Is Wall Street a Fraud? Adam Smith vs. Bernie Sanders

Mark Skousen
Posted: Feb 15, 2016 12:01 AM
Is Wall Street a Fraud? Adam Smith vs. Bernie Sanders

“The business model of Wall Street is fraud.” — Bernie Sanders, a democratic socialist who is running for U.S. president

I’m teaching a class on financial economics at Chapman University in Los Angeles this spring, and right now we are discussing the image of Wall Street.

I start off with quite a few quotations from famous economists and critics who have a negative view of Wall Street, such as:

“Wall Street is a gambling house peopled with dealers, croupiers and touts on one side, and with winners and suckers on the other.” — Nicholas Vargas, “Wall Street: The Other Las Vegas”

“For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs — a pastime in which he is victor who says Snap neither too soon nor too late, who passes the old Maid to his neighbor before the game is over, who secures a chair for himself when the music stops.” — John Maynard Keynes, “The General Theory,” 1936

“The capitalist economy is entailed by the rise of joint-stock companies, market speculation, gambling and swindling.” — Karl Marx (emphasis added)

This latter quote reminds me of Sen. Bernie Sanders, who is running for U.S. president as a self-proclaimed democratic socialist. He frequently claims, “The business model of Wall Street is fraud.”

Certainly, cases of fraud and deception are highlighted in the press. Once example is the Bernie Madoff scandal (see that accompanying “You Blew it” column).

But the truth is that Wall Street has on net balance a positive role to play in today’s society. In fact, selling stock to the general public is the most efficient way to raise capital and to advance our standard of living.

Peter Lynch, the famous manager of the Magellan Fund, clears the air when he states, “Although it’s easy to forget sometimes, a share of stock is not a lottery ticket. It’s part ownership in a business.”

And it is business that makes this country run. It is business — entrepreneurship, capital investment, banking, insurance companies and technology — that creates the jobs, the new products and services, and that pays the taxes. Wall Street, including brokerage firms, money managers, private equity and hedge funds, combine to employ eight million people. Are they all fraud peddlers?

In the “Wealth of Nations,” published in 1776, Adam Smith introduced a model, which he called “the system of natural liberty,” in which he described the three elements that are necessary to generate a progressive prosperity: freedom, competition and a system of justice (rule of law). He noted that the system of natural liberty would “moderate the passions” — not that it would eliminate fraud and deceptive practices in business and finance, but rather that it would minimize them. The vast majority of Wall Street firms are run by honest, hard-working people, many of them my friends. Sure, there are hucksters, like in any business, but most on Wall Street are dedicated to making money for both the customer and themselves.

Granted, there are stock manipulators even today, but long-term investors and retirees can be comforted in knowing that over time if you invest in profitable companies with a good outlook, you will be rewarded. I showed my students this chart below demonstrating that in the long run, it pays to invest in free enterprise (the stock market). In the short run, stock prices (S&P 500) and the economy — measured through gross domestic product — can grow apart, but eventually they come back together.