Market "Speculators" Are the Economy's Health
It didn't take long for the non-scandal that allegedly threatened the reputation of Goldman Sachs to die of its own contradictions. As a public company whose sole constituent is its shareholders, evidence quickly revealed that Goldman was serving its owners well through investment vehicles meant to match the needs of both its bullish and bearish customers.
Unfortunately, the non-controversy surrounding Goldman dredged up other, more dangerous notions about market speculation itself. To believe the naïve musings of commentators on the left and right, the oft-mentioned trades engineered by Goldman Sachs, along with others of the "speculative" variety, don't serve any economic purpose other than lining the pockets of the market actors who participate in them. Nothing could be further from the truth.
For background, financial commentator Roger Lowenstein noted in the New York Times recently that, "Wall Street's purpose, you will recall, is to raise money for industry: to finance steel mills and technology companies and, yes, even mortgages. But the collateralized debt obligations involved in the Goldman trades, like billions of dollars of similar trades sponsored by most every Wall Street firm, raised nothing for nobody."
New York Times columnist Andrew Ross Sorkin parroted Lowenstein in asking "What purpose does a synthetic CDO...serve for capital markets, and for society?" On the right, financial historian Niall Ferguson teamed up with LBO billionaire Ted Forstmann in a Wall Street Journal op-ed which reduced the ABACUS investment product structured by Goldman to "a wager with as much economic utility as a gigantic bet on a roulette wheel or a horse race."
In truth, market speculation of the kind mentioned above is an essential economic input. Without the price signals provided by traders with varying views on all manner of economic activity, the "economy" as we know it would lack the information necessary for its efficient organization.
All of that in mind, it can't be stressed enough that the word "speculator" is a pejorative one that incorrectly belittles what these market actors actually do. More realistically, we should describe them as "price givers"; the prices they provide us with essential when it comes to ensuring that limited capital reaches its highest use.
Considering the much commented on trade entered into by John Paulson and IKB, the fact that Paulson was enriched by the transaction is merely the "seen." The "unseen" in this case is the economic benefit that the trade's end result achieved. Specifically, Paulson's windfall unequivocally signaled to real estate bulls that their continued funding of subprime mortgages would not redound to their returns.
So while IKB "lost" on its subprime bet, unseen is how many investors avoided destroying even more capital thanks to Paulson's successful bet. Ferguson and Forstmann argue that the Paulson/IKB trade "increased the instability of the global financial system", but their suggestion is exactly backwards.
Instead, Paulson's trade limited the fallout from the recessionary rush to property this decade for IKB's losses forcing other mortgage bulls to re-think their investment strategies. That Paulson became a billionaire many times over thanks to his bearish met is once again the "seen", but the happy "unseen" is all the capital not wasted on profligate borrowers due to Paulson's brilliant detective work.
Importantly, "profligate" is surely a kind description of the individuals who took out loans of the subprime variety. Indeed, in his new book, The Big Short, Michael Lewis references a strawberry picker earning $14,000/year that was able to secure a $724,000 mortgage, along with two housekeepers who turned ownership of one condominium into six in Queens. More recently, an article in the Wall Street Journal recounted the struggles of a child-care provider named Stella Onyeukwu who, while strapped for cash, managed to borrow $786,250 from Fremont Investment & Loan.
In a column this week for the New York Times, financial writer Bethany McLean moaned that the ABACUS deal didn't "finance a world-changing invention or create any jobs." Wrong again. Since there are no companies or jobs without investment first, the trade seen by McLean as economically meaningless was nothing of the sort. Instead, it halted blatant economic waste that drove money into the hands of the irresponsible, and away from the productive, job-creating economy.
As evidenced by the collapse among subprime securities, further investment in them represented the very wealth destruction that is inimical to job creation. Paulson's financial bonanza was a certain job creator thanks to his prescient investments exposing investments that were destructive.
So for elite thinkers of varying political persuasions to cast aspersions on traders and "speculators" is for those same people to reveal how truly naïve they are about what drives ours, or any economy. To put it very simply, economic growth results from good, productive ideas being matched with capital so that what is merely a concept morphs into an economy-enhancing business.
In that sense, whether "speculators" or traders are right or wrong in their speculations, the market prices they give us are hugely stimulative for the information signaling where capital will best be deployed. We wouldn't have much of an economy without the John Paulsons of the world, so rather than denigrate his doings, we should be quite thankful for his self-interested trades ensuring that bad ideas are starved of capital so that good ones can receive it in abundance.