rated investment grade by for profit agencies and sold globally. Nobody knew exactly what was junk, so trust was destroyed everywhere, and the global economy almost froze up. Trillions of dollars were pumped in by central banks and it took years for the economy to recover. Nobody went to jail, so no lessons were learned.
"Dark Towers": Enrich (2020). In the 1990's the staid Germany Deutsche Bank decided it wanted to join the high return activity generated by Wall Street, and began building an aggressive investment group, with a goal of 25% annual return. To get this kind of return required creative bookkeeping, very risky deals, and a willful disregard for the international law. A large percentage of their business involved laundering questionable Russian money into the western banking system. One of their high value clients was Donald Trump and his family, even though no other western bank would lend to them because of their poor credit record. Russian economic leverage over Trump runs through Deutsche Bank. The 2008 crash, combined with increased international scrutiny, has now forced a complete restructuring of Deutsche Bank.
The seduction of increased fiscal return inflates the inherent separation between reality and money, generating self-destructive bubbles within the monetary system, which inevitably collapse, causing lasting damage in the real world. When fiscal values trump human values, society suffers.
