9.25.2008

Perspective:Never before in human history...


Lots of yak on the financial markets and housing crisis. I'se workin' on a post about the way of the world and the federal Reserve.

Meanwhile, on this porch and over in the K9's yard thar's been talk of Spengler over at asiatimes.com

Here is one of his recent columns that speaks to the situation. It is worth yore time.

Lehman Brothers survived the American Civil War, two world wars and the Great Depression, but today, Monday, the firm that set the standard in fixed income markets will be liquidated. Potential losses are so toxic that none of the major financial institutions was willing to acquire it. Lehman’s demise follows the failure last week of the two American mortgage guarantee agencies, Fannie Mae and Freddie Mac. It is remarkable that the US authorities, exhausted from their efforts to bail out the mortgage guarantors and other firms, have left Lehman to its fate...

(snip)

The income of American consumers might have stagnated, but the price of their houses doubled during 1998-2007 thanks to the application of leverage to mortgage finance. The profitability of American corporations might have slowed, but the application of leverage in the form of mergers and acquisitions financed with junk bonds multiplied the thin band of profitability.
Wall Street and the City of London rode an unprecedented wave of profitability by providing overpriced leverage to consumer and corporate markets.

Led by the financial engineers at Lehman, the securities industry grew an enormous infrastructure of staff, systems, and financial exposure. They were so successful that when the music stopped, there was no way to liquidate this mechanism gracefully. It only could be allowed to collapse.
The Great Crash of 2008 has entered a new phase, judging from the market opening in Europe and US equity futures prices. Lehman’s failure and the sharp decline at other financial firms, notably American International Group (AIG), the world’s largest insurer, have pushed equity values down to their lost levels of the year.

As I wrote on May 20, the proximate cause of the Great Crash is the enhancement of poor returns to capital through leverage. The decline of returns to capital, though, stemmed from a global imbalance of supply and demand for capital in response to the rapid aging of the world population.

The aging pensioners of Europe and Asia must find young people to pay interest into their pensions, and they do not have enough young people at home. Germans aged 15 to 24, on the threshold of family formation, comprise only 12% of the country's population today and will fall to only 8% by 2030. But one-fifth of Germans now are on the threshold of retirement and half will be there by mid-century.


In effect, Americans borrowed a trillion dollars a year against the expectation that the 10% annual rate of increase in home prices would continue, producing a bubble that now has collapsed. It is no different from the real estate bubble that contributed to the Thai baht's devaluation in 1997, except in size and global impact.
It is easy to change the financial system, I argued in my May 20 essay. The central banks can assemble on any Tuesday morning and announce tougher lending standards.

But it is impossible to fix the financial problems that arise from Europe's senescence. Thanks to the one-child policy, moreover, China has a relatively young population that is aging faster than any other, and China's appetite for savings vastly exceeds what its own financial market can offer.
There is nothing complicated about finance.


It is based on old people lending to young people. Young people invest in homes and businesses; aging people save to acquire assets on which to retire. The new generation supports the old one, and retirement systems simply apportion rights to income between the generations.

**Never before in human history, though, has a new generation simply failed to appear.** (Calling that idiot Paul Erlich)


The world kept shipping capital to the United States over the past 10 years, however, because no other market could absorb the savings of Europe and Asia. The financial markets, in turn, found ways to persuade Americans to borrow more and more money. If there weren't enough young Americans to borrow money on a sound basis, the banks arranged for a smaller number of Americans to borrow more money on an unsound basis. That is why subprime, interest-only, no-money-down and other mortgages waxed great in bank portfolios.


It is tempting to see in the failure of Lehman Brothers and the forced merger of Merrill Lynch with Bank of America a failure of "corporate culture". In the case of a great financial firm that has weathered many storms, the failure of a business culture contains more information. Credit markets connect what we do today with what we plan for the future. Because the future is uncertain we must have faith in the outcome, which is why the word "credit" derives from the same Latin root that denotes belief in the religious sense. We require a certain degree of trust in our counterparties.

It is the job of the great financial firms to create trust between borrowers and lenders and establish a link between the present and the future.
It is of small account in the great scheme of things, but in the sad, strange little world of business studies, Lehman’s culture was held up as an exemplar, a beacon to the ambitious and avaricious. Lehman’s demise is a minor event next to the travails of America’s mortgage guarantee agencies, which required a government bailout last week, to be sure, but it is a landmark in the unraveling of American corporate governance.

By a charming coincidence, the two great securities industries failures to date occurred at the extreme antipodes of the corporate cultural spectrum. Lehman is the second great American securities firm to fail this year, following the March demise of Bear Stearns, the shards of which were swept up by J P Morgan Chase. Bear was a group of scrappy outsiders, led by Jews of no social pedigree. Jimmy Cayne, the firm’s president, never finished college and began his career literally trading scrap metal. Bear’s managers played bridge, and prided themselves on having no corporate culture except a piranha’s instinct for the next trade.

A book of memos by Bear’s former CEO Alan Greenberg circulated some years ago, including a lampoon in which the Bear chief categorized his competitors who had bit the dust over the years according to the management philosophy each had embraced, eg, "total quality management" and other shibboleths. Bear proudly rejected corporate culture and management philosophy as a matter of scruffy pride.
At Bear, partners ran their own businesses and hid their best methods from their colleagues to prevent anyone from cutting in on their action. The favorite method of management communication was the one-minute phone call.


Lehman held meetings to plan the meeting that would set the agenda for the meeting that would make the decision, and of course every department and interest had to be represented. That was called "teamwork". As a result, all of Lehman’s resources were mustered for the projects to which the firm set its priorities.
Tongues clicked across Wall Street when Bear went down for the last time. "Nobody liked [Bear’s] Jimmy Cayne," a senior fellow at Lehman Brothers offered, "but everybody likes [Lehman Brothers CEO] Dick Fuld. Cayne was not our class, dear; the jumped-up refugee from a junkyard had risen too high and received his comeuppance.

The Federal Reserve opened its lending facilities for commercial banks to securities firms for the first time in history, the day after Bear Stearns went down. Lehman and others were the beneficiaries of official largesse that was not offered to Bear Stearns."
Everyone may like Dick Fuld, who presides over a socially-connected, politically-involved, army of networking specialists who have one of Wall Street’s best stock of favors done and collectable in return.

But no one likes Fuld well enough to buy his firm, which apparently has been rejected at any prices by a Korean bank, by Barclay’s Bank of the UK, and finally by Bank of America.
Earlier this year, the American authorities allowed financial institutions to mark their books at fictitious values, in the hope that eventually prices for mortgages, consumer debt structures, corporate structured instruments and so forth would come back. If the authorities had forced the banks to mark to the existing market bid, all of them would have been insolvent.

The trouble is that the fundamentals are getting worse, not better - the prices of all this structured product aren't coming back and cash flows in some cases are being impaired. Six percent of American mortgages are delinquent, and recovery on liquidation seems to hover around 50%, rather than the 98% level that prevailed when home prices were rising. The longer you wait, the worse off you are. Everyone looked at Lehman's portfolio, compared it to the market bid, and realized that they might have a black hole of losses. The same is true of Washington Mutual, the American thrift institution likely to go next to the chopping block.

The failure of Lehman and Bear Stearns does not reflect the breakdown of a particular kind of corporate culture. As noted, the two firms embodied radically diverse views of corporate culture. What took both firms down, rather, is a sudden break in the chain of expectations between the present and the future. Today’s savers no longer can have any confidence that they will earn enough to fund their retirements by putting money at risk. They have discovered that in one form or another, their investments have fed a securities market bubble rather than the creation of value.
Market participants are responding by running away from risk, as well they should. That is the stuff out of which great crashes are made. The bouncing-ball pattern of declining stock markets was marked by bear market rallies each time the American and other governments stepped in to bail out the latest victim.

The US government’s ability to influence events, however, seems exhausted. The Treasury and Federal Reserve can’t bail out everyone. After Lehman, the insurer AIG and Washington Mutual may be next to fail, followed by several regional banks.
I see no solution except to allow American households to begin the painful process of rebuilding their balance sheets, which implies a slowing economy for the next two years. It is too late to stop the Great Crash of 2008. The question remaining is how best to pick up the pieces.

10 comments:

The Troll said...

Take the Obama Quote Quiz!

K9 said...

scrap metal - hey theres an idea. i think the thieves are already on it - copper from air conditioning units...stadiums...even stealing from the scrap yard.

maybe i should make the ornaments out of metal.

to your post -or spenglers - it goes back to first principals. no respect for life. and look at all that follows......no people, no buyers, no integrity, moral relativism and the regular people holding the bag. very nice.

Anonymous said...

I am feeling the gloom!

The Troll said...

What's a "heritage seed"? I tried to look it up to no avail.

moi said...

Great article with some perspectives I hadn't thought of an info I didn't know.

And now, Paulson wants to continue the speculation by buying low and eventually selling high. That is, after all, what he DOES. Problem is, he's using the wrong till and will have to print more money to do so. Which doesn't solve the problem five years from now when his low investments are now worth double, but the dollar is worth zip. By the time any of it trickles down to us? Pennnies . . .

I'm still in favor of burn, baby burn.

Aunty Belle said...
This comment has been removed by the author.
Aunty Belle said...

Okay--yikes--I'se got so MUCH work to do today, so this is quick to ever'body:


Troll-Man, heritage seed post comin' up on FRONT Porch--stand by.


Yep, Pup, folks still have trouble seein' that when you do not respect life, respect for all else dies too-all but the buck, heh. Now, I'se gonna say what pal Spengler din't say:

When a nation no longer believes in the future by MAKING the future--that is, when lovemaking is no longer productive once in awhile, then that nation dies--and dies in filth. Why?

Because the people become debauched. They turn love making into "just sex" with no meaning other than scratchin' an itch. If it ain't got no more meaning than that, then it can be used to sell beer and cars and viagra.It can be used for ill.

But most of all, it becomes hedonistic--sex cut off from its original purpose, the unity of the married couple and/ or the children they raise, is sex that destroys the community rather than builds it up. This sort of sex has no meaning, no purpose beyond a momentary distraction. It carries no commitment to something larger than and beyond the moment.

A nation with this attitude toward sex, marriage and family (And Europe is far advanced in this) is a nation concerned only with the present. No concern for future generations because they don't even MAKE the future generation--hence it is "all about me, baby". But not about making baby.

This nation makes junk--disposable crap, that is, profitable garbage that will be in the landfill next year. Nothing has permanence, nothing is designed or built to have lasting value. AND, note this--such a nation starts to turn out UGLY thangs. UGLY architecture, UGLY clothes, movies, art, furniture and crocs. This is on account of them makin' stuff that reflects they own internal vision of they debauched selves. When what me make is no longer beautiful, its because we see ourselves as devalued.

And the economy of such a nation is not looking to the long term, they do not care if they destroy the future since they doan plan to be thar'! Oh, they might care about the future of the fruitfly, but not of babies.

Aunty thinks we's in a mighty wake-up call. We had one on 9-11, this is our 7 year itch. Miss this call and I ain't sayin' what's next.

* * *
(note to married folks who do not have chillens: Ain't sayin' nuthin' against yore married life--not at all. MArried people who do not have kids but who would if it happened is every bit as productive to the community. Their marriage is a fine witness to the goodness of marriage and family because they almost always nurture
other people's lives in wonderful ways. The POINT is they have the openness to life that makes them happy to nurture the good of others without expectin' pay fer it. To do it as a labor of love-- that is, your own love as a pair is willin' to love others without attachin' no price tag.)

Anonymous said...

Take the fresh printed trillion bucks, divide it between all US CITIZENS tax them on it and make them spend it on any mortgages/ HLOCs and student loans and credit card debt before gucci handbags and shiny wheels for their cars. Banks ok, money into system and all is well. I think it works out to be about 400k per adult citizen.

Silly?

Better than handing it over to the anti free market scum that will rape the situation and abscond with untold amounts of cash. What is the difference?

If we are being stampeded into this crazy scenario of our government becoming the lender of last resort and the largest market participant in the world...you might as well just call this what it is...collectivism. Kiss capitalism goodbye folks, welcome to the last act in the play of the republic.

Fishy said...

Aunty,
Can't begin to tell you how sad I was to hear the "experts" explain we got into this mess from too much credit debt....now the credit lenders is out of supply ...thus we have to resupply them so's they can lend more credit cause...
" credit is what moves America's markets".
Guess what happens to a nation that chooses "credit" as their primary product? And according to them talking heads, we should do it all again!
Screaming at the flat screen don't do no good atall...believe me I tried!

Anonymous said...

Our beloved USA needs to take a serious look at becoming isolationists rather than getting sucked down into the globalists hellhole!. We are blessesd as we can produce everything we need within our borders. No more funds to the UN, no more funds to the WHO, no more funds for tsunami victims or hurricane victims or invaded countries victims or AIDS victims and no more $10k per year subsidy for every Israeli man, woman and child.

No more illegal aliens sucking down all our resources for medical and housing services, no more illegal alliens suing our docs and hospitals and townships. In fact, once they step forward...we should either place them in jail or send them back to their homelands and charge their governments for damages to our services systems.

We should not just freeze but access all the funds parked here by the wealthy Iraquis who smile at our resources and our blood protecting their family fortunes while they race horses and ski.

We cannot abandon our progress in Iraq but we can by damn OWN 20% of that nations assets until we are paid in full. We cannot set a value on a single life, but we can establish a standard payment to the families of the fallen.

We should publically whip all CEO's who practiced greed instead of business ethics, access all their funds , liquidate their holdings and indenture their families as punishment for their transgressions. I think it would be just to make them walk all day in chains and hair shirts, ringling bells and chanting "greed and eviil walks among you!"

We should file a class action suit against the stupid senators who abandoned their people in order to serve their lobbyiest donors and their greed network cronies. At the very least they should be stripped of their fat government pensions and sent to jail for malfeasance.

We need to downsize federal government by 50% and increase state choice by about 500%.

We need to get very damn serious about what America is to be now and in the future.Hopefully we can still choose to be a God respecting, family honoring pursuers of freedom and happiness nation.