JD over at getrichslowly.org sparked a little controversy with the we-are-Number-One-crowd last week when he posted this chapter from the Story of Stuff. The offence taken certainly indicates how screwed up this whole consumer thing has gotten. For one thing, we are all tied into the process through our economics (social capitalism) and our economy (the free market) and our politics (based in a fear of communism) and our religion (the failure to recogize the atheist in all of us). So any discussion of this kind leads almost inevitably to arguements and anger and dismissal of the original idea which was that we all have too much stuff.
Archive for Books
I’ve written before about the credit crunch, most recently in a six part review of Charles R. Morris’, The Trillion Dollar Meltdown. I’ve also mentioned my love of irony a time or two. So this article in the LA Times just seemed too funny to be true. The LBO industry is in deep trouble. Of course, so are we because of it but that is the other story.
. . . some experts predict that buyout funds launched in the last two years will generate poor returns because they overpaid for the companies they bought and some of those companies will run into deep problems if the economy keeps weakening.
This seems to me more proof that the wizards who run these top funds are no smarter than the ordinary home buyers who somehow convinced themselves that the hype they were creating by buying and trading up was true and the ride up the roller coaster slope would never head down. Oops! Overpriced and now the search is on to find a buyer before they lose anymore equity.
It is a hard choice to trust our government these days. Immense budgets, inefficient actions, regulatory nightmares, lowered taxes, deficit spending, incomprehensible debt loads and that’s just at the local level. One of the main reasons for the swell of support for Obama is the hope that his election might change some of that. So the final chapter of Charles R. Morris’ The Trillion Dollar Meltdown may prove to be just what the doctor ordered.
Chapter Eight: Recovering Balance
Less is more. In a free market environment that dictom can and, according to Morris, has been taken too far. For by trusting to the market place to be self governing, we have come to the possible unwinding of not only the US financial markets but the world’s as well. The term writedown (the act of reducing the accounted value of an asset) has become commonplace to the current financial news. To Morris the real disaster, the elephant in the room, is the danger that the rest of the world’s confidence in American financial markets may be lost. To deal directly with this problem means,
Any program to restore confidence in American markets must start with the banks. Loans to very highly leveraged parties should carry penalty capital charges. Absurdities like prime broker loans to hedge funds that do not disclose ballance sheets should simply stop. Banklike capital requirements should apply to all lending entities, including intermediaries like mortgage bankers who plan to warehouse deals for securitization. Loan originators should always retain first losses, and put-back agreements should get much stiffer capital hits than they do now. Accountants shouldn’t recognize credit insurance purchase from thinly capitalized entities, which would put leveraged credit hedge funds and the insurance monoliners out of the riskier portions of the credit insurance business.
Reading the list above reminds me of my own feelings about banks. They always seem to be ready to help when you don’t need it. See the barrage of credit offers when your FICO is good. But don’t seem to know your name when the mortgage resets and a refi would really save the day. In other words, banks give the impression of not taking risks but as the list above and the first seven chapters of this book point out, that really isn’t the case. Morris cites, and he is not alone in this, the removal of Glass-Steagal Act controls in 1999 which then allowed the commercial and investment banks to comingle as one culprit that could be corrected.
As an example of another reason why re-regulation of the marketplace is a good idea, Morris takes a long look at the health care industry. Just like with the financial market you might have to stretch your mind a little bit to deal with that idea. See it isn’t about you and your doctor. It isn’t about the best treatment for your family. It is about how
America’s high-speed technology adoption cycles produce higher financial returns for drug companies, device makers, and aggressive medical practitioners, but often it is not good medicine and is very expensive.
Health care is a business, son. What a business is about is ROI. Patient care doesn’t rank very high in the listing of incomes next to manufacturing and producing cardiac stents or over-priced drugs. Says Morris, “Much of the problem stems from the insistence that health care is just like any other consumer market. It’s not.”
I wont pretend to know exactly how the Pareto principle is supposed to work but I can see clearly how it can be used by the free marketeers to justify their financial outlook. The claim however to this idea as being some sort of natural law of economics however begs the question. If all the wealth is concentrated in one sector while all the debt is in another, that only makes the world work for the 20 percent. The 15,000 who pull in 284 billion a year while the rest of us struggle to make do on an hourly wage. We need a market place reset. We need to stop worshiping at the alter of retirement luxury, of being rich, of having it all, and recognize the rule that says enough is enough.
Attacking the rich, maligning the poor, driving a wedge into the widening gap between the top and the bottom of the workforce, these are the topics of concern in The Trillion Dollar Meltdown’s penultimate chapter.
Chapter Seven: Winners and Losers
It is perhaps apt that this next to last chapter has this title since we have become a nation that lives and dies with the sports metaphor. But just as the sports’ news has been dominated by spectacular betrayals of trust and honor so to has the world of finance. Superstars, yes. Superheroes, no. What has become clear to the outside observer is that the last forty years have led us to a point where the idolization of the rich, and unfortunately their methods, is the major characteristic of our psychology. Winning at any cost, walking away with it all, that is what we idolize. We are number one in our admiration and acceptance of the rich and their apparent right to have it all.
So what if Blackstone guts Travelport of $4 billion while laying off 841workers. We cheer as,
The private equity kings insist that they are management wizards, not financial engineers. But, at least in its most recent phase, the numbers show that the private equity game, like subprime CDOs, is just another arbitrage on cheap money and rising asset markets.
Billion dollar dividends to opportunistic takeover artists are just one wavelet in a long-term, and for many, increasingly dusturbing, tidal shift in American society – a widening disparity of wealth and income not seen since the Gilded Age.
Consider these wins:
- “the top 1percent, or the top centile, who doubled their share of national cash income from 9 percent to 19 percent.
- “the top one-hundreth of 1 percent, of fewer that 15,000 taxpayers, quadrupled their share to 3.6 percent of all taxable income.
- “the average tax return, of those 15,000, reported $26 million of income in 2005, while the take for the entire group was $384 billion.
Seems fair to most conservatives apparently because they still claim that the poor through the government’s entitlement programs, and the middle class through tax-deferred savings, and the elderly’s social security and other retirement plans got more. Only here are the facts of the matter according to Morris:
According to a 1999 Treasury study, 43 percent of the tax benefits from retirement savings programs went to the top tenth of households. 66 percent to the top fifth. and only 12 percent to the lower three-fifths.
Whiners and winners, that’s the net analysis. Didn’t finish school, did your job get automated? Well, that’s your lower class for you. Didn’t understand that subprime mortgage contract, well that’s too bad, isn’t it?
There is no conspiracy against the poor and the middle class. It’s more the inevitable outcome of our current money-driven political system combined with “the disposition to admire, and almost worship, the rich and the powerful,” which Adam Smith fingered as :”the great and most universal cause of corruption of our moral sentiments.”
Meanwhile, consider the drive to privatize. Sallie Mae is an example. Designed to be a government program to assist students in furthering their education has instead become a private company that “was fully privatized in 2004, a year in which it made an astonishing 37 percent after-tax profit.” See, say the free marketeers, that’s what business is all about. When the government ran it, it just helped thousands of student learn their way to success. But when it became a private company, and still retained the aspects of governmental protection from state usury laws, it made money. As a matter of fact, it even spun off a separate SLM business line that racked up $800 million in debt management fees in 2005. Imagine that. The rich, CEO Albert Lord’s compensation package in 2003 was 12.7 million with options by 2005 up to 189 million, get richer. While the poor (students) and the middle class (their parents) incomes stay flat.
We are apparently developing three kinds of services in this country. The service industries that provide jobs for the lower class, the government and industry service which provides jobs for the middle class, and the financial services which provides wealth and leisure and privilege for the upper class. Need proof, just look at Countrywide or Bear Stearns or Cit group or the K Street Project. When they make money they are private and successful models for how to work the free market. When they fail, the government, through the Fed or through pressure of other lenders/banks, bails them out. Socialized capitalism is what we have.
The great consolidations of banking and investment banking into financial mega-players has proliferated armies of mega-income executives Besides driving cash income shares toward the top of the payroll pyramid, it has greatly enhanced the political clout of Wall Street – as evidenced by steady cuts in taxes on capital gains and dividends and the persisitence of absurd tax advantages for private equity funds.
It takes a certain kind of confidence, some would say faith, to believe that we can come out of this cycle with our overall system still intact. Reading about the power of these forces and having watched what has happened even though the Democrats have assumed the political power for now, does not argue for success. Those armies of execs, those walls of money strategies, those free market confidence games are not just going to go away. America, you and I on the bottom may just have to do something about the top.
Next up: Chapter Eight: Recovering the Balance
This has been a bear of a week. As much as I have enjoyed coming to an understanding of this book, The Trillion Dollar Meltdown, I have also come to see that the amount of information that plays a part in these financial transactions is almost beyond what one brain can contain. For one thing, we are a consumer economy but have become an investment dominated culture. I remember waking up every morning to the sound of CNBC Market Week with Mario Bartiromo, when the commentaters were stars, and the line of ticker tape across the bottom of the screen, in reds and greens, was something we devoured along with every breakfast.
But back in the early 90’s, in between volleyball games at the beach, I’d be passing the ball back and forth with someone while I could hear in the background these old guys who used to play discussing their Wall Street Journal and wonder WTF. Since then times have changed and those retirement funds that are playing such a large part in our current story, those are yours and mine. So get used to it, we share in the responsibility of this emerging disaster. We have taken the free market ride and this has been our destination all along.
Chapter Six: The Great Unwinding
Remember the perky little CDOs from chapter four, and the credit swaps that were used to create synthetic CDOs, well they are back in this chapter with a vengence. As you might recall, the grouped mortgages were sliced horizontally to create tranches of funds with the bottom tier becoming the high risk but very lucrative high yield toxic waste. The question then was who or what would buy into such an investment? The answer now becomes clear,
Hedge funds are unregulated investment vehicles that cater to institutions and wealthy individuals, and promise extraordinary returns.
As of mid-2007, hedge funds deployed an estimated $2 trillion to $2.5 trillion of equity capital, and much higher economic capital due to their aggressive use of leverage.
I recall driving out to Vegas while we listened to real estate mogul, Robert Kiyosaki, explain how leverage worked. Of course, we could buy one property with our $100,000 but wouldn’t it be better to use the money to buy ten properties. With $10 k down, the banks would lend the OPM to do the rest. This is the thinking that dominates in the world of finance. Leverage your money. Use your tranche of CDOs to credit swap up. Buy a house for $200,000 in two years sell it for $500,000 use the $300,000 gain to buy a million dollar home. It all works unless, of course, the market comes tumbling down. Or you are using a subprime mortgage that resets in 3 yrs at twice the interest rate. It is after all an immense illusion. Everything depends on no one noticing that the king is still naked. And just as million dollar homes aren’t really worth a million so to the CDOs aren’t really worth there original valuation either.
Think of it this way. Your Wiley Coyote hedge fund is one tiptoe on the ledge and the rest of its body of mortgage liabilities teetoring over the cliff. All it takes is one slight breeze of interest shifts upward to tip the mark to market balance. Says Morris,
The hedge funds’ appetite for the riskiest positions has made them a major source of liquidity in the CDO and credit default swap markets. Their willingness to employ leverage to maximize those positions amplifies their impact. The funds’ demand for higher-yield products is pushing the industry up the risk ladder into CDOs constructed from second-lien loans, bridge financings, private equity, and other less liquid assets, often with minimal protections for higher tier buyers.
The shift in credit hedge fund investing wawy from cash-flow CDOS toward credit derivatives, Fitch reports, “introduces its own unique risks that have not been fully tested in a credit downturn . . . (and) could foster greater short-term price instability.”
Morris’ walk through of a leverage example on pgs. 111 and 112 shows just how high the ledge really becomes in one of these deals. 5:1 becomes 20:1 becomes 100:1 just like that. “Now assume the CDO incurs a 3 percent loss.” The deal value which started at $20 million hedge funds and $80 million bank loans for a total of $100 million is now only worth $40 million. The hedge fund and bank have to raise another $40 million just to cover their losses. Think Bear Stearns, which was credit default swapping in billions, then multiply that by the fact that there are 100s of hedge funds and you can see the problem. Not only is this credit market teetoring and ready to fall but that is us at the base of the cliff waiting to get crushed.
Do you know what a Ponzi scheme is? You collect money from one set of investors and use it to pay off a second set, then a third set, fourth set, etc, etc, etc. As long as the money keeps coming in and no one regulates it but yourself, everything will appear to be fine. But Morris concludes this chapter by referencing Hyman Minsky, “a Keynesian economist who became famous for his theory of financial crises. Unlike the Chicago-based school of free-market ideologues, Minsky believed that instability and crises were inherent features of financial markets.” Put a Ponzi scheme of 100’s of hedge funds and real estate subprime loans and credit card debt into his model and you can see where we are heading. Morris would have us reveal all the deals and face the music but as he notes at the chapter’s end,
The American financial sector today is far more powerful than it was in the 1970’s (when the pendulum swung towards the free-market theory). And to date, its response to the looming crisis has been, overwhelming, to downplay and to conceal. That is a path to turning a painful debacle into a decades-long tragedy.
Tomorrow: Chapter 7: Winners and Losers