Belief and Blame

As regular readers probably can tell, I had a nice conversation with George Ure yesterday.

The take-off point was yesterday’s blog on destructive oscillation, which he mentioned on his wildly popular netblog today.

[Reading this before hitting the “send” button, I think it’s only fair to issue a rant alert.]

George asked how it was that he can just pick up the phone in East Texas and get the straight skinny about structured finance, yet somehow Larry Kudlow (to pick an example) doesn’t have someone like me in his Rolodex.

I told him that Larry’s old colleagues at Bear Stearns most certainly would have told him what’s wrong with his idea that Fannie and Freddie caused the crisis.  Since it conflicts with Larry’s fundamental beliefs (think religion here), he simply couldn’t accept the facts, and stuck with an explanation that fits his beliefs.

We then talked a bit about the nature of belief and blame.  A lot of the talking heads busy explaining why we nearly saw the end of the financial world in late 2008 simply can’t give up their religion of “free” markets to see the real cause.  In Kudlow’s case, Fannie and Freddie are creatures created by the Devil of Socialism, so must be to blame.

Like Puritans who found witches and satanic spirits to blame when they had unneighborly thoughts, it simply won’t do for a “True Believer”  to admit that there is no natural corrective force in a free capitalistic market that counterbalances profit-seeking through leverageOn the contrary, excesses brought about by leverage are self-reinforcing.

Either the trend toward higher leverage is corrected by external forces (regulators or policy-makers), or it keeps going in the direction it is going until every penny that can be borrowed has been borrowed.  Every financial asset, property or company that can conceivably be projected to support additional debt becomes the basis for additional debt, because the purveyors of debt in the upward cycle can pay a higher price for those assets, that property, or that company than others who choose to be more prudent.

It wasn’t just subprime borrowers living a bigger lifestyle through cash-out refi’s.

Everywhere you looked, companies, investors, households and the government were all borrowing their way to “prosperity” in all its forms – increased GDP, higher total sales, and increased net worth.

Some were even cutting revenues at the same time, due to their strange belief that cutting prices always makes a stronger business, or equivalently, lower taxes always make a healthier economy, even if the government spends more than it takes in from taxes or the company spends more than it gets in additional sales.  If they could keep borrowing more based on their increased GDP or sales volume, they could maintain the illusion of greater wealth.

Nearly $900 billion in private equity deals got done in 2006 and 2007, and every deal depended on assuming that even struggling companies could somehow support massive additional debt under the stern, but wise, leadership of hedge funds or private equity groups that took over the companies or properties they bought.

Commercial properties kept getting bid higher and higher, and equity investors (for the first time I know of) accepted lower expected cash-on-cash returns than even senior debt holders.  The equity return of commercial real estate traded to yields as low as 4% to 5%, and that’s only after assuming commercial rents would never go down, but would increase every year.  Needless to say, many of those equity investors are now wiped out, and even refinancing has slowed to a trickle (estimated at under $15 billion this year).

Our government was no slouch in the debt department, either, with “free market” true believers in charge, proceeding to give away trillions of dollars in list price prescription drugs, hugely increased welfare payments to agribusiness, and starting a couple of expensive wars with enormous no-bid military contracts, all while simultaneously cutting revenues dramatically.

I guess if the people running our government the last few decades said to themselves that they were for “small government” and “free markets” enough times, they could avoid seeing what they themselves were doing, making the government a dramatically larger part of the economy, and interfering in markets every day.

It’s like a religious man, caught in a grotesquely compromising situation, claiming he couldn’t be committing a sin, because he’s religious.  For some reason, he can’t see that his belief in his own fundamental “goodness” might be misplaced and that his deeds define whether he’s a sinner or a saint, not his words.

The hard light of reality should have caught up with the faux free marketeers when they chose to guarantee private debt for virtually every major piece of the world economy.  Right across the world, it didn’t matter what political system was in place, or whether the left or right was in power in October of 2008.  Every major country stepped in and nationalized (or provided government guarantees) for its private banks and private short-term debt system.

You have to ask yourself, why is it that in America, the UK, Europe, the Pacific Rim and China — every government, in all the forms they take, found it necessary to adopt emergency “socialist” fixes to address the crisis?

If private enterprise and free markets are to be taken seriously as guiding economic policies for long-term health, why wasn’t at least one country able to come up with a private enterprise or free market solution to the crisis?

Already the so-called economic conservatives are forgetting that even AAA industrial GE applied for, and got, a taxpayer guarantee on its CP issuance, that lifeblood of private enterprise working capital.  Put another way, to make sure it could keep paying its receivables and its payroll, mighty GE turned to the taxpayer to guarantee their corporate promise.

Private equity firm Cerberus got help for its Chrysler purchase, but the market religion true believers now think that bailout was done on behalf of the auto union.  I don’t remember the UAW launching billions in additional junk bonds and syndicated bank loans in the run-up to the meltdown (all the while paying themselves hundreds of millions in special dividends), but that’s the way the story is being told today.

And don’t even get me started on the financial institutions.  Goldman is enjoying the benefit of having billions of its debt guaranteed by taxpayers even now, and is still borrowing on credit lines from the Fed.  That is true for every bank or brokerage firm that “paid back” the TARP stock that Bush, Paulson & Co. bought in the depths of the crisis using our taxes.

Since when is paying back the money on one emergency line of credit and not the others “payment in full?”  Only in the minds of those whose belief system would collapse if they admitted their guiding principles are faulty.

I’m reminded of the Millerites.  [They weren’t beer freaks, for those of you who watched all the NFL playoffs.]  They were a cult of fundamentalist Christians that were convinced the world was coming to an end on a certain date in the 19th century.  They gave away all their earthly possessions (I sometimes wonder if Mr. Miller offered to get rid of their property for them), and waited on a hillside to be taken up to Heaven in the Rapture.

When it didn’t happen on the specified date, they didn’t give up their belief, but became even more convinced that the event was coming.  It was just a simple mathematical error that they corrected when they went back to the Scripture and re-did their calculations.

Sort of like our deep thinkers who believe that capital gains tax cuts and deductible  interest, accelerated depreciation, and tax credits will somehow be the medicine that will cure our sick economy.  They believe this even though the demonstrated results of these incentives is to encourage house flipping, leveraged buy-outs and chasing trading profits, a definite shift away from productive wage-earning or business building.  The policies of the past few decades actually discourage retaining earnings and long-term reinvestment.

The problem wasn’t just that we aligned the incentives to reward those who “extract value” from companies or assets more than we reward those who build value over time.  There were also policies like giving lenders a giant regulation-avoiding loophole to stroll through that makes them “non-banks”, a category that covered 90% of the subprime mortgage market.  It wasn’t Fannie and Freddie.  It also wasn’t banks.

If the people who call themselves conservative and responsible keep repeating that our economy is better when we follow their policies, it must be better, right?  So what if the problems that led to the collapse are directly caused by the policies the free marketeers espouse?

Anything NOT part of the free market catechism is obviously the work of the Devil, and should be blamed for all the problems, no matter how far-fetched that blaming process looks to any observer with enough perspective to see reality.

If your beliefs are strong enough, it’s easy to find someone to blame for all your problems – it’s the non-believers!


6 Responses to Belief and Blame

  1. Inspectordan says:

    Excellent writing and even better thinking!

    Great perspective…..fair and balanced for real!

    Good work, thanks.

  2. dwm says:

    You point out the psychology of belief perfectly.

    You identify leverage.

    You are remiss in allocating:
    -under-valued collateral
    -no collateral

    A well run monetary system requires honest weights and measures with real oversight and real penalties for non-compliance.

    Capitalism is a wonderful ideal but our human nature gets in the way.

    • hhill51 says:

      Note to other readers (and dwm)… your nice formatting disappears the way this blog publisher handles formats, but you were correct that allocating risk and collateral value among market participants has to be taken into account, with honest disclosure to all parties.

      My point about the subprime and CRA story is that they WERE appraised, and that real down payments did exist, and borrowers did document their income. When someone who should know tells you otherwise, you have to ask yourself why they feel a need to lie about it.

      • hhill51 says:

        By the way, those who think investors know nothing about the underlying loans are ignoring the reality that many investors insisted on seeing loan tapes before buying.
        Today, the need to update the status on each loan has spawned a number of services that cover property values and individual borrower performance. Check these two from the last few weeks: ……. [valuation service] ……. [performance updates] ….. these are in addition to CoreLogic’s Loan Performance data service, which has been available for more than a decade.

  3. dwm says:

    If only prudence was endemic! Recent events prove an epidemic of other than. That yield curve is saying what; trust me? Sure, smart folks like you will win. At what cost?

    A rambling interview with Brian Petti here:

    slide to 30 minute mark.

    Appreciate your insights re financing; you are good. Are you free?

  4. Larry says:

    I love the religion analogy.

    “And many will say to Me in that day, ‘Lord, Lord, have we not prophesied in Your name, cast out demons in Your name, and done many wonders in Your name?’ And then I will declare to them, ‘I never knew you; depart from Me, you who practice lawlessness.”

    We don’t have a free market any more than we have a republic. We have cartels and oligarchy covered by a thin veneer of Flag-waving free-market rhetoric.

    And many said, “Free market! Free Market! Did we not pass capital gains tax cuts and deductible interest, accelerated depreciation, and tax credits in your name!” And the Market said, “See if the Chinese will lend you more money or just print some more, because I never knew you.”

    And just like your Millerite example, the TRUE believers in the free market (anarcho-capitalist libertarians etc.) are just a fringe group of nutjobs. But like the Millerites, at least they actually BELIEVE what they are saying.

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