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Leaving Lehman, exposing Wall Street

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network, coming to you again today from San Francisco. We are at the Momentum Conference of Tides Foundation, and joining us now is Sony Kapoor from Re-Define.org. And please define for us Re-Define.

SONY KAPOOR, MANAGING DIRECTOR OF RE-DEFINE: It’s an international think tank working on applying finance to get better outcomes on development, environment, and fairness in society.

JAY: So I’m going to put this a little more dramatically. You have gone to Dante’s Inferno. You have investigated the netherworld of international finance capital. You emerge somehow without being consumed by the fires. You’ve moved from corporate profiteering world to nonprofit advocacy world. Am I right so far? Tell us a bit of the story here.

KAPOOR: A slightly less dramatic version would be more accurate, but I have been burnt brown, as you see. The quick version is I started out my career in investment banking and worked for a bank called—or what used to be called Lehman Brothers, amongst other things, and did leverage finance and private equity, then did derivatives trading for a firm which was one of the biggest trading partners for Enron, amongst other things. So got to see quite a bit of the drama of the financial system from the inside, but then quit in about 2002, 2003 to apply the financial skills I had to trying to achieve better outcomes for society.

JAY: Your friends must have been telling you how crazy you were. You could have been fabulously wealthy, one would assume, if you were good at what you were doing, and I assume you were. So what brought you to this decision?

KAPOOR: I wasn’t very sure what the work I was doing was adding up to. And, you know, when you work as hard as you often do in banking, and you spend long hours, and you have a lot of money, but you don’t actually have the time to do anything with the money—. But more than that, when you go to bed, you are not very sure what you did during the day, and at some point, you know, the realization dawns that, hey, I think I should be doing something different. This is not for me. That, combined with the fact that in my, for example, very first two weeks at Lehman Brothers, you know, I was offered by one of the accounting firms to open my salary bank account in the Cayman Islands, a tax haven, I saw the Chinese walls being broken, and I for the first time understood what Richard Gere said what he did in Pretty Woman, which was buy companies, break them up, and sell them.

JAY: [inaudible] Danny DeVito’s [inaudible] with Other People’s Money.

KAPOOR: Absolutely, with Other People’s Money. And it was a fast learning curve. And so there was a lot of systemic stuff that I saw from the inside which grated with what I believed in, and both emotionally, but also intellectually. You know, it wasn’t just a moral question. It was just intellectually it did not seem to be a sound model. It was a house of cards.

JAY: So talk about what you learnt about the construction of this house of cards and how this helped contribute to this current crisis we’re in.

KAPOOR: The financial system, because, you know, you can’t eat or drink finance, you can’t sit on it, it’s easy for it to get very dissociated from reality, and I think that’s what happened. The financial system became more and more self-referential and inward-looking, where more and more money was pumped in. For a long point of time, the most profitable investments were actually to—instead of putting money in a real factory or, you know, building something up [inaudible] investment, it was just to put money in speculation, in bonds, in the financial industry itself. So it fed on itself, and it became this giant monster.

JAY: It’s called—in another form of work it would be called swine flu, where if pigs start eating pigs, we get—or mad cow disease when cows start eating cows.

KAPOOR: It’s a very incestuous world, and it’s so easy to lose connection with everything else outside, ’cause you only interact with your brethren.

JAY: So tell us what you found.

KAPOOR: Well, it was just-in-time finance, just like, you know, you have just-in-time production lines where, in the name of efficiency, things move faster and faster. It was very big, and it became bigger and bigger. The financial markets have grown by, you know, exponential amount for the past several years. It became more and more complex, both in terms of the nature of institutions—Citicorp has 2,000, for instance, subsidiaries. You had complex products like CDOs, etcetera. So what you had was a system which was faster than ever before, more tightly connected just-in-time than ever before, and less transparent and larger than ever before. And this was akin to driving a fuel-laden truck on the highway with a drunken driver, and with a massive fog having descended, with poor visibility, and this was a system that was just waiting to crash. And, yes, we associate the particular crash we are in now a lot with the subprime assets or CDOs, etcetera, but the fact of the matter is the financial system has crashed before, before these things existed, and would have crashed in any case in a different trigger, and will crash again. So there are more fundamental forces at play as to why finance does this.

JAY: Well, let’s try to break down some of these fundamental forces. So, certainly, one of them must be that the world is awash in capital. There’s been such a transfer of wealth to the top two, three percentile. And then what do they—as you say said, you can’t just sit on this wealth; you’ve got to do something with it. So talk a bit about this.

KAPOOR: Well, that’s actually been a very problematic thing, ’cause this is the end result of—you know, what you see is a manifestation [of] increasing inequality. And what you have, for example, in the United States is depressed average wages. And for most people the real wages haven’t gone up, or actually have gone down. But the fact of the matter is, in a country where two-thirds of the economy or more is driven by consumer demand, you need to have that demand, and if people don’t earn enough money, they’re not going to have that demand. So a serious problem is, as more and more wealth gets concentrated at the top—and we all know, you know, the lower income you have, the higher percentage of that income you actually spend, ’cause you have to fulfill your needs—as more and more income is concentrated upwards, it means that a smaller proportion is recycled into the economy as consumption, and more and more of it is put in assets, because these people save—the richer you are, the greater your percentage of your income you save. And if there are only a limited number of assets available to invest in, these savings flowing into the assets inflates the prices of these assets at the same time as aggregate demand in the economy is getting depressed.

JAY: Okay. Break that down into simple language, with [inaudible] perhaps as an example.

KAPOOR: Well, the simple language is they’re—people simply are not earning enough wages to spend enough money, and the only way people were sustaining themselves and their lifestyles was by borrowing against the assets, houses, where the prices were rising because of a lot of investment coming in from the top income groups. So it was not a sustainable system, and it’s a bad substitute for having a fair wage-distribution system where everybody has enough purchasing power, everybody has—and it’s a long-term, aggregate, you know, sustainable rate of growth.

JAY: So you have this massive transfer of wealth over the last 30, 40 years. As you said, wages are relatively static or even going down. But productivity’s going up.

KAPOOR: Yeah.

JAY: So that productivity equals wealth and more capital going into two, three percentile, mostly. And then they’ve got to do something with it, ’cause they don’t want to sit on it and they want it to grow. So where does that lead them?

KAPOOR: Well, that leads them to put money wherever they think they can maximize the returns, and that leads to a large amount of money chasing a limited number of places to invest money in, which is okay. Now, if you just think of a stock market and, you know, the aggregate value is $100 billion or something, $1 billion of new investment comes in, the price prices of stocks go up, but they go up by $10 billion. So suddenly the value of the stock market is $110 billion, but $9 billion of that wealth has been generated by magic, out of thin air. And that leads to this feeling of wellbeing, and people spend more. But the fact of the matter is the minute people start selling those stocks or try to take that $1 billion they [inaudible] out, the prices fall.

JAY: Break down the magic. What is the mechanism, what you’re calling "magic"? Because that’s what—like, even in this bailout, we hear—like, it’s very hard to get one’s head around where is the money actually going in the bailout. What is the mechanism of what you’re calling "magic"?

KAPOOR: Well, there’s a difference between the flow of money, or, you know, income, in our parlance, and the stock of money or, you know, the stock of assets. So just think of it in terms of houses. So let’s say you have a certain income, and with that income you can afford a particular mortgage, let’s say $100,000. Now, you buy a house with that, and suddenly you find the price of the house is up $200,000. You feel richer, but everybody else who bought the house at $100,000 is equally feeling richer at the same time. But the people who want to buy houses now with that same income can’t afford those houses anymore. So this is the dichotomy: there is a difference between the sustainable relation between how much income you earn and what—.

JAY: And one of the reasons that a house went from $100,000 to $200,000 is ’cause there was so much cheap credit around.

KAPOOR: Absolutely.

JAY: I mean, I know myself I was getting phone calls every three days. "Do I like to increase my limit on my card? Would you like a new card?" We were being sold credit endlessly.

KAPOOR: Yeah. And I think there’s a little bit of issue there, because what you had at the global level, but also, you know, within the United States, was this bifurcation of the economy, where people, for example, who had good credit histories, etcetera, got 20 credit cards through the door. These were people who did not need credit. But you’ve got 20 cards, you know, zero percent, you’ll spend. And there was a whole section of people, millions of them, who were completely left out of access to finance and access to credit who were getting payday loans at 600 percent. So what you had was the people who actually needed the credit, who could have made do with it, who might have, you know, invested in some micro-enterprise or put it, the money, to good use, they did not get the money. They were shunted out. They were shut out of that. And too much money was concentrated where it was already. And the second problem with this was, unlike in the past where banks knew their customers, and a good bank lent to people that nobody else lent to but did not lend to people that everybody else was lending to—. But here every bank had access to the same credit ratings, the same credit histories, every bank is chasing only the people with good credit histories, and every bank was leaving out everybody else. So the system lost diversity, the system lost resilience, and it became extremely brittle because every bank ended up with exposure to more or less the same customers, the same asset groups. And what happens with that is any time there is a disturbance in one section of the market, like the subprime assets, for example, it means it generates losses, which generates pressure to sell other assets, which infects other markets. So the whole system goes up together but goes down together, too. Diversity in finance brings resilience and stability, and the uniformity we have seen in finance developing meant that everybody is doing the same thing at the same time, which like soldiers crossing in step on a bridge would mean the bridge collapses, as it has now.

JAY: Well, in the next segment of our interview, let’s talk about the stampede factor. And let’s also talk about complication, because as I’ve learned from you, the more complicated it gets, the more money you can make. Please join us for the next segment of our interview with Sony Kapoor.

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