History’s Greatest Ponzi Scheme

Very few of the ever-growing number of books about the recent and current world financial crisis try to identify the ultimate causes of this astounding implosion of the longest, strongest and most widespread economic boom in history. Any such analysis by officials became impractical because it became mired in the uneven exchange of allegations between the politicians and the private financial sector. The political class locked arms from across the spectrum to blame private sector “greed”. With the exception of a few media outlets, such as the Wall Street Journal, this theme was taken up by the press. And this version of events has been amplified by the Obama administration’s effort to claim and to execute a mandate to take the country much more sharply to the left than the public wishes or would abide. Any disposition to exchange fire with the politicians has been stifled by Attorney General Eric Holder’s practice of steadily thinning the ranks of the private sector’s blame game debating team by indicting a swath of businessmen.

In fact, it was a joint government-industry effort. It could not have occurred without the legislative and regulatory coercion and monetary policy encouragement of the federal government. In the US, despite its unabashed capitalism, the business community is politically inept. There are no Agnellis (Fiat), Dassaults (Dassault Aviation) or Herrhausens (Deutsche Bank) to influence the government. There are many businessmen who are closely involved in industries that dominate congressional districts and largely fund the careers of these congressmen. These legislators are reliable supporters of the interests of such benefactors. Most congressmen are in what amount to rotten boroughs of about 700,000 people, 7.5 times the population of the average British parliamentary constituency. About 300 of the congressional districts almost never change party. Once arrived at the Capitol, the congressmen form alliances with other legislators to support each other’s initiatives for their local interests. This is a permutation of democracy, but is far from what the authors of the Constitution had in mind, or early admiring visitors such as de Tocqueville found.

The country largely despises the New York financial community for its intermittent reckless blundering. The only businessman with any standing in the country is Warren Buffett, who before he lost $25 billion on paper in October and November 2008 (most of which he has since recouped), had been demanding that his taxes be increased to help disadvantaged people. He has worn thin his status as America’s avuncular aphorist, but has deservedly retained his prestige as an investor and as a financial epigrammatist. But he has only occasionally carried the standard for the private sector in the counter-accusations over the financial debacle. 

The other great financiers skulk around like nerds or emasculated chameleons, claiming to be philanthropists and collectors and to having only a passing interest in the pursuit of lucre. Only the brave, the buccaneers and the showmen — Ken Langone, Kirk Kerkorian, Carl Icahn, Nelson Peltz and Donald Trump, for example — admit to being capitalists at all. 

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I was asked to read and comment on three books about the economic crisis: Vicky Ward’s The Devil’s Casino (about the failure of Lehman Brothers); Kate Kelly’s Street Fighters (about the demise of Bear Sterns); and Michael Lewis’s The Big Short (about the clever inventors of some of the more explosive financial instruments and techniques that were used to profit from it). 

The first two are works of journalism based on oral recollections and contemporary media accounts with whatever memos, text messages and other primary material were available. No such work can comfortably be taken as authoritative, but they are diligently assembled, well written and portray vividly the human characters behind the impersonal drama. Lewis’s book is more ambitious, as it effectively claims to identify the sorcerers who saw the opportunity, aggravated the problems and helped to bring on the deluge, which they then exploited by a comprehensive programme of short sales. None of these books seeks to identify the larger ailments of the political and financial systems that led to these vulnerabilties. But they are all worthwhile, interesting and engaging reads as far as they go.

They dance lightly around the regrettable fact that every part of the system failed. The US government pushed the private sector into issuing trillions of dollars of bad debt. Both parties in Congress imposed the obligation on lending banks to make 25 per cent of their mortgage business commercially unjustifiable (following an upgrade of banking debt). President Bill Clinton ordered the giant government-sponsored mortgage companies (generally known as Fanny Mae and Freddie Mac) to put more than half of their huge mortgage portfolios into such investments. This was a political free lunch. Thus the Democrats took the credit for increasing family home ownership and boosting the building trade and land development industries at no cost to the taxpayer.

The financial system leapt at the opportunity presented by this massive market operation. The Securities and Exchange Commission allowed the investment banks to borrow 30 times their equity base against overvalued collateral. The requirement of quarterly adjustments of asset values to reflect market fluctuations was retained, leaving the more aggressively borrowed companies as sitting ducks to short sellers such as those Lewis wrote about.

The rating agencies approved many hundreds of billions of dollars of debt that they knew to be practically worthless. These were sold as if they came from solid issuers, with the insurance industry then picking up billions of easy dollars on swaps it must have known could blow up with any agitation.

Everyone failed. The conduct of Goldman Sachs was questionable. Its former chairman, the Treasury Secretary Henry Paulson, acted bizarrely, rushing about like a headless chicken, buying failed assets instead of preferred shares in the banks that had invested in such assets — the formula devised by the Roosevelt administration in the Thirties. He assisted in salvaging the creditors of Bear Sterns, let Lehman Brothers go to the wall and took good care of his company’s own coat-tails.

I used occasionally to encounter Alan Greenspan in the early 2000s and I once asked him (during an intermission at Carnegie Hall) whether he wasn’t concerned that the country had no savings. He said he was not. The public, he maintained, would do better out of rising house values than from the stingy interest rate his Federal Reserve had allowed as a return from deposit-taking institutions. My diffident reference to economic cycles brought the assurance that monetary policy would mitigate their effects. Politicians, government departments, agency heads, board chairmen and regulators are responsible for translating the national interest into public policy and enacting and enforcing that policy. Businessmen are there to make profits and obey the law. Despite all the nauseating antics of the corporate governance charlatans, who effectively sell priggishness and collectivisation of executive responsibility instead of financial performance, it is not the purpose of corporate America to divine and pursue public policy, beyond assuring that it does not affront it.

Once the Congress, the administration and the Federal Reserve had gone for broke on home-ownership, when trillions of dollars of mortgage-backed debt representing almost no equity were poured out, a senior Citigroup official infamously said: “When the music is playing, everyone has to dance.” That is not what one hopes to hear from the head of one of the world’s greatest banks. But most businessmen are Buggin’s Turn intramural politicians, not auxiliary 

national leaders. 

The banks had almost ceased to be lenders. They were distracted by and infested with financial high flyers and used their basic businesses to issue premium corporate paper, with which they bought higher-yield offerings of increasingly high risk. They merged or became one-stop financial shops, absorbing investment banks, insurance companies and other financial service-providers which had different corporate cultures. Even the legendary banking nationalities — the Swiss, the Dutch and the Scots — largely lost their way. The regulators, who had all the powers they needed to avoid the crisis, predictably demanded more authority as a reward for having failed so completely to use the powers they already possessed. 

This highlights the two fundamental problems that have created and aggravated the financial crisis. Since economics is half psychology and half Year Three maths, the crisis has demoralised America. First, no one saw the crisis coming, except the silent manipulators Lewis writes about. Second, those few professors and eccentric investors who spoke out were considered too erratic or obscure to command much prior notice.

In terrible policy failures and crises of the past, such as the mistakes of appeasement in the Thirties there were serious people such as Winston Churchill and Charles de Gaulle who were there to lead their countries when the errors they had decried were exposed. The gigantic follies that led to the financial meltdown should have been obvious enough to arouse serious dissent, but didn’t. This reveals something deeply disconcerting about the American political and business elite.

Some people detected some aspects of the approaching crisis. Even I was shrieking from the rooftops for years about the $800 billion annual US current account deficit. But again, apart from a few technical financial wizards identified in Lewis’s book, almost no one predicted the tsunami of sub-prime mortgage defaults. I had dealt with many of the main lending banks and almost all of the leading investment banks in New York and London. I was never impressed with the service they provided or the quality of their advice. They were a cartel in New York, and in London a little back-scratching society at the feet of the Governor of the Bank of England.

Very few of them had any loyalty to the client. They lacked any real notion of relationship banking and just led those they advised to their habitual sources of capital, preceded by their corporate wallets. They gouged the offering price of the new debt and share issues by short-selling their clients’ stock to depress the issue price, assuring a pop for their financial partners and their own trading accounts as soon as the issue came through the window.

For decades, the chief objective of the financial industry has been not to make good deals but to make many deals, take their fat fees, and to hell with the public. The regulators could have tightened some of these regulations but apparently never considered it. Greed compounded the problem, but was not its origin.

National per capita wealth is measured in Gross National Product divided by the population. But if Paraguay decreed that everyone in the country write a poem and sell it to someone else for $100 ten times a day for a year, Paraguay would have the fifth largest GNP in the world and per capita income of an astronomical $300,000 per year. This would be a mirage.

But so was much of the Clinton-Bush/Blair-Brown economic boom and its foreign imitators’ replications. In the US, there are now a formidable 48 metropolitan areas with more than one million people. All of them have clusters of skyscrapers filled with busy and talented people who don’t really add value to anything. Merchant bankers promoting deals that later usually go sour; lawyers generating a trillion dollars annually in legal bills, half of which should not have been run up in this insanely over-lawyered country; consultants generating another trillion dollars of billings, for telling well-paid executives how to do their jobs; $2.4 trillion of medical expenses, $3,000 more per capita than any other advanced country; and teeming masses of retail sales people. They don’t produce much, but make money move around faster and multiply transactions that add to the GNP. Yes, the learned professions, medical research and the drug companies are indispensable, but the US legal and healthcare systems are hideously over-expensive, and this administration, after a few verbal throwaways, has done nothing to reduce the cost of either.

About 30 years ago, the West acted on the self-important delusion that overalls and metal lunchboxes were beneath it and we plunged into the fool’s paradise of the service economy. Some parts of that economy, such as computer programming and, up to a point, academics, are legitimate value creation, but most are not.

Even 30 years ago, sophisticated economies were manufacturing economies, balanced by natural resources, heavy industry and professional and technical executive support of adequate depth and innovation. Resource economies were just hewers of wood and drawers of water, as natural resource importers such as Japan financed new production of everything they imported and maintained a buyers’ market.

Now, with China and India representing 40 per cent of the world’s population, with annual economic growth rates of six to ten per cent, there are steady, firm and rising prices for almost all base and precious metals, energy, agriculture and forest products. Manufacturing has been outsourced to developing countries, with only the most sophisticated, such as aviation, high-tech and advanced defence production, retained. Resource-rich countries with relatively small but well-educated populations, such as Canada, Australia and Norway, are now the most successful in the world.

When economic meltdown hit, the Left, battered into a coma by Reagan and George W. Bush, rose up and proclaimed the ignominious end of Reaganomics and Thatcherism. But those leaders had left their countries in excellent condition, with current-account surpluses and, in America’s case, only a modest budgetary deficit. This crisis is no victory for the Left.

America carried Western Europe, the Middle East and Japan on its back for decades. It was rewarded with endless lectures on the evil of current-account deficits from those who had benefited from them. Oil imports and prices skyrocketed, French and Italian luxury goods and German — and Japanese — engineered products poured into the US. When George Bush Senior gave his economic message in 1992, it was to urge Americans to spend all and more than they had. This was not responsible advice.

Administrations and Congresses of both parties sat as inert as suet puddings. The mighty American economy, with its highly motivated and incomparably skilled workforce, abandoned savings and investment and became helplessly addicted to perishable consumer goods, personal debt and speculation. Millions of manufacturing jobs were outsourced. Millions of undocumented immigrants were allowed into the country and trillions of dollars were borrowed from China and Japan to buy outsourced manufacturing from China and Japan. None of it made any sense and the US itself became history’s greatest Ponzi scheme. 

Given that, inexplicably, no one audible saw what was coming, it is not surprising that no one seems to have much idea of what to do about it. The Obama administration’s hydra-headed economic team speaks in many tongues. But it has given few hints of what alternatives will be considered to the present forecasts of a decade of trillion-dollar annual budget deficits and money-supply increases. This is a policy that will drastically erode the dollar’s value. The administration is raising taxes, always an unwise action when a country is trying to shake off a recession. But it is doing so not as quickly as it is raising expenses and making imprudent concessions to Luddite labour unions. It has given most of what is left of the US auto industry to the United Auto Workers, which is chiefly responsible for the industry’s near-death experience.

Obama apparently bought into the fairytale of creating millions of green jobs making windmills and solar panels. He padded around the most inane high-level conference in world history, at Copenhagen, promoting a $100 billion annual payoff to Hugo Chávez, Robert Mugabe and other barbarous monsters for the carbon emissions that resulted from the economic growth of the advanced countries. Fortunately, the evaporation of the global-warming canards that carbon emissions had anything to do with the world’s temperature eliminated this hare-brained nostrum.

The second intractable problem is that while capitalism is the only economic system that works and is incomparably the best route to economic growth — because it is the only one that is aligned with human nature’s drive for more — it will always, because of that drive, arrive at the brink of self-destruction. All the fatuous claims of Gordon Brown and Alan Greenspan to manage prudently to avoid booms and busts have been exposed as fraudulent. All the well-meaning claptrap about a social market merely slows the speed of the Gadarene rush to the brink and does nothing to change the destination.

Financiers seek profits and as they have little sense of any broader interest will fall for almost any risk if temptation is dangled in front of them for long enough. This always leads to an economic crack-up, but governments almost never have the slightest aptitude to deal with the crisis. They have the duty to tackle it because they make and enforce laws, issue money, and control interest rates and the money supply, not because they have any talent at financial management or economic prescience.

As we stay in the same rut, what is needed is original thinking. The only perceptible sign that someone close to the decision-making process in Washington may be thinking useful thoughts on this subject is the former chairman of the Federal Reserve, Paul Volcker, who now serves as head of Obama’s Economic Recovery Advisory Board. He has spoken recently about taxes on fuel and financial transactions which would be huge revenue generators, reduce oil imports and help prevent the re-emergence of a bloated financial industry. 

There is no sign that any of the major debt-heavy economic blocs has any real disposition to pay its debt down instead of devaluing the currency in which it is denominated. But none of the major currencies is really worth anything and they are all just measured against each other. They are like mountain-climbers on a bare face, connected to each other but not to anything secure. The Chinese have impressive foreign reserves, but not a word of their economic claims and statistics is corroborated or believable. By traditional standards, Australia, Canada, Norway, Singapore and the Swiss have the world’s only hard currencies. 

With inflation removed from the figures, the annual rise in stock market values since 1929 is a very sober four per cent or so and not largely greater than productivity increases. There is no painless way to bring down the crippling debt and no apparent political will to do so. The most sensible national leaders in these terms are Germany’s Angela Merkel and Canada’s Stephen Harper. Yet they are not the greatest rousers of opinion since Peter the Hermit. Obama simply refuses to address the issue. His predecessor, George W. Bush, uttered the stirring tocsin, “The sucker could go down,” by which he meant the US economy, not the army of voters who had twice elected him to his great office. 

The greatest problem in the West is the European death-wish. This anaesthetising torpor has transformed the exaggerated hopes of a united Europe regaining its status at the centre of the world it enjoyed 100 years ago. It is now almost incapacitated by a financial problem in Greece. The looming problems of Europe will require a political de-socialisation and recovery of procreational energy or all those ancient nationalities will fade away like the North American carrier pigeon, which darkened the skies in Audubon’s time but passed into extinction in Cincinnati in 1922. Europe will have to redefine itself sensibly, incentivise work and demographic renewal, stop replacing the unborn with immigrants who don’t want to assimilate, and pull back from the road to extinction.

Although one who was very vocal in my reservations about Britain joining the euro, when I had some standing to make my views known, it gives me no pleasure to see it in such straits. Southern Europe appears to have signed on to a German-backed hard currency after filing a false prospectus about its own financial condition. I don’t see how those countries can be revived without local devaluation that, at the least, will require two currencies — a southern and a northern euro. Continuing to throw money at the problem in such huge dollops could bring down the whole structure. It is time for the Euro-federalists to engage in an agonising reappraisal.

Europe after the hecatomb produced by its Nazi, communist and fascist movements was essentially liberated, revived and coddled by the US until the Soviet threat imploded. In the ensuing euphoria, the old continent had an intense flirtation with a continental political fantasy. And the US has authored one of recent history’s prominent ironies. It rose with unprecedented swiftness in two long lifetimes, from 1783 to 1945 from fragile colonies to half the economic product of the world, a nuclear monopoly, huge moral authority and cultural influence and overwhelming military strength. 

It won the greatest and most bloodless strategic victory in the history of the nation state in the Cold War, crowning half a century of inspired strategic policy. All aid short of war (1939-1941); the conduct of the Second World War in overall planning by Roosevelt and Marshall and in all theatres by Eisenhower, Nimitz and MacArthur; and the containment of communism under nine consecutive presidents of both parties earned the US its unprecedented primacy. Inexplicably, with all rivals laid low, the US has spent more than 15 years trying to spend itself richer and to drink itself sober.

Although disturbingly corrupt and gratingly commercialised, at least it remains a vital, proud and determined country, unafraid to deploy its superb military forces for good causes. It will respond to leadership and has historically had one when it had to have it, though there is no ground for optimism that it will be forthcoming from the present administration.

The revived trend to saving will free up money for investment and reduce consumption of foreign-made luxury goods. The savings rate has risen from zero to five per cent and the current account deficit has fallen by approximately half in 18 months, with no help from Washington. “Green” energy will cut America’s fuel imports and create a relative oil-buyers’ market. As about 95 per cent of US transport is fuel-based, it is now on both sides of the struggle with radical Islam. Saudi Arabia is a joint venture of the House of Saud and the Wahhabists, and US strategic thinking will have to catch up with these ambiguities. 

We should end the immediate recourse in inflationary times to automatic interest rate increases. Every one per cent rise in the prime rate raises the rate of inflation by half of one per cent until a bone-cracking recession starts the cycle over again. Governments should arm themselves with the right to impose stand-by tax increases and reductions that would incentivise saving and discourage inflationary spending and price and income increases. This is a more subtle instrument than raising interest rates that force the eviction of families from their homes and of workers from vulnerable businesses. 

These changes would rally all the markets, if presented with some conviction and panache. They would reduce deficits while promoting sensible spending and saving.

The challenge is to harness the aggressive spirit of capitalism to produce socially desirable results, without blunting or warping the powerful motivation of self-enrichment. Just taking money from people who have earned it and giving it to people who haven’t in exchange for their votes while selling a fable about social justice hasn’t worked well. And awaiting the ingenuity of avarice to combine with the complacency and financial illiteracy of government to lead us from crisis to crisis won’t do either. 

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