Viewpoint: How Wall Street Rigs the Game

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If you watched the recent presidential debates or the Republican and Democratic conventions, you might have gotten the impression that the practices of Wall Street that led to the worst financial crisis since the Great Depression have been fixed. None of the candidates are talking about it. Aside from Massachusetts Senate candidate Elizabeth Warren, politicians are noticeably silent on an issue that still poses a real risk to people’s economic futures: a financial system that is rigged against the ordinary citizen in favor of the banks — and allows the gains to be privatized to an elite few, even as the losses are socialized to everyone in America.

The truth is that the problem has not been fixed. Did you know that four years after the crisis, and more than two years after the passage of “landmark financial reform,” fewer than one-third of the new laws have been implemented and more than three-quarters of the required deadlines have been missed by the regulators? Did you know that the Wall Street lobby has spent more than $300 million trying to kill — or insert loopholes into — key rules that would ensure greater transparency in derivatives and forbid banks from betting against their own customers? Did you know that the nation’s five largest banks are even bigger than they were before the financial meltdown? Unfortunately, the politicians and regulators are buckling. There is a leaking dam, and what lawmakers and regulators have done so far is put a Band-Aid over it.

Who gets hurt when the revolving door between Washington and Wall Street starts turning and both the former chairman of the SEC, Arthur Levitt, and Jake Siewert, former aide to Treasury Secretary Tim Geithner, go work for Goldman Sachs? Or when Governor Tim Pawlenty leaves politics to head up the most powerful Wall Street lobby in the country? Or when big banks like JPMorgan and Goldman Sachs are overwhelmingly funding the campaigns of the very people who are supposed to be making laws to regulate them? The answer is that you get hurt, because your lawmakers get influenced, their objectivity gets compromised, and they lose their ability to ask the hard questions and fix the problem. Witness the recent case of JPMorgan’s losing $6 billion on reckless trades, claiming it was a “hedge” and allowing the executives who ran the group to leave with millions of dollars’ worth of golden parachutes.

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When Wall Street CEOs are hauled in front of Congress, as Lloyd Blankfein was amid the SEC fraud charges against Goldman that ultimately resulted in a half-billion-dollar settlement with the government in 2010, they tend to make the “we’re all big boys” argument: essentially that because they are dealing with sophisticated investors, they don’t have an obligation to tell their clients when they are getting themselves into trouble.

But whose money are we talking about here? There is a misconception that Wall Street is composed of rich people gambling with other rich people’s money, but this couldn’t be further from the truth. The secret that Wall Street doesn’t want anyone to know is that hedge funds comprise less than 5% of assets in the stock market. The real big players in the market are individual households and the pension funds, mutual funds, university endowments, charities and foundations that are entrusted with your savings, donations, retirement funds and 401(k)s. They are the owners of trillions and trillions of dollars invested with Wall Street banks. So, in effect, you are the big player in the market. And when a Wall Street bank overcharges a teacher’s retirement fund or a charity on a complex product, or misprices the Facebook IPO, causing billions of dollars of wealth destruction, or helps the governments of Greece and Italy cover up their debt, or rigs interest rates affecting trillions of dollars of loans, it ultimately affects you directly and comes out of your pocket.

But how does Wall Street make so much money anyway? Surely there are times when it must lose? Actually, not as often as you might think. Consider this: There are certain quarters when a Wall Street bank makes money every single day of that quarter in its trading business. Yes: 90 days in a row. One hundred percent of the time, it generates a profit. Bank of America has pulled off this amazing feat. That is like batting 1.000. A perfect record. How is this even possible?

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Two words: asymmetric information. The playing field is not even. The bank can see what every investor in the marketplace is doing and therefore knows more than everyone else. If the casino could always see your cards and sometimes even decide what cards to give you, would you expect it ever to lose?

Here’s how it happens: Because Wall Street is facilitating business for the smartest hedge funds, mutual funds, pension funds, sovereign wealth funds and corporations in the world, it knows who is on every side of countless trades. It can effectively see everyone’s cards. Therefore, it can bet smarter with its own money. Worse, if Wall Street can persuade you to trade a custom-made and impossible-to-understand structured product that serves the firm’s needs, it is as if your cards have been predetermined. There is little risk that the casino will lose in this scenario.

Also consider where the gambling takes place. In a real casino, it is on a casino floor with cameras all over the place. Even if you don’t like Las Vegas gambling, it is regulated. On Wall Street, by contrast, the gambling can be moved to a darkened room where nothing is recorded, observed or tracked. With opaque unregulated derivatives, there are no cameras. In this smoke-filled room, there is maximum temptation to try to exploit unsophisticated investors and conflicts of interest. And this temptation and lack of transparency are what led to the global financial crisis in 2008.

Finally, think about the dealer. Your banker might seem objective — like a friendly casino dealer who jokes around and is on your side — but there are times when he or she might be trying to steer you toward the thing that makes the casino the most money. If you were playing blackjack and you had 19, would the dealer ever tell you to hit? Sometimes, on Wall Street, he urges you to take another card.

With all these advantages, how can Wall Street ever lose? Even real casinos don’t make money every single day of the quarter.

The reforms Wall Street is pushing back the hardest against are in the areas it knows are the most profitable: derivatives and proprietary trading. But these also happen to be the areas that are most dangerous to the stability of the financial system. Wall Street hates transparency and will fight as hard as possible to prevent it from coming.

I want to be clear about something: I am a capitalist, and I believe in businesses’ growing by making as much money as they can. But in order for capitalism to work, it must be done fairly and transparently and on an even playing field. I simply don’t believe that free-market capitalism can operate effectively without ethical as well as legal boundaries. And I certainly don’t believe that deceiving your customers is necessary to generate maximum returns. In my view, today’s take-the-money-and-run model is neither responsible nor sustainable.

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How can it be that four years after the crisis, not enough has been done to fix any of this? Don’t we live in the greatest democracy in the world? People should be outraged that there is no political will to fix a problem that hurts everyone, enriches a superminority that has learned to rig the game and could threaten the world with another calamity in a few years’ time.

After the stock-market crash in 1929, the U.S. Senate conducted the Pecora hearings to investigate the sources of the crash. This inquiry led to real reforms that held banks accountable and eliminated the abusive practices that had caused the crash. This was followed by decades of calm in the financial system. Before you go to the ballot box on Nov. 6, shouldn’t you be asking your Senate, House or presidential candidate this question: Why don’t you have the guts to do the same thing?

Until he resigned in March 2012, Greg Smith was a Goldman Sachs executive director and ran its U.S. equity-derivatives business in Europe, the Middle East and Africa. He is the author of the new book, Why I Left Goldman Sachs: A Wall Street Story. You can follow him on Twitter @GregSmith_NY

54 comments
ericus
ericus

@TIME i see storm coming...

JDAGARWAL
JDAGARWAL

@SethShruti Surprise Surprise !!

ZICONOTIDE
ZICONOTIDE

@TIME and.... It's all coming to an end...

debbytravels
debbytravels

@TIME I'm sick of the rich getting richer while the rest of us just wallow above water line to eat,live & pray.Greed is a horrible condition

Darzpost69
Darzpost69

Hi there! I saw your interview. Don't believe the Hype from Maria's commentary that really should be f2f! @gregsmith_ny @time

dochosvet
dochosvet

I thought General Powel was right this morn on a news broadcast.  Most of the problem is congress who are supposed to make laws etc and the prez signs them or veto's them.  If congress doesn't act than we are stuck with a president who must do things by decree wether he is a republican or dem.

JosephPijanowski
JosephPijanowski

Greg is right on the money! There is a large formal organization which is ONE part of this RIGGED system. In addition to affecting ALL workers, it is particularly corrosive to our entire system of democracy. Many of you have not heard of this organization, or if you have, you do not know all that much about it. I cannot possibly convey how important it is for all voters to know who they are and what they do…..it is called ALEC. The American Legislative Exchange Council. Once fully informed your blood will boil, motivating you to TAKE A BIG SWING AT THEM THIS NOVEMBER 6th!

Bill Moyers lays them bare in 30 minutes..... .http://billmoyers.com/segment/united-states-of-alec/

Then go to http://www.sourcewatch.org/index.php/ALEC_Politicians 

 and see which politicians are ALEC members in your state! THEN VOTE!

Disgusted
Disgusted

41 comments - you'd get more from a bad replacement ref call.  Americans are stupid; we're ready to move.

LiberatedCitizen
LiberatedCitizen

Obama's in charge the buck stops with him figuratively and  literally (Bribes from Wall St. see below) and the Statute of Limitations is running out with his term. No President in history has been more corrupt!

For all the bluster of Obama, pre- and post-2008, as well as that of Attorney General Eric Holder concerning the alleged criminal activities on Wall Street, there have been zero Wall Street prosecutions under Obama/Holder. Compare that with his predecessors Bush and Clinton:GAI [Government Accountability Institute] details how the George W. Bush and Bill Clinton administrations both actually took down financial criminals - unlike the Obama administration.

Bush - 1,300 convictions;Clinton - 1,000 convictions;Obama - Zero attempts.

http://dailycaller.com/2012/08/07/report-cronyism-political-donations-likely-behind-obama-holder-failure-to-charge-any-bankers-after-2008-financial-meltdown/

Five Senior Goldman Sachs Execs Gave $130K To 'Obama Victory Fund' WHILE Eric Holder Was Deciding Whether To File Criminal Charges

http://dailybail.com/home/convicted-bush-1300-clinton-1000-obama-00.html

Why Can't Obama Bring Wall Street to Justice? 

Obama came into office vowing to end business as usual, and, in the gray post-crash dawn of 2009, nowhere did a reckoning with justice seem more due than in the financial sector. The public was shaken, and angry, and Wall Street seemed oblivious to its own culpability, defending extravagant pay bonuses even while accepting a taxpayer bailout. Obama channeled this anger, and employed its rhetoric, blaming the worldwide economic collapse on "the reckless speculation of bankers." Two months into his presidency, Obama summoned the titans of finance to the White House, where he told them, "My administration is the only thing between you and the pitchforks."

The bankers may have found the president's tone unsettling. Candidate Obama had been their guy, accepting vast amounts of Wall Street campaign money for his victories over Hillary Clinton and John McCain (Goldman Sachs executives ponied up $1 million, more than any other private source of funding in 2008). Obama far outraised his Republican rival, John McCain, on Wall Street--around $16 million to $9 million. As it turned out, Obama apparently actually meant what he said at that White House meeting--his administration effectively would stand between Big Finance and anything like a severe accounting. To the dismay of many of Obama's supporters, nearly four years after the disaster, there has not been a single criminal charge filed by the federal government against any top executive of the elite financial institutions.

http://www.thedailybeast.com/newsweek/2012/05/06/why-can-t-obama-bring-wall-street-to-justice.html

Barack’s Wall Street Problem is Now America’s

http://www.noquarterusa.net/blog/4939/baracks-wall-street-problem-is-now-americas/

epagbreton
epagbreton

Good job, Greg

Keep going.

Congrats on having the sense and wisdom to get out of GS.

Breton

mfmass
mfmass

@kellenschnee unfortunately, I think it's hard to argue that many of the circumstances that caused the meltdown don't still exist today.

RyanPCassidy
RyanPCassidy

@kellenschnee about +95% of this article is opinion if not misinformation by the way.

MatthewYetter
MatthewYetter

It goes even farther than what Mr. Smith has said. It's no coincidence that campaigns have become increasingly expensive. The more it costs to run for office, the larger each candidate's war chest must be. This puts them increasingly in need of sponsorship from big business and special interests. The truth of the matter is that by the time most candidates even make it to the primaries they have already been bought -- often by the same special interests! The result is that you're given a "magician's choice" when you vote. It doesn't matter which option you choose, you're still going to get exactly the same results.

wecandobetter
wecandobetter

Thank you Mr. Smith for caring about your country.  People, the problem is corruption and conflict of interest.  Laws and regulations are an attempt to control it.  When people are corrupt and immoral it is almost impossible to control.  Those who are good and moral with a care for the future of an American economy need to push for regulations and laws that are simple, straightforward, and easy to implement.  This was done after the depression.  What is being done now is like implementing the tax code, it's an intentionally layered mess because of the conflict of interest alluded to above and alluded to by Romney in the first debate.  Pres Obama and the rest of the elected politicians in Washington have been ineffective to stand up to the financial powers.  It is up to the common person, the honest, caring, hard working, and responsible person, the true backbone of the American economy.

Dana J Warren
Dana J Warren

too big to fail is just getting bigger; where's our common sense??

Rim Hakiki
Rim Hakiki

Big Brother is Still Watching You..

Mike Rosen-Molina
Mike Rosen-Molina

Oh the Executive Director of Goldman Sachs recognizes that Wall Street rigs the game? How unfortunate that he was never in a position to do something about that. OH WAIT

AmiyaKPalit
AmiyaKPalit

Those undecided voters,who are yet to decide whether they should or shoudn't vote for President Obama or Governor Romney should question them,reading this wonderful article,if President Obama deserves another term or not.His presidency is being hijacked by the goonies in the wall street.It's time for a wake up call for the middle class now.

GaryRMcCray
GaryRMcCray

Many people believe in capitalism as the most important and single most valuable aspect of the USA.

This is both true and not.

Relatively unfettered capitalism has let America prosper like no other country for decades.

Unfortunately, uncontrolled capitalism provides many avenues for abuse and these flaws are catching up with us.

Jefferson became famous as an advocate for human rights and abhorred and was intent on abolishing slavery, but when he became financially successful, his own lifestyle incorporated and was dependent on a large population of slaves he shifted into a capitalist view of them as workers and a valuable, breed-able and salable commodity.

Mostly we remember Jefferson for that first part of his life and don't talk much about the later part.

The lesson is clear however, capitalism is power and unfettered capitalism has a very strong tendency to displace all other values with its own ethic of short term personal success at any cost. 

Absolute power corrupts absolutely.

Capitalism needs controls, but in a technological age, the power of capitalism grows quickly and it's influence is eventually able to subvert or corrupt any impediment, government, religious, ethical that stands in it's way.

But capitalism does not know how to run governments or care for a population, all it knows how to do is to win and prosper and grow.

Of course, with no really long term plan eventually it uses up and destroys it's own world and fails completely.

There is no end game and we are at that point now.

We trusted capitalism when there was really nothing there to trust.

We had to make capitalism work for us and we didn't.

Now we will pay.

CarrieChang
CarrieChang

The upper crust is seeking to enslave us all.  WAKE UP MIDDLE CLASS, no one is on your side, least of the all the government or the ruthless corporate bosses you work for.

@TIME Great article. Mainstream media needs to give these issues more attention and let people know what is really going on.

CanePazzo
CanePazzo

The crooks on Wall Street will pump money into any campaign they perceive to having a chance to win.  Both sides get their hands dirty, it only differs by degree.

Public financing is the cure for this problem.

JohnYuEsq
JohnYuEsq

GREEDY, SOCIOPATH Romney MADE-OFF like MADOFF and ENRON.  SAVE the American Middle and Working Class.  VOTE the DEMOCRATIC TICKET.

csteveevans
csteveevans

Of  course the system is rigged against the average american. It always has been, but not always as bad as now.  The hyenas are fighting over the last scraps of the U.S./ economy.  Since the beginning american corporations have always depended on free or nearly free labor and stolen resources.  They no longer need a consuming american middle class; there is one growin overseas.  Now, they can throw the scraps of the american middle class to the dogs.  The american scheme is nearing its ulitmate fruition.  We will be slaves once again.

east_coast_alpine
east_coast_alpine

This problem will not go away until two things happen:

1. Institutional investors (the pension funds and other entities whose investments represent a substantial portion of the assets of major banks) begin to demand transparency, and actually follow-through on threats to move their assets elsewhere if they aren't placated; and

2. Stockholders of these institutions vote out the Jurassic "Old Guard" Boards of Directors, which primarily consist of Upper East Siders with boundless feelings of entitlement who actually look down with disdain upon their investors.

Until then... we only have ourselves to blame.

ChadPyle
ChadPyle

How curious that there's no mention of the Federal Reserve: a consortium of international bankers that preceded the Great Depression, has consistently devalued U.S. currency, since its inception, arbitrarily tinkers with interest rates; and is under no compulsion to disclose where the trillions of Fiat currency go. Curious indeed...

kmyers000
kmyers000

Yes.  Asymmetric information.  Spot on.  Thanks Greg ...

rjb77573
rjb77573

As a former investment banker myself, I know this article to be spot on.  Not only can the big banks and hedge funds see your cards, they know the results of your play before you do with all of the trading systems they have on or near the trading floors.  These algorithmic trading systems (think day trader on steroids) can make trades in under a millisecond and are responsible for siphoning off many millions of dollars from the markets every year.  When the average investor executes a trade, it takes several seconds for the results to be displayed due to network latency.  In that same time, the algorithmic trading system has bought and sold that same stock hundreds of times. 

Investors should be required to hold a stock for some incredibly long period of time, like a day or an hour to eliminate this type of nonsense.

RickFitzpatrick
RickFitzpatrick

Nothing a few guillotines wouldn't fix. I'd pay one years income to release the lunette on Goldman's CEO.

YParadisios
YParadisios

Statute of Limitations, approaching. Enforce rules. Stop donations by WS to weaken or not fund rules or Die! RT @TIME http://t.co/FWhAKNZq

keybd29
keybd29

The federal political class has special privileges in the areas of annual pay raises, education, health, and retirement. Maybe more?  Privileges wildly beyond those of the US electorate.  Our republic is quite broken.  But look on the bright side.  After all it COULD be worse.  We could be charged with teaching civics or constitutional government--or some other fiction--to children.  

keybd29
keybd29

Greg Smith writes, " . . . you get hurt, because your lawmakers get influenced, their objectivity gets compromised, and they loose their ability to ask the hard questions and fix the problem."  

Granted, of course I as a member of the public/electorate get hurt!!  I share this concern, but see it as past fixing.  

How can THE PUBLIC (the electorate) firewall  or ring fence lobbying and industry/government chumminess and collusion?  Come on, at this stage?   How can the public, for that matter, ring-fence big media interests from big government interests?  IMO none of these partnerships are answerable to the public or within reach of the electorate:  Big media interests, big business interests, big government interests.  

SamuelSatter
SamuelSatter

Welcome to America, bought and paid for lol.

www.Overly-Anon.tk

JonathanMartin
JonathanMartin

Like qdav said, we can't trust politicians to fix this problem The problem goes far beyond the need for better regulation since those who enforce the rules are going to be subject to the same moral hazards as the politicians who refuse to act. The solution is to get away from what feeds these financial monsters: fiat money. Making more regulations is like appointing new wolves to protect the sheep from other wolves. Lets just stop feeding the wolves and watch them die off. People need to get this: no dictatorship is ever built telling people up front that their wealth and freedom is going to be taken away. The structure is put in place using public interest excuses. But once the structure is built, it's only a matter of time before it gets redirected to it's real purpose. Wake up!

qdav
qdav

Smith:  Bravo!  Thumbs-up!  Here-here! etc, etc ... 

Now.  What do we do about it?  Put our trust in politicians???  Ha!  The only reason they're not screwing America over quite as badly as Wall Street is because they're not as smart.  It certainly isn't from lack of trying.  

May as well face it; the deck is stacked against regular Joes, and it's stacked against anybody that tries to live their life morally and honestly.  It isn't absolutely impossible to get ahead without selling your soul, but it's a he11 of a lot easier it you do.

chokingkojak
chokingkojak

Smith, you're the money man, here.  If anybody is up to taking on the powers that be in the financial services industry, it's you.  You -- or others like you -- will have to be the leader(s) of any uprising, so to speak, concerning this matter.   That's the bad news.

The good news is that, if you do take the lead, my guess is that you will find plenty of popular support behind you -- money, people, all the tools you'll need to see your objectives met.

kellenschnee
kellenschnee

@RyanPCassidy I know it says viewpoint, come on man! I'm not attacking people of ur interest! Just interesting to read. No1 knows the truth

GaryRMcCray
GaryRMcCray

@AmiyaKPalit 

And the point is that "good old Republican Romney" is going to improve that situation.

Are you out of your mind, he is the problem and would do nothing but give them more scope to rape and pillage the general populace on behalf of good old American capitalism.

duardon
duardon

GaryRMcCrayNot to harp on your view of history, but my understanding of Jefferson was that purchasing and owning slaves was the only way he could support emancipation and equality in a slavery-dominated political sphere. It was Jefferson after all who, when drafting the Declaration of Independence originally included "all humans" are created equal, only to see the verbiage removed on later revisions as a compromise for slave states taking part in the declaration. Jefferson would only have advocated a political solution to slavery, and as such felt the only way to fight back against society was to practice what he preached.I hardly think Jefferson's slaves were the byproduct of his rich-capitalist mindset overpowering his republican principles given that:

1. He slept with a slave and may have had offspring2. His "slaves" loved and revered him, even after his death3. He died completely in debt, and his estate was foreclosed on

I don't see how your point holds weight in light of all this...

duardon
duardon

@GaryRMcCray 

Not to harp on your view of history, but my understanding of Jefferson was that purchasing and owning slaves was the only way he could support emancipation and equality in a slavery-dominated political sphere. It was Jefferson after all who, when drafting the Declaration of Independence originally included "all humans" are created equal, only to see the verbiage removed on later revisions as a compromise for slave states taking part in the declaration. Jefferson would only have advocated a political solution to slavery, and as such felt the only way to fight back against society was to practice what he preached. I hardly think Jefferson's slaves were the byproduct of his rich-capitalist mindset overpowering his republican principles given that:

1. He slept with a slave and may have had offspring

2. His "slaves" loved and revered him, even after his death

3. He died completely in debt, and his estate was foreclosed on

I don't see how your point holds weight in light of all this...

RyanPCassidy
RyanPCassidy

@kellenschnee who complains that he got attacked by his pet snake.

RyanPCassidy
RyanPCassidy

@kellenschnee didn't see it as an attack but if they don't want taxpayers to bail out banks, then don't bail out banks. It's like the kid

RyanPCassidy
RyanPCassidy

@kellenschnee CR. IC/Clinton on weekends. Occasionally NYC for interviews.

kellenschnee
kellenschnee

@RyanPCassidy the real question is where are you right now CR, VT, IC, NYC, CLNTN? I've lost track due to grad school and ball.

kellenschnee
kellenschnee

@RyanPCassidy I love the analogy, I laughed! I hear you man. I just have to read all sides/op-eds since I have no idea what is truly up.