GAME OVER : The Rise Of Dictators Via Economic Crisis and The End of Our Financial Illusions


The Rise Of Dictators Via Economic Crisis

Michael MaloneyBy Michael Maloney

 

In this instalment, we travel to Berlin and Frankfurt, where we were able to film the money museum inside the Bundesbankone of the world’s largest Central Banks.

This episode serves as an ideal primer for those waking up to the monetary matrix around them, as it clearly shows the history of true money and why it so important to our freedom.

The quality of a society is directly proportional to the quality of its money.

Debase a currency for long enough, and you end up with dangerous deficits, debt driven disasters, and eventually...delusional dictators. History proves this to be true.

For further insight on what it was like to film inside a central bank, check out the Exclusive Presentation that goes along with this episode at our website. In it, Mike tells what it was like to look at the displays and explanations from an Austrian Economics perspective.

He also shows where he believes we are in the following cycles:

Inflation/Deflation
Quality Money/Quantity Currency
Capitalism/Collectivism

It’s a fantastic 30+ minute presentation which also reports on personal freedom, gold and silver, the US dollar, and economic freedom.

Now I’d like to ask you , the reader, to dwell for a minute on Mike’s last question in the video:

What use is money if you don’t have freedom?

London evening standard LogoThe flash boy: Brad Katsuyama on Wall Street scandals and the morality of money

Michael Lewis’s new book on rigged trading has caused a storm in the City. In his first British interview its hero, whistleblower Brad Katsuyama, talks Wall Street scandals and the morality of money with Toby Green

Crusader: “Anyone with a pension or retirement is an investor in the stock market,” says Brad Katsuyama, who believes those markets should be fair and neutral (Picture: Chris Goodney/Bloomberg via Getty)

Crusader: “Anyone with a pension or retirement is an investor in the stock market,” says Brad Katsuyama, who believes those markets should be fair and neutral (Picture: Chris Goodney/Bloomberg via Getty)

Brad Katsuyama realised it was a pretty big deal when best-selling author Michael Lewis flew out to Canada to meet his parents and childhood friends. But only once Flash Boys — the latest exposé of Wall Street from the writer of hits The Blind Side and Moneyball — was finished did Katsuyama find out he was the hero of the whole book.

“Though I knew that I was going to play a central role, it wasn’t until I had the book in my hands and was flipping through the pages that I looked at my wife and said, ‘Oh my gosh’,” says the 35-year-old.

Since its publication less than a month ago, Flash Boys has split the financial world — both in the States and here in London. Yet Katsuyama certainly wasn’t an obvious candidate to take on the modern-day wolves of Wall Street.

A mild-mannered Canadian, he was about as far as you could get from the flashy, Gordon Gekko-like stereotype of a Wall Street trader. When the story starts he was working in New York, where he had moved when he was 23, for Royal Bank of Canada a fairly nondescript bank compared with the Goldman Sachses of the world, with a reputation for being a bit, well, nice.

But Katsuyama had discovered what he believed was a way traders were using computers to rig stock markets and screw over the general public.

Trading is now a million miles away from men in suits shouting and waving bits of paper at each other — it has virtually all been computerised for decades. Traders still decide when to buy or sell shares; they just do it from their computer screens.

But many use algorithms to trade for them. If the computer sees a lot of shares in, say, Tesco being bought, it can be programmed to start buying as well and crucially make that decision in a tiny fraction of a second.

This so-called high-frequency trading, Katsuyama is eager to point out, isn’t necessarily a bad thing. But what he found was that some programs were not just reacting to shares being bought; they seemed to be pre-empting the orders.

He would go to buy a share, and in the time between clicking the button and the order being completed — a fraction of a second — the price had risen.

His journey to find out why this was happening led him down a warren hole in which

he discovered traders were exploiting the fact that different stock exchanges received orders at slightly different times — a matter of milliseconds, but crucially enough for the computers to jump in ahead of the trades.

The race for speed was so fierce that firms would pay to put their computers as near as possible to the stock exchanges, cutting down the distance their orders had to travel. One firm spent millions to install a fibre-optic line as straight as possible between Chicago and New Jersey, sites of two exchanges, and traders were charged a small fortune to use it, just to shave off three milliseconds.

Common cause: ex-Wall Street trader Michael Lewis approached Brad Katsuyama to help with his book shining a light on dark financial practices.

Common cause: ex-Wall Street trader Michael Lewis approached Brad Katsuyama to help with his book shining a light on dark financial practices.

Katsuyama was shocked by the discovery and adamant that this side of high-frequency trading was unfair to the general public. “Anyone with a pension or retirement is an investor in the stock market,” he says. “I think that there is  an underlying belief, or there should be this underlying belief, that the markets are fair and that the markets are neutral, and I think that what we’ve seen over time is that the markets have become unfair in certain ways.”

So he decided to expose the practice — coming up with a computer program to neutralise it and starting to tell Wall Street about what was going on.

In Flash Boys, Lewis describes Katsuyama‘s thought process thus: “It feels like I’m an expert in something that badly needs to be changed. I think there are only a few people in the world who can do anything about this.

If I don’t do something right now — me, Brad Katsuyama — there’s no one to call.”

Katsuyama says it wasn’t hard to decide to shine a light on what was happening: “I had spent my career trading on behalf of clients and it just seemed natural to take this information to them.”

Lewis, a former Wall Street trader himself whose success as a writer has been built on turning complicated subjects — often financial — into gripping tales, heard about what Katsuyama was doing and approached him about helping with his latest book. Katsuyama, who has two young children, knew this would put his head above the parapet: “I talked to my wife and said to her, ‘Are you OK if this doesn’t work, if I never work on Wall Street again?’ And she was OK with it, and so was I.”

Still, knowing the anger the book was going to create, at one point he asked Lewis whether he should consider getting security: “Any time you’re looking to create change, you realise that those who don’t want change to happen will be very forceful in preventing it.”

The response to Flash Boys has bitterly divided Wall Street and sparked a furious debate across the rest of the world, nowhere more so than in London. There has been an outpouring of support — Katsuyama has received thousands of emails and calls, and people have even come up to him while he and his wife have been out to dinner.

But there’s been no shortage of critics —

it was “kind of shocking to see how many people within this industry are fighting back,” he says.

Most notably, Katsuyama was involved in a blazing row on live television with William O’Brien, the president of stock exchange BATS Global Market. Having left RBC, Katsuyama last year launched his own market venue, IEX, designed to remove the negative aspects of high-frequency trading, and an animated O’Brien attacked the book as a “300-page commercial” for the firm.

Katsuyama took a while to respond to the tirade but eventually fought back:

“I believe the markets are rigged, and I also think that you’re a part of the rigging. So if you want to do this, let’s do this.”

He was remarkably collected for his first live television appearance. “I didn’t know what to expect, to be honest — I think that a thoughtful discussion could have taken place. That’s obviously not what happened.”

The critics of the book, he says, have “come into this with a bias and they don’t want the market to change. They don’t want the market to be more transparent a lack of transparency is how a lot of these people make their living.”

On the very day the book was published it emerged the FBI was investigating high-frequency trading.

Other bodies have followed suit, although Katsuyama refuses to speculate about any link with the book.

Coincidence or not, there’s no doubting the effect Flash Boys has had, and it even looks likely to be the latest of Lewis’s books to be turned into a film. With Sandra Bullock having starred in The Blind Side and Brad Pitt in Moneyball, Katsuyama — who keeps fit by running and plans to do the New York marathon this year with his wife — doesn’t have a view on which movie star would play him. “We’ll leave that up to Hollywood if that ever becomes a possibility.”

The book is gripping Londoners just as much as New Yorkers — on its first day of publication Waterstones said it was the top seller in the capital. So does he think London’s Square Mile — already reeling from a number of scandals, from Libor rigging allegations to PPI mis-selling — has the same problem?

Although he’s a fan of fellow Canadian and Bank of England Governor Mark Carney, whose appointment he calls a “smart move”, Katsuyama is careful to clarify that his knowledge of the UK markets is more limited. But, he points out,

Wall Street and the Square Mile have many similarities.

Ultimately, he says, the financial markets in any country are being forced to become more open by a society which, thanks to the internet, is used to having knowledge at its fingertips. “Finance is a central part of any economy, but you have a society where it’s about free access to information and information for everyone. Then you have [financial markets] which have always been about private information, knowing more than the person that you’re trading against.”

The good thing? “It feels like society is winning right now.” And this is promising, he says, both for the financial world and the general public: “I think part of why Michael wrote this book, as sceptical as he was, is that there are actually people on Wall Street that are trying to restore trust and hope and faith that people can actually make money and run businesses and serve a greater purpose and serve society.

The wolves of Wall Street remain and are fighting back.

But “the good guys are growing in force,” says Katsuyama, “and they’ve never had a better chance of winning — ever.”

 

 The End of Our Financial Illusions

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The global financial crisis that broke out following the collapse of Lehman Brothers in September 2008 was a big shock. This is literally true in terms of the impact on investors and market prices; a wide range of financial variables moved rapidly in unexpected and worrying directions.

But what happened was also a shock to the realm of ideas about finance.

Before September 2008or at least before 2007, when some of the underlying problems first became more clearly manifest — the prevailing consensus among officials and specialists was that financial innovation was a good thing. In isolated instances, a particular new product might not work out as planned, as happens, for example, with medical innovation. But over all, the consensus went, financial innovation led by the private sector was making the system safer and more efficient.

This view was wrong.

In its day, this line of thinking justified the legal and regulatory changes that allowed some banks to become very large and to build up a much more complex range of activities in the 1990s and early 2000s, including through various kinds of opaque derivatives transactions.

In retrospect, much of the financial innovation in the previous decades built up risk for the financial system in ways that were not properly understood by regulators or, arguably, by management at some of the largest banks.

Of course, some bankers knew exactly what they were doing as their companies increased their debt relative to their equity. On average, large complex global banks had about 2 percent equity and 98 percent debt on the liability side of the balance sheet before the crisis, meaning they were leveraged 50:1 (the ratio of total assets to equity).

The good news is that the official consensus was shattered in 2008, and is not coming back. Systemic risk slapped everyone in the face with an undeniable wake-up call.

However, the process of reforming the financial system is still at an early stage. The Dodd-Frank financial reforms of 2010 represent a useful start — including the Volcker Rule‘s restrictions on excessive risk-taking — and the recently adopted Basel III framework for capital regulation nudges equity requirements higher.

But the world’s largest banks will, by one informed estimate, end up — as things currently stand — with about 3 percent equity and 97 percent debt as the average structure of their balance sheet liabilities. In the United States, if the latest leverage rule is implemented and enforced properly, this will become 5 percent equity and 95 percent debt for the biggest eight banks by 2018.

While 20:1 is better than 50:1, this is still not enough equity to assure a reasonable degree of financial stability in the foreseeable future.

The argument about finance has now shifted and is much more about whether capital requirements for the largest banks should be increased further. Those opposed to such a move offer three reasons why big banks should not be required to fund themselves with much more equity.

First, some people contend that the crisis of 2008 was a rare accident and Dodd-Frank fixed whatever problems existed. This is completely unconvincingparticularly because many of the same people have spent much of the last four years opposing and delaying financial reform.

Most importantly, it ignores the ways in which incentives and rules have changed since the 1980s. As James Kwak and I asserted in13 Bankers”, the structure of the financial system is quite different now from what it was in 1980.

In particular, the largest banks have become much bigger and more able to take on (and mismanage) much more risk.

The second argument is that the costs of the crisis were not huge, so there is no reason to fear a repeat. This is the view sometimes associated with former Treasury Secretary Timothy Geithner. (Mr. Geithner has a book coming out soon, and it will be interesting to see his current position on this point).

But the impact of any financial crisis is not measured primarily in terms of whether the Treasury made or lost money on specific investments.

The criteria instead should be what happened to output and jobs, as well as what the impact was on the country’s fiscal accounts. How much more public debt do we have now relative to what we had before — and what kind of lasting negative effects will that have?

Mr. Kwak and I took this on in “White House Burning”, putting the recent surge in public debt in the longer-run context of American fiscal policy. No matter how you look at it, the financial crisis was a complete disaster for the real economy and, given the way fiscal politics work in the modern United States, for the budget and for investments in any kind of physical infrastructure and education.

The third counterargument is that large complex financial institutions are needed because they provide some sort of magic for the broader economy. This still seems to be the view of some people at the Federal Reserve Bank of New York, which recently published a set of research papers on the topic.

But the benefits they find are small relative to the potential costs. Anat Admati and Martin Hellwig’s The Bankers’ New Clothes makes the vulnerability of modern banking abundantly clear.

recent report from the International Monetary Fund finds that the United States and other governments are providing large implicit subsidies to these big banks: The prospect of potential government support lowers their funding costs by about 100 basis points (one percentage point).

Many people are involved in the official sector’s rethinking of finance. This is the lasting contribution from books such as Sheila Bair’s Bull by the Horns, Neil Barofsky’s Bailout and Jeff Connaughton’s The Payoff”. In government circles, key decision makers were swayed by officials including Thomas Hoenig and Jeremiah Norton (both of the Federal Deposit Insurance Corporation) and Sarah Bloom Raskin (then on the Board of Governors of the Federal Reserve System; now at the Treasury Department). As chairman of the Commodity Futures Trading Commission, Gary Gensler had an immensely positive impact, both directly on the regulation of derivatives and also more broadly.

The Democratic senators Sherrod Brown of Ohio, Jeff Merkley of Oregon and Carl Levin of Michigan and Ted Kaufman of Delaware (who has since left the Senate), along with David Vitter, Republican of Louisiana, played key roles in shifting opinion. Elizabeth Warren’s work, both before and after her election to the Senate from Massachusetts, has also had great influence.

Of all the civil society organizations seeking to promote financial stability, Dennis Kelleher’s Better Markets stands out for its major impact through a relentless surge of arguments, comment letters and research. Its report on the cost of the crisis made clear beyond any reasonable doubt that the crisis had profound negative consequences for millions of people.

Many other officials have also shifted their views in important ways. We are not going back to the old ways of thinking about finance, and allowing for changes in these theories is an essential part of any modern economy. Finance needs to be regulated effectively, and large banks should fund themselves with much more equity than is currently the case.

 

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