The following is an excellent excerpt from the book “THE END OF WALL STREET” by Roger Lowenstein from Chapter 20 on page 294 and I quote: “Spending policies has a dark side—they shredded government finances. Among the G20 nations, deficits soared from an average of 1 percent of total GDP to 8 percent. The United States was among the worst offenders, with a deficit equal to 10 percent of GDP. In the year after Lehman, America’s debt rose by $1.9 trillion ([Robert] Rodriguez had predicted $2 trillion) to a staggering total of $11.91 trillion. “In our opinion,” Rodriguez wrote, “this is a very dangerous road we have chosen.”
By 2009, each American (if accorded his or her share of the federal debt) owed $24,000—twice as much as a decade earlier. Moreover, unlike after World War II, when the government borrowed mostly from Americans—in effect, from itself—this time the country had borrowed from overseas; each American’s share of the debt included $2,500 to China alone.
It is arguable that the U.S. government resolved the crisis simply by appropriating Wall Street’s debts, transferring a private sector problem to the public. In any case, its “solution” further depreciated its international account. America borrowed from overseas to pay for the bubble; now it was borrowing for the bust. The British precedent comes to mind. Britain emerged from World War II in an indebted state; its currency was soon replaced as the international standard, and Britain acquiesced to American monetary leadership. The U.S. will be challenged to avoid a similar fate. (The dollar plunged 12 percent during Obama’s first nine months in office.)
The failure of America’s model stirred a geopolitical realignment. Europe no longer slobbered to imitate the U.S.; Asian economies were ascendant. Americans at the 2009 economic summit in Davos, [Switzerland] accustomed to preaching the wonders of the market, were subjected to lectures by the potentates of command economies. Russia’s prime minister, Vladimir Putin, gloated over the virtual death of investment banking. Premier Wen Jiaboa of China aptly faulted “excessive expansion of financial institutions in blind pursuit of profit.” Sounding as scolding as western missionaries of yore, he excoriated Washington for promoting an “unsustainable model of development characterized by prolonged low savings and high consumption.” Since China was the U.S government’s biggest creditor, his lecture could not be ignored. Indeed, Geithner promptly traveled to Beijing where, before an audience at Peking University, he pleaded, in the manner of a humbled plenipotentiary, that his government continue to be afforded credit.
The legacy of the bust—what Wall Streeters called the “new normal”–entitled, prospectively, a weaker dollar, a greater government presence, more joblessness, and higher taxes. It was a world of pinched horizons. From roughly the 1980s on, no horizon had been deemed necessary. Ronald Reagan had decreed that government was the problem, not the cure. Markets were viewed as self-regulating eco-systems. The province of regulation shrank, the volume of market innovations commensurately expanded. By the 2000s, the market’s innovations were no longer even questioned: Anything invented on Wall Street was perforce good. Complex creations such as securitized assets basked in the presumption of safety. [Alan] Greenspan’s 1998 testimony, recall, was that “regulating of derivatives transactions that are privately negotiated by professionals is unnecessary.” The notion that the Street should run a casino, taking bets on which companies will live and which will die, did not strike observers as even mildly objectionable. The belief that the market data composed a sort of sacred text, on which forecasters could reliably predict household default ratios and the like, was accepted by faith.
A generation invested a higher proportion in stocks, fed on the nostrum that risk was, essentially, outmoded. Just as the fall of the Iron Curtain supposedly ended history, Wall Street’s smooth rise through most of the ’90s and the ’00s was to have ended market history. (No more earthquakes—just steady gains.) The crash of 2008 spelled the end of that end. The prejudices of a generation, the conviction, repeated so often it had become gospel, that stocks were ever and always a sound long-term investment, smoldered into ash. In the aftermath of the crash, not only was the return on stocks negative over ten years, it trailed the return on government bonds for the previous twenty years. Indeed, stocks were barely ahead over a thirty-year time frame. The ramifications were profound. Portfolio allocations by individuals as well as by endowments, pension funds, and other institutions were rewritten. Society altered its view of an acceptable level of risk.
Previous to the crash, it was casually assumed that no statutes or rules were needed to prevent banks from making foolish loans; after all, the theory went, why would institutions ever jeopardize their own capital? This cornerstone of efficient market theory—the view of economic man as always rationally self-interested—was rather embarrassingly upended. Similarly, the faith that bankers know best, that they could be counted on to preserve their firms, was shattered.
The peculiar prominence of finance was now seen as dubious and, in all likelihood, temporary. Prior to the ’90s, the profits of financial firms had averaged about 1.2 percent of the GDP, with little annual variation. But in the ’90s and ’00s they soared; in 2005 such profits totaled 3.3 percent. There is no inherent reason why finance should have suddenly tripled its share of the national output, and in a world with less leverage, less risk, less appetite for exotic securities, and, off in the distance, higher interest rates—no reason why it should continue. The proper end of Wall Street is to oil the nation’s business; it became, in the bubble era, a goal in itself, a machine wired to inhuman perfection.
It may be too much to expect that, in the future, economists take forecasting models with a grain of salt, or that executives refrain from relying on “liquidity” to bail them out of a jam. But the worst recession in sixty years—unsuspected by most economists even when it had been under way for more than six months—should inspire a modicum of humility. Speculation will return, of course, and so will bubbles. The question is whether Americans will treat them so lightly.
Overseas, the notion that central banks should restrain speculation is hardly controversial. In the United States, it was. Both Greenspan and Bernanke devoted many words to rebutting the notion that bubbles should be “pricked.” [Footnote: Bubble pricking (and bubble spotting) would not require a new systemic risk monitor, as has been proposed. The Fed is already charged with raising interest rates to ward off excessive inflation. It could also raise rates to tamp inflation in the credit cycle—which is rather easy to recognize. Irrespective of the absolute level of interest rates, when the premium charged to risky borrowers narrows, it is a sign that credit standards are weakening. The economist Robert J. Barbera has proposed a simple formula for adjusting rates that would incorporate not only changes in the consumer price index but also credit spreads. If such a change were adopted, easy credit would constitute ground for a presumptive, if not an automatic, tightening. This is not to say that a robot could run the central bank. Monetary policy is intuitive as well as mathematical. And banking regulation is inherently subjective. An effective Fed governor has to recognize that when banks across the country are issuing loans without asking the borrowers to document their income—to document their truthfulness, that is—something in the system is rotten.] Instead, they endorsed a policy of cleaning the mess up afterward. This reflected their doubts that mere humans, even Fed governors, could detect whether an elevated market was irrational—whether any market was irrational. Even after the crash, Bernanke could barely bring himself to utter the word “bubble,” preferring to speak of the mortgage “boom.”
The formative lesson that Bernanke drew on in 2008 had been sketched prior to and during the Great Depression when, he believed, the Fed had erred in clamping down on credit formation, including the credit used to speculate in stocks. In other words, the Fed had been too restrictive. Future central bankers may draw an opposite lesson from 2008: the Fed let speculation go on far too long.
The end of the era on Wall Street was also an end for Robert Rodriguez. The investor who anticipated the trouble earlier than most—who renounced the debt of Fannie and Freddie early in 2006, who scrubbed his bond portfolio clean of “suspicious” mortgage-backed securities, who warned of an “absence of fear” in mid-2007, and who saw that it would require capital, not just liquidity, to save the system—announced that he would leave his firm in 2010 for a one-year sabbatical. Coincidentally, 2009 marked his twenty-fifth year at the helm—a quarter century of investing in increasingly bubbly markets buoyed by ebullient bankers, optimistic investors, ever-tolerant officials, and, ultimately, a mortgage mania. Rodriguez had tried to avoid the speculation inherent in those bubbles so as, he thought, to lessen his exposure to the consequent busts. Through the end of September ’09 his stock fund, FPA Capital, had recorded an annualized return during his stewardship of 14.77 percent, the best of any diversified mutual fund over 25 years. The S&P 500 returned only 10.36 percent over the same span. Even in a market dominated by bubbles—perhaps especially through bubbles—careful investing still paid.
In October, already preparing his exit from Wall Street, the cautious investor entered an American Le Mans Series race in Monterey, California, sharing, with a codriver, the wheel of a Porsche GT3 Cup. The four-hour race was his first Le Mans. The field included thirty-three contestants, mostly professional racers, driving cars like his as well as Ferraris and Corvettes at speeds surpassing 150 miles per hour. The track was two and one quarter miles with eleven turns—one of which, known as the Corkscrew, was said to be equivalent to a three-story drop, or perhaps, in terms of the flow of adrenaline it occasioned, a bank run. “It gets your heart pumping,” Rodriguez noted. Six cars were put out of action; two collided and one hit a wall at the finish. Rodriquez finished third in class. He survived to compete another day.”
(THIS LAST SEGMENT IS ZEROING IN ON THE GDP, WHICH HAS GOTTEN WORSE EVER SINCE RONALD REAGAN MADE THE STATEMENT THAT THE GOVERNMENT WAS THE PROBLEM. THE BIG INVESTMENT BANKS WERE HAPPY TO HEAR THAT AND THEY WERE EVEN MORE ANXIOUS TO GET RID OF the GLASS-STEAGALL ACT, WHICH TOOK PLACE IN 1999. THEN GET ALL THE MONEY THEY COULD FROM THE GOVERNMENT THROUGH LOWER INCOME TAXES AND KEEPING PEOPLE AROUND IN THE FEDERAL RESERVE LIKE ALAN GREENSPAN, WHO STATED THAT “REGULATION OF DERIVATIVES TRANSACTIONS THAT ARE PRIVATELY NEGOTIATED BY PROFESSIONALS IS UNNECESSARY.” THIS CONTINUED ALL THE WAY THROUGH BILL CLINTON’S ADMINISTRATION BECAUSE HE KEPT ALAN GREENSPAN AS FED CHM AND THE ECONOMY FINALLY COLLAPSED IN 2008 UNDER PRESIDENT GEORGE W BUSH AND ENDED UP WITH THE $700 BILLION TARP BANK BAILOUT. PRESIDENT GEORGE W BUSH HIRED BEN BERNANKE AS FED CHM ON FEBRUARY 1, 2006. THINGS DIDN’T IMPROVE WITH THE OBAMA ADMINISTRATION BECAUSE HE KEPT BEN BERNANKE, HIRED TIMOTHY GEITHNER AS TREASURY SECRETARY AND BOTH WERE INVOLVED IN THE FINANCIAL CRISIS OF 2008. PRESIDENT OBAMA ALSO HIRED LARRY SUMMERS AS AN ECONOMIC ADVISOR AND MR SUMMERS HELPED TWART ATTEMPTS TO REGULATE DERIVATIVES UNDER PRESIDENT CLINTON WHEN HE WAS A DEPUTY AT TREASURY. THE SCARY PART OF ALL THOSE GROWING, TOXIC DERIVATIVES IS THAT ACCORDING TO ELLEN BROWN’S BOOK “THE PUBLIC BANK SOLUTION: FROM AUSTERITY TO PROSPERITY” IN CHAPTER 29, STATED THAT THE BANKRUPTCY CODE WAS CHANGED IN 2005 AND IF A BIG BANK GOES BANKRUPT, THAT PEOPLE HOLDING DERIVATIVES CONTRACTS GET THEIR MONEY BEFORE THE FDIC-INSURED DEPOSITORS. THIS CONCERNED ME SO MUCH THAT I SENT A LETTER TO THE EDITOR OF MY LOCAL PAPER, WHICH WAS PUBLISHED AND I CONTACTED MY ELECTED OFFICIALS TO DO SOMETHING BECAUSE I FELT SOMETHING THIS RIDICULOUS WOULD CREATE SUCH A BIG BUBBLE THAT MAYBE THE WHOLE WORLD WILL EXPLODE BECAUSE OF THE UNREGULATED, GROWING, TOXIC DERIVATIVE MARKET AND NOW ADD IN BITCOINS, WHICH ARE EVEN MORE VOLATILE. ALL OF THESE PROBLEMS HAPPENED BECAUSE THE GOVERNMENT WASN’T REGULATING THE FINANCIAL INDUSTRY, PROVING THAT RONALD REAGAN COMMENT THAT THE GOVERNMENT IS the PROBLEM IS WRONG.
LaVern Isely, Overtaxed Independent Middle Class Taxpayer and Public Citizen and AARP Members