Him That Hath Has Less Than He Thought
Politics always lists to the port side. But markets are more exquisitely balanced, between fear and greed. When investors had the wind at the backs, they were ready to believe the most outrageous things – that the financial sector could get rich by lending money to people who couldn’t pay it back…and that a whole economy could flourish by luring consumers to spend more than they could afford.
“They are in trouble in New York,” said J.P. Morgan to Bishop Lawrence.
In October, 1907, J.P. Morgan was 70 years old…and attending a church meeting in Richmond when the importance of the sacred was disturbed by the urgency of the profane. Telegraphs kept arriving from New York; they warned of a disaster. According to Dun’s Review, 8,090 companies had failed in the first 9 months of 1907. Then, a failed takeover of the United Copper Company caused a panic.
“A correction is equal and opposite to the deception that preceded it,” Morgan would have said, if he’d thought of it. Since he didn’t, it falls to us.
Morgan had been around the block when it came to money. He had taken over his father’s banking business decades ago. He’d seen panics, crashes, bankruptcies. And, now, it must have seemed that his whole life had been spent training for this one test. He returned to New York; crowds of investors looked to him to save the day. And he did. He put his own money on the line to help shore up troubled companies. He rallied friends, colleagues and competitors to do likewise. A trust was in trouble…then the New York Stock Exchange itself…then the City of New York…one after another, Morgan brought in the financiers…came up with the money…bullied and cajoled…until the storm had passed and they could all enjoy a good drink.
And when it was over, Senator Nelson W. Aldrich, realizing what Morgan had done said: “Something has got to be done. We may not always have Pierpont Morgan with us to meet a banking crisis. “
As it turned out, Pierpont Morgan was a ghost four years later. But in that same year – 1913 – the US Federal Reserve was set up to fill his big shoes. This year, it’s the Fed that is being tested.
Armageddon seemed to arrive in Manhattan on Monday. And not just in New York, but in Moscow, Hong Kong, London and Frankfurt too. Germany hastened to succor bank account holders. In Rejkavik the pandemonium was so hot it seemed to melt the ice. Then, on Tuesday, all the plagues and locusts we’ve been warning about here in the Daily Reckoning were loosed on the world: The US stock market fell hard again. Japan was sinking into the sea. Brazil’s market was down 51%, year to date. Central banks were cutting rates like pulpwood. Even so, unemployment was on still the rise. Consumer spending was falling. House prices were going down.
Of course, the world improvers were intervening in the usual clownish ways. Short selling was blamed for more accidents than alcohol. And everywhere, the authorities were getting ready for show trials…perp walks…and public hangings. Over on the Guardian’s front page, for example, was an extended whine about how much Richard Fuld earned at Lehman Bros. before he bankrupted the 158-year institution. $480 million was the number given for the 8 years of disservice. “Is that fair?” asked Congressman Henry Waxman.
Congressman Waxman seemed to think that something needed fixing. But that just goes to show how little he appreciates the free market. Investors handed Fuld that money of their own free will; they got exactly what they deserved. The system was fixing itself.
Politics always lists to the port side. But markets are more exquisitely balanced, between fear and greed. When investors had the wind at the backs, they were ready to believe the most outrageous things – that the financial sector could get rich by lending money to people who couldn’t pay it back…and that a whole economy could flourish by luring consumers to spend more than they could afford. These hallucinations created an immense worldwide bubble of debt and dollars. But now, the wind has swung around. A huge anti-bubble is forming – equal and opposite, in true Newtonian form – a financial whirlpool marked by exaggerated thrift, debt destruction and sweaty-palmed investors.
And where is Morgan when we need him? Where is the Fed? Ten years ago, the giant hedge fund – LTCM – had overdone it. As in 1907, according to Roger Lowenstein’s account, “Rushing for the exits…[traders] posed a danger not only to themselves, but to the entire world financial system.” So, the Federal Reserve Bank of New York called in the big financial houses to help with the rescue. It worked. The crisis was averted. LTCM’s positions were liquidated in an orderly way, just the way Morgan would have wanted.
But this time, the fix doesn’t seem to stay fixed. Bad positions can’t be unwound in an orderly manner; there are too many of them. And it’s not just a handful of speculators who are getting whacked – it’s half the population of the United States of America and Great Britain. Trillions of new cash and credit are being pumped in. The Fed is buying ‘assets’ you would throw out of your refrigerator. Her majesty’s government is now proprietor of 50 billion pounds worth of banking shares; the government of George W. Bush is preparing to enter the banking business too. But as trillions go in, trillions more leak out. So far this year, world equity markets have lost $20 trillion. U.S. property markets alone have lost $6 trillion over the last two years. It is not just a few investment decisions that are being corrected, in other words, it’s the delusions of an entire generation.
“These prices make no logical sense,” said a Wall Street trader, referring to mortgage backed derivatives at Wal-Mart-style discounts, and missing the point. Markets are not scientific. They are poetic. After the liquidity comes the liquidation. After the outsized recklessness comes the appropriate regret.
Enjoy your weekend,
The Daily Reckoning
October 10, 2008
Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.
Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now.
We are thinking about retiring. Taking up cattle ranching maybe. Or maybe becoming a hermit.
Those are the kind of thoughts that must have passed through millions of minds yesterday.
“The Reckoning…” the New York Times is calling it.
Yesterday, the Dow dropped another 678 points. Today, is fell below 8000 for the first time since 2003. Dow 5000 – here we come!
But we can’t take any pleasure in it.
“Our business is offering people financial advice,” explained a colleague. “When the market goes down like this, people just lose interest. Nobody wants financial advice. They just want out.”
Now, everyone seems to want out.
And so…the reckoning falls on The Daily Reckoning too…and everyone looks to his own: “How will I afford to pay for the vacation home we bought last year?” “What if I lose my job?” Well, at least I’m not the only one!”
At least, we hope our Dear Readers are safe and sound. Did you pay attention to our “crash alert” flag? Did you sell stocks on rallies, like we suggested? Did you buy gold on dips?
We hope so. That’s about all you can do.
What about bonds? Yes, U.S. Treasury bonds have been rising too. As the crisis deepens, they will probably rise more. But where’s the margin of safety? Put your money into a three-month T-bill and you get almost zero interest. True, you won’t lose any money in nominal terms. When the moment comes for the U.S. government to pay you back, you can be sure the money will be there. But, eventually…and maybe it is still a couple of years away…that money will go bad. (More below…)
Today’s news tells us that the Treasury is getting ready to follow the British example – by nationalizing the banks.
The U.K. approach, explained colleague Andrew Vaughn, “provides Tier 1 capital and a requirement, not a mere hope, that banks will lend. The package specifically precludes the possibility of a bank taking the money, and then just hoarding.
“Yesterday’s interest rate cuts around the globe were a watershed moment,” Andrew continues, “because they were coordinated. It gives markets the signal that action by the authorities in one country is no longer simply going to cause capital flight elsewhere. Without interest rate cuts outside of the U.K., yesterday’s U.K. events would have caused a fall in the pound – the bailout package because of the surge in government borrowing associated with it, and the interest rate cut because of the resulting interest rate differential (the pound would otherwise have become lower yielding relative to other currencies).”
Yes dear reader, it is the new world order. Governments now work together. They’re all going to take over the banking business – to one degree or another. They’re all going to guarantee deposits. They’re all going keep the wheels of finance turning. Hoorah for government! Guvmint is no longer the problem; it’s the solution. And not just one government…but all the world’s governments working in harmony to make a better, safer world.
Or, as David Brooks summed it up in a NY TIMES editorial…what we all need is “leadership.” Hail to the chief!
But wait. Aren’t these the same chiefs who have been regulating, controlling, meddling, intervening, rescuing, and leading mankind since civilization first appeared on the banks of the Tigris? Well, yes. But according to the prevailing sentiment, our leaders took a break after the Reagan/Thatcher revolutions. They went into exile…loafed…worked on their tans…and got fully rested. And now, it’s time to call them back to service. Bring back the old aristocracy of bureaucracy. Let them do what they do best – make an even bigger mess of things.
So far, the more the authorities fix things, the more they don’t work. Prices are going down to where they want to go – despite the efforts of the regulators.
But what’s ahead? No one knows, of course. But it looks to us as though there is more credit contraction where this came from. The boom ran its course. The bubble ran its course. Now, it’s the bust that will run its course.
And the authorities will do what they do too. Look for more intervention. More government spending. More takeovers. More controls. More bodies dragged through the streets.
The feds will continue to try to reflate the bubble. But there are a thousand leaks already…and more holes seem to be popping open every day. Every time a family is pinched by tighter credit or lower revenues, it closes its wallet…cuts spending…and further reduces the air pressure. Every business that sees its revenues falling… Every banker that checks his balance sheet and realizes he has to call in loans… Every investor who looks at his positions and panics…
All of them gasp together…
…and the Great Credit Contraction gets worse.
*** But let’s turn to happier subjects. Finally, Alan Greenspan is getting beaten up in the press.
More than any other man – living or dead – Alan Greenspan bears the blame for the intensity of the current financial crisis. Booms and busts are inevitable, but the former Fed chief made this one much worse than it should have been. This he accomplished by acts of omission as well as acts of commission.
As to the commission, he almost single-handedly caused the great real estate bubble by lending money far below the inflation rate. The housing market is extremely sensitive to changes in interest rates; Greenspan’s “emergency” low rates hit it like a shot of whiskey on an empty stomach. Within months, bulldozers were scraping new roads…and thousands of nail guns made the suburbs sound like a battle zone.
But it was the omission that the New York Times thought was important:
“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient,” said “the maestro” in 2004.
Greenspan was talking about derivatives – the complex financial instruments that are now blowing up in accounts all over the world.
“George Soros, the prominent financier, avoids using the financial contracts known as derivatives ‘because we don’t really understand how they work.’ Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential ‘hydrogen bombs.’
And Warren E. Buffett presciently observed five years ago that derivatives were ‘financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.’
“One prominent financial figure, however, has long thought otherwise. And his views held the greatest sway in debates about the regulation and use of derivatives – exotic contracts that promised to protect investors from losses, thereby stimulating riskier practices that led to the financial crisis. For more than a decade, the former Federal Reserve Chairman Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street. ‘What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,’ Mr. Greenspan told the Senate Banking Committee in 2003. ‘We think it would be a mistake’ to more deeply regulate the contracts, he added.
“The derivatives market is $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago. Theoretically intended to limit risk and ward off financial problems, the contracts instead have stoked uncertainty and actually spread risk amid doubts about how companies value them.
“If Mr. Greenspan had acted differently during his tenure as Federal Reserve chairman from 1987 to 2006, many economists say, the current crisis might have been averted or muted.”
*** Will the synchronized rate cuts solve the problems in the international financial system? Our correspondent in Buenos Aires wants to know.
“Developed economies spent the last decades criticizing decisions made by developing economies in the midst of crisis,” notes Horacio Pozzo. “Today, the world’s leading countries take the same measures without considering the consequences…”
And here we return to the scene of a crime that has not yet been committed. An explanation: all sovereign governments have the power to steal. They do it openly – through taxation. They also do it clandestinely – by means of inflation. Each country controls its own money (with the exception of the countries of Europe, who have decided…perhaps temporarily…to use a common currency). Since this paper money can be created at negligible cost to the creator, countries are tempted to create more of it than they should – especially in times of war or financial crisis. Historically, what has kept this from happening was that the paper currency was tied to gold. More recently, currencies are tied to the dollar. And since countries trade with one another, a sin by one country – printing too much money – is punished by the others. They mark down its money.
But now, all the world’s major countries are conferring, colluding, and conspiring. They’re all going to do the same thing. They’re all going to take over their banking systems, support their financial industries, bail out important businesses and rescue their citizens from their own mistakes. Where will they get the money for all this? Will they borrow it from each other? Don’t be silly; they will print it.