The economy worked in such a way that I didn’t have to think about it or even be curious about how well it worked. It worked so well that I had the confidence with all my intellectual gifts that I would be safe in majoring in English with a creative writing component without really worrying about what kind of job would be available on the back end.
What I didn’t know, as I was in college and then in grad school was that there was something going on in the securities markets. The stock market was growing, and housing prices were going up. If you have American cable 15 year ago, you couldn’t avoid televisions shows about house flippers extolling the get rich quick properties of property. Incidentally, this retrospective thought triggered “Mihelic’s First Rule of Finance” in that if a television commercial exists for a product, you are the one getting scammed. Gold, Reverse Mortgages, Quicken Loans? All there to take your money at a rate above what a savvy investor would be able to do if they weren’t relying on television commercials. What was going on that housing prices were not just rising. They were being pulled up by the creation of demand for loans. The loans were sliced up into securities and sold onto other investors, and maybe this process was done again and again. You also had companies like AIG Financial Products writing credit swaps on the loan derivatives that they did not have the capital to back up. So, this demand drove banks and other originators to lower their credit standards so that they were offering loans to people with poor credit and no jobs and no way to pay the loans. They sold loans that were negative amortization loans, meaning that the monthly payment did not cover how much was added to the loan in interest so that the amount outstanding on the loan grew every month even if people were staying current. They sold these loans at high rates and with teaser rates that were going to reset, and they sold these loans to people who could have qualified for better rates but got a horrible deal because they were in traditionally underserved communities. While this was going on there was lax underwriting and undocumented transfers on the chain of title of loans and property. And none of it mattered as long as house prices were appreciating.
But it did matter when the house prices stopped appreciating. Everything blew up, and to mix my metaphors, Chuck Prince of Citi famously justified all of it by saying that “As long as the music is playing you have to get up and dance,” but then the music stopped and we saw who was wearing no clothes. None of this would have mattered if, like the tech bubble, it was just a handful of people on Wall Street and Sand Hill Road that lost money, but because they were pulling from the real economy, when the music stopped people lost their homes, people lost their jobs, and the government felt that the best way, the only way to intervene was to recapitalize the banks and financial institutions that created the mess in the first place. It is no surprise that this led to populists reactions on the right and the left from the Occupy Movement to Tea Party candidates in congress and the political rise of Bernie Sanders and Donald Trump. Something was fundamentally broken in a way that was not evident for the whole of the Great Moderation. And I know this because I was affected by the wave that washed over the economy. I was unemployed for two years and sent out thousands of job applications and ended up with only a handful of interviews as I read everything I could to try to figure out what happened. So that means that the lizard brain part of me thinks of the securities market what I want to do is burn the whole thing down.
However, there is a more analytical part of me. Once the signal from the amygdala clears, then the frontal lobe gets its say. Securities markets, like all institutions, exist because at their founding they filled a niche that needed to be filled. I think of the origin story of Wall Street, how dealers met at in the shade of the buttonwood tree on Wall Street to clear transactions. It was easier to have one central place to meet instead of having young boys just running through the city all day. New York was not even a city as we think of what a city is now. The tallest building was a church and most of uptown was still farmland, yet there needed to a central place to trade shares in businesses.
Securities markets do have two key roles in the economy. The first is that they provide liquidity and working capital. A business can offer shares for sale or bonds and then they get an infusion of cash. This cash can be invested in productive activities in the real economy instead of the business waiting for investable cash through business activities. The business does give up some right to future cash flow in terms of what the bond’s coupon is, or what the expected dividends are, but this offering is like a bank in that liquidity is key because sometimes you have a good business but it is cash limited. The other important role is in both the primary market when a business sells on securities and in the secondary market when securities owners buy and sell existing shares or bonds, is that the market is a continual process in finding prices for existing businesses, and in the aggregate it becomes a way for everyone to know what the right price is for these securities. The price discovery mechanism makes it easy to invest in public, security offering companies, distributing ownership to anyone who can buy a share and potentially democratizing the economy.
The problem is that at some point from a nascent institution coming into being to fill a niche, as it grows and evolves to meet the needs of the environment it is in, it can move from being a useful part of the economy to being a drag on the economy itself. In addition to this, path dependency means that something like the securities market insinuates itself in parts of the economy where it is a net harm but where it is impossible to create policy that just rolls back the clock to whatever imaginary point where it crossed the line. So, as much as I still want to blow up the whole thing, I realize that there are problems with ripping out the institution root and branch because it does have a productive purpose to play as long as we have capitalistic social relations. Ultimately, the securities market in the economy is like a diseased heart in an individual. It may kill the person one day, but up until then it still pumps blood.
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