Financial Reform, Populism and the Prudent Investor

Includes: BAC, C, GS, JPM, MS
by: Tom Armistead

Critics of Obama's efforts to re-regulate the financial system, including his most recent proposal to reinstate Glass-Steagall, have made numerous accusations that he is pandering to “populist rage” for political purposes. Populism has become something of a pejorative in this country, so much so that it serves as a useful shorthand argument and attack, a quick way of discrediting the opposing view.

Populists hail from some distant past: ignorant and unwashed, they band together outside the mansions of their betters, armed with torches and pitchforks. They are the peasants, the peons, the serfs. They come with vengeance in their eyes, motivated by murderous rage rising from imagined grievances against those more intelligent and refined than themselves.

As always with “isms” these terms accumulate a tremendous burden of assumption and stereotype, frequently deflecting discussion away from facts and into a never-never land of conflicting and irreconcilable ideologies. Populism, when properly understood, has genuine insights into the serious and as yet uncorrected problems that brought the economy and financial system to the brink of chaos.

The purpose of this article is to explore these insights, and develop an investment philosophy and strategy that benefits from this knowledge.

Definition - Wikipedia offers a definition as follows: “Populism, defined either as an ideology, a political philosophy or a mere type of discourse, is a type of political-social thought which juxtaposes "the people" with "the elites", urging social and political system changes and/or a rhetorical style deployed by members of political or social movements.” Another characteristic, added here, is a concern for injustices created by excessive power, whether in the hands of big business, big banks, or big government.

Disregarding definitions and labels, and resorting to pragmatic observations, the US has certain specific and not uncommon problems:

Elites – the United States has a problem with our elites – they are not serving their proper function. They are not getting the job done. Unity and prosperity have vanished: in their place we have poverty and strife. The elite have not participated in the suffering: indeed, they seem more prosperous than before.

System Changes – it is self-evident that changes are needed: what we have now is not working. It is not working because changes were made: sometimes surreptitiously, often openly; piecemeal and ultimately wholesale; the principles and protections that guarded the system of free-market capitalism gave way to jungle-ethics financialism.

A Financial/Government oligarchy has sprung up in the midst of our Democracy.

The People – it is this concept that underlies the use of the term Populism. The Declaration of Independence starts with the phrase “We the people.” Lincoln, in the Gettysburg Address, spoke to us of “government of the people, by the people, for the people.”

Our politicians come in two flavors: Democrat and Republican. Both parties campaign on contentious and divisive issues, the things that separate us. We the voters are not a people, but a collection of warring special interests, to be pandered to, divided and conquered. Our politicians unite and act as one in catering to the financial oligarchy, so it really makes no difference who wins the election: the same interests are served with an unswerving and servile devotion.

Pragmatism - a basic element of the American character. Americans are result oriented: they look at what works; and at what does not work. They judge the truth of a proposition not by the fine thread of ideological reasoning, but by its consequences – where does this line of reasoning lead us?

A corrosive ideology – a bizarre and sickening fallacy led us to empower an elite who have impoverished us, to accept the repeal of laws that protected us, to ignore the disarmament of regulatory agencies that defended us, and to acquiesce in the corruption of the political process.

We accepted as Gospel the fiction that Greed is Good. We subscribed to its corollaries: that greedy men acting collectively would regulate themselves, that superior cunning was a mark of distinction, that lying was an acceptable business practice, that personal wealth was the ultimate measure of success, indeed, the final arbiter of Darwinian fitness to survive.

Pragmatic Populism respects the power of greed, rationalization and self-deception. It recognizes that big business will abuse its powers, gouge its customers, stifle competition, and assiduously strive to create a monopoly. It notes that fraud, abuse and manipulation in financial markets lead to destructive cycles of boom and bust, creating fictitious wealth and then crushing poverty.

The Investment Bankers can come up with a hundred reasons why they should not be regulated, and with a thousand explanations to support the view that they have done nothing wrong. Greed is like that, the rationalizations and the self-deception: they actually believe their own bullshit.

Populism remarks with sorrow on the propensity of politicians to seek and receive bribes for favors granted with public funds. But it advocates punishing the guilty.

Populism ultimately unites the 98% of the population who are not among the elite sufficiently to achieve four important goals:

  1. Establish a cadre of elites who perform their function without unjustly enriching themselves or others.

  2. Establish (or re-establish) a rule of law and system of regulation that prevents the greedy from harming others in their pursuit of happiness or personal enrichment.

  3. Reduce the size and power of big business, big banks (and big government) to what is necessary to serve the common good.

  4. Prevent fraud, abuse and manipulation in financial markets from endangering the real economy.

Do not be misled – Populism is not some kind of outworn relic of an agrarian past, an aberrant philosophy of the unwashed, bitter and resentful. Populism accurately identifies the problems that afflict our financial system and government, and offers pragmatic, effective and time tested solutions.

The Securities and Exchange Act of 1934, the Taft-Hartley and Sherman Antitrust laws, and Glass-Steagall come to mind. CDS are insurance contracts, and could easily be regulated as such, rather than enjoying the complete exemption from regulation they received by means of CFMA. Not to mention their additional exemption from bucket shop laws dating back to 1907.

Our populist ancestors noticed that gambling in the financial markets created serious problems, and they outlawed it. Our elites are better informed, apparently, since they have been so innovative in that regard.

Existing laws and regulations, if enforced by regulatory agencies empowered rather than hindered by elected officials, will suffice to bring an end to the fraud, abuse and manipulation that have plagued this country's economy and financial system.

Those who created and profited from the losses that have crippled our economy can be relieved of their duties and of their spoils. Those who broke the law can be fined or imprisoned. Others can be found who will serve the common good for a just reward.

Probability of Meaningful Change – that would depend on your time frame. What can be verified by direct observation is that none of the existing elites will agree to or accept any meaningful reform, or modify or retreat from unsafe, unsavory, and unsound practices.

This cannot continue indefinitely, and the longer it goes on, the more catastrophic will be the denouement.

The main thing you can do is consider yourself a member of the people rather than the elite. All else follows. If you are in point of fact a member of the elite, you can redefine your goals in life in ways that are compatible with the public good.

Investment implications – do not invest in any company that is a power in the financial/government oligarchy. Avoid any company that is subject to their whims like the plague. Do not accept any investment advice from any investment bank. Do not invest in situations that require a member or members of the elite to act in the public interest. Do not rely on any regulatory agency to perform its appointed duties.

Unless or until current elites are replaced, big banks downsized, CDS regulated, and laws against fraud, abuse and manipulation enforced, you can anticipate that sooner or later another financial crisis will arise, equally as devastating as the last.

This cycle will repeat until the changes Populism suggests are made. The longer it goes on, the more serious the consequences for the present elites, their servants and allies, and the further the prudent investor will be from dependence on their good fortune or on the stability of the financial system. When the shit hits the fan, you want to be standing far away.

The mission of the Populist investor is to keep his money as far away from the financial/government oligarchy as possible. It's like a black hole, it sucks in your money and it is gone, forever.

Disclosure: No position in any investment bank