How the Financialization Scam Works
What is it? How does it happen? Does it matter? Who cares?
Let’s begin with the last question: Who cares?
Answer: Nobody… until it blows up.
Financialization creates a fantasy world… funded by a mis-priced, rigged credit market.
Here is how. Imagine that you are 12 years old and you set up a lemonade stand. You make lemonade. You sell it to passers-by for more than it costs you to make it. You end up with a profit.
That is the Main Street economy… the world of the win-win deal… the face of honest capitalism. You want money. You need to give something in return – lemonade.
This is where all real wealth comes from – working, saving, investing, and learning… over time. No tricks. No gimmicks. No stimulus. No counter-cyclical monetary or fiscal policies.
Now, imagine that your lemonade stand is a great success. The local convenience store complains that you are taking its business. The local bottling plant complains that you are stealing its sales.
The feds notice that you aren’t paying minimum wages… and that you don’t have a handicap-access bathroom… that you don’t have your employment posters up on the jobsite… and your nonexistent kitchen has not passed a health inspection… etc., etc.
But imagine that you somehow survive all the feds’ attempts to shut you down… and that your lemonade stand makes a profit of $97 per year.
Then, along comes a guy in an Italian suit with a Boca Raton accent. He says:
“Hey, kid. You wanna make some real money? We can take this thing public.”
“But I only make 97 bucks per year.”
“At the current P/E (price-to-earnings) rate,” he points out, “the lemonade stand ought to sell to the public (after spending about half a million on accounting and legal preparations) for about $2,000.”
“What sense does that make,” you ask.
“You can sell half to the public and keep half. Then, you can give yourself a salary of $1 million a year… with bonus and stock options that should be worth $10 million or more…”
“But the lemonade stand only earns $97 a year…”
“No… no… no… you gotta think big. Why is this lemonade stand such a big success?” he asks.
“Well, I think it is because I work so hard and make such good lemonade.”
“Nah… that’s not very interesting. Do you use a computer?”
“But don’t you let your friends know that you are selling lemonade… you know, on those chat lines… like WhatsApp… or Twitter?”
“Well, wouldn’t you say that you have the world’s first distributed ledger, social networked, blockchain-based lemonade stand?”
“Well… no… it’s just lemonade.”
“Forget the lemonade. We’ll probably get it freeze-dried and outsourced to China. Just add water or some sh*t… You don’t understand. This has got nothing to do with lemonade. There is beaucoup money floating around Wall Street. This is a way to get some of it.
“So here’s what we’ll do…”
The man proceeds to lay out the most outrageous plan. “The lemonade stand will be ‘branded’ as Refresh.net. Then, a franchise package will be put together, with franchises operating in towns all over the world.”
“Like Starbucks,” he explains, “but without the fixed costs of a restaurant and staff.”
Then, a team of experts will prepare pro-forma balance sheets and operating statements out to 2025.
“We’ll get financing – maybe $200 million or so – from an investment bank.
“We’ll set up kids selling lemonade everywhere. Then, the bank will set us up on a road trip… talking it up to large investors all over the country.
“Boston, New York, San Francisco… we’ll hit all the major financial centers,” he continues. “And you be sure to wear a hoodie… You’ll be the nation’s youngest unicorn billionaire.”
“But I’m just 12 years old… making $97 per year,” you protest.
“Look, kid, you don’t understand anything about finance. This is not about how much you earn… it’s about how much financing we can get – from lenders… and then, from equity buyers. Just look at Lyft. Or Uber. Or WeWork. Or Tesla. They earn less than you do. A lot less.
“But they get millions… billions… And nobody expects them to turn a profit. They lose money; they don’t make it. And now they’re worth billions.”
“But why do people give their hard-earned money to companies that don’t make money,” you ask naively.
“Because it’s not hard-earned money. It’s fake money. Nobody ever earned it. Nobody ever saved it. There’s no GDP or output to show for it.
“Look… you could operate your lemonade stand from now until kingdom come and you’d make peanuts. Because it takes time… and lemons… and sugar… to make real lemonade. Real stuff.
“And that’s the real-life, Main Street, old-time economy. You give something. You get something. But as long as you’re stuck in that real-life economy, you’ll never make any real money.
“This is the new economy. You sell ‘dreams of avarice beyond your wildest imagination.’ And people buy, because they’re not risking their own money. It’s all fake.
“The money is fake. The companies are fake, too. GDP is fake. Inflation is fake. Interest rates are fake. And the president gets up and says fake things about a fake economy to the fake news media.”
“The whole game is to try to get as much of this fake money as you can, as fast as you can. Because the Main Street economy can’t tell the difference between this money and the real money… you know, the money we had before, which you had to sweat and strain to get. Like your lemonade stand.
“The feds say they are stimulating the economy. You’ll get millions in options and bonuses. I’ll get millions for putting the deal together. The bankers, lawyers, advisors will get millions in fees. And early speculators will get millions in stock gains. We’ll all be stimulated, won’t we?
“The big players can borrow this new money for less than 3% interest. Who knows what the real inflation rate is, but it’s probably more than that. So, they have a cost of carry of less than zero.
“You know what a cost of carry is?”
“Well, it’s the key to the whole financialization scam… It’s what it costs to buy a ticket to ride this train. I’m talking about the great big speculation train – the DebtBall Express – that pulled out of the station back in 1971.
“You gotta pay to get on board. We call it the ‘cost of carry;’ it’s what it costs you to get money you need – its’ the interest rate on speculative funds. Usually, interest rates are set by buyers and sellers of credit. The credit is real money that someone had to earn and save… and then, the buyers and sellers decide at what rate they will lend it out.
“So, if you’ve got a hot new electric car… or a new idea for office space… or you wanna speculate on your own shares – you know, so you’ll hit some target and get a big bonus – or you wanna buy some goofball IPO…
“Well, you wouldn’t want to risk your own, real money on this kind of stuff, would you? If you’re smart, you borrow. And if you have zero as your cost of funds, you can speculate on just about anything. ‘Cause… who knows what will pay off? And it just has to pay more than zero… and you’re in the money.
“But, when markets are working properly, there’s always a risk. When lenders get worried, or they think your idea stinks, or the economy tanks… the cost of carry goes up and you can get whacked hard.
“Then, you might be strung out on some speculation that hasn’t paid off yet, and you need to refinance… but the interest rates shoot up and suddenly you are f… Sorry, kid, I mean, you are up the creek without a paddle.”
“I don’t know… that sounds risky…”
“But that’s just the point. In a normal world, the threat of higher interest rates… or a higher carry cost… keeps speculators honest. And it keeps these kinds of wild-ass deals – you know, like these money-losing unicorns – to a minimum. I mean, who wants to risk real money on them?
“But this is not the real world. This is the financialized world. And the fix is in. The game is rigged, in other words. Did you hear about the Powell Pivot?
“I didn’t think so. But that’s why stocks are going up… when they ought to be going down. The feds have practically guaranteed to protect Wall Street gamblers from higher carry costs. The Fed has left its key rate at right about zero in real terms. And it as much as told the world that if interest rates go up… it will be there to push them down again, fast.
“So, what do you say, kid? Let’s go for it. We can’t lose.”
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