This thesis is simple: The market tends to move risk, but not the rewards, from the honest investors and onto greedy bastards.
I am not necessarily referring to anything illegal because there are lots of men who follow the letter but not the spirit of the law. Charles Munger once referred to EBITA as “bull*** earnings” that make no sense but which fund managers use to justify risks. Likewise, the archnemesis of Jack Bogle was investment bankers finding all sorts of creative ways to charge higher fees. Just think of the average private equity fund that won't outperform the market but will still charge over 1% a year in management fees for a decade-long lockup period.
To prove this, I first point out how there is really no incentive to stop market bubbles from occurring as they tend to subsidize the consumer experience at the expense of people who were trying to get rich. Case in point, during the Dot Com, Railroad, and Housing Bubbles a lot of expensive infrastructure was built by men pumping up valuations. Of course, the bottom line was there were not enough users for it all, so prices became dirt cheap and a lot of firms went under, mostly the ones that had excessive leverage. These cheap prices are what enabled a lot of consumers to start using these services, and things improved for the companies in the following decades.
In this case, it isn't a perfectly efficient system. During the Housing Bubble a lot of people were buying a house both to live in and as an investment and most of the people who simply wanted a place to live simply put off buying, but undoubtedly someone was foolish enough to buy. During the Dot Com Bubble there was Worldcom's problem where the cable they laid wasn't getting the customers they thought, although the greedy bit came later when the CEO committed accounting fraud to hide this. With the Railroad Bubble, a lot of people who had nothing to do with the crunch were affected. Nikola Tesla was running a tech startup at the time and suddenly his investors wanted their money back, but Mr. Tesla simply gave up his salary to save the venture money.
We allow speculators onto the market because it “aids price discovery” and “increases liquidity.” Price discovery is keeping the value of what an investment is trading at as close as possible to its real-world value. Given the volume of active investors, if any investment gets too far out of whack then it will be bought up or sold immediately. And liquidity is simply how easy it is to find a buyer/seller at a given moment, the presence of speculators simply increases this.
However, speculation is a zero-sum game. Studies of day traders showed the more trades they placed, the lower their returns. Of course, a large portion of that is simply gamblers. However, you'd be surprised by the amount of degeneracy you will see coming from smart people who know better. All sorts of contrived arguments exist to justify playing around with asset allocation and losing mountains to fees.
To be more specific, with the Bill Hwang scandal was where this knucklehead ended up subsidizing ViacomCBS. This was his main position, and his scheme was to lie to a bunch of brokers about his diversification and then use each one in succession to pump up the stock. Since the leverage allowed was determined by stock price, this was infinitely repeatable… Until ViacomCBS management saw the insanity, and decided they could use the money, so they diluted shares. The losers were Mr. Hwang and all the bankers dumb enough to let a convicted fraudster use 5x leverage, while the winner was a struggling business trying to stream movies.
Or consider basic options arbitrage. Buffoon A buys a call option, and the dealer that sold that option will immediately buy shares and a put option so that he has zero risk. The effect is the option buyer is taking all the risks off the hands of the actual shareholder, but not necessarily any of the rewards. Recall there's no inherent need for call options to exist at all.
This is also how Warren Buffet justified his reinsurance business while refusing to become any sort of options dealer. In reinsurance, most of it is simply derivatives on the weather. For instance, a home insurance agency in Florida may buy a contract that pays out if a hurricane lands in Florida. Mr. Buffet says there is an inherent need for this insurance because there are real-world risks that people are unable or unwilling to take. However, the exotic contracts that investment banks offer have no fundamental need to exist as most of them simply increase the risk/reward of a given investment.
A general rule is that if making money and buying things is somehow exciting, there is something wrong with the venture. The overall trend seems to be that men who are greedy, men who have a pressing desire for more than their fair share of the stuff in the world, will inevitably take upon themselves all the risks to their own detriment. Just as importantly, greedy men invariably squander any gains on frivolous or riotous living, but that is another matter.
Of course, there are innocent victims in this as a lot of greedy men will screw others over by both legal and illegal means. The fools who lie about company earnings to pump up the value of their own shares certainly are robbing honest investors, and there comes a point where if you throw enough greed into the mix the whole system simply breaks because you cannot trust anyone. Not sure where the tipping point is, but the number of honest investors must outweigh the greedos.
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