Saturday, June 27, 2009
Winning The Greed Game
Presented in a style similar to Lifestyles of the Rich and Famous, Super Rich: The Greed Game chronicles the methods by which the super rich have become super richer.
According to BBC documentary maker Robert Preston, the secret to this has been leveraging -- the act of borrowing in order to invest. Leveraging allows individuals and businesses to quickly flip their investments for quick profit, allowing individuals and businesses to generate a tremendous amount of profit off of comparatively small amounts of money.
Preston offers as his test case the example of buying a house. If an individual pays 10,000 pounds sterling down on a house that costs 100,000 pounds, he can effectively double his money by selling the house if it increases in value by only 10%. Clearly, the more money one has to invest in this process -- and clearly, possessing more money brings with it additional borrowing power -- the more one can profit. Leveraged investments of thousands of pounds offers the prospect of thousands of pounds. Leveraged investments of millions of pounds offers the prospect of millions of pounds in profit. If one has the ability to borrow billions, this process quickly begins to speak for itself.
By paying off the loans taken out for these leveraged investments quickly, these investors pay a minimum of interest on those loans. Leveraging allows investors who otherwise wouldn't be able to invest so lavishly to maximize the profitability of investing comparatively small amounts of money.
The eagerness of exporting countries to loan their money led to an environment in which cheap credit could quickly be obtained to invest in increasingly expensive commodities.
With credit flowing so freely, debt quickly accumulated. Low interest rates set by Alan Greenspan at the US Federal Reserve enticed many otherwise cautious investors to play their hands more liberally.
The same pressure applied by the most zealous supporters of market economics on Bill Clinton in order to get him to scrap his promised reforms was applied to the British Labour Party's Gordon Brown. Brown, who had once promised tax reforms to shift tax burden toward the super rich (which, one should keep in mind, is a comparatively tiny fraction of any country's population) instead embraced policies that have favoured the super rich.
There is, of course, an economic risk that comes with adopting tax policies that provide a country's wealthiest citizens with an incentive to leave for countries with more favourable policies. That being said, however, it's important to keep in mind that the wealthy primarily have a single rule: invest where profit can be made.
Tax policies that no longer favour the super rich as stringently as before do little to change the mean economic value of any particular country. So long as a country remains prosperous and its economy vibrant, the incentive for the wealthy to invest will remain. After all, not even the super rich can increase their rich if they decline to invest where profit can be made.
In many cases, leveraged investments produce little in the way of new wealth. In many ways, leveraged investment is a predatory practice that simply takes advantage of immediate opportunities.
One perverse element of leveraged investments is the transfer of risk from investors to lenders. An investor who gambles and loses may seek refuge in bankruptcy, which will significantly reduce a creditor's ability to collect that debt.
Low interest rates didn't merely make leveraged investing more attractive. It also reduced to incentive to save money -- after all, saved money accumulates interest at the same rate that borrowed money increases. With little money being saved, the subprime loan scheme was introduced in which loans and mortgages were extended to people with few borrowing prospects -- sometimes using predatory practices -- then sold off to other investors for profit.
In many cases, these deals were structured in ways that only one or two investors would see any return on their investment. This has become known as the derivatives market. Only under the best-case scenario would all of these investors recieve a return on their investment. In most cases, someone was bound to take a loss. In the worst-case scenario, however -- the one that eventually emerged -- everyone loses, except for the initial lender.
It's hard to feel sorry for many of these individuals. Any informed investor buying in to mortgage derivatives should know full well the magnitude of the risk they're accepting. Then again, considering the deceptive and predatory practices of many subprime lenders, it's questionable how many details many of these investors were privy to.
Manipulation of investment rating systems -- which could be better described as willful negligence -- contributed to the deception of many investors. Investments that due to their very nature were extremely risky were instead promoted as risk-free.
The costs to investors has been fairly minimal compared to the costs to the borrowers who were enticed into taking out these subprime loans. Many subprime borrowers have given up hope of things as comparatively simple as home ownership.
In the wake of an economic collapse precipitated by these practices, it's perhaps insulting to realize that the luxury goods market hasn't been affected by the recession. The super rich enjoy spectacular degrees of security because the scale of their investment renders them "too big to fail" (in the increasingly unpopular parlance), legislators are obligated to issue bailouts in order to avoid a complete economic evaporation.
To add insult to injury, many of the same investors who have helped precipitate the current recession are actually in a position to profit from it. The need to correct a regulatory deficit in the global economy is beyond evident.