What has happened to our institutions?
The trend of the modern institutionalization of our system began in the late 19th century, but didn't gain worldwide support until the early 20th century. It reached its peak after World War 2, when the feeling was that global institutions could stave off further bloody conflicts. Without WW2, establishing institutions such as the United Nations, the International Monetary Fund, and eventually the European Union, would not have been possible.
A post WW2 America saw a mass flocking to institutions, and large corporations posing as them. To use the banking industry as an example, The United States used to have an extremely fragmented banking system with thousands of currencies named after the bank, during the Free Banking Era. Although it was at its peak during the mid 19th century, the practice of this system continued until the establishment of the Federal Reserve System in 1913. Before the introduction of the Fed, anyone with money could open a competing institution, issue their own currency, or even act as a clearinghouse -- such as the Suffolk Bank of Boston did. Thus, the Fed replaced thousands of smaller institutions, consolidating the industry power into one Fed.
This trend took place in most industries, seen in corporate America with the global super conglomerate evolution, most notably displayed by ITT Corporation. In politics, institutions such as the United Nations replaced previously fragmented diplomacy and smaller regional organizations. Another example is provided by a trend of stock ownership, where in 1932 almost all stocks were owned by individuals, now over 66% are owned by institutions.
The body public took great solace of their safekeeping by institutions. They were trusted with their assets, rule-making, and health safeguards. No one questioned actions taken by large institutions-- just the mention of their name and involvement was enough to stop any inquiry into their activities. Support by public leaders, celebrities and other notable individuals, solidified this trust, which was passed down through several generations. Modern humans may not remember a time when their great-grandfathers lived, a time in which this trust did not exist.
Wall Street Decay
We can see the beginnings of institutional decay during the 90s but at that time, the entire system was supported by an economic boom, stock market bubble, and a dismantled Soviet apparatus, leaving the only real economic force in the world by itself. There has always been fraud and mismanagement. But only recently does the fraud perpetrated by a single individual destroy an entire institution.
MF Global, a brokerage firm with $42 Billion in assets, was found to be misappropriating customer funds. This previously well respected institution on Wall Street-- a favorite of hedge funds and institutional traders-- is now in a bankruptcy proceeding and an ongoing investigation by the regulators.
Frauds perpetrated by criminals using Wall Street as a means to an end have been common since the popularization of Wall Street as a means of investing. However these frauds were not capable of bringing down the entire bank. As we have seen with the recent JP Morgan (JPM) loss now reaching $9 Billion, an individual trader known as the "London Whale" was responsible for a series of trades that created the loss. While Jamie Dimon as CEO has accepted responsibility, and not blamed this trader directly, it was the trade itself that caused not only a $9 Billion dollar loss for JP Morgan but an additional $20 Billion when one considers the share price, and an undoubted loss of confidence by clients. JP Morgan is an interesting example because it is an institution in a class by itself, the 800 lb. gorilla of Wall Street. If this is possible at JP Morgan, is any institution safe from such reckless mismanagement?
In a European example, Swiss banking giant UBS (UBS) had a similar rogue trader lose $2 Billion for the firm. Societe General (SCGLF.PK) faced a similar situation losing $9 Billion. A large firm cannot possibly monitor every single action taken by their employees, however it can have some type of protections in place, making these types of rogue trades impossible.
The list goes on and on, but an underlying trend (or more appropriately countertrend) is forming. Yves Smith of Naked Capitalism recently posted:
The Chicago Booth/Kellogg School Financial Trust Index published yesterday shows that only22% of Americans trust the nation's financial system. SmartMoney notes today that more and more Americans are keeping valuables at home because they have lost trust in banks.
Robert Shiller said Monday:
Our whole economy has been affected by variations in confidence. Central banks are sort of trusted, but the actions they have often affect people's confidence by appearance rather than substance. We're not in the most trusting mood now."
- A tiny percent of Americans believe that the U.S. government has the consent of the governed
- A higher percentage of Americans believed in King George of England during the Revolutionary War than believe in congress today
- Many Americans disbelieve the government's rosy statements about the economy
- An NBC News/Wall Street Journal poll from November found that 76% of Americans believe that the country's current financial and political structures favor the rich over the rest of the country
- The U.S. financial system is so corrupt and unregulated that many don't believe the government and businesses' promises to follow the rule of law … and simply won't do business here anymore
It's not just the U.S. As the Economist reported in January, trust in institutions is plunging worldwide.
Trust is the only Currency
The only driver of any economic system is trust. A lack of trust, between trading partners, and between the public and trading partners, is what created the modern trend in institutionalization of politics, corporate America, and Wall Street. Part of the reason the US Dollar (UUP) is so widely used (even in Cuba) is in part because the users trust the United States, they trust that the value will not be deteriorated by hyperinflation or radical political moves.
While people are losing trust for institutions, they are not losing trust altogether. A recent CNN article "In the U.S. we don't trust" outlines local currencies issues by communities and local governments.
"When you go to Home Depot and buy $100 worth of lumber, some of that profit is leaving your town and going to a different part of the world, never to come back," said Rich Creyer, co-founder of the currency. "By making trade money, we have created a sealed system. It's our own little economy and country in a fishbowl."
If we cannot trust our banks to keep our money safe, and we can't trust our brokerage houses to keep our accounts safe, and we can't trust the world's largest investment banks to have proper risk protections in place from rogue traders, and we can't trust our governments to enact economically destructive policies such as Austerity measures, who can we trust?
Investors who open accounts with any financial entity-- whether it be a fund, bank, or other institution-- should do an extraordinary amount of due diligence. The regulators do a great job regulating markets, but did not stop the frauds of Madoff, Sanford, and others. Nor did it prevent the collapse of MF Global, Refco, and many other institutions.
The risk of loss in trading foreign exchange markets (FOREX), also known as cash foreign currencies, or the FOREX markets, can be substantial.
Forex Risk: Disclosure here
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.