The Promise Makers of Wall Street

by Brian T. Lynch, MSW

Not long ago a dollar was backed by the promise that it could be exchanged for gold or silver. To back up that promise the US gold reserve was established at Fort Knox in Tennessee, for example. The confidence of our people, and of the rest of the world, in our currency was far less certain than it is today.  The gold standard was perhaps a necessary step towards establishing the good faith of the US Government.

Look at a dollar bill and you will see that it is a Federal Reserve Note. Before the creation of the Federal Reserve Bank, many banks issued their own currency, or "bank notes".  The worthiness of those bank notes wasn't inconsistent. The Federal Reserve Bank standardized and stabilized our national currency. It's important to remember that the word "note" is another word for an I.O.U.  A banknote is a promise that a coin or a paper document can be exchanged for a stated amount of "tangible value."

The important point for this discussion is that all currency is a form of debt. A U.S. Dollar is a government-backed loan. Our trust in its worthiness has become an intrinsic faith in our government's ability to guarantee its face value. (Which is why the Congressional Freedom Coalition's talk of not raising the national debt ceiling is so dangerous.)

I recently saw "Junk" on Broadway. It is a play partially based on the story of Wall Street financier Michael Milken.  It is a cautionary tale of money and corruption. Milken's new approach to finance made him a billion dollars over just four years in the 1980s. He was like a god on Wall Street and all the normal rules didn't seem to apply to him until he got caught breaking the laws he willfully ignored.

More than that, Junk is the story of the paradigm shift Milken pioneered in how modern bankers and business leaders have come to understand wealth and power.  It is a view of wealth that can be summed up by the slogan, "debt is an asset".  Specifically, any financial instrument that reliably conveys the promise of value to another person or entity can be used as a form of currency.

Government regulated Federal Reserve Notes are no longer central to the exchange of wealth. Nor is any physical collateral or real estate necessary. It seems almost any promise of payment for money owed is sufficient to make financial transactions on Wall Street. These creative financial instruments often have clever names and deceptive structures. They are increasingly complex and difficult to understand or regulate. But they all have one thing in common, they are all based on debt. They all create wealth on a promise.

In  Milken's case, he began with generating cash by selling very high risk, but high yield bonds and then using those bonds as collateral to finance corporate takeovers. These "junk bonds" (as they are still called) were used as currency to finance "leveraged buyouts" of other businesses. Whole divisions within companies purchased in these buyouts often had to be chopped up and sold off to pay back these high-interest bonds.

The charges brought against Milken were ordinary financial crimes, such as insider trading. But his creative financing resulted in a whole new banking culture that upended how business was conducted around the world. It has lead to an economic environment where new methods for wealth extraction competes against more conventional methods of wealth creation on a global scale.

The growing methods and culture of wealth extraction do transfer wealth from one party or entity to another but doesn't create new wealth. It doesn't grow or manufacture anything. It only creates more opportunities for the wealthy to grow richer while disadvantaging mid-sized businesses and manufacturers. It is one of the drivers leading us into the next gilded age, but it hard to see just where it is taking us. It is harder still to know what we can do to make our economy work for everyone again.