The Antidote to Systemic Financial Corruption

By Jon Herring

"Investors Daily Edge" <support@investorsdailyedge.com>

An article in the recent issue of Fortune highlights some flawed thinking about the current financial crisis and the financial system in general. There is a quote from the article, featured in a sidebar that reads: “The idolizing of free-market finance has been thoroughly discredited.”

Wrong. The problem is not “free-market finance”. The problem is that there is no such thing in today’s world.

We do not have free markets. If we did, there would not have been a short-selling ban last summer. The legitimate short-sellers (as opposed to naked short-selling which is criminally fraudulent) did more than anyone to expose the fraud and abuse within the financial system.

If we had a “free market” then the institutions which failed to manage their risk (to put it kindly) and those that engaged in fraudulent accounting would have failed, making way for more capable allocators of capital and better managers of risk.

In the wild, species grow stronger by natural selection. The weakest are culled and the strong survive. The same principle should work in business. Instead we have a system of “unnatural selection” where your tax dollars are used to bail out crooked bankers and prop up failed institutions like walking zombies. Many of these people should go to jail. Instead we’re handing them money.

Ayn Rand summed it up as well as it can be said in Atlas Shrugged:

“When you see that trading is done, not by consent, but by compulsion - when you see that in order to produce, you need to obtain permission from men who produce nothing – when you see money flowing to those who deal, not in goods, but in favors – when you see that men get richer by graft and pull than by work, and your laws don't protect you against them, but protect them against you – when you see corruption being rewarded and honesty becoming a self-sacrifice – you may know that your society is doomed.”

Allow me to pull a few gems from her quote:

• You see money flowing to those who deal, not in goods, but in favors
• You see that men get richer by graft and pull than by work
• Your laws don't protect you against them, but protect them against you
• You see corruption being rewarded

I don’t have to point out the parallels in the above statements – which were published in 1957 – to what has been exposed in the financial system in recent years. And, yes, I mean recent years. Don’t forget Enron, Tyco, Worldcom, Adelphia, Global Crossing, etc.

We do not have free markets, and we most certainly do not have a system of “free-market capitalism”. What we have is an anathema to capitalism -- a cancerous, mutated form of capitalism known as “crony capitalism.”

A lot of commentators have wondered aloud how the financial regulators could have been so inept. How many times have you heard that the regulators were “asleep at the switch”, like some drowsy ship captain that runs ashore?

There is no doubt that the regulators are inept. We have ample proof of that.

For nine years, investment professional and mathematics whiz Harry Markopolos tried to persuade the Securities and Exchange Commission to investigate Bernard Madoff. He showed definitive proof that the firm’s returns were not only improbable, but mathematically impossible.

In an email documenting his frustration with the regulators, Markopolos wrote:

“Meagan Cheung, branch chief, in New York actually investigated this but with no result that I am aware of. In my conversations with her, I did not believe that she had the derivatives or mathematical background to understand the violations.”

How in the world does the SEC hire someone to head the New York branch office of their enforcement division, who does not have the skills or the background to perform their stated duty?

Perhaps, because they are not meant to perform that stated duty. Remember what Ayn Rand wrote? “Your laws don’t protect you against them, but them against you.”

On the whole, the regulators are certainly inept. But they are also horribly corrupt.

The rot within our financial system goes well beyond the risky and fraudulent behavior that has been exposed. It extends fully to the institutions that are meant to discourage that risky behavior and prosecute against fraud. The corruption and rot are systemic.

Former Senior SEC. investigator Gary Aguirre is one of the good guys. I say, “former” because he was fired by the SEC. Why was he fired? Evidently it was because he didn’t understand that the unspoken mandate of the SEC. is to protect the politically and financially powerful from the people, instead of the other way around.

Aguirre was working on an insider trading case. When the trail led toward John Mack, who was then CEO of Morgan Stanley, Aguirre’s supervisors killed the investigation. They told him that Mack had “too much juice” to pursue.

The following is from a letter that Aguirre wrote to the United States Senate:

“Fixing the SEC so it can protect investors and capital markets from hedge fund abuse will not be an easy task. Powerful interests want the SEC to stay just the way it is or, better yet, to become even weaker. Those interests are not just the hedge funds. They include the financial industries that are receiving tens of billions of dollars in revenues for helping hedge funds cheat other market participants or close their eyes to the carnage. At the top of that list are the big investment banks, e.g., Goldman Sachs, Morgan Stanley, Merrill Lynch and Bear Stearns. Those interests know how to reward friends and punish perceived enemies. Their tentacles reach far. They stopped the hedge fund investigation I was assigned to conduct. They cost me my job.”

We don’t have anything even resembling “free-market capitalism.” What we have is a thoroughly corrupt version of capitalism. It doesn’t reward those who win in fair competition. It rewards those who have the most “juice.”

A common misconception about “free-market capitalism” and “libertarianism” is that they lead to “anarchy” or “anything goes”. This is patently untrue. The ideals of libertarianism, for example, state that you should be free to do whatever you wish as long as you do not infringe on the rights of another to life, liberty and property.

Hiding liabilities on your balance sheet, for example, to disguise what your company owes and its true financial strength is fraudulent. Fraud is theft. And theft is depriving another of his property. We don’t need more laws against these things. We don’t need more regulation. We need to enforce the laws we have.

But that is not what you get in a crony capitalist system. You might have heard the saying that the “insane are in charge of the asylum”. For a long time, that is how I have felt about our financial (and political) systems. The criminals are running the prison.

I could go on and on about the bought-and-paid-for credit ratings agencies… the outright manipulation of various markets… the naked short-selling scam that has destroyed any number of companies… the massive theft associated with the taxpayer funded “bailouts”… and the “asleep at the switch” regulators who didn’t see nothin’.

Instead, I’ll focus on one of the very few financial assets that cannot be manipulated and which has no counterparty risk. Gold and silver that you hold in your physical possession.

But wait, you say… gold is being manipulated too. And you’re right, the price of gold on the spot market has been manipulated for years. In fact, the orders and means to do so have come from the highest halls of power – the Central Banks, U.S. government agencies and the largest investment banks. And all under the watchful eye of a very “drowsy ship captain” – the U.S. Commodity Futures Trading Commission.

But the “spot price” of gold in the manipulated futures market is not the same as gold you can hold in your hand and sell to another in a private transaction. Recently the price of gold in the “spot market” and the price of gold in the “free market” have begun to diverge. I strongly believe that not only will the price of gold rise in the months and years ahead, but the premium that someone is willing to pay for the real thing, will rise as well.

I am not suggesting you abandon the markets entirely. Over the very long term there are few passive investments that are better than buying stock in well managed, growing companies at a significant discount to intrinsic value. What I am suggesting is that if you do not have at least a portion of your net worth in tangible assets that you can hold in your hand, you’re swimming naked with sharks.