"Time and persecution brings many wonderful things to pass."
- George Washington
We are reading the new biography of George Washington from the pen (ok… laptop) of master biographer Ron Chernow. We are wholly absorbed in the tale, and Chernow’s insights about the Father of this country and his time shed much light on our present season of discontent.
Today the underlying issue is a total abdication of responsibility on the part of those invested with the Public Trust. The reason it has become compelling as an ongoing policy matter to debauch the once-proud Dollar is that our society has established a pattern of behavior, reaching back certainly to the post WWII period, of encouraging excessive behavior by consumers. The rest of the world recognized US indebtedness as a nascent problem as far back as the early 1980’s. Is it realistic for Washington now to push back on generations of excess? We search in vain for anyone in a position of public trust to take a stand against this madness.
Not Fed Chairman Ben Bernanke, who said this week, “We are still learning about the efficacy and appropriate management” of “non-standard policy tools that do not rely on interest rate deductions.” Chairman Bernanke, who appears to have taken classes in opacity from his predecessor, was telling us that he wishes he could reduce interest rates further. But, while in mathematical modeling Zero represents merely a reference point, in real world economics it takes on all the characteristics of a physical barrier, forcing the great minds (who in these matters certainly Think Alike) to get creative.
As a society, we appear to be on the cusp of disaster. Our elected officials, desperate to abdicate responsibility, appoint academics to make key decisions. The academics say “This worked great on the blackboard,” but there is a very real risk that appointed officials will come to believe in their own infallibility. We saw this under Emperor Greenspan, and the same has happened to Summers and Geithner. Tossing the hot potato to another player, then ducking out of the room, does not constitute a proper system of checks and balances.
“…still learning about the efficacy and appropriate management…” in plain English, the Chairman is telling us – “We haven’t quite gotten the knack of handing your money, but we are making progress. Another few trillion and we should really have it down to a science.” Like journeyman stockbrokers and money managers who learn their craft by losing large quantities of their investors’ money, those charged with managing the economy have resorted to guessing. And, like the broker who has put you into six losing trades in a row, we are now being asked for “one more shot.” Chairman Bernanke’s Princeton-educated guess notwithstanding, recent policy decisions broadcast the message that We Don’t Know What We’re Doing, But We’ve Been On This Course For Too Long To Change. In the movies, this is generally what the driver says a moment before shrieking “Oh my God! We’re going to crash!”
To return to a linguistic bugaboo we have already criticized: some three years into this Awful New World of global finance, we disagree with those who persist in calling our current position a “crisis.” We are no longer in the midst of an abrupt and temporary departure from the norm, but are feeling our way, albeit reluctantly, in the New Norm. There is no longer a Mean to which our markets and our society can revert, and we must establish a new orientation. True, this change was precipitated by crisis, but major societal shifts generally require an explosion to counteract generations of inertia. As pointed out by economist Hyman Minsky, the cycle of Boom, Bubble and Bust is built into the very structure of our financial markets. It is thus perhaps not even fitting to call the turbulent events of three summers ago a “crisis” – which implies a lack of predictability, a sense of disbelief – except to point out that they were of greater magnitude than, say, the “crisis” of the dot-com bust or the “crisis” of the S&L failures.
“Crisis” is what strikes the unprepared, otherwise known as the Public. For the prepared – those who drove the economy off the cliff – it is a pause to reload and map strategy for the next phase of the campaign.
It being in the nature of cycles to overlay other cycles in concentric, or spiraling patterns, some future economic historian will trace this period’s origins to longer-term forces, rather than to the lame excuse of the “perfect storm.” Incredibly, everyone from Blankfein, to Fuld, to Greenspan has sat before Congress and testified to the equivalent of “My dog ate it,” all of which has done nothing more than stoke a moment or two of Congressional testiness. Where are the mobs with the pitchforks, we ask? Where the honorable suicides, as legislators acknowledge how horribly they have failed their country?
The year 1893 saw a depression where unemployment ran in excess of ten percent, and for the better part of a decade. The period saw social unrest, labor union violence, and the surge of the Populist and Free Silver movements. With Glenn Back pitching gold ingots, with the Tea Partiers treading a fine line between inclusive dialogue and crypto-fascist, social exclusionary fear-mongering – with unemployment hovering at the double digit threshold and no end in sight – are we experiencing an extended-wave repetition of a long-term cycle?
The Kondratieff Wave is named for Soviet economist Nicolai Kondratieff, who posited that capitalist economies are subject to cycles of 50-60 years. Later theorists posited a longer wave stretching beyond a century, the rough equivalent of two Kondratieff waves (“K2”?). While admitting that economics is hardly an exact science, approximately two Kondratieff Waves ago, in 1893, there was a period of economic upheaval in this country. And approximately two Kondratieff Waves before that, in the early 1770’s, the economic crisis in the American colonies unleashed a sequence of events that led to the creation of this country. “The World Turned Upside Down,” the British called it.
Chernow says it is curious and unique that the American Revolution was started not by the impoverished oppressed, but by the upper classes, struggling under the economic disadvantage forced on them by the Crown and its attendant explosion in personal indebtedness. Murmurings of tax revolt at home spurred Parliament and the Crown to increase the tax burden on its productive colony. Americans were constrained to sell all their produce through British factors, who set prices arbitrarily. A Virginia planter would ship his tobacco crop to London and would find out only months later at what price it had been sold. Americans purchased all their furnishings from London purveyors. This included not only the tools with which they built and farmed their plantations, but their personal wardrobes, books, trinkets and the textiles from which their slaves’ clothing was sewn. Chernow paints with livid strokes Washington’s evolution from a young soldier yearning for recognition from the Mother Country, to a mature and accomplished citizen whose devotion to the revolutionary cause arose inevitably from his potent sense of justice and fair play.
As Washington observed, if people are mistreated long enough, they will change their behavior. And a change is not a “crisis” – unless, that is, you happen to be King George III.
We are struck by the shocking disregard of social equity in today’s system – American society has long been a colonial province of Wall Street, its subjugation assured by Washington (“DC”, not General George!) The Wall Street Journal paints a perfect picture of the chasm between philosophy and reality (12 October, “Wall Street Pay: A Record $144 Billion”). Ponder with us, if you will, the world-view this article reveals.
“Many firms say that if they don’t adequately compensate employees, they risk losing top talent.” Surely this applies to any area of endeavor. Why is this different? Later on the article says “Tough new rules about how much capital banks must hold could force Wall Street to cut back on compensation in an effort to preserve returns on equity for shareholders.”
The financial industry is highly people intensive, and firms pay out about half their revenues in compensation. For all the regulation the industry is famously subject to, the basic model has not changed: investment banks are run for the benefit of their employees, not their shareholders. It is oddly poignant that Dick Fuld and many of Lehman’s top executives had the majority of their personal wealth in Lehman stock – stock they had not disposed of when the walls came crashing down.
In short: the more bankers, traders and salespeople are required to work for the benefit of their shareholders, the more likely they are to seek out employment at a firm that is less focused on creating value. The manager / producer / shareholder paradigm is not what it used to be. The investment banks all went public specifically to undo the link between firms’ risk taking, revenue producing activities on the one hand, and the risk-bearing function of shareholder capital, on the other. They retain the benefits of private partnership – witness the pay packages they receive even in losing years – while laying off the capital risk associated with ownership onto public shareholders. The notion that the nations of the world need to band together to legislate that capitalists should work for the benefit of their shareholders is the single clearest indicator that the system has run right off the rails.
We note with horripilation the measured, bland reportorial tones with which the Journal describes Wall Street’s forthcoming bonus orgy as the paper notes (“Bankers Are Still Upbeat About Pay”, 11 October) 50% of Wall Street professionals expect higher bonuses this year than in 2009. “They Like Money,” quips the headline, curiously juxtaposed with a report (“Signing Bonuses Haunt Wall Street”) of losses suffered by firms that lured brokers from rival firms with fat up-front signing bonuses, based on prior years’ production. When a broker can not generate the same levels of assets or commissions as he used to – for example, when the markets get trashed and everyone is terrified – his new employer will not recoup this outlay. As it says in the mutual fund prospectus, prior performance is no guarantee of future returns.
The signing bonus is just another symptom of the ongoing search for customers who can provide revenues for the firm – and not a search by the brokers for firms which can provide revenues for the customers. Bankers publicly criticize their competitors as being venal and unscrupulous. In the next breath they will tell you that, if they don’t pay outlandish bonuses, their own employees will leave in a heartbeat and go work for these low-lifes. “As long as the music is playing, you’ve got to get up and dance,” famously stated Chuck Prince, former CEO of Citigroup, as though he had no choice. Everyone gives mournful lip service to the notion that this system stinks, but no one is willing to step off the financial murder-go-round.
This, then, is the social and political cowardice that reigns today – the Qualitative Easing that has allowed us, three years on, to continue to struggle in this fiscal cesspool. The Fed has transitioned from Stimulus, to More Stimulus, to Quantitative Easing, to – as our CEO Keith has smartly characterized it – “Krugman Kryptonite.” Because Washington is afraid to inflict pain on the moneyed interests, we are, at last, down to the proverbial Mess of Pottage. Mysteriously, the pain and suffering of the American People is acceptable – which is why the greatest broad-based housing crisis in history is consistently called a “banking crisis.” A couple of million families thrown out of their homes pose less concern to the mind of Washington than a few dozen bankers deprived of their bonuses – or a few dozen banks taking hits to their balance sheets. Because even in their millions, these people have far to go before they form a consolidated bloc that will seek a political goal.
But we hear a distant drumbeat.
The Journal features a piece (16-17 October, “What The Tea Partiers Really Want”) that purports to clarify the Tempest in the You Know What. The author says Tea Partiers are outraged that government is in the business of protecting Americans from the consequences of their actions – and to guaranteeing equality of outcome to those who have trouble keeping up. We agree that, in broad strokes, these are bad polities – and probably not the job of government. Stupid business decisions should lead to failures. Highly competent and motivated people should succeed. But the analysis stops short. The article fails to underscore how far government is removed from the actual public interest. One could build a multi-generational conspiracy theory in which the entire program of government served to do nothing more than distract the people from the fact that those in government primarily feed their own self interest, and screw the public royally in the process.
Washington undercuts the likelihood of a broad coalition of the angry from ever descending on the Capitol, pitchforks in hand. It does this by making sure the rich stay rich, and the poor are mollified with health care, housing and income support. Underclasses are held in subjugation by programs that cater to their vanity. Bilingual education, for example, perpetuated the second-class status, not merely of the immigrant generation, but of their American-born descendants.
Lately, Washington has managed to keep the rich rich, but things with the poor haven’t gone so well. Many of the formerly not-poor have been tipped into the dustbin along with the societal trash so many of them have worked so hard to rise above. Amazingly, they are not yet angry enough, or organized enough, to do any real damage. We thought the twin housing and employment disasters were going to be seen as a Ruby Ridge moment, driving the newly dispossessed to violence. Frankly, we are surprised that no one has been assassinated.
In our simplistic view of the world, the government could have used the TARP billions (our money, we remind you) to gut the Gordian Knot of fugazy homeowner mortgage finance. Since the money was being handed over to the banks anyway, it should have been funneled through the homeowners. By paying off underwater mortgages, the federal government would have relieved the burden on the homeowners – freeing up current income for consumption. It would have relieved the pressure on the banks’ balance sheets, wiping out billions in debt that would otherwise have to be charged off. And it would have buoyed home prices, by ratifying the obscenely overinflated prices of houses bought with fraudulent mortgages. Call it a “cram-up.”
In their infinite wisdom, the Mother Country – Washington and Wall Street – determined this would reward a lack of virtue and of foresight on the part of the consumer. Congress voting to bail out the taxpayer – can you imagine?
Chief Compliance Officer
HEDGEYE RISK MANAGEMENT