The Austrian Way: How investment banks took over the world

I’ve been writing recently about the great deformation in finance and economics caused by corrupting money itself and a range of smaller deformations that come result from it.

So, without further ado, let’s look down into a festering fold within this giant fiat money distortion and see how investment banks grew from insignificant little white shoe businesses run by steady Eddies in 1980 to giant, to the globe reaching squid-like institutions run by the Lloyds and Jamies of today.

It all starts after the 1970s when the Great Inflation nearly wiped out most of Wall Street and a chap called Paul Volcker took charge of the Fed.

The fiscal conservative Volker, in a way I believe no Fed governor would be able to do today, raised rates so high that he broke the back of inflation in the early 1980s and started a 30 year bull market in government bonds. In fairness, this bull trend was also helped by typical market over reactions to things and the cooling of the hysterical panic about the soundness of the dollar in the late 1970s.

Such market trends are not possible in a sound money system – note the British consul which traded at a constant three per cent yield for 131 years, except for minor, short fluctuations around war.

Nonetheless, we are now about to see three decades of rising bond prices and falling yields in the US debt market, and other Western debt markets too.

Here comes the carry trade

Wall Street today really owes its great rise to a multi-decade asset inflation scheme which the Fed engendered and would then under new more dovish governors always try and keep going.

With the help of the growing Greenspan Put and Bernanke’s Great Moderation Wall Street became more and more confident of the continuing upward direction of assets. From this it grew and grew thanks to the biggest carry trade ever seen.

To milk this carry trade all investment bank prop desks had to do was buy assets they thought would keep rising with increasingly cheap short-term debt and harvest the positive spread down the line.

With bond prices rising for 30 years and the cost of carry in the wholesale money markets falling also – from 16 per cent in 1980, to six to eight per cent for the next fifteen years, until dropping from 4 to1 per cent between 2001 and 2003 – this carry trade was the gift that kept on giving.

Here’s David Stockman, putting it more eloquently than me: ‘In the face of an 85 per cent plunge in Wall Street’s cost of production – that is, the cost of financing its assets – there was hardly an asset class imaginable that did not generate gushers of positive cash flow… The huge “spread” gifted to Wall Street by the Fed was equivalent to handing the dealers their very own printing press.’

Seeing such a constant arbitrage opportunity, with lots of other variants around it, and the easy profits that it gave, Wall Street entered carry trade nirvana and gorged on it.

How investment banks became giant hedge funds

The main Wall Street investment banks then sought to grow their balance sheets faster and faster to reap ever greater returns from this rich seam. A nuclear arms race in balance sheet growth got underway.

Between 1980 and 2008 the balance sheets of the most famous five investment banks – Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Stearns and Lehman Brothers – grew 200 times. By now their collective balance sheets amounted to nearly $5 trillion, making them larger than Japan’s annual GDP – yet behind this balance sheet enormity sat only $140 billion of equity.

30 times leverage and unstable foundations were becoming normal on Wall Street.

With departments like underwriting and advisory services needing little capital to support them, this incredible balance sheet growth was due to the sales, trading and prime brokerage functions of these now giant and incredibly leveraged Wall Street firms.

This growth of Wall Street was unnatural, to become a toxic imbalance in the financial system and is once more well described by David Stockman below:

“There is not a chance that the free market would have tolerated such radical leverage ratios; that is absent the assurance that the central bank stood behind the distended balance sheets of these firms no one would have done business with them.”

Accelerating towards the brick wall

This Fed-enabled carry trade craziness then continues and is even more positively reinforced after the fiasco concerning the huge hedge fund, Long Term Capital Management.

This most ironically named hedge fund flamed out in spectacular style in 1998 and given its own size and 30 times leverage threatened to take down some of its Wall Street partners with it, whose own prime brokerage desks had granted LTCM its own leverage.

The Fed’s accommodative actions and helpful noises regarding LTCM and its organised unwinding gave further blessing to Wall Street’s modus operandi. The Fed was telling the investment banks loud and clear that ‘we’re here for you boyz!’

So here we are today, with a giant, rent-seeking casino part of finance calling out to investors around the world to ‘come and lose your money with us’, constituted of mega-investment banks who stand like spinning tops on tiny capital bases and 30 times leverage ratios.

As we try and get across when criticising our shitty financial system – don’t hate the players, hate the game.

There’s no point in blaming bankers for the staggering growth of Wall Street and the City and the power now wielded  by them – they’re are just private agents, like us, seeking to get ahead.

It was the Fed wot dun it, with its partner central banks.

This is just one of the smaller deformations caused by messing with our money.

11 comments on “The Austrian Way: How investment banks took over the world

  1. Michael
    October 8, 2013 at 2:58 pm #

    And look at the recent Conservative pledge to deny benefits for those under 25 which focuses public anger on these minor recipients of government largesse. Government destroys the prospects of the working class by forcing them into low-standard government provided education, forcing down wages by making them compete with millions of foreigners (who themselves are subsidised by government) and destroying jobs with minimum wage laws, environmental taxes, endless bureaucracy and hidden taxes.

    Contrast the above with these too big to fail banks funded by central bank largesse with their implicit government guarantees and access to the printing press, the citizenry would do well to realise they don’t need Government FOR ANYTHING but the elite need government for ALMOST EVERYTHING.

    When the fiat money collapse get into full swing and society starts to become much more localised (despite government attempts to increase their power), many will finally come to the conclusion that they didn’t need to hand over their money and liberty in order to get “free” education, “free” healthcare and government “pensions” after all.

    Off topic – if you enjoyed Stockmans excellent book, I highly recommend any of John Taylor Gatto’s books on the Great Deformation of the education system. In particular his book “Weapons of mass instruction”, showed the part compulsory education played in overturning America’s unique experiment in Liberty. Read it and weep.

      October 9, 2013 at 8:30 am #

      Hi Michael,

      Thanks for stopping by, reading and commenting. Comments like this make all our volunteering to spread the Bogpaper word worthwhile!

      You’ve hit many nails on the head here, with the corrupt of money indeed being a huge reason for the growing income disparities in the economy… not evil capitalism, nasty bosses etc! This is bastardised, croney-capitalism, espoused by would be Keynesians, that’s causing the problems.

      Let us hope for a freer, more localised future free from failed state-enforced ‘solutions’. All power to the internet and technology to bring us there!

      (Thanks for the book recommendation, I might seek that out over Xmas. Have you read Douglas Carswell’s ‘The End of Politics’? – it tells of a future we both seek and how it’ll happen).

      • Michael
        October 9, 2013 at 3:55 pm #

        Thanks for the recommendation. It looks a great synopsis and one that I tend to agree with – things will got very bad for a while but eventually we’ll come back to a society based on co-operation rather than coercion.

        Carswell is one of those rare breed of politicians that “gets it” – we’ve created a system that is politically unbreakable but which is financially unsustainable. We need more Carswells, Bakers and Farages in the House of Commons. It was a shame Bloom got punted out of politics as behind that media painted buffon image, was a politico more than most that got the money issue plaguing us.

  2. silverminer
    October 8, 2013 at 8:22 pm #

    Bankers have captured government. Governments are being controlled by bankers. You only have to look at the revolving door between government, central banks and the investment banks. They’ve created a system designed specifically to enable them to line their pockets.

    They’ve been found guilty time and time again of fraud and get nothing more than a slap on the wrist and a fine, which is either paid by their shareholders or the taxpayer when they next get bailed out. They should never have been allowed to incorporate. They’d have thought a bit harder about their business ethics and their degree of leverage had they remained as partnerships. Some jail time wouldn’t hurt either.

  3. Apparent bigot
    October 9, 2013 at 8:23 am #

    Very, very good description. I cannot help believing the author is a financial insider like Stockman, who has been turned vegetarian by closer looks at the sausage factory. I look forward to reading more of your stuff.

      October 9, 2013 at 8:29 am #

      Thank you Apparent bigot,

      Next week’s rant will be about the latest, preferred ‘wealth creating’ playground of politicians and central bankers – the property market.

      If you, or any other readers, have ideas/desires for future articles, do let me know here or on Twitter (@AustrianWay).

  4. Tim
    October 9, 2013 at 9:14 am #

    Ssso, we’re still banker bashing 5 years down the line.

    Can we have a go at the laywers and MPs again soon?

    • Honey Badger
      October 9, 2013 at 9:01 pm #

      Well it would help if they didn’t keep screwing-up! Money laundering, PPI miselling, swap miselling, LIBOR rigging etc.

      What galls me is that they happily precipitate their clients’ bankruptcies to get some of their money back, but as soon as their own bankruptcies came into view they went crying to government for a bailout.

      If you want to play with the big boys you have to play by the big boys’ rules. Unfortunately bankers are snivelling little boys who run to mummy as soon as things get uncomfortable.

    • Apparent bigot
      October 10, 2013 at 7:28 pm #


      Try a bit of Mises, Rothbard, Hayek and others and tell us we’re still playing the man not the ball.

      I’m a 20 year financier, 10 years into appreciation for the Austrian School and I firmly believe central banking run amok is the most dangerous thing on this earth. IMHO this school of economics has it most right… or least wrong! I with the author.

  5. silverminer
    October 9, 2013 at 9:51 am #

    Tim, 5 years down the line, no one has yet addressed the key point. Why do we give a select group of private actors (i.e. banks) in the economy the right to create unlimited amounts of money out of thin air and lend it out at interest? Until we deal with this question can be no solution.

    • Apparent bigot
      October 10, 2013 at 7:30 pm #

      Well put, Sir. It’s all about wild credit creation.

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