The Failure of Speculative Capitalism

BY Angelo Matera

January 11-17, 2009 Issue | Posted 1/5/09 at 12:47 PM

Since the global financial crisis began in September, stock markets around the world have careened hundreds of points up and down almost every day, sometimes within just a few hours.

Investors are nervous, uncertain about the future, wondering whether tomorrow will mark the start of a recovery or the beginning of a disastrous depression. So they buy or sell on a whim. Such is the irrationality of our financial markets.

What’s happening? How can a trillion dollars of company value be created or destroyed in just a day? What caused the financial meltdown in the first place? While the media blames good old-fashioned greed, the reasons are more complex, involving financial practices that constitute a “structure of sin.”

Catholic moral and social teaching tell us that a financial system that purposely channels greed into speculation and usury, rather than into productive investment, is inherently irrational and unstable. A collapse was inevitable.

Put simply, usury is lending money at punitively high interest rates, and speculation is high-risk investing that is actually a form of gambling. From the Catechism of the Catholic Church to the social encyclicals issued by popes going back to Leo XIII in the 19th century, the Church has recognized usury and speculation as harmful forms of lending and investment (the Church is not alone — most civil governments have laws against excessive interest rates and “Ponzi” investments schemes. The FBI recently arrested Bernie Madoff for running his much-heralded investment fund as an actual “Ponzi” scheme for two decades. His investors stand to lose $50 billion).

These dangers are clearly understood in Europe because of its Catholic heritage. When European leaders met several months ago, they blamed “speculative capitalism” for the crisis. French President Nicolas Sarkozy contrasted the difference between real productivity and speculation when he said: “We want a capitalism of entrepreneurs. We don’t want speculators.”

This distinction echoes what Pope John Paul II said, in his encyclical on the dignity of work, Centesimus Annus:

“Ownership of the means of production, whether in industry or agriculture, is just and legitimate if it serves useful work. It becomes illegitimate, however, when it is not utilized or when it serves to impede the work of others in an effort to gain a profit which is not the result of the overall expansion of work and the wealth of society, but rather is the result of curbing them or of illicit exploitation, speculation or the breaking of solidarity among working people. Ownership of this kind has no justification and represents an abuse in the sight of God and humanity.”

This is not a pie-in-the sky critique. The most influential American critic of stock speculation is Warren Buffet, one of the richest men in the world and considered by many to be the most successful investor ever. The Tao of Warren Buffet (2006), a book authored by Mary Buffet and David Clark, is filled with his scathing criticism of investment firms for focusing on short-term results:

“The trading madness that goes with the mutual and hedge funds is almost boundless … if there is even the slightest drop in earnings, they will sell the stock, and if there is even a modest rise in earnings, they buy it. … This is not investing; it is speculating under the guise of investing. Investing is buying a piece of a business and watching it grow; speculating is throwing the dice on the short-term direction of the stock’s price.”

This speculative mentality is at the root of the current crisis: Beginning in the 1980s, laws and regulations enacted after the Great Depression to restrict dangerous and unproductive speculation were peeled away in the name of “deregulation.”

As a result, investment banks, hedge funds, private equity firms and other speculators, operating without any oversight and looking for outsized profits for themselves and for investor clients not satisfied with merely average rates of return on their money, were able to invest trillions and trillions of dollars in ever more complex and opaque financial instruments, turning the stock and credit markets into a monstrously high-risk, high-leverage, financial casino.

When the subprime mortgage market (mortgages issued at high interest rates to people who were poor credit risks) ran into problems last year due to the end of the housing boom and other reasons having to do with fraud and usurious practices, it started a chain reaction that now threatens to bring the whole shaky structure crashing down. (For the most detailed, definitive analysis of the crisis, see Charles Morris’ The Trillion Dollar Meltdown.)

Like sex outside the generative context of marriage, making money through speculation — gambling on price increases caused by luck, mass psychology, or some other arbitrary reason — is a form of mutual exploitation, a zero-sum game where winners gain at the expense of losers. In real business, profit is the result of something else; it comes from “creating a customer,” in the words of the late, great management guru Peter Drucker.

When we consider our slowly declining standard of living, we should consider Drucker’s prescient observation about Wall Street, as cited in a 1999 article in The New York Times during the height of the Internet stock market “bubble”:

“Typically, Dr. Drucker gave the global bankers the back of his hand: They have introduced not ‘a single major innovation in 30 years,’ he said. Rather, the financial industry has turned inward to perfecting ‘supposedly scientific derivatives,’ in a shortsighted hope of wringing the risk out of financial speculation, like Las Vegas gamblers who futilely try to devise ‘systems’ to beat the house.”

Or, as Warren Buffett concisely put it, “… according the name investors to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic.”

Ironically, like “safe sex,” safe speculation has proved to be an illusion.

Angelo Matera is publisher

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