From where comes the profit?

Robin Blackwell, a Marxist professor of economy, says that modern financial profit comes basically from three sources: the annulation of promises, loan sharking and improved understanding and management of risk.

Annulation of promises refers to the vast devalorization of promised pension rights of millions of American workers (only General Motors has 1,000,000 pensioners !) by separating the financial obligations from the actual production, and selling these obligations in the financial market. American workers also lost much implicit future promises by annulation of health care rights. Many companies declared bankrupcy and freed from the pension burden, became profitable and attractive holdings. It happened in the steel business, it is happening in the automobile industry. In a sense, I feel, the vultures are doing a disgusting, but necessary work.

Loan sharking refers to sinking the American households in increasingly unmanageable debt, with platinum credit cards and subprime mortgages. While initially attractive, the heavily indebted American household is gradually forced to recur to usurious loans, in a veritable debt slavery for life.

Improved risk management is a legitimate scientific advance, making more efficient the allocation of capital and therefore of its yield. Risk arbitrage hinges on the possibility of interpreting securities in multiple ways . . . In contrast to value investors who distil the bundled attributes of a company to a single number, arbitrageurs reject exposure to a whole company. But in contrast to corporate raiders, who buy companies for the purpose of breaking them up to sell as separate properties, the work of the arbitrage trader is yet more radically deconstructionist . . . For example they do not see Boeing Co. as a monolithic asset or property but as having several properties (traits, qualities) such as being a technology stock, a consumer-travel stock, an American stock, a stock that is included in a given index, and so on. Ever more abstractionist, they attempt to isolate such qualities as the volatility of a security, or its liquidity, its convertibility, its indexability and so on. Thus whereas corporate raiders break up parts of a company, modern arbitrageurs carve up abstract qualities of a security . . . Their strategy is to use the tools of financial engineering to shape a trade such that exposure is limited to those equivalency principles in which the trader has confidence. Derivatives, such as swaps, options and other financial instruments play an important role . . . Traders use them to slice and dice their exposure.

In order to cash out their bets the arbitrageurs need ‘events’. A placid market with nothing happening and no volatility is bad for the hedge funds and for those on the ‘risk arb’ desks. But normally the traders need not worry since, as Hyman Minsky put it in a classic article, firstly ‘the internal workings of a capitalist economy generate financial relations that are conducive to instability’, and secondly, ‘the price and asset-value relations that will trigger a crisis in fragile financial structures are normally functioning events.’ One of the reasons for this is precisely that the prospects of a given stock cannot be distilled in a single figure since the balance sheet of an enterprise will always comprise a complex of receipts and liabilities in which the past, present and future uneasily coexist. The de-regulation of financial markets has also increased their proneness to ‘events’.