Wednesday, October 10, 2012

happy capitalist

In 2007, the richest 1 percent owned 36.5 percent of all the private wealth in the United States and over 42.4 percent of all financial assets. Part of this estimated $20 trillion in wealth was in the form of land, houses, artwork, jewelry, private jets, and other private property. But an enormous fraction of it was in the form of stocks, bonds, and ownership stakes in the world’s corporations.

Almost everyone in the 1 percent has investment professionals who advise them about allocating their invested wealth. Imagine for a moment that you’re a member of the 1 percent, with $200 million in wealth.  A typical asset allocation strategy is to park a portion of your wealth in stable investments that are a bulwark against serious market downturns. These include insured deposits in banks and credit unions and bonds backed by local, state, or federal governments. This guarantees that you will always be rich, even in tough times. The problem is that these have relatively low rates of return. In fact, in 2005, we’re talking 2–3 percent returns. Another portion of your $200 million is invested in some long-term growth equities—companies that have been around for a long time. These include Ford, General Motors, and General Electric, the “blue chip” or seemingly stable companies. But it’s the same problem again: modest returns on investment, maybe 5–6 percent. With another portion of your funds, we’ll start to increase risk and return, looking for a diversified mixture of small- and large-capitalization new companies outside the stock market. These have the potential for higher returns, in the 7–10 percent range.

However, a new class of investments that are generating very high returns. These new investment vehicles are complicated but highly lucrative— returns of 10 or 15 percent. Some funds have even had 20 percent returns for five years in a row. To get those returns, however, we have to make speculative, high-risk investments. These include investments in hedge funds, derivatives, and credit default swaps—some of the financial innovations that some very smart young fellows on Wall Street have designed. These are not investments in the “real economy,” in which firms make actual things or provide services that people use. Rather, these are ways to place financial bets on the movement of money and markets.

Think about your $200 million. If all you had was $20 million, you would be able to live a very wonderful life, meet all your material needs, and guard against most possible problems. You might not be able to buy eternal life, though you’ll probably live longer. With another $20 million, you will be able to provide the same to your progeny. So, setting aside that $40 million, you have $160 million you’re willing to gamble with. So we allocate a large portion—let’s say $80 million—to the new financial instruments. Add to this the trillions in cash accumulated by the world’s corporate 1 percent—banks, insurance companies such as AIG, and the finance arms of corporations such as General Electric. As a result, huge amounts of wealth shifted into the speculative market.

Wall Street drove this process by seeking more and more high-risk deals. One of their favorites was high-interest mortgage debt, known as subprime mortgages. Investment banks and brokers such as Morgan Stanley, Citigroup, and Bank of America called up mortgage lenders and people who bundled mortgages together and said, “Bring us more of those high-return, high-risk deals!”

By 2007, the speculative bubbles had grown, not just in the housing market but also in other sectors of the economy. Commodity futures rose, pushing up the cost of foodstuffs and triggering food riots across the world. Speculation in oil futures drove up the cost of oil, and a gallon of gas during the summer of 2008 topped $4 a gallon. Americans spent hundreds of billions of dollars more on gas in 2008 than they did the previous year.4 Funds that could have financed a transition to a green economy went to the oil industry, which enjoyed unprecedented profits—in 2008, ExxonMobil set records with profits of $45.2 billion.

It hasn’t stopped. As long as the 1 percent has excess money to bet with, they will continue seeking speculative investments.  And the people paying the price with ruined lives are not in the 1 percent.

Adapted from here

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