“The very idea of a ‘free’ market has become synonymous with an ‘unregulated’ market—one that is unaccountable to the wider public that must act as a lender of last resort when their financial machinations come to a grinding halt due to an engineering flaw of their own design.”
Sabotage: The Hidden Nature of Finance by Anastasia Nesvetailova & Ronen Palan, PublicAffairs
The more books I read about economics—economic theory, economic history, and current events—the more it seems obvious to me that those who champion the efficiency of unfettered markets the most are the most likely and the most able to skew markets in their own favor. They do so by interfering with or improperly (if not exactly illegally) influencing markets to further their own financial interests, and in so doing undermine the very efficiency they champion. That interference and undue influence has another name: sabotage.
Thorstein Veblen, who introduced sabotage as an economic concept in a work on “On the Nature and Uses of Sabotage” in 1919, has fallen out of fashion in economic thought. Anastasia Nesvetailova and Ronen Palan make a compelling case in their new book, Sabotage, for revisiting his ideas to restore and revitalize the regulatory framework managing the role of finance in our economy. They were prompted, as Veblen was himself, by a historical (rather than analytical model) view of economic events:
[I]n the wake of the 2007-9 crisis, and in light of the revelations of the Panama and Paradise dossiers and the like, one unavoidably begins to ponder whether Veblen’s theory of sabotage is relevant for making sense of the many apparent crises in the capitalist organization.
The financial institutions of today differ by many degrees from the industrial institutions and trusts that Veblen studied (mostly through the congressional record) in his time, but:
The principle, however, has remained: if you want to make money—real money—in finance, you need to find ways for sabotaging either your clients, your competitors or the government. If you are big enough, you can succeed on all three fronts.
The irony is that, as the authors write, “Veblen was, in effect, an early believer in efficient market theory.” He came to this concept of sabotage largely because, according to his observations, the industrial owners of his time were not making their fortunes by introducing new efficiencies and new innovation, or by playing by the rules of the market, but by interfering and controlling it—“whereby production is kept short of productive capacity,” in his words. As the efficient market theory suggests, and they understood, there is no real way to consistently beat the market, so they sought instead to control and monopolize it.
Looking at modern finance through this lens, what the authors found is that the source of the outsized (and according to efficient market hypothesis, unexplainable) profits in the financial sector …
… involved elements or attempts at controlling markets; that is, sabotaging the price mechanism, through either internal misrepresentation of information or facts, or predatory practices that are presently or potentially damaging to clients, competitors or the government, or a combination of all three.
It is not necessarily a willful harm, but one based on what any business seeks: reduced risk and increased profits. It is in the pecuniary interest of any firm to benefit as much as possible from any transaction. And in the world of finance—the business of managing other people’s money—that interest easily comes into conflict with that of the customer, as well as the interests of competitors and the government. So, rather than viewing such behavior as rogue, the authors suggest (and suggest that history suggests) that it is simply in the nature of the business, if left to its own ends, to engage systematically and systemically in such practices. Rather than offering the traditional, analytical, and rational actor model of economics, they suggest:
In today’s business world, and particularly in that most lucrative yet most competitive of all sectors, the financial system, the practices of deploying all the means available may offer a better insight into the actual practice of financial businesses than do conventional theories of market and economic behaviour. By ‘all means available’ we do mean all means available, including innovation, obstruction, undercutting, impairing, damaging, vandalizing and cheating—generally within the letter but in the spirit of the law, and sometimes beyond the limits of the law altogether.
The book offers a full section each to describe the ways in which financial institutions sabotage their clients, each other, and the state. The stories the authors tell of banks sabotaging their own small business and retail clients—often bankrupting them in the process—for their own financial gain are intimately distressing and infuriating. The stories of the ways in which they sabotage each other and the state feel more esoteric at first, but end up being just as immediate and as harrowing, raising the level of concern to a more institutional and societal level.
The problem with the solutions we’ve put in place is that they are predicated on propping up and stabilizing the system of sabotage that is in place, essentially acting as an insurer and lender of last resort when such carnage leads to system-wide collapse.
I believe in free trade and free markets. I am pro-business. I don’t want to (and don’t like it when politicians) demonize everyone on Wall Street. I believe enough in Robert Shiller’s prognosis in Finance and the Good Society that I believe finance is, can, and should be mostly good for society. When the authors provide a brief history of “futurity” of financial instruments and products dating back to Mesopotamia, and bring it up to date to show what it looks like in today’s intangible, debt-driven economy, I don’t lose hope or think we’ve irrevocably lost our way. But I have also come to understand that financial innovation is always benign. For instance:
Junk bonds, MBSs (mortgage backed securities), securitization and CDS (credit default swaps) were so enthusiastically adopted by the ‘market’ because they could be used as instruments of sabotage.
By innovating new types of financial assets—often by combining several aspects of economic activity in a new way and creating a marketplace for this practice—financial innovators gain a structural advance over others in the industry, the regulators and society.
But we’ve been here before. Sabotage closes with a discussion of the Pecora Report, produced in 1934, which was “in effect,” in the authors’ estimation, “a detailed study of sabotage in finance” that occurred leading up to the Great Depression, and that reads a lot like a list of the abuses that led to the 2007-9 crisis, as well. The report’s conclusions were that:
First, the financial industry is highly conflicted, and, if allowed, is likely to abuse its clients.
Second, financial houses are leveraged to the hilt; if allowed, they will use their knowledge of the economy in an abusive manner.
Third, the bigger financial houses have tended to short-change the smaller ones.
Fourth, bankers ensure that profits are flowing to them, but if left unpunished will also ensure that their mistakes are paid for by others.
Fifth, financial houses use financial instruments for tax evasion and avoidance purposes.
Sixth, financial houses use investment funds, holding companies and the like to achieve great leverage, conceal ownership and create accounting opacity. It takes longer, therefore, for the regulator to appreciate the faltering state of finance.
In the New Deal era, we found a way to combat those abuses. In ours, we’ve found a way to allow them. In the interest of financial stability, the government propped up the very institutions that made it so unstable in the first place—‘socializing the risks, while privatizing profits.’
The idea of a “free market” in finance has come to mean freedom for financial professionals to control it. It has come to mean, in our era, “sabotaging government rules” that were set up almost a century ago to protect ordinary investors and the real economy, “rules that were supposed to maintain the free and open market.” Indeed, today:
The notion of the free market, to which all businesses in finance purportedly subscribe, is used as a perfect veil to sabotage clients, competitors or the state. It is a world of smoke and mirrors, where ideology and political debates are harnessed in support of techniques of sabotage.
Yes, those who now tout the efficiency of markets are the leading culprits in making markets less efficient by interfering with or influencing it to further their own financial interests. The very idea of a ”free” market has become synonymous with an ”unregulated” market—one that is unaccountable to the wider public that must act as a lender of last resort when their financial machinations come to a grinding halt due to an engineering flaw of their own design..
It may not be willful harm, but the risk is still passed off to, and the profits come from, all of us. Such sabotage, as the authors see it, is once again a “systemic feature of the financial system.” Which is why, in the end, they call for a financial system that is more pro-market but anti-business (in the profit-seeking sense), because the financial industry shouldn’t be seen as “managing ‘other people’s’ money,” but as an industry in the “business of creating and managing our wealth.”