Occupy this

There is a condescending chorus of comments by prominent bankers and economists protesting the woes of capitalism as an acknowledgement to the occupiers of Wall Street.

They ponder the limits of market economics and its tendency towards income inequality.

They attribute the social protests to a lack of understanding of the basics of the dismal science and a general sense of frustration with the current state of affairs.

They consider the skewed distribution of income to be a natural aspect of the market. In other words, they do not see anything wrong with the 99/1 split. Unfortunately, it is they who are ignorant and mistaken. Our current economic arrangement is a far cry from capitalism, and very little of it is based on free-market dynamics. Ours is a world full of regulation and barriers to entry that create monopoly rents for incumbents.

Under a pure free-market arrangement, the state would play a minimal role. It would provide some public goods, principally the enforcement of contracts and property rights.

Barriers to entry would be extremely low, allowing the number of competitors to multiply to the point that marginal returns approach zero.

Retail activity

This is the type of retail activity typically seen in most developing countries. Entrepreneurs battle each other, undercutting everyone else in order to gain market share.

Of course, this is a chaotic environment that provides for very little accumulation of wealth and capital. Therefore, economic agents band together to create cartels that will allow them to stabilise their margins. They do this in a variety of ways, such as using patents, brands, licences or collusion.

However, the principal way they do is by subverting the state.

Through the optimal subversion of the state, these economic agents can convert a fully competitive marketplace into a monopoly arrangement that can completely distort the distribution of income. This is what creates frustration among the general population.

It is no different than the anger that is brewing in Russia. There is very little difference between the open corruption of the siloviki, who use their former KGB connections as a way to gain power and wealth, and the cadre of Wall Street veterans who use lobbyists and contacts to subvert the rules of the game in their favour.

None of the occupiers of Wall Street complained after the collapse of Lehman Brothers and Bear Stearns.

That is how a market operates. There are winners and losers. However, they howled at the bailouts of the banks. They scoffed at the various rescue packages. That is not capitalism. 'Too big to fail' was not a phrase used in Adam Smith's Wealth of Nations or David Ricardo's Principals of Political Economy and Taxation.

Inefficient economic system

The sad fact is that Wall Street co-opted the political establishment to ensure the preservation of a highly inefficient economic system that siphons off a disproportionate part of the society's wealth.

This is done through the creation of a complex set of battle works that ensures such high barriers to entry that it limits competition.

The truth is that financial transactions are highly commoditised. It makes very little difference who does a foreign exchange, bond or equity trade.

Given technological advances in systems processing and communications, the transactions can be done anywhere and by almost anyone on the planet.

In a fully competitive market, the marginal returns of investment banks would approach zero - thus reducing the allure of the investment banking career.

Market share was traditionally gained through the provision of crisp execution, insightful research and sound advice.

However, a new generation of bankers were able to obfuscate a wide range of costs through a variety of structures in order to boost compensation schemes. Financial engineering is nothing more than a set of methods used to legally boost fees for basic transactions by disguising simple operations.

Investors are mesmerised by the complex jargon and PowerPoint presentations that are used to explain CDS's, ETFs and ABS's.

Each credit enhancement thickens the veil that shrouds a mountain of hidden risks, thus allowing the masters of the universe to reap inordinate rewards. However, to see such impunity take place under the nose of financial authorities roils the blood and makes people take to the street.

Therefore, the occupiers of Wall Street are far from ignorant.

A close look will see many of them clutching Hayek's Road to Serfdom. They know all too well that a free market will never allow the patronage that is dotted on privileged sectors, such as finance.

They also see political candidates campaign on platforms of change, only to see them become the stooges of the financial patriarchs.

Therefore, do not write off the occupiers as ignorant youths who do not understand the complexities of market economics.

They know very well what is going on, and they know that this is not capitalism. It is cronyism, but with a touch of civility.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC. wmolano@bcpsecurities.com