… pretty soon we’re talking real money
By Bob Gaydos
Mark Zuckerberg lost $2 billion the second day after his company, Facebook, raised $16 billion in an initial public offering. Maybe you didn’t notice because Mark is still a long way from visiting the soup kitchen.
Facebook sold 421.2 million shares at $38 a share on May 17, a Friday, the biggest technology IPO in history. By Monday, the share price had dropped below $34, delivering that “blow” to Zuckerberg’s wallet. By the close of business Tuesday, Facebook shares had dropped to $31, but the founder, whose financial interest in the company stock was estimated at $17 billion, was reportedly enjoying his honeymoon and not fretting about the public’s judgment that his wildly popular social media enterprise was also wildly overvalued. He actually got married after the IPO (photo), which to me implies true love.
At roughly the same time, JP Morgan Chase, the bank that is too big and too smart to make an investment mistake, much less fail, announced it had blown $2 billion -- there’s that number again -- on something called synthetic derivatives. This is what we make in America today instead of shoes and cameras and tires and auto parts. Jamie Dimon, the Zuckerberg of JP Morgan, was uncharacteristically embarrassed and apologetic about the loss, which, as with Zuckerberg, barely put a dent in the JP Morgan bank account, although it did get some people fired.
The problem with the JP Morgan fiasco, though, is that it is a bank as well as an investment company and $2 billion is still a lot of money to lose. It tends to weaken people’s trust in your judgment and maybe even make them put their money elsewhere.
Even worse, nobody, not even supposed experts on complicated investment schemes, can seem to explain what the heck a synthetic derivative is in the first place. I asked a college business professor to explain it and all I got was a blank stare. As far as I can tell, a synthetic derivative seems to be something akin to a fantasy baseball league for bored stock traders looking to hedge their bets on other investments. Whatever that means. I think they make it up as they go along. The main requirement seems to be that not even the people who create it know exactly what they’ve created. Maybe Mary Shelley would understand.
Once upon a time, banks weren’t allowed to take such risks with clients’ money, but that was before all the smart Wall Street guys and gals convinced their bought-and-paid-for members of Congress that really, really, really, really, really big banks didn’t need to be regulated and could be trusted to deal responsibly with complex investments as well as mortgages and savings accounts. Why? Because they were really big and really smart and could make a heap more money for the people who were bankrolling congressional campaigns -- and for themselves. And because most politicians were too embarrassed to admit they didn’t have a clue what the big banks were up to.
I don’t venture into the world of high finance often because, like most Americans, never mind politicians, I don’t understand it very well. But at least I admit it. Plus, I get depressed hearing about $25 million golden parachutes for CEOs who mess up, lose other people’s money, but still somehow deserve to be handsomely rewarded for their service. It seems to me if you can’t hit a curveball anymore, you get released. Period.
I also find it had to understand why anyone these days would trust the same bankers who mortgaged this country’s future with phony baloney home loans to people who didn’t have a prayer of repaying them, then gobbled up federal bailout money to make profits, and then foreclosed on all those people to whom they gave bad mortgages -- often without bothering to do any real follow up on the loans and their clients to see if they could maybe work out a way to pay.
These are not honorable people. These are people who see only the need to make more money, in any way possible, including conjuring synthetic derivatives. I’d rather invest in a crystal ball factory. The people who work at these super banks are this way because no one has paid the price for their greed. They say they are merely applying the principles of a free market to their trade -- a market that returns less than 1 percent on savings accounts and charges fees every time someone answers a customer’s question.
This change in the approach to banking began at the end of the Clinton administration with repeal of the Glass-Steagall Act, which prohibited banks from co-mingling commercial and investment accounts. Risking clients’ savings by creating exotic investment packages and selling them to other clueless investors was forbidden.
In the wake of the 2008 banking crisis, the Dodd-Frank Bill was enacted, to return some modicum of regulation over the super banks that were created when Glass-Steagall was repealed. Part of that bill is the so-called Volcker Rule, which prohibits proprietary trading by commercial banks in which bank deposits are used to trade on the bank’s investments.
The rule is named after former United States Federal Reserve Chairman Paul Volcker, who was named chairman of the President's Economic Recovery Advisory Board by President Obama when he inherited the banks’ financial mess in 2008. Things being what they are in Washington these days, the Volcker Rule is not scheduled to go into effect until July 21 of this year. And no one expects that deadline to be met.
What’s more, some economists feel the rule is still too weak because it is full of exceptions and would not have prevented the JP Morgan Chase fiasco. (Volcker himself warned about the risks of derivatives.) All of this has, predictably, led to a lot of calls for stricter regulations on these super banks.
But Morgan’s Dimon, chagrined and embarrassed as he may be, isn’t ready for a return to the old days, when banks were banks and investment companies were investment companies and people knew their money was safe. In fact, he wants Volcker weakened so his minions can try to create even more exotic investment thingamajigs. Apparently, he just plans to watch his help a lot closer from now on and wants us to trust that he will do it. Shame on him.
Most likely, given the political climate, nothing is going to change. Democrats will argue for more regulation as they have for years. Republicans, who lately seem to believe only the rich should get richer, will demand no regulation at all. Meanwhile, these 20 or so super banks that now control the U.S. economy will continue to try to create billions out of nothing because sometimes it works. No one knows quite what they do, but everyone involved at the bank winds up with tons of money when it works and a chunk of that money finds its way to congressional campaigns. So it apparently doesn’t matter that none of it seems to create jobs or promote economic development or entrepreneurship. The derivatives just keep feeding the same overstuffed mouths over and over again.
Too big to fail? Too big to regulate? These banks are really too big to exist, but no one except the Occupy movement is making this argument publicly and persistently these days.
Which brings me back to young Mr. Zuckerberg. I don’t feel sad for him that his IPO didn’t cash in as big as some had predicted. (Some of that, by the way, was due to bad calculations by the NASDAQ and the big banks that handled the initial offering.) He and his partners made their millions or billions and one of them (not a native American) even renounced his U.S. citizenship to protect his profits from the IRS.
But hey, the way I see it, they’re entitled. Heck, they created Facebook with their own brains and there is nothing synthetic about it. They made it into the closest electronic version of a living, breathing organism. It has a pulse. It is a vehicle for people around the world to communicate instantly with each other at any time. Their product is useful, portable, entertaining, ubiquitous -- and free. In our economic system, that should equate to profitable. It may just not be as profitable as its creators thought it was.
But that’s what happens when people have even the slightest understanding about what they’re being asked to buy.