Why No Outrage?
UPDATE: 23 Mar 2009: I am re-publishing this and a February post (Where is the outrage?) because of the situation at AIG. In my view, the outrage that has finally boiled over in the AIG bonus scandal has long been simmering.
In reading the column from James Grant in the Weekend Journal, I felt I had a kindred spirit in wondering where the outrage is over the financial turmoil we are experiencing. This is one of the best editorials I have read in quite a while and a damning piece coming from one of the great market observers in Jim Grant. I cannot recommend this article highly enough. If you read anything this weekend, read this article (link at the bottom of this post).
His column on the front page of the Weekend Edition of the Wall Street Journal is subtitled:
Through history, outrageous financial behavior has been met with outrage. But today Wall Street’s damaging recklessness has been met with near-silence, from a too-tolerant populace, argues James Grant.
These are my sentiments exactly. I, for one, am outraged. You might say that many bloggers like myself are out there as the 2008 edition of the netroots who appeared in 2002 before the Iraq War to protest and discourage what they saw a likely disaster. That war did happen to the general regret of most citizens of the world.
Will we be able to stop financial calamity here in 2008? I wonder. The American people, as in 2002, are a very tolerant bunch. Over the past 8 years, we have witnessed the meltdown of the largest stock market bubble in U.S. history, the largest terrorist attack on American soil, the largest residential property bubble in American history, home repossessions on a breathtaking scale, and a global credit crisis of monumental proportions.
Yet, there is no outrage.
In 1968, a year in history to remember, there was outrage: in the universities of the United States and France, at the Democratic National Convention, at the Summer Olympics in Mexico, at the death of Bobby Kennedy and Martin Luther King, in Czechoslovakia (a country that did exist 40 years ago) and in many other countless ways.
A generation later all I can see is apathy. And I am appalled.
Grant puts it this way:
Long ago and far away, a brilliant man of letters floated an idea. To stop a financial panic cold, he proposed, a central bank should lend freely, though at a high rate of interest. Nonsense, countered a certain hard-headed commercial banker. Such a policy would only instigate more crises by egging on lenders and borrowers to take more risks. The commercial banker wrote clumsily, the man of letters fluently. It was no contest.
The doctrine of activist central banking owes much to its progenitor, the Victorian genius Walter Bagehot. But Bagehot might not recognize his own idea in practice today. Late in the spring of 2007, American banks paid an average of 4.35% on three-month certificates of deposit. Then came the mortgage mess, and the Fed’s crash program of interest-rate therapy. Today, a three-month CD yields just 2.65%, or little more than half the measured rate of inflation. It wasn’t the nation’s small savers who brought down Bear Stearns, or tried to fob off subprime mortgages as “triple-A.” Yet it’s the savers who took a pay cut — and the savers who, today, in the heat of a presidential election year, are holding their tongues.
Possibly, there aren’t enough thrifty voters in the 50 states to constitute a respectable quorum. But what about the rest of us, the uncounted improvident? Have we, too, not suffered at the hands of what used to be called The Interests? Have the stewards of other people’s money not made a hash of high finance? Did they not enrich themselves in boom times, only to pass the cup to us, the taxpayers, in the bust? Where is the people’s wrath?
Look, we have been witness to a financial mess of criminal proportions. The list of regulatory irresponsibility, predatory lending and corporate greed is longer than I can imagine and all of the major actors in this drama share the blame. The lion’s share of the blame goes to the U.S. Federal Reserve.
The U.S. Federal Reserve
Alan Greenspan is a man who once espoused the Gold Standard and hard money. In an essay entitled “Gold and Economic Freedom,” he actually argues quite well in favor of the Gold Standard and the abolition of the Federal Reserve, an institution he later came to chair. However, as Federal Reserve chairman he was quite another figure altogether — politically motivated, soft on inflation, remiss in regulation, and very much the mastermind behind the financial turmoil we experience today. Far from Maestro, Alan Greenspan will be remembered as one of the worst Fed Chairmen in history.
Every time there was an overheated economy where asset bubbles were clearly distorting savings and investment, time and again, the Greenspan Fed did nothing throughout his 19-year reign. Instead of acting as a regulator or monetary steward who takes the punchbowl away when the party gets out of hand, Greenspan did nothing — that is until the hangover began. The he gave us drunks another drink of low interest rates and liquidity as a shot in the arm to cure the hangover.
He did this in 1987, 1991, 1995, 1998, and most famously in 2001. It was the same asymmetric policy remedy every time: hands off during the overheating and asset bubble, excess liquidity and low interest rates afterwards. This also meant moderated rate hikes at the peak of the boom followed by drastic slash and burn cuts afterwards.
Why do you think there have been so many crises during his tenure? The S&L crisis preceded his 1991 liquidity infusion, the bond bubble and Mexican crisis preceded his 1995 liquidity. The Russian default and Long-Term Capital Management meltdown preceded his 1998 liquidity injections. And the NASDAQ bubble preceded his famous 1% Fed Funds policy in 2004. The cause and effect are easy to see.
Meanwhile, on Main Street, Americans were oblivious to this whole charade. Debt rose and savings fell. Stock prices went up, house prices went up and everybody was convinced that there would be no day of reckoning.
Question: Why do you think the financial services industry grew dramatically in the last 25 years? It grew from less than 8% of the S&P 500 market cap to over 20% in the housing bubble heyday. Obviously, when everyone is leveraged to the hilt and not saving any money because interest rate policies incentivize this, the financial services industry will grow. Americans are, if nothing else, entrepreneurial. We needed all of these stock brokerage firms, investment firms, mortgage companies, insurance companies, credit card companies, and banks to fund our lifestyle.
So, when the last bubble that the Fed could induce under the new bubble blower in chief, Ben Bernanke, came in the form of commodity prices instead of asset prices, we finally woke up to the inflation that had been there all along. Let’s be clear here: if common measures of inflation were adjusted to include asset prices, the inflation would have been evident much sooner.
One cannot condemn the Federal Reserve strongly enough for not raising margin requirements during the NASDAQ bubble, for not cracking down on predatory lending during the housing bubble, for not raising reserve requirements before the LTCM crisis and for running a policy of easy money and no regulation.
The Bernanke Fed has set interest rates at 2%, three full percentage points under the rate of inflation. What incentive for savings and deleveraging is that? It is an invitation to borrow yet more and to continue to save too little. The Federal Reserve under both Alan Greenspan and Ben Bernanke has been negligent in the extreme.
But there are other factors here.
Where is the fiscal restraint? The U.S. Government is as bad as anyone else here. Beholden to lobbyists and special interests, the Congress and various Presidents of the United States have allowed deficits to balloon out of control. Yes, Clinton did balance the budget eventually, but only with the help of inflated tax receipts from the stock market bubble of the late 1990s. The reality is that our government cannot rein in its spending because there are so many constituencies to pay off for their support. The America political system in the early 21st century is broken.
But, let’s not forget that it is the U.S. Government which appoints the Federal Reserve Chairman and confirms his tenure in office. I didn’t hear of Presidents Bush, Clinton and Bush arguing that the Fed was not living up to its role as a regulator and monetary steward. In fact, President George H. W. Bush blamed the Fed for not being easy enough before the 1992 election in his los to Bill Clinton. And the only two legislators of merit who have come out against the Fed are Ron Paul and Jim Bunning. This is a large reason why Ron Paul has a big following in America.
Financial Services Industry
I am not going to belabour the point about how rotten the industry has become with charging fees, loose lending standards, obscene pay and so on. This is obvious. But I will say two things.
First, the Financial Services Industry of yore was one of Glass-Steagall separation of investment banking, insurance and commercial banking. The Investment Banks were all partnerships which stood to lose their pay (partner capital) for making bad decisions. There were no golden parachutes for fired CEOs in the partnerships of pre-bubble Investment Banks. The incentive structure of Wall Street is all wrong now. We have a principal-agent problem. We shareholders are not being represented by our agents, the managers of the firms.
Decisions made by those managers today that have a multi-year effect and outcome require a multi-year remuneration. Partnerships align pay with decision-making. Salaried employees receiving yearly bonuses have no interest in outcomes down the line. After all, they may be long gone when the trouble hits. Witness Stan O’Neal, Sandy Weill, and Chuck Prince of Merrill and Citi. No one’s asking for their bonus money back — at least not yet. Were they partners in a firm, their payouts would have suffered from their poor stewardship. The partners are both principal and agent. No misalignment of incentives there.
Second, Wall Street reacts to the incentives it is given. No one ever accused bankers of being in it for the good of society. It’s all about the money. And the fact of the matter is the incentives were set by poor regulators and poor monetary stewards. It’s like going away for the weekend and leaving your keys in the Porsche’s ignition in the garage and not expecting your 17-year old adrenaline-addled, testosterone-filled son not to take a joy ride. Ferris Bueller, anyone. We reap what we sow.
And finally, there is us — the consumer. How could we let ourselves be duped like this? While Stan O’Neal and Sandy Weill were making millions, we were loading up on debt and saving nothing. How could we e so stupid?
For example, think back to 9/11 and its aftermath. Everyone was saying buy, buy, buy. We’ll show those terrorists they can’t harm our economy. Uhhh… have you ever taken a personal finance course? Buying stuff doesn’t make you rich. Saving does.
And then there’s the old line, “but my house and stocks are doing the saving for me.” I don’t know what to say to that except, you deserve to get smacked upside the head if you think you don’t have to save money because your house and stocks are appreciating in value. Again, personal finance says there is a difference between realized and unrealized gains. The conservative investor considers all unrealized gains to be non-existent.
But, of course, leave it to those money-making banking entrepreneurs to come up with the idea of home equity loans — the housing ATM — so that we could turn unrealized gains into cash. Here’s another smack for you. Psst…. the gains are still unrealized; you haven’t sold the house yet. Why are you spending money that you don’t have?
The long and short is we have to blame ourselves for getting duped into a high consumption, high debt, low savings lifestyle.
I’m sure you can tell I’m a little upset by all this. Why? I care about my country. I hate to see it degraded and downgraded by people who are only out to enrich themselves and their friends or by people who have no backbone to do the job they are paid to do. You should be angry too. This whole free-market, no regulation experiment has been going on for some 25 years and only now are we waking up to its hollow core.
It’s time for people to get up and go out and do something to keep these shenanigans from happening again. Do your part. I’m doing mine.
Why No Outrage?, James Grant, Wall Street Journal, 19 Jul 2008