The Econosphere

I don’t usually read and tell, but I am going to make an exception today.  I am going to write about what is wrong with Roger Lowenstein’s premature eulogy of U.S. investment banking, which is appropriately titled The End of Wall Street.

As a piece of journalism, The End of Wall Street is a triumph.  This book will be among the few that will be forever referenced by historians logging what has transpired in our economy and our society over these last several years.  Believe me when I tell you that I have read too many books about the financial crisis; and after reading all of those, I believe that this one is the best piece of financial journalism among the lot.  Well done Mr. Lowenstein. 

Unfortunately, as high as it soars in this regard, it sinks just as low as an editorial piece.   Throughout the book, you sense that it is coming.  There are bits of scolding, judging, admonishing and sermonizing that peek through the story from time to time.  You sense the journalist/author has something he wants to get off his chest, and you sense that you’re not going to be dismissed from school without first getting a lecture.   I don’t want to ruin the suspense for you if you are planning on reading the book, but the lecture begins on page 273, browbeating the reader until parole arrives after page 298.  The balance of the book is darned good, so maybe it’s worth sitting through the sermon.  I would liken the whole experience to be something akin to reading In Cold Blood with an extra chapter tacked-on in which Truman Capote lectures the reader about society’s role in driving Perry to kill the Clutters.  I think Truman was wise to have ended it where he did.

Nonetheless, it’s not as if I haven’t received this lecture before.  Heck, I worked for Citi; maybe I deserve it.  I just think it demeans the accomplishment of the book.  And more importantly, I think the lecture is plain wrong…and it all comes down to page 288.

Mr. Lowenstein commits his cardinal sin when he writes, “That investors could be so blind refuted the strange ideology that markets were somehow perfect (“strange” because the boast of perfection is never alleged with respect to other human institutions).

Roger, the market is perfect; it is information that is imperfect.  More to the point, the market is not a “human institution.”  The market is our social environment, akin in every way to our physical environment.  That lemmings run off of cliffs is not an indictment on topography in the same way that people investing in subprime mortgages is not an indictment on the econosphere.  We may inhabit our market economy, but it is as natural an “institution” as is the biosphere that we inhabit.  We are compelled to produce, consume and trade with one another because it is our instinct to do so.  By labeling the market as a “human institution” and thereafter comparing it to our political process, you are suggesting that we created the market in the same way that we created Congress or the Presidency.  We did not invent the market any more than we invented gravity, oxygen or the moon.  The fact that we need to trade is a fact thrust upon us by the finite nature of our resources, skills and our very lifespan.  We are compelled to make the best of these resources and we are guided by the market in the distribution of these resources.  That we have booms and busts is evidence that we do not have all the answers, but says nothing of the ability of the market, nor does it suggest that the market is an imperfect creation of our own.  If I drown, is it the fault of the tide?  Can we regulate the tide such that it never rises above our heads?  And if we could, should we? 

I’m sorry you didn’t care for the recession Roger, I didn’t like it either, but the answer is not to fix nature; the answer is to understand nature.  We need to improve information, not improve the market.  Never should anyone think that they are clever enough to improve upon nature.  Even if one is smart enough to write 270 pages of great journalism, one should not assume that he can or should remake the world to his tastes in a 30 page lecture.

Shhh....Larry's Sleeping

Did you ever feel sort of numb?  I don’t mean physically numb, but rather mentally, emotionally and/or psychologically numb.  Did you ever feel that sort of way?  I kinda do.

Part of it is that the world seems to be moving in slow motion right now.  I do believe that we are on the edge of a much more convincing economic recovery than we have experienced thus far, but it is a little late, and we are all mostly underwhelmed.  We are just sort of waiting and preparing for it.  It feels like all of the U.S. is at a bus stop.  We anticipate that the bus will come, and deep down we’re really not all that worried.  But, the bus is a little late and we’re just kind of standing at the bus stop, staring at each other, and otherwise occasionally looking down the road to see if the bus is coming yet.

We are waiting.  People are waiting for an absolute bottom in the housing market, the return of jobs, for commercial properties to start trading again, for the next major consumer trend to begin, etc…  Not that there isn’t a ton of prep to be done and strategies to be formed in the meantime, but all that work behind the scenes doesn’t make for a very exciting news day, nor does it necessarily make the phones ring.  It kind of feels like late-June and the beginning of a meandering summer, but it’s only late-March!

The malaise has even robbed me of the desire to remark on the one place in the economy where there has been some action of late: Washington.  How could there have been a massive healthcare bill passed, and yet I can’t seem to find the enthusiasm to remark on it? I think that it may not just be the slow current economy; the new programs themselves are designed to invoke malaise.  They phase in so slowly that it will be a slow drip of change.  Moreover, let’s face it; none of it has much to do with me, that is, until it’s time to pay the higher taxes.  It wasn’t written to make my life better.  It was written to make someone else’s life better.  So, while I am happy for them, there isn’t much under the tree for me to open. 

What can we say?  Well, it is a very large new program designed to transfer some wealth from one cohort to another, and also a program that is designed to take some of the burdens of life off of every individual’s shoulders and onto the government’s shoulders.  Health care is now supposed to be one less thing to worry about….kind of like retirement savings and Social Security.  The new bill actually communicates the message to “go ahead and be a little numb,” we’ll take care of things if you get really sick.  So I guess that’s nice.  But I do wonder.  Is it good for all of us to feel numb?

To examine that question, let’s look at Social Security.  It is said that Social Security is the most popular Federal program ever, and I am apt to believe that.  I think it is popular because it has retained its “you take out what you put in” aura—even if it is quite imperfect in that regard.  People don’t see it as welfare or a redistribution program, so people generally do not begrudge paying into it.  If I were to have to guess about the program’s future, I would guess that it is slated to eventually lose that aura entirely as the burden of the payroll tax becomes more progressive and benefits are eventually scaled back for the wealthy, but for the time being, people seem to like it, and maybe people will like the new healthcare laws, as well (though the healthcare’s redistributive qualities are much more apparent right from the onset).

But I do wonder what would it be like if there was no Social Security?  For my household, I would prefer that Social Security didn’t exist.  I would like to believe that I could do a better job investing those funds than does the government.  Thus, I’d just as soon keep that cash with me.  As for others who, perhaps, would rather not have the burden of personally saving fully for their retirement, Social Security is probably a great program.  Certainly, Social Security has likely prevented extreme poverty among many thousands of elderly who might have saved too little or invested poorly—the likes of which is what prompted the creation of the program to begin with.  So all things held equal, I guess we can see the program’s merit.

But things are never held equal!  And I can’t help but think how the world might look if people were able to control more of the wealth that they create.  How would the world look if we all had our payroll taxes back?  Would there be more money available for college tuition?  Yes there would.  Would there be more investment capital?  You betcha.  Would banks be better capitalized and better able to lend freely?  Yes.  And once all that excess capital, free to find its highest use, finds all these now highly educated people, would the world be better off and more productive?  Yes, it probably would be.  The new wealth created could make the likelihood of poverty among the elderly far less likely.  We could be robbing ourselves of a more productive, more dynamic economy by outsourcing our saving and investing to the government.

Still, with the government taking care of retirement and healthcare decisions, and maybe with new policies to protect consumers and homeowners, and who knows what else is in the pipeline, pretty soon we won’t have to worry about nearly as much as we used to.  Sure, the economy may remain slow like it is currently, but we might be reasonably comfortable standing at that bus stop, waiting for the bus, or waiting for the mailman with our benefits check, and we’ll have time to stare blankly at each other and, well, be sort of quiet and subdued and mentally, emotionally and/or psychologically numb.  It sounds kind of nice, sort of like being sedated.  In fact, I already feel a little sleepy, and unengaged, and generally….zzzzzzzzzzzzzzz…..wake me when my check arrives…..zzzzzzzzzzzzzzz….

I despise the phrase “too big to fail.”  There are people all over the world who are constantly looking for the thing that is going to end life on this earth.  Global warming, nuclear weapons, pesticides, rap music, you name it, there is someone out there who thinks that something or other is going to end life as we know it.  Well, I am one of those people and I hate to break it to the anti-nuke crowd, but far scarier than a dirty bomb are those four dreaded words, “too big to fail.”

They’re just four words (we can even shorten them to something cool looking like 2B2F).  Someone probably just said them off the top of his or her head one day.  So easy to say, but once they were said and once someone put some TARP muscle behind it, it changed everything.  Four words threaten the one thing that allows us to prosper, our meritocracy.

Really, this issue isn’t new.  We lived with this for years with Fannie Mae and Freddie Mac.  Fannie and Freddie were set free, sort of, by Congress to live as private firms.  The problem was that no one ever believed that they were really on their own.  Despite their functioning as private sector mortgage servicers, the markets believed that their debt was backed by the federal government.  This implied backing meant that their money was cheaper than any of their competitors’ money, which is really the key to understanding the problem at hand. 

In the world of finance, there are only two ways to make above-average profits.  The first way is to have smarter money; the second is to have cheaper money.  Very few people have smart money (and Lord knows that Freddie’s and Fannie’s money wasn’t all that bright), but you only need one of the two, and they had cheap money.  Cheap bottomless money meant that Freddie and Fannie could grab market share at will, and they did.  Not only was that not fair to the competition, but it was an accident waiting to happen as their portfolios got larger and riskier (riskier not only because of scope and hubris, but also at the prodding of policymakers).

I was actually at a meeting in Washington DC years ago when the Treasury came to address the group and brought TV cameras with them.  Representatives from Fannie were in attendance, and the Treasury (I think it was the Assistant Treasury Secretary) gave a very angry speech for the cameras admonishing Fannie and swearing that the U.S. would not back its debt. 

Well, no one believed him for one second, and history has proven the doubters correct.  When the sh*t hit the fan, the Treasury was on speed-dial and both Fannie and Freddie were taken back into the government fold.  Not only did Freddie’s and Fannie’s implied government backing unfairly steal business from honest competitors for years, but it encouraged the kind of risk taking, concentration of assets and distortion of incentives that helped lead us into recession.

Keep in mind, Freddie and Fannie were not made in a day.   These were serious entities that formed over the years and were the product of a good deal of legislation, monitoring and debate.  They were a train wreck, but they were a slow moving train wreck.  Flash forward to today; 2B2F has created a fast-track to Freddie and Fannie infamy.  With just the utterance of a phrase, “too big to fail,” we have created how many new Freddies and Fannies?  Who knows?  In an instance, Citi is now a GSE (government sponsored enterprise).  Bank of America is a GSE.  GMAC is a GSE.  GM is a GSE.  Is Exxon a GSE?  Is GE a GSE?  Is Kraft a GSE?  Are all the S&P500 companies now GSEs?
 
If something is too big to fail (and let me go on the record as stating that nothing is ever too big to fail), will its money be cheaper?  Who will they be working for, their shareholders or their government backers?  Do we break them up?   Well where does the government find the authority to take something owned by shareholders and destroy it?  What a mess…and all because of just a few uttered words.

And yes, I know that the Treasury has gone on the record saying that there is no such thing as too big to fail.  But why should we believe them?  No one at that meeting in DC years ago believed the Treasury was going to back away from Fannie, even as they broadcast their anger over the networks.  So, why would anyone believe them now?   The answer is that they won’t.

With just a few words, we’ve created 500 Freddie Macs.  The horror.

This all kind of reminds me of another phrase that just about brought our meritocracy to its knees: “highly confident.”  It was 1985, I believe, when Drexel Burnham Lambert sent out their first “highly confident” letter.  At the time, Drexel’s Michael Milken just about owned the junk bond market.  He created it, and he controlled it.  As a result, Drexel’s money was the cheapest on the street, and no one doubted their ability to raise money in support of any hostile takeover.  So unquestioned was their access to capital that at some point, they realized that they didn’t even have to raise any money at all; they would just send a letter to the quarry stating that they were “highly confident” that they could raise the money on behalf of their client to finance a takeover.  Just the receipt of that letter would force the prey into the arms of their pursuer.

I never thought I would ever see another phrase as powerful and destructive as “highly confident.”  Well, we have one right now that puts “highly confident” to shame.  “Too big to fail” is the new “highly confident” and the U.S. Treasury is the new Michael Milken.  They put Milken in jail and Drexel out of business.  But what are we going to do with 2B2F?  I don’t know.