Economic Whales and their Parasites

Today’s New York Times Business section features an interesting article on the recent JPMorgan multi-billion loss. Entitled “The Hunch, the Pounce and the Kill: How Boaz Weinstein and Hedge Funds Outsmarted JPMorgan“, the article explains how a risk-prone hedge fund manager named Boaz Weinstein was able to exploit errors by JPMorgan and end up on the ‘gain side’ of the big bank’s big loss. In the most straightforward of narratives, the article outlines the dynamics by which large amounts of money can be lost and won in the financial markets. One of the take-home messages of the article is that “for every loser on Wall Street there is also a winner”.

This idea that “losses and gains” on Wall Street are all a part of a zero sum game may be empirically true over the short term, but I believe that articles such as this one seriously distort the economic reality of the financial world inhabited by big banks and hedge funds. The origin of these markets is lending, and lending clearly has social value: those who have earned money lend it to those who need capital to start businesses, buy homes, and pay for education. Although this is now a controversial subject in the over-leveraged land of American federal, state, and local governments, lending is also an important means of making investments in future social goods. If all lending were banned, our economy would sputter because lack of capital would retard entrepreneurship, education, home buying, and investment in social infrastructure. It is this very slow-down in lending that has hampered our recovery from the Great Recession of 2008.

But somehow throughout this slow recovery period, the markets continue to rack up huge profits. How does this happen? If fewer people are working and less social value is being created through labor in our economy, how is it that some people continue to make large amounts of money? The answer — as suggested by this article — is that by properly manipulating where money is lent and borrowed, a hedge fund manager can make huge profits at the expense of other investors. In doing so, this hedge fund manager creates absolutely no social value; in fact, the losses they create for others may have serious socio-economic consequences. What does this tell us about the role that markets — which are where most of society’s lending and borrowing goes on — play in the larger society?

As I have suggested before, there is a certain danger to income generation via lending. If a substantial number of people in our society make money by charging interest on loans to other people, this can create two problems:

1. The talents of Lenders are under-utilized in society, as these Lenders at best only provide the servicing of the loans they make and more often perform no socially valuable labor; and
2. The labor of Borrowers is devalued because a substantial proportion of the capital they generate is lost to Lenders.

Obviously the degree to which the above problems plague lending varies with the context of the loan. A pension fund that invests in government bonds or helps to fund home loans will generate a modest amount of income for its investors, empowering those investors to enjoy some period of retirement. Although there are reasons to worry that such a system might only work in a constantly-expanding population (in other words, is a mild form of pyramid scheme), the actual lending itself can be justified as a reasonable exchange of value: the Borrower gains the chance to expand her economic possibilities through the best use of her own labor, while the Lender earns a modest return on the loan of value created by past labor.

Where these two problems with lending are most dangerous is where this simple exchange is most abstracted; one such abstraction of lending-for-interest-payment is the derivatives market. Here the extremes of Lender extraction and Borrower loss are magnified, and Lenders can go beyond simply not providing social value in exchange for loans: at some point, Lenders are parasitizing the mainstream value-creating economy. In using the word “parasite”, I am taking what I would call a “socio-ecological approach”. I am considering that human societies and the economies they create are like ecosystems in that they are composed of a series of interactions. The interaction that best explains the role of the derivatives market is “parasite”: traders and their clients are not producing any social value, but instead look to skim off value from the mainstream economy through effective betting on the markets. Like biological parasites, these socio-ecological parasites are completely limited by the success of their host: if their host is not successful, they have nothing to parasitize. In contrast, for the host the presence of the parasite is limiting, an additional burden on success. Parasites multiply most fruitfully when their hosts are abundant, but if parasites overwhelm their hosts they have the potential to cause the extinction of both their host and themselves.

In response to my argument that segments of the financial markets are parasitic, some might point out that because hedge funds ‘bet’ on the markets there is also a risk of loss for these speculative traders.  But this potential for loss does nothing to really diminish the fit of the word “parasite”. Plenty of parasites make the wrong bet and perish because they fail to find a host or are detected and destroyed by their host’s immune system. What defines a parasite is not that it is always successful, but that it has the potential to sap its host of some of its success in the ecosystem. I realize that the word “parasite” has very strong and negative social meaning (and frankly I do not regret this secondary meaning), but I apply the label based on a functional assessment of how these kinds of markets function within society.

I think “parasite” is an accurate description of the socio-ecological role that hedge funds like the one run by Boaz Weinstein occupy. What exactly comprises Weinstein’s brillance? The Times article does not seem to mention anything of social value: Weinstein is “chess master”, a “high roller”, and perhaps even a “monster”. But through a proper playing of the markets Weinstein was able to earn his wealthy clients a huge return at massive expense to JPMorgan. One might say “who cares?” given that JPMorgan itself is a huge bank that is more than willing to extract value from the economy, but I think that such an attitude can only stem from an improper analysis of the socio-ecological system in which we live. Society will do just fine if hedge funds like Weinstein’s Saba go under (in fact, the failure of these funds might be a wonderful way to inject capital into markets that actually help the larger society), but when Saba wins at the expense of a big bank like JPmorgan, there is a social loss. We have seen these losses: when a big bank becomes unstable, we must bail it out using taxpayer money in order to prevent further destabilization of the economy. And even if this extreme measure is not required, there are still losses to be tallied: loss of confidence in banks like JPMorgan decreases the willingness of non-parasitic Lenders to offer credit to value-creating Borrowers. And we should remember that while there are a spectrum of investors who lost when JPMorgan was infected by Saba, many of these investors were the kinds we need: pension funds and other value-creating investors.

Ecologically speaking, if parasites exact a sufficient toll on their hosts, the entire interaction can be destabilized. Because host organisms are so finely tuned to the threat posed by parasites, a single parasite cannot destabilize an entire ecosystem. At most, a parasite might reconfigure that ecological community by eliminating one of the species from the overall web of interactions. But socio-ecological parasites are far more general, as they can parasitize a great variety of hosts. This makes them more of a threat to the overall system, and requires that regulations (the social equivalent of the organismal immune system) be constantly updated to plug new holes through which parasitic traders seek to extract social value.

One thing this article makes clear is that the mainstream business and economics community (and the media that highlights their escapades) do not think ecologically. There is absolutely no discussion in this article of the potentially destabilizing role that hedge fund parasitism has played in recent economic times. There is no questioning of the social effects of these large extractions of value by people who do nothing to earn that value. In a democracy in which cooperation and non-zero-sum (i.e. synergistic) value exchange occur on a massive scale, The New York Times fails to analyze the actual role that these market players occupy. Perhaps rather than entitling this article “The Hunch, the Pounce, and the Kill” the Times ought to have selected a more biologically apt metaphor: “The Lurk, the Infection, and the Parasitism”. This seems to better describe the socio-ecological effects of these particular financial markets.