Friday, September 26, 2008

It's A Simple Game

All right, so far I've kept pretty quiet on the whole bank meltdown. I've been mulling this post in my head since reading my old friend Deadspot's excellent post on what he wants out of the bailout.

See the book at the top of this post? It's Adam Smith's classic "The Wealth of Nations," which was first published in 1776. It's sort of an owner's manual for capitalism. Unlike most people, including, presumably, most people working in on Wall Street and the banking industry, I've actually read it. I read it for an assignment in an Economics class in college and wrote a paper on it.

Remember in the movie Bull Durham where Trey Wilson's character, manager Joe Riggins, throws a tirade at the slumping Durham Bulls? He tosses an armload of bats across the locker room and yells at the players:

"This is a simple game. You throw the ball, you hit the ball, you catch the ball. You got that?!"

Adam Smith lays it out just like Joe Riggins. You get the materials. You hire some workers. You produce something. You sell it for more than the cost of labor and materials that you paid for. Your reward for your trouble is the difference between the costs of production and what you sell it for. It's called "profit."

Yet, somehow capitalists can't seem to manage to get it right. It's a simple game. Produce something someone wants to buy and sell it for more than it cost you. Or loan out some money with the anticipation of being paid back with some interest. Or lease or rent something you own for more than it cost you. Simple, right?

But if you read the Wall Street Journal or the business pages of the New York Times, you enter an alternate universe of bizarre economics. Hedge funds. Futures. Derivatives. "Flipping" property.

Reading about these guys, 28-year-old hedge fund managers who live in mansions on Martha's Vineyard, you got the impression that actually producing something seemed to be looked on as a sucker's game. The really big money was in the high stakes gambling of buying and selling increasingly amounts of precarious debt, debt that in their perverse universe got more valuble the riskier it was.

These people apparently have the attention span of four-year-olds. Remember the internet bubble, less than ten years ago? Remember how internet stock values rose and rose, until they defied the ability of even the best-performing companies to deliver a profit even remotely commensurate with the inflated stock values?

And of course they brought the rest of the stock market down with them, especially after 9/11. My parents, who were getting ready to retire, watched in horror as their retirement portfolio lost over a third of its value.

We keep learning the same lessons-- or maybe not-- over and over again. Remember the collapse of the Savings and Loan industry in the eighties? That cost us $500 billion to bail out that one. They keep making the same mistake, for hundreds of years, it turns out. The first time this happened in Western society was the Tulip Bubble of the 1600's in the Netherlands.

The tulip was first imported to Europe from Turkey, then part of the Ottoman Empire, in the late 1500's. Since tulips were able to tolerate the rough weather of Northern Europe, they rapidly gained in popularity. They became sought-after status symbols. Rich people contracted out with growers, and the first futures contracts were born, for tulip bulbs.

Throughout 1636, the spectulative price of tulip bulbs skyrocketed. Then, in February of 1637, the prices collapsed, and tulip bulb speculators learned the hard way what so many businesses have had to learn as well-- that in the end, no matter what your computer program, derivative, "gut" or whatever other method you have of figuring, that in the end, someone has to buy a rail-car full of pork bellies, pay a mortgage, purchase electricity (hello Enron)-- or a tulip bulb-- for you to make some actual real money. It seems like every ten years or so, business people need to find that out the hard way. Too bad we taxpayers always seem to be the ones who end up footing the bill for their lack of understanding that it's a simple game.


SkylersDad said...

It's a simple game until men with power get greedy, then it all crumbles...

MacGuffin said...

No fears, cutting out pork-barrel spending will solve everything, right?

I think there might be criminal investigations concerning the ratings agencies who gave AAA and AA rating to highly dubious mortgages bundled into securities which in turn were obscenely over leveraged. At least, there should be.

Great comparison btw.

FranIAm said...

What a great post Johnny Yen- you really break it down beautifully.

Tragically greed is something that never seems to change in any meaningful way. Of late I have simply been pondering why in the freaking hell anyone needs to earn amounts like $500 million a year, like some of these CEOs do.

It is sick sick sick.

Erik Donald France said...

Absolutely dead on.

(Smith also advocated letting the American colonies go independent, and then keeping them in the Empire's "free" trading system, yes? I read it, too, once upon a time ;)

Stone lays it out bluntly in Wall Street, also, with the old timers being the wiser characters.

I'm with Obama-Biden -- everyone making more than 250k needs to pay a lot more in taxes as part of their patriotic duty.

Menawhile, the Chinese have a space walking cosmonaut and the Russians make a deal with Venezuela. The beat goes on with us or without us.

Distributorcap said...

when we gave up manufacturing for moving money -- we were sunk. we dont make anything anymore - we ceded that to asia a long time ago --

this was all built on a house of cards - and you nail it perfectly. this is not capitalism - it is american capitalism - and it is an abject FAILURE. not only do we worship greed over anything else -- we also poo-poo anyone who wants to help those who dont profit from this house of cards -- call it socialism. which is INGRAINED in us as very very bad.

meanwhile while we are told socialism like cuba and china is bad, the socialism in sweden and norway seems to work out ok.

america is failing not only because of greed and and lack of leadership but because of lack of compassion and the narcisstic outlook we continue to hold so near and dear

MacGuffin said...

What I want to know is how the hell are we going to deal with the faltering 43 TRILLION dollar credit default swap market? With all global derivatives possibly equaling 500 TRILLION! What a handful of these financial wizards have done in fourteen years is probably the envy of terrorists everywhere, I'm sure! Bravo boys, br-a-vo!

Anonymous said...

Hi !.
You re, I guess , probably very interested to know how one can manage to receive high yields .
There is no initial capital needed You may begin to get income with as small sum of money as 20-100 dollars.

AimTrust is what you haven`t ever dreamt of such a chance to become rich
The firm incorporates an offshore structure with advanced asset management technologies in production and delivery of pipes for oil and gas.

Its head office is in Panama with offices around the world.
Do you want to become really rich in short time?
That`s your chance That`s what you really need!

I`m happy and lucky, I started to take up income with the help of this company,
and I invite you to do the same. It`s all about how to select a correct partner who uses your funds in a right way - that`s AimTrust!.
I earn US$2,000 per day, and what I started with was a funny sum of 500 bucks!
It`s easy to join , just click this link
and lucky you`re! Let`s take our chance together to feel the smell of real money

Anonymous said...

Hi there!
I would like to burn a theme at this forum. There is such a nicey, called HYIP, or High Yield Investment Program. It reminds of financial piramyde, but in rare cases one may happen to meet a company that really pays up to 2% daily not on invested money, but from real profits.

For several years , I make money with the help of these programs.
I'm with no money problems now, but there are heights that must be conquered . I get now up to 2G a day , and my first investment was 500 dollars only.
Right now, I managed to catch a guaranteed variant to make a sharp rise . Visit my blog to get additional info. [url=]Online Investment Blog[/url]