Who to blame for the mess we appear to be in? Greedy Wall Street bankers? Fatuous Europeans who expect to retire at age 55 after a lifetime of loafing? Inept oil drillers fouling America’s southern coastline? When times are tough you can count on politicians to score points by blaming everyone in sight, rarely noticing that many of our problems today are the results of legislation enacted by previous Congresses. No one seems to want to accept individual responsibility-it’s always the Other Guy’s fault. I’m convinced that this nation’s greatest enemy are those who insist on seeing the glass as half empty, whatever their political persuasion.
I’m slowly wending my way through Hank Paulson’s chronicle of the End of Days (or nearly so) in 2008 when, no kidding folks, we almost lost the economy. In the chronicle, George W. Bush comes out sounding Presidential, steady at the helm and willing to do anything, to keep the America he loves from falling into another Great Depression. Other Republicans, like Alabama’s Jeff Sessions and House members who refused to vote for emergency government powers are seen as ideologues willing to visit untold economic suffering on Americans rather than relax their defense of smaller government. John McCain, Paulson implies, was a loose cannon, while his rival, Senator Obama was knowledgeable, engaged and supportive. Nancy Pelosi, although supportive of the rescue process, nearly destroyed the chance for bipartisan cooperation, while Barney Frank is seen as one of the more insightful financial minds in Congress. Crises make for strange bedfellows. Nothing I’ve read so far has changed my belief that in those terrible days, those of us who prefer smaller government just had to hold our noses and support the largest Federal intervention in the free market in modern history. There was simply no private source powerful enough to bring confidence back to a paralyzed financial system in which even General Electric was finding it difficult to generate working capital through the issuance of commercial paper. A century ago, in the Panic of 1907, J.P. Morgan stepped onto the floor of the New York Stock Exchange and began purchasing bank stocks. With his massive purse, and his reputation, that was enough to bring blood back into the faces other investors and the panic was broken. The formation of the Federal Reserve was, in large part, a response to that near catastrophe. Yet the Fed was more hindrance then help after the panic of 1929. With lessons learned, and another century of practice the Bernanke Fed proved its worth in calming the markets eighteen months ago. They stepped in and accepted questionable collateral to justify lending into a system in which few in the private sector would participate. This bought enough time to allow for the creation of TARP in which, with backing from President Bush and Congress, the government loaned money to “systematically important” banks to stave off their demise and stabilize the system.
The question today is who is big enough to save teetering Europe? It is unlikely the United States, which has shot its wad, and where opposition to additional government borrowing has hardened, can come to the rescue. Japan has already borrowed to the hilt. Perhaps China will extend credit, but don’t count on it, Europe represents a far smaller export market to them than does the United States. The spread of free market capitalism across the planet over the past 20 plus years has brought prosperity and hope to billions of people. Capitalism harnesses greed for the greater good, but does so imperfectly. Poor judgment combined with self interest inevitably and periodically leads to financial panics. In the most recent, United States based melt down, real estate brokers sold homes to those unable to afford them, took their commissions and were absolved of any further responsibility. Mortgage bankers handed money over to unqualified buyers with terms impossible to pay off, then passed the loans on to the banks. The banks that packaged these loans into bonds and sold them to pension plans and insurance companies around the planet. Wall Street found a way to improve on this process by taking the original mortgage backed issues, subdividing them into mini bonds or “tranches”. This allowed them to sell the same bonds over and over again (like a graveyard sells real estate) and earn enormous commissions in the process. Recently we learned that Wall Street went further. Goldman Sachs created so-called “synthetic” bonds, not tied to any underlying mortgages but simply as a “tracking” device that allowed investors/speculators to make bets on the direction of bond prices. This reminds me of those who stand at the side of a craps table and bet on someone else’s roll of the dice. Are these people evil? Aren’t they just part of the glorious unfettered free market that sees Indian tribes building casinos/skyscrapers in remote regions of California, creating jobs for construction workers, valets, and card dealers? Aren’t they are just all capitalists seeking to maximize personal profit?
No one, as far as I know, has latched on to something Treasury Secretary Timothy Geithner said in testimony before a Congressional committee last week:
“Whatever the crises..real estate has been at the center of the crime.” (May 6 2010)
While offensive to the real estate industry, a powerful lobbying force,this claim is based in historical fact. As far back as the Panic of 1837, when banks collapsed after funding land speculation in the West (today the Midwest), poor decisions about real estate have been the fundamental cause of most financial meltdowns. And yet, the Federal government chooses to attack Wall Street bankers while coddling the real estate industry. Less than a week after Goldman Sachs was publicly pilloried at a Congressional hearing, the Federal Housing Administration, the government agency that insures a bigger and bigger portion of home loans, announced plans to rely more heavily on lenders to police mortgage brokers. Yet mortgage bankers are cited as one of the key reasons so many lousy loans were made leading up to the crisis of 2007- present There is little no talk of meaningful Federal regulation of this sector, none, when compared to the way stock brokers and banks are regulated. The banks clearly failed to monitor the quality of loans funded via mortgage brokers in that last crisis, so how can they be expected to do much better once the current air of caution wanes? Not surprisingly, “The National Association of Mortgage Brokers generally supports the FHA’s changes. Grant Stern, president of Miami brokerage Morningside Mortgage Corp., said they represented a “huge cut in red tape” that should produce better rates for consumers” (Wall Street Journal, May 8, 2010). It strikes me as incredible that this industry continues to benefit a cornucopia of Federal loan guarantee programs and tax incentives while experiencing minimal Federal oversight or regulation. Perhaps this is because so many in Congress made their fortunes in real estate or because the industry is so adept at financing politicians in ways both legal and not.
Meanwhile, a worrisome witch hunt plagues Wall Street, which, like it or not is one of America’s strongest industries. Spencer Jakab, writing in the Financial Times on April 30 expressed my misgivings in a far more articulate manner than I can muster:
“..Goldman has become a scapegoat for millions of homeowners and investors psychologically unable to admit at least partial fault for succumbing to the madness of crowds and lure of easy money. The one investment bank that hedged appropriately and enjoyed a hugely profitable rebound is an obvious target. “The idea that Wall Street came out of this thing just fine, thank you, is something that just grates on people,” said Senator Ted Kaufman. Goldman may or may not have done anything illegal, but most Americans do not give them the benefit of the doubt.”
“If Goldman is innocent – and they should be presumed so – do they still deserve to be hated? However satisfying it feels to bash millionaires in a recession, vilifying Goldmanites simply for being smarter and richer than the rest of us may be bad for society, not just the Park Avenue set. Projecting our insecurities onto others is the root of scapegoating.”
As I’ve written in prior blog entries, I’m not sure Goldman did anything so terrible. Although the transaction in question appears to have been a gambling arrangement with questionable social value, it does not appear to have been illegal. Meanwhile the SEC/NY Attorney General’s joint attack on Goldman, one of the strongest banks in the world, has served to rally those who want to strip banks of their ability to engage in investment banking-like activities. While the idea has some appeal, this notion has thrown much uncertainty into the banking sector at a time when certainty is much needed. Financial companies constitute one of the largest segments of world stock market indices. Further, with the need for free flow of capital never greater, the political persecution of this industry leaves the world more vulnerable to another, illiquidity driven meltdown. Playing in the background is the Greek Tragedy. While I will not claim to understand the counterparty risks, undoubtedly many financial institutions are endangered by the idea of a default by Greece on its bonds. Likewise, the entire PIIG complex is seeing a negative reappraisal of creditworthiness by the markets. This has to hurt the balance sheets of multiple lenders, worldwide, with ominous echoes of US banks’ troubles eighteen months ago. When bank assets are marked down, there is a negative leverage effect and lending becomes less possible. A credit squeeze is imposed by the free markets, something the fragile economies of the developed world do not want to see right now.
Lastly, there is this wild card: what will BP’s inability to contain a horrific poisoning-by-oil of the Gulf of Mexico ecosystem mean for the US economy? For the economies of other nations bordering the Caribbean? Certainly, new plans for offshore oil drilling will be slowed if not halted, and these projects could have generated jobs and cheap energy. What of the fishing industry? Tourism? With an environmental knife to their throats $ Billions in economic activity are at stake.
So, there are enough uncertainties to justify the current pause. I suspect that the fundamental expansive momentum of the US economy is such that the markets will regain their footing, but I also suspect the current correction will affect a wider swath of share prices.
I am disturbed by two events of the past week: 1)Thursday’s 1000 Dow plunge and 2)Advisor sentiment as reflected at the Morningstar.com web site. While initially thought to be based on an erroneous, large sell order, Thursday’s unprecedented plunge remains unexplained and as the days go on, it appears that something like this could happen again…and again. Circuit breaker rules imposed at the NYSE following 1987’s computer led crash have become insufficient, as trading is now largely conducted in a computer-to-computer marketplace away from the open outcry exchanges. This is likely to frighten away individual investors, who were just dipping their toes back into the market. Also bothering me was an unscientific survey of subscribers to Morningstar, largely professionals, this past weekend, suggests these guys are, like me, still nibbling when the market sells off. While I’m in alignment with this approach, philosophy, believing we are in a bull market, this chorus of agreement gives me great discomfort. I’ve never seen a market bottom reached until nearly everyone has to change their diapers. So, caution ahead. Own good businesses and collect dividend checks. Bye for now!
