What Went Wrong

The Occupy Wall Street movement has done a good job of listing what’s wrong with our economic, financial, and political systems. They’ve been criticized for a lack of “demands” – for failing to propose solutions. I’ve heard some say that’s not their job, that it’s the job of our elected officials to change the rules and structures. If, as those on both the left and right contend, our government is beholden to “special interests” it is foolish to expect them to fix the problems on their own. Any change they propose will favor their benefactors every bit as much as the current system.

But before we propose solutions it will be helpful to look beyond the symptoms of growing inequality and persistent unemployment / underemployment and try to get at some of the underlying issues. The better job you can do of defining the problem the better job you can do at crafting a solution.

Remember what we talked about yesterday – people have evolutionary instincts to preserve and promote themselves. All but the most mindful of us will make choices based on what’s best for us now. Some of us will consider what’s in our long term interests. Very few of us will consider the impact on others – particularly if those others are people we don’t know.

The cumulative impact of those seemingly minor, seemingly logical decisions can be larger than we imagine.

There are many reasons why we are where we are – I want to look at two of them.

Wall Street – From Efficient Allocator of Capital to Casino

The financial markets have a legitimate, necessary and valuable mission – to efficiently and effectively match investors with entrepreneurs. Businesses – from the smallest sole proprietorships to the largest multinational corporations – need capital. They need to buy facilities, tools and equipment and they need working capital – cash to finance purchases of materials and supplies.

Investors – from the guy flipping burgers who saves a few dollars each week to heiresses with billions – need a way to put their money to use. An efficient financial market matches businesses with investors. That helps businesses owners grow their businesses and it helps investors grow their savings. Providing loans and lines of credit and selling stocks and bonds is a valuable service for which financial institutions can honestly charge fees to both buyer and seller.

That’s what they teach you in high school economics and that’s the original mission of the financial industry. But as buying and selling financial instruments got easier and easier, more and more people stopped investing and started speculating. They weren’t buying stocks for the dividends, they were buying stocks hoping that the price would go up and they’d sell them at a profit. With the advent of computerized trading, the “hold period” got shorter and shorter. This has led to what I was complaining about on Monday – executives who make decisions based solely on what will make the price of the stock go up.

It gets worse when you get into more complicated financial instruments like the mortgage backed securities and credit default swaps we’ve heard so much about since the housing market crashed in 2008. Too much of the financial industry has moved from investment (loaning money to someone in anticipation they’ll make profits in which you can share) to speculation (buying something with the intention of selling it as soon as it rises in value). But when you pay brokers and fund managers huge bonuses based on this quarter’s results or even this year’s results, they aren’t motivated to concentrate on long-term investments – they’re motivated to do whatever it takes to make the numbers go up now.

The laissez faire fundamentalists say these are big boys who know what they’re doing and if you can’t stand the risk you should stick to buying CDs. That might be OK if it was only their own money they were wagering. But when the market crashes we all suffer. Beyond that, we’ve seen the bailouts of institutions deemed “too big to fail.” In a perfectly free market they would have failed and those involved would have suffered the consequences – but the consequences for everyone would have been too high. The federal money either has been or will be paid back, but the risky behavior wasn’t punished and is likely to be repeated.

When money is invested and used to produce products and services the profits represent a real increase in wealth. When money is used for speculation the profits represent an increase in paper value only. Paper increases, as the housing market has shown us, can disappear in an instant.

The World Economy – Jobs Moved Because We Demanded It

Why is Wal-Mart the largest retailer in the world? Because you can get it there cheap. We see “low prices” and we make the perfectly rational decision to pay less at Wal-Mart instead of paying more somewhere else.

But that decision has repercussions: not just to the independent retailer who can’t compete with Wal-Mart’s economies of scale but also to the Wal-Mart buyer who has to keep finding cheaper and cheaper sources. I remember when Wal-Mart put “Made in USA” stickers on everything they could. They stopped doing that because their customers – that’s us – would pass up the Made in USA products for the Made in Korea and Made in China products that were a few dollars less. That affected me personally – the factory where I worked closed because we couldn’t get our costs low enough to beat the Koreans’ prices.

The emergence of Asian countries as the world’s factory is nothing short of phenomenal. In total this is a good thing – it’s raised their standard of living tremendously. It’s kept prices low in this country. But it’s transferred millions jobs out of this country – not just the low-skilled and semi-skilled assembly jobs, but also the high-skilled jobs (tool and die makers, electricians, machinists) and the white collar jobs (plant managers, parts buyers, manufacturing engineers) that support them.

The world economy has made most of us slightly wealthier – you can buy more stuff from Malaysia than you can buy from Michigan. But if you’re one of those Michigan factory workers who’s out of a job the world economy has made you a lot poorer.

This is one of the most important causes of wealth inequality in our country. “Low cost country” sourcing is Robin Hood in reverse. It takes a lot from a few people in the middle class and spreads it around to everyone else.

All because everyone involved made the seemingly rational decision to buy from the cheapest source.

Individual Reflections

We aren’t in this mess because of some grand conspiracy. Truly criminal behavior (i.e. – Bernie Madoff) is notable because of its rarity. We’re here because a lot of people at a lot of levels over a long period of time made decisions they thought were in their best interests but turned out to have disastrous consequences for us all. Like I discussed on Tuesday, in the absence of intense social pressure or the force of law, people will grab as much as they can for themselves whenever they can.

If you’re old enough to read this you’re old enough to have experienced this for yourself. Maybe not on this scale, but you’ve done it – you’ve made a decision that seemed right at the time but that turned out very badly. Maybe you only hurt yourself. Maybe you hurt someone close to you. Maybe you hurt someone you didn’t know and couldn’t see.

Give this some thought – we’ll come back to it in the final OWS post this weekend.

But next I want to look at some of the reasons Occupy Wall Street is going to fail.