Bubble Kings

The Daily Reckoning PRESENTS: If you read the Forbes list of rich people, you will find hedge fund managers in droves, but our Bill Bonner guarantees you won’t actually find one hedge fund investor. Today, Bill explicates his thoughts on the titans of speculation…


“I had by this time got too rich to live down in Bleecker Street. I was becoming one of those big bugs in the financial world. There weren’t so many back in those early days – Jake Little, Vanderbilt and a few others. If these fellows could have big, fine houses to live in, I thought I ought to have one too.”

The Book of Daniel Drew
Bouck White

Every era has its clowns, its heroes, its fools…and its winners and its losers. Often, the honorable among them are sent to the scaffold; the dishonorable go to Congress. The burden of today’s essay is to try to tell them apart. And here, it is only fair to give warning: Karl Marx would be pleased with us. For we will argue that today’s big winners make their gains in a new and perverse way; unlike the winners of the past, they get rich at the expense of the poor.

At the very top of the hero category, now wiggling a bit, is our recent Fed chief, Alan Greenspan. Featured on the cover of Time magazine, along with two other men, he is thought to have “Saved the World.” He did this, and indeed all his acts of monetary heroism, at someone else’s expense. He flooded the world with cash that did not belong to him and with credit he didn’t have. The result of this was that the world was spared the correction it desperately needed at the opening of the 21st century and awaits the more severe correction now.

We wonder how the maestro’s reputation will survive? For this wave of liquidity led to what Kevin Phillips calls the “financialization” of the U.S. economy. It was as if Mr. Greenspan had blown up the Grand Cooley dam. A wall of cash and credit flood around the world like a rogue wave. One after another, markets were lifted up.

Of course, Mr. Greenspan was not the inventor of excess liquidity, nor was he the only man with access to monetary dynamite. The Japanese set off their own deluge in the late ’80s, and then again in the mid-’90s, dropping interest rates to zero.

The combination of Nipponese desperation, with American ingenuity, is what we have to thank for today’s bubbles.

After the Japanese stock market imploded in 1990, the U.S. tech stocks took off – up 900% between 1995 and 2000. Then the Kuwait stock market ballooned up 471% in the next five years. Bombay stocks took off in 2003 and rose 340%. Meanwhile, U.S. housing priced doubled between ’95 and 2005. In England, the increase was even greater. Average house prices rose 220% in the last 10 years.

But Alan Greenspan is not our target this morning. All he got from the bubbles he created was an undeserved reputation; it will pop, too, we predict, along with the bubbles themselves.

Our target instead is the new aristocracy brought forth by all the bubbling. When the going is good, as always, it is much better for some than for others. “Them that has gits,” is the general drift of things. In countries like France, where the gittin’ of those who have is more obviously done at the expense of those who haven’t got, the latter naturally detest the former. “Behind great fortune lies a crime,” observed the great French novelist Balzac. A sensible man in France tries to look poorer than he actually is.

But in the Anglo-Saxon countries, it is different. A man tries to appear richer than he actually is, because there is a shared assumption that wealth was honestly got. The lower classes tend to envy and even admire the rich; they have no desire to cut their heads off. In America, a man who wants others to think highly of him has an easy time of it. He just has to appear wealthy. He sends out the news that he has swindled the Department of Homeland Security or won the lottery and he rises in stature overnight. If he appears wealthy enough, people will even begin to care what he thinks. They will ask his opinion on politics or even wine. That is why he is willing to risk everything to buy a big house and a fancy car on credit. In fact, the poor man genuinely believes the rich are better than he is. Tthey are smarter. They are better educated. They have more information and better contacts. He even supports low tax rates for the rich, as long as he preserves a lurking chance of joining them.

Thanks to the current issue of Vanity Fair, we are able to press our noses to the glass and look in on the lives – or at least the architectural follies – of the super-rich.

Backed by speculators from Goldman Sachs, builders are putting up a mammoth 19,000-square-foot spec house on Zaccheus Meade Lane in Greenwich, Connecticut. They will spend $5 million to build the house. Who will buy it? “Hedge fund guys,” guess the builders. They expect to sell it for $12 million.

There are already plenty of hedge fund guys in Greenwich. Known as the “richest town per capita in the world,” they swarm toward the place like hooligans to a soccer match. The average house sold in the city last year brought $2.5 million, up 40% in the last two years. Five times as many sold for $10 million or more than two years ago. Clifford Asness, of AQR Capital Management, bought a 12,500-square-foot place on North Street for $9.6 million. Steven Braverman, of Braverman Asset Management, paid $9.5 million for his pile. And David Ganek, of Level Global Investors has a nine-bedroom, 15,710 square-foot English-manor house, not far away. Trader Monthly reports that Ganek made between $75 million and $100 million last year. We also learn that he hired LA artist Ed Ruscha, famous for doing paintings of words, to paint the word LEVEL on canvas for the Ganek house.

One house that probably won’t be built is one proposed by Joseph Jacobs of Wexford Capital It is a house of 32,000 square feet, with an additional 1,165 square-foot pool house. The house, according to Vanity Fair, is reminiscent of Venice’s Ducal Palace. It has everything a deluxe hotel should have – including wine cellars, exercise rooms, panic rooms, hockey rink, massage rooms with waterfalls, and even a yoga room.

“Enough is enough,” said the local authorities. Jacob’s house was considered too big, too gaudy, too over-the-top even for Greenwich. They denied him a building permit.

Of course, Greenwich has long been a haven for titans of industry. It was a haven for the rich in the 1920s, too. Zalmon Gilbert Simmons made his fortune in mattresses, “the nighttime furniture of the nation,” said the New York Times in his obituary. Some of his fortune was spent in Greenwich, constructing a monumental house, which later became the home of the Skakel family, one of who, Ethel, was married to Robert Kennedy. Phelps Stokes, heir to the Phelps Dodge fortune, had a 16th-century Tudor house taken apart in England so that it could be reassembled in Greenwich. There was also Daniel Gray Reid, who made his money in tin plates…Jeremiah Milbank of Borden Condensed Milk, the widow of “Sugar King” Henry O. Havemeyer, the Rockefellers, Carnegies and even Prescott Bush, father of one president, grandfather of another.

These men and women were the winners of their time. They made themselves rich, but they made the nation rich, too. For while the machinery of the industrial age thumped and humped, wages rose steadily. Families that lived in stinking tenements with hardly enough to eat at the beginning of the 20th Century, ended it in air-conditioned houses with wall-to-wall carpeting and too much on their plates.

But what about the new winners? What have they brought? What have they wrought? They are winners and titans, too, but of what? Have they given the nation steel? Coal? Soft mattresses to rest its weary bones? What advances have they brought the common folk who admire them so?

We have no ready answer. These rich really are different. Not only have they more money; they got the money in a new way. No, these are not giants of industry or commerce. They are titans of speculation…they are the Bubble Kings.

What did they do to get rich? And here, our wish is not to attack the Bubble Kings, but to save some admiration for them, too. No one likes the highwayman who robs the poor of their last pennies. But, who can fail to appreciate the polished society burglars, who pass among the rich only to relieve them of their diamonds and gold? What these super-rich hedge fund managers do is almost respectable: they separate the rich from their money! You can verify this for yourself. Just read from the Forbes list of rich people, where you will find hedge fund managers in droves, but we can guarantee you, not one hedge fund investor.

But let us back track. While them that had were gittin’ more, the poor wretches at the bottom of the income ranks were not. General wage levels in America stopped rising in the ‘1970s. Since then, it has been hit or miss, with little to no real gains in purchasing power per hour worked by those in the lower-paid positions. Even college graduates have found money hard to come by. Real hourly wages of young college graduates have picked up slightly over the last year after declines for three years in a row. Hourly wages in 2005 were $23.10, up from $23.03 in 2004, but still below the level of $23.77 in 2001.

Though real incomes did not rise, Mr. Greenspan’s bubble policies doubled the price of a typical house. This led typical Americans to make a serious mistake: they borrowed much of the increased “equity” in their houses and spent it. Now, they live in the same miserable house – though they’ve added marble countertops – and owe more money on it. They are poorer in the way that counts; they have more debt and no more money to pay it with.

Now, we turn back to the super rich. As reported here in The Daily Reckoning, the 26 top hedge fund managers – many of them with houses in Greenwich – earned an average of $363 million last year, up 45% from the year before. Steven Cohen of SAC Capital Advisors, with $10 billion under management, took home $1 billion in the last two years. Eddie Lampert of ESL Investments earned almost $1.5 billion in the same period. Both have places in Greenwich.

Where did all this money come from? A quick answer is easy: they took it from people with too much money and too little sense. According to the Vanity Fair report, Steven Cohen keeps as much as 50% of the returns on other peoples’ money. Celebrity fund managers are able to put together big piles of money and take a big cut, 2%, before any performance fees. On a fund of $2 billion, that’s $40 million in management fees alone.

Commendable as that is, it is only part of the story. And not the best part. More interesting is that in this new “financial economy,” more profits are made from lending money – that is from “finance” – than from manufacturing. No wonder the financiers have gotten rich. They mongered debt when people wanted a lot of it. While most of the financier’s paid cash for their own palaces in Greenwich, they managed to lure the middle classes into more than $11.8 trillion in outstanding mortgages. And when the bubbles finally pop, it won’t be the hedge fund managers who lose their houses, it will be the lower classes…the proles…the lumpen with no savings and no way of earning more money to pay their debts.

We don’t know what will happen next, but here we offer some unsolicited advice to Greenwich’s super rich: don’t show off too much. When the lumps figure out what has happened to them, they are likely to have revenge on their minds…and a rope in their hands.

Bill Bonner
The Daily Reckoning
London, England
June 9, 2006

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount – just click on the link below:

The Most Feared Book in Washington!

Gold dropped $18.80 yesterday to a two-month low.

We don’t know whom to thank – calculating manipulators or panicking speculators. But we have two hunches. One, that the price of gold will probably drop below $600 before this correction is over. And two, that anyone who sells now will feel like a genius next week and a moron a year from now (We admit that we filched that last line from an article in this coming weekend’s Sunday Times. We liked it so much we couldn’t resist. Then, we realized that it was attributed to us! Readers will wonder how we get to read the papers before they are printed. But we have to have some trade secrets).

It was not just gold. Investors dumped whatever investments they considered too speculative for those they thought safer. A worldwide “flight from risk” is underway.

The trouble with “flights from risk” is that they are often going to the wrong airport. While emerging markets, commodities, and gold sell off – the Dow steadies, while the dollar and U.S. Treasury bonds rise. This is a little like picnickers fleeing the slopes of Vesuvius. Hearing the rumbling, they scramble into a jet, fly around the world, and then lay down their blankets on the side of Mt. St. Helens. Ah, home again! Back where never is heard a discouraging word…and the skies are not cloudy all day.

For now, the “flight from risk” seems to be full of speculators, carrying them from “risky” markets, such as the Bombay Stock Exchange, which dropped 4.7% yesterday, over to the New York Stock Exchange, which rose modestly.

The Fed has tightened all the way to a funds rate of 5%. Meanwhile, Japan’s fire hose of liquidity suddenly began to splutter and dribble. Then, the head Fed man stepped up and said right out loud that he was worried about inflation. Finally, the race speeded up yesterday: Asian central banks – from the Korean to the Indian – announced tightening measures. Even the Europeans declared they were girding their loins to fight inflation. The ECB raised its funds rate by a quarter of a percent to 2.75%.

Faced with this sudden binge of sobriety, of course, speculators took flight. Their faces twitched. Their knees jerked. Their palms began to sweat. And what would you expect? They boarded the “flight from risk,” high-tailing it away from the exotic, foreign, and mysterious investments they were only just chatting up. They fled back into the arms of the old, familiar dollar. They came back to mama.

Alas, the old girl ain’t what she used to be. Too many wild parties. Too much liquidity late at night. Too much smoke and mirrors. The years and abuse have taken their toll. In the dark night of panic, speculators may not notice the deep lines of debt on her face, the cheap makeup with which she covers up her deficits, and the hidden girdles and padding that buff out her faded posture and swindle her admirers. Wait until they get a good look at her!

Speculators, a notoriously fickle crowd, are quite capable of changing their minds – even in mid-flight. Right now, they see risk in gold and safety in paper. That their eyesight will improve is the abiding faith of The Daily Reckoning. It is what keeps us going.

When their vision is clearer, speculators will see things as their forefathers did before them. They will come to see the dollar as a risky piece of paper and gold as a sure store of wealth. They will come to see what foreign governments already know. Yesterday, we learned that the Russians have now moved as much as half of the foreign exchange reserves of its central bank into Euro and Sterling.

That speculators nonetheless fly away from gold rather than toward it proves to us that this bull market in the yellow metal has barely begun. When the bull really begins to rampage, speculators will run out of the dollar, not into it, and see every new drop of liquidity as more evidence that mama dollar has lost her mind.

More news from our friends at The Rude Awakening…


Kevin Kerr, reporting from Chicago:

“Hurricanes destroy almost everything in their path…except call options on commodity futures.”

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening.


Back to Bill Bonner…

*** U.S. forces proudly displayed the photo of a dead man yesterday. Bombing a house to kill the man, reports said, U.S. airmen also killed five other people – including a child. What the child did to deserve the death sentence was never addressed.

But this is war. And in a war, innocent people die as well as the guilty, especially when it is a war against nobody-in-particular.

What are we fighting for? We turn to the Commander-in-Chief for elucidation:

‘This is only the beginning. The message has spread from Damascus to Tehran that the future belongs to freedom, and we will not rest until the promise of liberty reaches every people in every nation.”

*** We walked home from work yesterday. Our course took us by many of London’s great monuments. Every few paces we were reminded of the greatness of the empire. There was Nelson at Trafalgar, and Wellington at Waterloo. And there was Apsley House, given to the man who defeated Napoleon by a grateful nation. And there in front of Buckingham Palace itself, a large fountain commemorates the empire’s victory over nature and economy, too…with statues showing her people bringing industry, commerce and agriculture under control. And then, at the end of the park are pillars recording how the British Empire ruled not merely the waves, but the continents: Asia…Africa…North America.

Ah yes, what a great time to be white and English. When God was still in his heaven. When Queen Victoria was on her throne. When Brittania ruled the world!

Passing by St. James Park, we caught a glimpse of the marshal splendor of it. There were horse guards, a band, and what looked like a whole regiment dressed in bright scarlet uniforms. And another decked out with gold filigree. Exactly what the occasion was, we didn’t notice, but we saw that it cost seven pounds for a seat in the bleachers.

As we walked through Knightsbridge, we saw more of the residue of empire…or perhaps the marks of the new era of globalization. There were restaurants of every conceivable variety, from Chinese to Argentine. And on the streets, a Babel of languages. In the space of two blocks, we heard German, Swedish, Spanish, Italian, French, and a variety of African and Indian languages we couldn’t identify.

“The wogs start at Calais,” the British used to say. But now the wogs begin at Charing Cross – and they’re taking over the city. Everywhere you look there are foreigners (ourselves included!). Forty percent of the property in central London sold last year was bought by foreigners. And last week’s news reported that 45% of the City (equivalent to Wall Street in New York) is now owned by foreigners. Now, rich Persians sit while Englishmen shine their shoes. Rich Indians drive around in new Lamborghinis sold to them by middle-class Brits. Rich Russians rent storefronts to English real estate agents, who sell their best properties to foreigners. That is how it goes, isn’t it? You rule the barbarians…until the barbarians rule you. The flies conquer the flypaper.

The Daily Reckoning