The Fed Grasps At Straws

Here is a really stupid headline and story summary from the WSJ, which I believe is worth saving for posterity as it is indicative of the times in so many ways:

Federal Officials Say No Thanks to Negative Rates
Fed officials don’t think negative rates are needed in the U.S. because the economy and job market are improving and they are hoping they will never have to use them in the future given their uncertainty about whether the policy works.

They claim they don’t “need” negative rates because things are improving, but they won’t raise rates, which is what typically happens when they’re done subsidizing with monetary policy.

But despite their present judgment, they’re simply “hoping” they wont have to use them in the future, which suggests they’re not confident about their present judgment.

Meanwhile, the reason they’re hoping they won’t have to use them is because they don’t know if they work. So, they’d be willing to try something that has some chance of making things worse, in order to see if it has a chance of making things better.

So this is the era we live in: the central bank refuses to return things to “normal” while insisting things are on the mend, is open to conducting monetary science experiments on the economy despite initial misgivings, and reporters write stories about this chicanery as if these are all serious and respectable ideas to entertain. Couldn’t a bunch of Fed chimpanzees at the trading consoles have a reasonably good chance at improving upon this model?

The Open, Free Intellectual Environment Of The American University

A fellow investor friend of mine sent me an e-mail and suggested I read “What’s the point?” by UK fund manager Terry Smith. We were originally talking about Michael Burry’s commencement speech at UCLA [PDF] and the idea that one of the things that was so extraordinary about it is the way he unmasked the villains and the corruption and spoke the truth unapologetically in such a public forum. I had also, in an earlier e-mail, complained about my lack of interest in blogging, feeling frustrated lately at the nearly overwhelming volume of fallacious bullshit floating around the net that seems to deserve a response yet leaves me tired and bored out of my mind every time I attempt another mud wrestling fiasco.

I don’t know if my frustration inspired the link to Terry Smith or if it was simply the next step in the theme of telling it like it is or what, but that blog post got me thinking. I’ve long thought about giving it one last hurrah and then hanging up my hat. Because, seriously, what is the point? You can tell the truth a million times but if your opponent is bent on lies and deceit, nothing can be done. (Of course, Mises adopted the slogan, from Virgil, of “Tu ne cede malis”, but he’s a smarter man than I, with more energy, apparently.)

In light of this, I wanted to share three critical experiences I had in college during my sophomore, junior and senior years, respectively, which have stuck with me to this day and serve, subtlety and fundamentally, to color my view of the intellectual Opposition. I believe my experiences are not unique, although few people besides me may have had the required awareness to realize it, and as such where I went to school back then is not important to the story. This is not about an institution but rather the institution of the American academic system and its culture as it exists today, and likely has existed for awhile before now and probably longer still in the future.

I want to give some insight into why I find it hard not to be dismissive of many people who claim to think differently than me on various philosophical subjects.

I first became suspicious of my academic curriculum when I learned that microeconomics was not a prerequisite for macroeconomics. Rather than being treated as fundamental knowledge built upon and reexamined from a more global standpoint in macroeconomics, microeconomics was treated as a separate discipline entirely, which could be studied before, during, or after macroeconomics or even not at all (at least, if you weren’t concerned about getting an economics degree). Of course, numerous macroeconomic theories contradicted accepted wisdom taught in the microeconomics course, but no explanation was given as to the nature and source of these apparent contradictions, nor where it was in the economic causal chain that things stopped making micro-sense and started making macro-sense. There was simply a dichotomy in place and you were expected to accept it and move on.

In my second year I was excited to take a class with a professor teaching “international trade” (you know, the separate set of economic principles and rules that apply when two people exchange goods across imaginary political boundaries). Everyone I knew who had taken the class spoke highly of this professor as a competent and entertaining lecturer and said the material itself was quite fun. We spent a lot of time in that class studying the roles of quotas, tariffs and other government interference in the economy. It was really about political economy, not economics, because economics doesn’t change when you move stuff over imaginary lines.

But what rubbed me kind of raw in the class was when this beloved professor spoke quite approvingly of the idea, built into his theoretical examples in class, of providing “transfer payments” (read: violent redistributive extortion for special interest groups carried out by the government) to currently privileged groups who would be “hurt” by “free trade”. This professor advocated that paying these highwaymen off and reaping the benefits of freer trade was a good idea in the long run.

“Uh, question, professor– wouldn’t it be best to just have free trade, without a complicated system of quotas, tariffs and transfer payments to interest groups? Isn’t that most economically efficient? Why don’t we learn about that?” This question got a knowing smirk and a request to meet the good professor privately during office hours to discuss, as there simply wasn’t enough time in lecture to discuss such twaddle.

Dutifully, I scheduled some office hours time to meet with the beloved professor and discuss. Again, I posed the question to him, why are we paying these people off? Isn’t it better to let them figure out their own way to survive a competitive market place without getting welfare from everyone else? After all, they have no right to a certain income or position within the market place. Again, a knowing smirk as the professor launched into a short anecdote about how he once was full of piss and vinegar like I about these subjects. But the truth of the matter, he told me, was more complicated.

And then he, in so many words, spilled the beans– if “we” don’t bribe these special interest groups with redistributive social justice, they’ll get their pitchforks and their torches and elect another Hitler. That was it. That was why he doesn’t teach actual free trade economics in his course. That’s why he thinks transfer payments are good. That’s why he was for FDR’s New Deal and the Social Security scam. He saw it as the only thing standing between us, and Hitler.

I tried to make the point that if you fear totalitarianism, transfer payments are actually a step toward totalitarianism, not a step away. He responded by suggesting that granting these dictator-electors-in-the-wings a little welfare would create some kind of social anchor where we’d go no further toward socialism past that point, having bought the evildoers off. Never mind people tried to buy Hitler off and he just asked for more until he went to war. And never mind that the US government has had to move far, far beyond the New Deal since then to keep neo-Hitler at bay, according to his logic.

At this point, having no response to my observation of yet another contradiction, I was informed that office hours had suddenly come to an end (I’d only been there for thirty minutes and had scheduled an hour and I didn’t see anyone waiting in the hall for an audience) and that although he really enjoyed our conversation, he was going to have to ask me to come visit with him during the summer to continue the conversation. Of course he knew I was an out of state student who would be returning home during the summer so he was actually dodging his responsibility to make sense of his intellectual positions.

I left his office reeling in confusion and frustration. Here is a guy that my peers think is one of the best instructors the university has to offer, he is considered to be a thoughtful and intellectual person, etc. Yet, I come to find out he is teaching disingenuously. He is guilty of the “smuggled premise”, that is, his economic values taught in his class have nothing to do with sound economic reasoning but rather a personal, political belief that is never named nor mentioned which is thereby “smuggled” into the lessons. Instead of being honest and telling his students “I am teaching you a bunch of stuff that doesn’t make economic sense, because I think it makes political sense”, he carries out his pedagogical mission in such a way that he exploits his students ignorance and credulity.

Why can’t this professor just tell everyone what he really believes? Are we not old enough for the truth? Did we not pay for the truth? Do we not expect the truth?

To say I was disappointed by this experience would be an understatement. But I tried to put it behind me as I continued my economic studies.

During my third year, I had another run in with an economics professor, this time one teaching a “money and banking” course who had done some consulting for the Fed and who used as a textbook in his class the work of the notorious intellectual bungler, Frederic Mishkin. I raised a lot of challenges to the material which were poorly handled by the professor, but there is one in particular that will always stand out to me because of its zaniness. We were discussing the “money multiplier” of fractional reserve banking and how with a tiny base of reserves banks could pyramid large amounts of credit on top and lever up their balance sheets. I raised my hand and asked, “Doesn’t levering the balance sheet increase the risk of crisis for the bank and for the banking system?”

The professor acknowledged that, well, yes, it does, but it’s all done within the proscription of the FDIC guaranteeing everyone’s deposits and the Fed serving as lender of last resort to prevent a total collapse. Then I asked, “Well isn’t that crisis kind of inevitable when you create duration mismatch between funds that are borrowed short and lent long like this?” And the professor acknowledged, well, yes, it does, but again it’s all done under the keen watch of the overseer regulatory bodies, this time a little bit more apprehensive. And then I went for the F-word. I raised my hand, “But professor, isn’t it fraud to lend out people’s money that they think is being held for safe-keeping at the bank? Why not have the bank separate the two activities, safe-keeping and loan-brokering?”

There was a pause and he looked kind of startled. His skin color rose and his face contorted into a mixture of anger and glee, because now he had “figured me out” and knew my true motive. He exploded: “So I guess if it were up to you the banks wouldn’t make any money, huh?!”

A little shocked at his outburst, I stammered, “Well, no, of course not, I don’t really see what their profitability has to do with my question…” but he cut me off. “Yeah, I see what you’re trying to do. You don’t want the banks to make any money, do ya?! Well, it’s a nice ideal but it doesn’t work in the real world and if banks didn’t make any money, we wouldn’t have any banks and you wouldn’t want to live in a world without banks!” he growled, signaling that question time was over and it was time to get back to his brilliant lecture on fraud-based banking economics.

The episode was so instructive for me. So THAT’S what he’s about– shilling for fraudulent reserve banking, not trying to explore the truth of the matter. He neatly dodged my very simple, very honest inquiry of how we might live in a world without systemic banking risk, a world which would still allow profit opportunities for banking operations. Instead, he constructed a false dichotomy — systemic risk due to fraud, and profit; or no profit and no banks — and then browbeat me and anyone else in the class who was listening to avoid serious discussion of the principle. It suddenly put things into perspective for me. He wasn’t there to impart any real knowledge about the economy to me, he was there to be a hatchet man and paid minion for the banking establishment as it stands today. Wouldn’t want any bright-eyed college kids getting uppity and questioning the scam now, would we?

I really thought that would be the tops. But then I got to my Labor Economics class in my fourth year.

You might be wondering at this point, “Labor economics? Are you mad? Why did you take that course as an elective?” It would be a reasonable question, but the truth is that it was the least horrible option amongst what I had to choose from at the time. To say I went into it with low expectations is an understatement.

Those low expectations were met admirably on two separate occasions, which were not the only examples to choose from but simply the most illustrative.

My professorista had spent her entire life after high school in academia and government bureaucracies like the Bureau of Labor Statistics. I would be surprised if she ever held a part time job as a youngster in the private sector. She demonstrated zero familiarity with the reality of markets. One day she provided the class her argument for government intervention in the economy, which was based on the “paradox of capitalism”, this being that capitalism is SO efficient and SO productive, that it drives things down to the cost of “near 0” (not actually zero, because that’d obviously imply superabundance and the end of scarcity for that good or service) and therefore these things become “uneconomic” to produce and won’t be provided for under the profit system, which means if we want them government must provide them as a public good.

One example she gave of this was childcare services. Now, let’s ignore the “empirical” fact that there are numerous for-profit childcare services out there, right here and now, which would seem to undermine her argument completely. Let’s just think about this logically for a second.

So long as a given good does not have a cost of 0, it is not superabundant and it is an economizable resource. For example, air is not an economic good because it is superabundant. You can breathe as much air as you need and don’t have to think about what you’d give up to ensure your supply of air, it’s just there. It has a cost of 0. But if it has a cost above 0, it must be economized, something must be given up to get it. And if at a particular point in time firms are so numerous and efficient at supplying a good, such as childcare services, that they can’t make a profit, what will happen is that the least efficient firms of the bunch will consume their capital (by earning losses over and over again) and exit the marketplace. And when they do this, the level of profitability for remaining firms will rise because the lowered supply will result in the ability to charge higher prices.

And this dynamic will play out forever over the life of the industry so long as people value childcare services. There will be a constant competitive dynamic tending toward the “right” supply of childcare services because the least efficient providers will exit with losses. And this is “good” from the standpoint of anyone interested in participating in the economy because it means that those extraneous resources will flood into other, underserved industries where profitability is much higher, indicating a relatively more important use for the resources versus childcare. At no point will the market stop providing childcare services entirely, requiring a timely government intervention and provision of this service to correct a “market failure.”

Well, recognizing that as the hogwash it was, I raised my hand and began disputing the logic just as I did above. She was so dumbfounded that I had the temerity to question her transparently flawed reasoning that she began what could best be called “sputtering”, rolling her eyes and trying to form even one word in response as if she were having a seizure. Finally, she gave up and said, “Would anyone like to respond to that and explain why he is wrong?” About ten different hands shot up, eagerly, and she called on a young man who halfway turned around in his chair to straddle his view between me in the back and her approving glances in the front. He began, “Governments can and should correct market failures, which happen frequently. For example, while I was studying abroad in Ghana, the government provided public bus service to the village I was staying at because it wasn’t profitable for private businessmen…”

I stopped him right there and pointed out that the lack of profitability is part of the phenomenon I just described, and it suggests the wastefulness of bus service to a small African village. The class erupted with anger and indignation. This was so not politically correct to suggest some poor villagers in Africa didn’t merit a dedicated bus service just because it wasn’t profitable to provide it! This lecture hall had about one hundred students in it. Suddenly, they were a-chatter, half of them noisily discussing how outrageous my view was amongst themselves, the other half turned and shouting/arguing with me simultaneously while the young man with the bus service anecdote continued droning on. This went on for several minutes before the professorista tried to get control back over the class and insisted we finish up the lesson, but by then it was too late as class was over and everyone made for the exits.

It was at this point that as people filtered out a guy sitting a little in front and to the right of me turned around and said, “For what it’s worth, I agree with you,” and then grabbed his bag and walked out. I guess it was better than thinking the entire class was ready to lynch me, but he certainly didn’t feel the need to come to my rescue in the heat of the argument!

The other memorable moment from that class came right near the end of the semester. The Wall Street investment banks were beginning their meltdown and that particular morning Bear Stearns had failed, which was all over the news and which had greatly agitated the students as several had received offers of employment there at the conclusion of the semester which were now in jeopardy. The professorista sought to calm everyone’s nerves by saying that this was a limited event, contained to a specific firm with poor risk controls and the Fed and the regulatory agencies were all over it.

I raised my hand and pointed out that this was indicative of a systematic impending crisis, that the authorities were NOT in control as evidenced by the fact that it had happened, and that it would get a lot worse before it got any better. I suggested that this was the first of many failures to come.

“Would you like to bet on that?” she said, mischievously, expecting me to back down with the bravado.

“I already have!” I exclaimed, as I had taken a few minor positions in my brokerage account at the time (don’t worry, I didn’t make out like John Paulson).

“Well, we’ll see…” she said, trying to quiet me down.

Yes, we did, didn’t we? I never followed up with her to see what she thought of giving me a hard time about my prediction in class, or whether she was willing to confess she had had it all wrong, but I think it demonstrates again a clear blind spot in the mindset of mainstream academics who are responsible for instructing this country’s (and the world’s) future leaders and productive people about intellectual curiosity, academic honesty and the nature of reality.

How many parents are aware of this when they insist their children must go to college? How many have audited the value of their kid’s higher education and determined that the small fortune it takes to get them through a “better” private institution is worth it in the face of antics like what I’ve described above?

Review – Panic: The Betrayal Of Capitalism By Wall Street And Washington

Sadly, Panic: The Betrayal Of Capitalism By Wall Street And Washington does not appear to be in print any longer. Luckily, I found a good used copy on Amazon and will cherish its now-secret message all the more.

As I read through this book several months ago, instead of summarizing my thoughts I just want to record a few key ideas and quotes for later reference.

“The Anti-Entrepreneurs”

In any modern state the government will always be the banks’ biggest client and therefore will always make most of the rules, even if it pretends not to.

The ideologues of modern finance offered to make any fool rich if only he renounced the first obligation of the capitalist, the burden of judgment.

This process of confronting uncertainty and successfully resolving it usually by dint of hard work, diligent analysis, and sound judgment is the only source of what many economists have called “entrepreneurial profit” or sometimes “true profit”.

Underpinning the ideology of modern finance is the notion that the insight, judgment and even diligence of the entrepreneur are irrelevant for investing in public securities markets. These markets, we are told, are special, too powerful and too perfect to allow any entrepreneur’s judgment to matter.

If the ideology of modern finance had a motto, it might be “thinking doesn’t work.”

Capitalism demands free markets because it needs free minds.

The bureaucrat of capital dreams of a world in which failure is impossible.

Crony capitalists on the right and socialists on the left united as always behind their most fundamental belief, that wealth is to be captured by power and pull rather than created in the minds of men.

“New Risks in Old Bottles”

The great mission of modern investment theory is to replace all idiosyncratic risk with systemic risk.

The primary skill for finance, under this theory, becomes diversification, which becomes an advanced statistical methodology for making sure a relatively small number of securities accurately represents a much larger class of securities.

If I know nothing, my need for diversification is infinite.

All investment is reduced to insurance.

Ignorance is the father of panic.

“The Misinformation Economy”

One way to think about panic is as a general, nonspecific response to a poorly understood particular and specific problem.

“To build a perfect model of the universe would require all the matter and energy in the universe, because the only perfect model, the only model that shed no information and made no compromises in order to achieve its object, would be the universe itself.”

The mortgage meltdown can be understood as an instance of model failure.

information is differentiation; information is what comes as a surprise against the background of knowledge already possessed.

If uncertainty and risk are nearly synonyms. then information and risk are nearly opposites.

It is not particularly unusual for all thirty stocks in the Dow to go up and down at the same time; that rarely happened when market participants were interested in the value of individual companies.

“The Reign of Risk”

Modern portfolio theory was a late bloom of the great eighteenth and nineteenth century impulse to explain human society by mechanical or “scientific” principles as regular as those of classical physics.

If economics were about entrepreneurship, it would not look like physics. It would look a little like philosophy. Mostly it would look like literature. [The Lion’s note: if you ascribe to the Austrian school, it does!]

To treat investment as a quantitative exercise relying on the efficiency of markets and advanced mathematics to eliminate the hazards of human judgment. [the ambition of investors under Modern Portfolio Theory]

MPT created a field for which PhDs could be granted and journal articles published. Before MPT, investment theory had been mere reflection upon experience, a wisdom literature dominated by amateurs like Benjamin Graham.

[MPT…] can be deeply attractive to those trying to support capitalist lifestyles with only bureaucratic talents.

The most important question any investor can ask: For what are investors paid? MPT’s answer: For accepting risk.

risk is not the foundation of profit but its most dreaded enemy.

The modern theory conceptually severed financial markets from the rest of the economy. [My note, ” Macro is to Micro as Financial is to Real”]

“The Romance of Risk”

Men and societies become richer precisely as they employ insight, skill and experience, effort and discipline to reduce risk.

Investors are paid for being right, not for the possibility of being wrong.

In life, men who make one good judgment tend to make more good judgments; men who make one bad judgment tend to make more bad ones.

the most important but the most difficult-to-identify ability in business management (or investment) is the ability to judge other men’s ability to judge. [meta-judgment]

“Zoom, Zoom, Zoom”

What modern capital markets do very well is raise large amounts of capital from a broad base of investors who are persuaded to give their money to perfect strangers with precious little idea of what those fortunate recipients are going to do with it. [And, I’d add, little control or legal right to have any say in such decisions; “crowd-sourcing”]

different markets make different trade-offs between liquidity and price discovery one one hand and confidence about value on the other.

Public equity investors demand liquidity in large part because they are unsure about value.

Humor is surprise

It is reasonable to call markets better or worse depending on how much surprise they can absorb before convulsing in dramatic disequilibrium

Lacking a more substantial basis on which to make decisions, financial markets set prices to an astonishing extent by watching– prices!

The most dramatic resolution of this conflict is to eliminate most of the shareholders altogether by taking public companies private

public companies have no owners

Companies, like most assets, do better with strong owners than weak owners.

“Strategic Ambiguity”

When New Dealers tried to set up a banking system immune to panic, their top priority was to remove Mom-and-Pop from their role as bank police.

“Insolvent Immunity”

Here is the quickest way to determine whether you are operating in an honest capitalist system or a corrupt imitation thereof: check the bankruptcy rates.

“Black September”

“Things are somewhat amiss when a country’s finance minister plays bond salesman for a supposedly privately owned company.”

By this time the government had: (a) intimated that deficits in the financial sector were so large and widespread that “anyone could be next” (b) terrified private investors from making investments that might preserve the solvency of deteriorating institutions (c) assumed unprecedented responsibility for investment banks outside the Federal Reserve system and then abandoned that responsibility and (d) made clear that its policy would change on an ad hoc basis. [on the US federal government’s initial response to the financial panic of 2008]

To assume that the buying and selling of shares amounts to managing the firm is the most extreme form of efficient market worship.

“Capitalism Without Capitalists”

The term for someone who rests his economic fate on unknowable future events is not “owner” or even “investor,” but “speculator.”

the government, the biggest player and the weakest owner of all. [criticizing the present ownership of major banks]

Another great review of this book was posted by “CP” at CreditBubbleStocks.com.

And after reading this book, I was inspired to purchase Frank Knight’s Risk, Uncertainty and Profit for my library for further study.

 

Do You Know What The NSA’s True Purpose Is?

A friend sent me a chilling article from Wired magazine about a new, gargantuan spy center being built by the NSA in Utah. The article started with this short background on the genesis, and current evolution, of the NSA:

For the NSA, overflowing with tens of billions of dollars in post-9/11 budget awards, the cryptanalysis breakthrough came at a time of explosive growth, in size as well as in power. Established as an arm of the Department of Defense following Pearl Harbor, with the primary purpose of preventing another surprise assault, the NSA suffered a series of humiliations in the post-Cold War years. Caught off guard by an escalating series of terrorist attacks—the first World Trade Center bombing, the blowing up of US embassies in East Africa, the attack on the USS Cole in Yemen, and finally the devastation of 9/11—some began questioning the agency’s very reason for being. In response, the NSA has quietly been reborn. And while there is little indication that its actual effectiveness has improved—after all, despite numerous pieces of evidence and intelligence-gathering opportunities, it missed the near-disastrous attempted attacks by the underwear bomber on a flight to Detroit in 2009 and by the car bomber in Times Square in 2010—there is no doubt that it has transformed itself into the largest, most covert, and potentially most intrusive intelligence agency ever created.

I want to channel G Edward Griffin a little bit here. Griffin is the author of The Creature From Jekyll Island, and in this book he put forth the notion that if the results of a policy consistently and widely diverge over time from the stated intentions, one has a sound basis upon which to question the stated intentions of the policy being observed.

In “Creature”, Griffin was discussing the Federal Reserve System and its “dual mandate”– to maintain stable prices and low unemployment. Of course, the Fed has never managed to achieve either one of its objectives since it was founded, leading a skeptical observer to wonder if the Fed was perpetually failing at its stated objective, or consistently succeeding on an unstated one.

Proponents of the NSA will argue that there are many successes we might never know about due to matters of secrecy. We can’t critically examine the veracity of these arguments because we’re not deemed worthy of the trust necessary to obtain the information required to evaluate these claims, so they must be ignored.

What we are sure of, as the paragraph above points out, is that there have been numerous “surprise assaults” that the NSA has done nothing to stop.

And yet, it only grows larger.

Maybe the NSA is succeeding wildly at its true purpose despite appearing to fail at its stated purpose. The construction of this massive, $2 billion facility in Utah is alarming.

But we should be even more alarmed that we do not know what is the true purpose of this multi-billion dollar agency.

Wall Street Mesmerized, Perplexed By “400% Man”, But Why?

Two separate friends sent me links to an investor profile in SmartMoney magazine entitled “The 400% Man“, about a college dropout in Salt Lake City who appears to have made a killing over the last ten years following the principles of value investing.

Allan Mecham, had been posting mind-bogglingly high returns for a decade at a tiny private-investment fund called Arlington Value Management, and the Wall Streeters were considering jumping on board. For nearly two hours, they peppered him with questions. Where did he get his business background? I read a lot, he replied. Did he have an MBA? No. I dropped out of college. Did he have a clever computer model or algorithm? No, he replied. I don’t use spreadsheets much. Could the group look at some of his investment analyses? I don’t have any of those either, he said. It’s all in my head. The investors were baffled. Well, could he at least tell them where he thought the stock market was headed? “I don’t know,” Mecham replied.

When the meeting broke up, “most people left the room mystified,” says Brendan O’Brien, a New York City money manager who was there. “They were expecting to see this very sharp-dressed, fast-talking guy. They were saying, I don’t get it, I don’t understand why he wouldn’t have a view on the market, because money managers get paid to have a view on the market.” Mecham has faced this kind of befuddlement before — which is one reason he meets only rarely with potential investors. It’s tough to sell his product to an industry that’s used to something very different. After all, according to their rules, he shouldn’t even be in the business to begin with.

The fact that people were mystified by this young man’s performance should be embarrassing to Wall Street. And, not to rain on Mecham’s parade, but it really doesn’t speak to the greatness of Mecham so much as it speaks to the “mysticism” of Wall Street.

Benjamin Graham’s lessons on value investing have been available to the general public for over 70 years. Graham’s greatest disciple, Warren Buffett, is also the greatest investor of all time and one of the wealthiest individuals in the world. The story of his success has been told in countless biographies (of which little old me has managed to read two), all of which make it abundantly clear that Buffett’s time at an Ivy League graduate program likely had little to do with his destiny in the financial world. In fact, the man has railed against the Wall Street paradigm for decades himself and has explained to anyone who will listen — and they are legion! — why you can’t make money playing Wall Street’s game.

So, why is this all such a big surprise to these people?

It’s a big surprise because Wall Street isn’t broken. Wall Street is a mystical financial priesthood, just as the Federal Reserve and other central banks infesting the globe are mystical monetary priesthoods.

Wall Street doesn’t “get” value investing and is “surprised” to learn of its existence, and successful practitioners, because if Wall Street ever acknowledged that such a school of thinking existed, they’d be admitting their own inefficacy and the whole jig would be up. This is just the same as how the members of the Fed remain ignorant of the teachings of Austrian economics– to acknowledge and seek to understand them would be the beginning of the end of their nefarious charade.

The Wall Street business model is a volume-based, sales operation. It isn’t any different from television sales, automobile sales, pharmaceutical sales or insurance sales in terms of mechanics and objectives. All that’s different is the sales people are better “educated”, wear fancier clothes and work out of taller, shinier buildings. It’s a fee-based business, and the fees are generated by controlling assets and repeatedly churning them– the more you manage and the more often you turn it over, the more fees you generate and the richer you get.

Because Wall Street lives off of hyperactivity, the philosophy of patient inactivity (Buffet’s “waiting for a fat pitch”) and concentrated portfolios is, literally, blasphemous. Under such a model, your only chance at earning a return for your services is… to generate real returns for your clients! With the Wall Street model, you can get rich even as you lose your clients money. In fact, if you’re a brokerage or investment bank, you might even be able to accelerate the pace at which you enrich yourself as your client loses simply by trading more losing positions more often!

This is not an indictment of capitalism, free markets or financial exchanges, all of which are socio-economic goods with real value. This is an indictment of the Wall Street money management paradigm in relation to the tenets of value investing, a paradigm which doesn’t “work” at generating real returns for investors because it can’t– it wasn’t designed to do that!

Again, to draw comparisons to the Federal Reserve and the nature of central banking, the Fed can’t “fight inflation” and “lower unemployment” because that is not what the Fed was designed to do. The Federal Reserve CREATES inflation by issuing new fiduciary media into the economy and, with the assistance of the fractional reserve banking system, expanding the monetary base. It does this because the purpose of the Federal Reserve is to provide an alternative, “silent” tax system for the political class while easing the built-in, we-all-fall-down tensions within the fractional reserve banking system, which is the whole reason such a system requires a “lender of last resort.”

Wall Street, as a moniker for the fee-based, AUM-central “financial services” industry, delivers precisely what it was designed to deliver– lucrative pay plans and an unearned sense of superiority compared to everyone else in the economy for the specially-entitled club members and graduates of the connected institutions who populate it. It, like the banking industry and the global central bank system, operates via the herd mentality simply because those who thieve together, hang together. If you want to avoid hanging together, you must be committed to thieving together.

Defining risk as volatility, as Wall Street does, practically ensures that you’ll repeatedly expose your clients to real risk (that is, the risk of permanent capital loss) while naively trying to juggle the impossible task of managing ex post facto-determined volatility risk. Operating off of an asset accumulation/inventory churn model guarantees that your incentive structure will never be aligned with your clients, no matter how well-intentioned you might be. Government coercion in the form of mutual fund industry regulation and others provides the necessary legal muscle to prevent anyone who can think for themselves from attempting to do so.

Mecham’s closing comment is prescient:

Where does Arlington head next? Mecham says he won’t compromise his strategy to play the Wall Street game. That leaves Ben Raybould battling to market a fund, and a manager, that many other money managers can’t even understand. Mecham is bemused that so many people expect him to hold a broad basket of stocks and follow a benchmark, such as the S&P 500. “It’s laughable to think that in this competitive world, you’re going to find brilliant ideas every day,” he says. “The world’s just not set up that way.”

Exactly. And Wall Street will never manage to successfully manage risk and generate real returns for its clients– it’s just not set up that way.