In the book which he dedicated to the 1929 Crash (*), John Kenneth Galbraith, made the remark that if everyone talks frequently of fraud during periods of crisis, it is not because an endemic disease has suddenly turned into an epidemic, but because with everyone paying more attention to it, he who imagines that the suspicion may come to rest on him, promptly transforms himself to all intents and purposes into a denouncer.
This is a fine observation but, judging from recent experience, another reason for such an increase must be the improved education of the public.
One complains bitterly that the man on the street is insufficiently informed of the ins and outs of the current crisis; nonetheless it is no less true that in comparison with preceding periods, the public today is bombarded with explanations related to financial mechanisms. It is possible to conceive that this may also have been the case in the wake of the 1929 crash and the ensuing years of depression.
It is this enhanced awareness of the manner in which finance operates which undoubtedly explains the recent indignation of those who pay a minimum of attention to contemporary economic and financial affairs with regard to two particular incidents: the first being the losses incurred by the American bank J. P. Morgan Chase due to a calamitous policy of risk management , which are proving difficult to quantify but certainly account for more than three billion dollars; the second being the emergence of irregularities which occurred during the company Facebook’s flotation on the stock exchange.
Today these practices, or the mechanisms that these practices reveal, seem scandalous although they have constituted the day-to-day practices of the world of finance for at least a hundred and fifty years.
Should we be surprised that the risk management committee of J. P. Morgan Chase was, until only a few days ago, comprised of “family friends”, no doubt highly remunerated but whose lack of familiarity with the affairs they were supposed to supervise was glaring? Take for example, Mrs. Ellen Futter, the president of the American Natural History Museum. Should we be surprised that the bank easily passed the recent stress tests required by the Fed for the 19 largest American banks, thus giving it the right to distribute generous dividends which are, today, unfortunately compromised?
Should we be surprised that the share price fluctuations for Facebook on the 18th May, the day of its stock market listing, led to gains for the banks responsible for the launch, and this whether the price went down or up because certain of their departments had bet one way and others in another? As Daylian Cain, professor of business ethics at the Yale School of Management, observed to the Wall Street Journal, “conflicts of interest are profitable!”
Should we be surprised, staying with the Facebook affair, that the biggest clients of the issuing banks had been alerted, off the record, that the future of the company was less rosy than was generally believed, which permitted them to not buy in and thus avoid any losses? Is not the explanation for this that the provision of this element of additional information had required more in-depth research which it would be unjust not to remunerate – even if the sacrosanct transparency of the markets should take a battering in the process?
Is it possible to prevent these abhorrent practices, all the more so when in a period of crisis like that of today, they find themselves splashed all over the front pages of the papers? The volatility which was artificially created on the 18th May was done so by short-selling, which is only possible because the holders of shares lend them to speculators who rush to get rid of them, before buying them back at depreciated prices. This “rental” can be highly profitable: the annualized equivalent of between 10% and 40% on the day that Facebook was listed. This practice is only legal, however, due to a loophole in the law: because the borrower is authorized to sell the shares that he has borrowed. Has one ever seen two people be owners at the same time of the same possession, other than in this unique case? What more is needed to prohibit this practice, whose harmfulness is so blatant? No more than a decree. Is such a decree in the pipeline? The markets will chant the same old refrain that “liquidity” will be affected – and everyone will nod their heads in agreement without seeking to find out what exactly they mean.
“Dumb money”: this is the manner in which the professionals poke fun at the operations carried out by private individuals. 10% to 15% of the initial offer is generally set aside for this dumb money. In the case of Facebook, 25% had been retained to this effect. Indeed, why put oneself to any trouble, when a new sucker comes along every day?
(*) John Kenneth Galbraith, The Great Crash – 1929, Houghton Mifflin, 1954