When Big Men Learn Hard Lessons

“It’s almost worth the Great Depression,” humorist Will Rogers reportedly remarked, “to learn how little our big men know.”

Apparently, the big men of Will Rogers’ day didn’t know all that much…or at least not enough to avoid the Great Depression. But that was then and this is now. Today’s big men are much, much smarter…Everybody knows that.

Barak Obama: Sharp as a tack
Ben Bernanke: Brilliant
Timothy Geithner: Pure genius
Goldman Sachs: MENSA Chapter, Downtown Manhattan

These are just a few of the “big men” who are winning accolades for rescuing the economy…or for profiting from the economy’s apparent recovery.

Thanks to the stock market’s dazzling 40% rally, and to the recent spate of less-bad-than-expected economic data, a spontaneous folklore is developing around the federal government’s response to credit crisis.

“Wicked homeowners, aided and abetted by wicked mortgage lenders, borrowed more money than they could afford to repay,” the folklore begins. “When the wicked homeowners stopped making payments on their mortgages, trillions of dollars worth of mortgage-backed securities plummeted in value. This event caught many investors by surprise, including many big American banks.

“Therefore,” the folklore continues, “many big American banks began to suffer big losses (through no fault of their own, by the way, because they never could have imagined that so many wicked homeowners would stop making payments on their mortgages). These big losses frightened the big banks, causing them to withdraw credit from their customers. The ensuing credit crisis threatened to destroy the entire American financial system.

“The stock market plunged. Job losses soared. And home prices plummeted. All hope seemed lost…until the federal government intervened. Faster than you can say, ‘quantitative easing,’ the government flooded the banking sector with trillions of dollars worth of bailouts, subsidies and guarantees.”

“At first, the public scorned and mocked the government’s noble efforts,” the folklore concludes. “But the government persevered. Within just a few months, the stock market rebounded and the green shoots of recovery sprouted from coast to coast.”

Nice story…Perhaps the most entertaining American folklore since Paul Bunyan.

No one would deny that America’s big men are riding high – very high. Bernanke and Geithner are riding high on a friendly wave of public adulation. Goldman Sachs and the other government-coddled financial institutions are also riding high…on a wave of resurgent profitability.

Why wouldn’t they be?

The big financial institutions, courtesy of the Federal Reserve, may borrow money at very, very low rates of interest and reinvest the proceeds in higher-yielding instruments. This tactic is simply a reincarnation of the old “carry trade,” but with two critical differences: the Fed is subsidizing the carry, AND guaranteeing that the trade won’t be company-killing.

Unfortunately, subsidizing private enterprise is an expensive activity, which is one of the reasons America’s federal deficit will soar to nearly $2 trillion this year. That’s a bad thing for us taxpayers. But, ironically, that’s a very good thing for the large Wall Street firms who are the “primary dealers” of Treasury securities. The larger the quantity of notes and bonds that Uncle Sam issues, the more money the primary dealers make.

So it’s true; everywhere one looks these days, the big men are looking pretty darn smart. But we don’t think they’ve learned as much as they think they have. The big men have learned how to game the game…for a while. But they haven’t learned how to cultivate an enduring recovery…or how to build a failsafe financial structure.

Don’t take our word for it; just pull up a chair and watch. Enduring economic vitality doesn’t sprout from massive debt-issuance and currency debasement. And economic vitality certainly doesn’t sprout from handing out favors to coddled companies, while increasing the tax burden on the rest of the population.

No, the big men haven’t learned that much, which is why this crisis isn’t over yet. When big men actually learn things, there’s pain. When big men actually learn things, everyone knows it. The evidence is undeniable…

When Louis XVI, one of the big men of his day, finally understood that the peasants weren’t happy, his head was rolling on the cobblestones of the Place de la Concorde; When General Custer finally learned that Indians could mount successful counterattacks, he was lying on a grassy knoll at the Little Big Horn with a bullet hole through his temple; And when Bill Miller, manager of the Legg Mason Value Trust, finally learned that stocks sometimes go down, his investors were yanking their capital even faster than he could lose it for them.

When big men actually learn things, everyone knows it.

While awaiting the fruits of their real-world educations, we little men must try to continue our little lives in ways that maximize contentment and minimize hardship.

The Daily Reckoning