CHICAGO BOYS' CURSE COMES HOME TO WALL STREET
by
Hazel Henderson,
September 2008

The famous school of economics at the University of Chicago led by the late Milton Friedman spread its market fundamentalism worldwide. Greed, selfishness, individualism and short-termism were conflated with freedom and democracy and elevated to the status of moral philosophy. The fatal flaws of this ideology fueled the reckless risk-taking, greed and arrogance that led to Wall Street's downfall.

The Chicago Boys and their clones stormed through Latin America in the 1950s, led the triumphant forces of capitalism to victory in the Cold War and sparked the Reagan and Thatcher era and the Washington Consensus of deregulation, privatization driving today's form of economic globalization. The roots of market fundamentalism, which stem from Adam Smith's Wealth of Nations (1776) while ignoring his Theory of Moral Sentiments (1759, 1790) and from the Austrian School of Ludwig Von Mises, Friedrich Hayek and others, became the ideological basis of US libertarianism and the neoconservatives' revival in the George W. Bush administration.

Elevating individual freedom and free markets to a higher moral status than community responsibility and the role of government helped destroy the excesses of communism and Stalinism. Yet, this lure of "rugged individualism," making money in markets free of regulation, also drove the narrow calculus of Milton Friedman's famous single bottom line: the only purpose of private enterprise and corporations is to make as much money as possible for shareholders. Academics created "free market" curricula, and business schools reaped grants from corporations and from conservative and gullible liberal foundations. Media joined in promoting the "animal spirits" of individual entrepreneurs, the glorification of business leaders and the "wealth" of Wall Street raiders, hedge fund titans and private equity kings. Money was seen as the only form of wealth.

The computer revolution which automated trading on Wall Street and linked financial markets worldwide played a key role in the excesses of short-termism, now measured not only quarterly but in nano-seconds. In September, split-second trading and short-selling of United Airlines stock on a false rumor lost the company $1billion in its price in 12 seconds (www.seekingalpha.com, London, Sept. 15, 2008). Now the short-sellers are turning on each other, shorting the financial firms at Wall Street's core. The "free market" ideology prevented regulation of today's global casino – even as finance ministers fretted about the need for a global financial architecture after each crisis. The Asian meltdown of 1997-8 was followed by the Russian default and the blow-up of the Long Term Capital Management hedge fund in1998, the Argentine default of 2002 to the 2008 bailouts of Bear Stearns, Fannie Mae and Freddie Mac, the demise of Lehman Brothers and the rescues of Merrill Lynch and AIG – costing the Fed $900 billion so far.

Calls grow louder for re-regulation, cracking down on outsize executive pay, golden parachutes, lobbying and campaign contributions. The laissez-faire free markets turned into today's free for all. Stock market specialists, whose role is to assure orderly markets, began manipulating asset prices by shorting stocks, as reported by Richard Wendling at www.bearfactsspecialistreport.com. Seemingly the clean-up task in the USA will be left to the next president. Both Obama and McCain expressed outrage at Fannie and Freddie's reckless risk-taking and influence peddling – even though both took contributions and were deeply-involved with favoring these two housing giants which hold over $5 trillion of US mortgages. Both candidates blame Wall Street's recklessness and greed while faulting regulators asleep at the switch.

Automated program trading is now 50% of all market activity. "Value-at-risk" and other mathematical models created by all those academic "quants" are still proving inaccurate while all the financial "innovations" from sub-prime mortgages hailed by Federal Reserve Chairman Alan Greenspan, to the securitization of debt in CDOs, SIVs, CDSs are revealed as little more than ponzi schemes. Shockingly, pension funds, charitable foundations and university endowments played the same games, competing for higher returns. They piled into hedge funds, oil and commodity speculating, risking their beneficiaries' retirement incomes in real estate and private equity deals in spite of their special status as universal owners (i.e., such large funds own shares in most corporations, so it is foolish to try pitting them against each other for short-term gains).

We now know that capital markets built on individual and corporate self-aggrandizement, unrealistic profit targets, competition in seeking these "alpha" returns, lack of transparency, dishonesty and greed are bound to fail. We know that narrowly-calculated single bottom line, "externalizing" social and environmental risks and costs to others, cannot address these impacts it creates: from pollution and hazardous waste to global climate change. The illusory "wealth" booked in this faulty economics is being exposed, and no amount of bailing from sovereign wealth funds or central banks' money creation can keep this global fiat money bubble inflated.

Chicago School economists have been de-frocked in prime time as market players, including AIG with its $85 billon in Fed loans, and now General Motors and Ford line up to be bailed out by taxpayers. True believers in "free markets" and tax cuts to "starve government" are red-faced as those despised governments now come to the rescue. The new mantra is that the titans of the free market are "too big to fail" and so their losses and risks must be socialized. Yet in spite of multi-hundred billion dollar liabilities to taxpayers, the bad news keeps on coming. Official statistics are fudged to conceal the bad news: for example, the US Commerce Department's estimate of 3.3% growth of GDP in the second quarter of 2008, if corrected for the real 5.6% inflation rate, would have been negative, while the average 6.1% unemployment rate still concealed millions of workers dropped from the rolls as "discouraged" (www.shadowstats.com).

Are we seeing the end of the US neocons' efforts to repeal the New Deal and the demise of the Chicago Boys' free market capitalism? Where do we go from here? Happily, there are ample alternatives which conserve and update the role of markets while restoring the role of government as referee as I have outlined elsewhere (www.ethicalmarkets.com). Regulation in the public interest is now acknowledged as urgent by Bush Treasury Secretary Henry Paulson. Paulson now blames Wall Street's excesses, i.e., shifting of social risks, costs and environmental destruction onto taxpayers and future generations, even though he was CEO of Goldman Sachs prior to joining the Bush administration.

Three decades of socially responsible investing which screens out the worst of these excesses has proved successful in providing reliable returns (www.socialfunds.org, www.socialinvest.org). Research analysts, including Innovest, KLD, Calvert, Trucost and many others, report on companies' social, environmental and ethical governance performance (all at www.ethicalmarkets.com). Sustainability metrics beyond money-based GNP/GDP and conventional economics use multi-disciplinary, systems approaches to overall quality of life, happiness and ecological footprints (e.g., www.calvert-henderson.com). Triple bottom line accounting, pioneered by the Amsterdam-based Global Reporting Initiative is used by over 600 global companies to report their social, environmental and governance performance as well as profitability. All these new statistical reforms constitute the greatest revolution in accounting since the invention of double-entry bookkeeping in the Renaissance. All these reforms of markets, economics and accounting accelerated after Enron and are now growing even more rapidly in response to Wall Street's downfall, leaving the Chicago Boys in the dust. Meanwhile, local "green" economies are flourishing, creating local currencies, alternative liquidity networks, online community credit facilities and barter systems, reported by the Schumacher Society (www.smallisbeautiful.com).

A crisis is a terrible thing to waste! Each new revelation of greed, recklessness and stupidity will drive the emergence of new forms of more ethical markets suitable for human needs in the 21st century. The US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have been aroused from their decades-long slumber by public outrage. Yet, both agencies are timid in addressing the sleaze and rot still coming to light in financial markets. The SEC placed a brief moratorium in August 2008 on short-selling of 19 troubled financial companies – with little effect. Finally, on September 17th, the SEC ruled "naked shorting" illegal (i.e., when a trader sells a stock he doesn't own and doesn't even bother to borrow some stock to "cover" the trade). The SEC, after downplaying the fact that this practice is illegal, will now prosecute naked shorting as fraud. Selling into a declining market (the "uptick rule") was also outlawed in the 1934 law which set up the SEC and will need reinstating. Efforts to rein in speculation, which is estimated to have caused over 50% of the run-up in oil prices, have been defeated in Congress, together with higher margins and capital reserve requirements.

Wall Street must be about investing, seeking fundamentally valuable, well-run companies offering useful goods and services, even paying dividends. Trust must be restored – ignored in Chicago's School of Economics – because it is the bedrock of all markets. Financial markets metastasized in the USA and Britain toward 25% of their GDPs with too many people trading exotic paper and too few people actually producing goods and services. For the past decade, the market players have focused on trading, with ever-faster turnover of stocks and forcing managers of even the best-run companies to report even-higher quarterly earnings and punishing their stocks for missing short-term profit targets. Thus managers focused on short-term rushes to post profits, or cook the books, whatever the long-term costs of the company's future or society.

As the public caught on to all this, the Chicago Boys and Bush neocons' effort to privatize Social Security and turning over future retirees' benefits to private accounts managed by Wall Streeters was revealed as a bad joke. More revelations each day point to billions more "toxic waste" (i.e., almost-worthless bonds packaged with dicey mortgages) still not "marked to market" (i.e., properly accounting for the falling house prices and foreclosures). Sixty-two trillion dollars of outstanding credit default swaps (CDSs, a form of fraudulent insurance on assets owned by third parties) must be written down on the balance sheets of Wall Street titans JP Morgan Chase, AIG and others. Yet all the federal bailouts can only hasten the further decline of the US dollar.

As the frantic trading of all this alphabet soup of "innovative securities" speeded up, the main private unregulated company responsible for settling and clearing these trades, the Depository Trust & Clearing Corporation (DTCC, www.dtcc.com) fell further behind in accounting for this avalanche of nano-second computerized trading. Next were the revelations about auction-rated securities sold by investment banks and brokers to retail investors looking for higher returns than on Treasury bonds. As the markets sagged, these regular auctions failed which were supposed to offer investors higher returns from these bonds, and investors were denied access to their funds and their promised liquidity. New York State Attorney General Andrew Cuomo began prosecuting brokers for consumer fraud and ruling that the money must be returned to the unsuspecting investors. The next shoes to fall will be in credit card and student loan excesses. Today, the USA is the world's largest debtor, borrowing from China, Japan and OPEC countries for its military adventures and insatiable consumption.

As documented in Chain of Blame (2008) by mortgage experts Paul Muolo and Matthew Padilla, the US housing bubble was driven by Wall Street's gigantic money bubble created by cheap credit and leverage. The multi-trillion dollar "losses" on Wall Street are simply cancelling out their illusory "gains." No amount of federal bailing and money printing can fill the black hole of unrealistic expectations created by faulty economics. Wall Street became a parasite on the real economy of Main Street and has spread its contagion around the world. The lesson is that financial markets must shrink; the non-bank investment firms' business model is broken. Yet with all these further blows to Wall Street's declining credibility, many firms went to Washington in mid-2008 lobbying to be allowed to manage the pension funds of corporations – to the horror of their future beneficiaries. Already the federal Pension Benefit Guaranty Corporation is $14 billion under water due to corporate defaults on their pension plans.

The task now is to manage the downsizing of Wall Street and the global financial casino and redesign regulatory systems and markets to restore their useful but limited role in facilitating the production of useful, ecologically-benign goods and services in the growing green economies of the Solar Age. The truth is now in plain sight: there was no invisible hand! Markets and money are both shaped by legislation, central bankers, tax policies, subsidies, lobbying special interests and cronyism. Economics has always been politics in disguise. Money was confused with real wealth: educated healthy citizens and the basic productive eco-systems of our planet.

*****

Hazel Henderson is author of Ethical Markets: Growing the Green Economy (2007). is president of Ethical Markets Media LLC, USA, and co-creator of the Calvert Henderson Quality of Life Indicators regularly updated at www.calvert-henderson.com.