The 1929 breakdown was at its roots, a moral breakdown. We were not living right. We had become extravagant. We had become intoxicated by the alluring notion that the royal road to riches did not lie through sweat but speculation. We discarded and scorned old-fashioned virtues.”
B.C. Forbes
Founder, Forbes Magazine
1932

Readings

“Forget The Past And You Make The Same Mistakes Again: The institutional memory of governments and the financial industry now has the lifespan of a fruit fly. In the past, the lessons of history have been forgotten because a generation of managers and policy people retired, taking with them their essential historical experience. Thanks to modern management techniques and high technology, though, we can now achieve near-complete amnesia in a year or two”…Financial Times, 3/18.

“In recent years, bankers have succumbed to the idea that the credit world was all about numbers and complex computer models. These days, however, this assumption looks ever more of a falsehood. For as anyone with a classical education knows, credit takes its root from the Latin word credere (“to trust.”) And as the current credit turmoil now mutates into ever-more virulent forms, it is faith—or, rather, lack of it, that has turned a sub-prime squall into what is arguably the worst financial crisis in seven decades. Make no mistake: what we are witnessing right now is not just a collapse of faith in one single institution (namely Bear Stearns) or even an asset class (those dodgy sub-prime mortgage bonds.) Instead, it stems from a loss of trust in the whole style of modern finance, with all it complex slicing and dicing of risk into ever more opague forms. And this trend is not just damaging the credibility of banks, but the aura of omnipotence that has enveloped institutions such as the US Federal Reserve in recent years. The credit world, in other words, now lacks credit—in the original meaning of “he/she trusts”…Financial Times, 3/18.

“Between 2002 and 2007, false beliefs in the private sector—the belief that home prices only go up, that financial innovation had made risk go away, that a triple-A rating really meant that an investment was safe—led to an epidemic of bad lending. Meanwhile, false beliefs in the political arena—the belief of Alan Greenspan and his friends in the Bush administration that the market is always right and regulation always a bad thing—led Washington to ignore the warning signs… The result of all that bad lending was an unholy financial mess that will cause trillions of dollars in losses”…Paul Krugman, 3/18.

“The marvelous edifice of modern finance took years to build. The world had a weekend to save it from collapsing. It was a Herculean effort, and it staved off the outright catastrophe of a bank failure that had threatened to split Wall Street asunder. Even so, this week’s brush with disaster contained two unsettling messages. One is analytical: the world needs new ways of thinking about finance and the risks it entails. The other is a warning: the crisis has opened a new dangerous chapter”…The Economist, 3/22

“Mortgage-credit losses are likely to be around $400 billion. That is a large number, but it is no worse than the losses that can be suffered on a bad day on Wall Street”…The Economist, 3/8.

“American financial-services industry’s share of total corporate profits rose from 10% in the early 1980’s to 40% at its peak last year. Its share of stock market value grew from 6% to 19%. These proportions look all the more striking—even unsustainable—when you note that financial services account for only 15% of corporate America’s gross value added and a mere 5% of private-sector jobs…In 1980, financial-sector debt was only a tenth of the size of non-financial debt. Now it is half as big. This process has turned investment banks into debt machines that trade heavily for their own accounts. Goldman Sachs is using about $40 billion of equity as the foundation for $1.1 trillion of assets. At Merrill Lynch, the most leveraged, $1 trillion of assets is teetering on around $30 billion of equity. In rising markets, gearing like that creates stellar returns on equity. When markets are in peril, a small fall in asset values can wipe shareholders out”…The Economist 3/22. 

“Market Preacher Losing Religion? ‘I have just spent a week in New York. And therefore I may have been particularly influenced by the developments. I no longer believe in the self-correcting nature of markets. It pains me to say something like this, as I am one of the biggest proponents of a market economy’”…Josepf Ackerman, Head of Deutsche Bank, Wall Street Journal, 3/13.

“Political Pendulum Swings Toward Stricter Regulation: Safety Scares, Crisis in Housing Rupture A Long Consensus: The idea that less regulation is better for the economy has held sway in Washington since the Reagan administration. Now that consensus is crumbling, posing a potentially costly challenge to business no matter who wins the White House in November”… WSJ, Page One Headline, 3/24.

“New Limits To Growth Revive Malthusian Fears: Spread of Prosperity Brings Supply Woes; Slaking China’s Thirst. Now and then across the centuries, powerful voices have warned that human activity would overwhelm the earth’s resources. The Cassandras always proved wrong. Each time, there were new resources to discover, new technologies to propel growth. Today the old fears are back”...WSJ, 3/24

“There is no exaggerating China’s hunger for commodities. The country accounts for about a fifth of the world’s population, yet it gobbles up more than half of the world’s pork, half of its cement, and third of its steel and over a quarter of its aluminum. It is spending 35 times as much on imports of soy beans and crude oil as it did in 1999, and 23 times as much importing copper. Indeed, China has swallowed over four-fifths of the increase in the world’s copper supplies since 2000. What is more, China is getting hungrier”…The Economist, 3/15.

“God and Man in China: What is the appeal of Christianity to so many Chinese—or, for that matter, of Buddhism, Taoism, Islam, the old-time peasant religions and the newfangled Falun Gong? In ‘smashing’ organized religion, Mao Zedong also destroyed the traditional institutions of charity and social support that used to provide succor to the lonely and the needy. Now that succor is desperately in demand, and the churches are there to meet it. The party also helped destroy traditional morality in the name of an ideology it has itself largely abandoned. To a degree that alarms even Chinese rulers, morality and ideology have been replaced by corruption, opportunism and widespread indifference to life’s ordinary decencies. Religion offers a corrective to this, too, as it does to the quandaries of 21st century existence”…WSJ editorial, 3/18. 

“War’s Spiraling Cost Inspires Shock and Awe: Six months before the start of the US led-invasion, Larry Lindsey, then White House economic adviser, estimated the war in Iraq could cost as much as $200 billion. The claim, which cost Mr. Lindsey his job, was dismissed as baloney by Donald Rumsfeld, the then defense secretary, whose own estimate was $50 billion to $60 billion. Andrew Natsios, head of the Agency for International Development, estimated the reconstruction of Iraq would cost the US $1.7 biillion. Those estimates have proved to be what the war’s critics say is just one of many grievous miscalculations. The Iraq war will be five years old tomorrow, and serious estimates suggest it will be, with the exception of the second world war, the most costly in US history. Two academics estimate the government is pending $12 billion a month in Iraq, while the Joint Economic Committee of Congress says the war has so far cost a family of four $16,900, a bill that could rise to $37,000 by 2017. The most conservative estimate of the war’s cost comes from the nonpartisan Congressional Budget Office, whose remit limits its analysis to US government spending. Up to September 30, the end of the 2007 fiscal year, it says $413 billion was spent on Iraq”…Financial Times, 3/18.

“Jimmy Carter Bush: Can it be true? A Republican president repudiating the anti-inflationary legacy of Reagan? That is precisely what George Bush is doing…Steve Forbes, Forbes, 3/24. 

Reflections

Habitat for Humanity knew.

It has long known that poor people can’t buy a home on market terms, much less sub-prime terms. Perhaps that is why Jim Collins, one of America’s best-known management guru’s, recently told The Wall Street Journal that he is incorporating what he has learned from studying the non-profit world during recent years into his philosophies of corporate management. He said business leaders “would do well to learn from the social sectors.” Peter Drucker basically said the same in Post-Capitalist Society. The fact that so many business schools and business guru’s now seem to agree is quite encouraging, even if it has been an expensive lesson.

Some of us on Wall Street have long believed that consciously blending the Golden Rule with business--what is called “socially responsible investing” and/or “corporate social responsibility”--might be worth the financial sector’s look. For example, the South Shore Bank in Chicago is a for-profit, market-based approach for putting people into affordable housing, rather than a non-profit social-based approach, as is Habitat, or a governmental approach. I’ve had a CD there for years as it has long affirmed the teachings of the prophets that the poor require credit on favorable terms, rather than at predatory terms, as “the market” too often seems to provide. 

Computers may never be able to remind us of that reality but preachers historically have. But to be brutally honest, I don’t remember a single preacher reminding its affluent congregation that those of us with excess money have a moral responsibility to lend a portion of it to those who need to buy homes. Those churches that do have financial ministries usually focus on how to get money rather than how to use it morally once you get it. And some politically active Christian financial ministries so focused our attentions on the federal debt that most of us didn’t notice the massive leveraging of our investment firms. Of course, Moses and the prophets did not make such mistakes of leadership. They knew that if we do not accept responsibility for teaching a financial morality that is favorable to poor borrowers, the market will always provide one that is favorable to affluent lenders. So over the past twenty-five years or so, America has increasingly followed the morality of free-market zealot Ayn Rand. She mentored Alan Greenspan and taught the moral purpose of our lives is to make a buck and that we have no particular responsibilities to the disadvantaged. CEO’s have also listened to the sermon of free-market economist Milton Freidman who taught that corporations, including commercial and investment banks, have “no social responsibility other than to make money.” In short, the philosophies of laissez-faire philosophers and economists in the US may have undermined traditional morality as surely as Mao did in China.

Fortunately, even two professors from the University of Chicago, where Friedman taught, recently confessed to Forbes (3/10) that: “if Friedman were alive today and paying attention to what shareholders and consumers wanted, he might well support corporate efforts to make the world a better place.” As a political science graduate, I too expect the great economist would be coming around. In political circles it’s often said the neo-cons in Bush’s White House are simply “liberals who have been mugged by reality.” The realities of today’s Wall Street are similarly mugging more than a few libertarian economic types. While it’s difficult to appreciate during this current storm, I strongly believe that is a very bright silver lining to today’s financial storm. The notions the market is god and the pursuit of a buck is the moral purpose of our lives seem to be dying a well deserved death at last. 

Yet reality, as I see it anyway, is that the current mess is far more a moral mess than an economic crisis. Contrary to more radical voices, I see no reason to jettison capitalism, only re-moralize it. The most credible of the economic pessimists around today may be Professor Nouriel Roubini of New York University’s Stern School of Business. According to the Financial Times (3/12), he believes total losses to the financial sector from today’s mess might rise to around $3 trillion. That’s a lot of money. But it’s less than 3% of the nation’s net wealth according to the 2009 budget report recently released by the Bush White House. I expect we might handle that.

However, the fall in housing values could cause some serious pain to a lot of Americans, particularly those in California, Florida, Arizona and Nevada that saw housing bubbles. Consider for example that the average American home-owner owes about 50% of the value of his or her home on a mortgage. Those homes can fall 50% in value before the mortgage lender begins to lose money. Of course, what is hurting the Street these days is the fact many Americans owe a lot more on their mortgages. Due to mortgage lenders again forgetting a primary virtue of the old religions was prudence, some Americans owe 100%. Some mortgage funds that have collapsed forgot the old principle of “moderation in all things,” including debt, and leveraged their funds thirty-three to one. So all it took for them to lose 100% of their equity was for the bond market to fall 3% in value, which it has historically done quite often.

Yet there are still a lot of dangers to our finances other than the excessive use of leverage. One is inflation. The costs of the war and the costs of the financial mess, not to mention the pressures of China becoming capitalist, are exacerbating inflationary pressures. Yet when people are afraid, they gravitate to the highest quality fixed-income investments, like government bonds. At the same time, many are avoiding investments that might help them keep up with inflation. Yet the Fed has lowered rates on short-term Treasuries to very low levels. I’m not predicting what interest rates are going to do but we should never forget that inflation has historically caused serious problems for such bonds. 

So what do we do at this point? Same thing we’ve done for years: diversify as broadly as possible in the strongest and most socially beneficial investments we can find. Manage our expectations. Be patient. Good times and bad times have cycled since at least the time of Joseph’s seven fat years and seven lean years in biblical times. As Warren Buffett says, the market is like a baseball game in which they don’t call strikes. We can stand here for quite a while anticipating a slow fat one to knock out of the park.

Yet we can also begin to anticipate the coming day when a more responsible cadre of corporate leaders--who have been trained the easy way by our more socially conscious business schools or disciplined the hard way by the markets--can see there is far more to business than making a buck for oneself in the short-term. The current mess--and the notion even Milton Friedman might be rethinking corporate social responsibility--may indicate that day is not as far away as I have feared in recent years.

I do not believe the US stock market is cheap. But neither does it appear significantly over-valued based on current earnings. The ever cautious investment guru Jeremy Grantham has suggested the economy and stock market may be poised for better times by the year 2010, which is getting quite close. Even Democrats are talking openly about faith in political circles. Perhaps we’ll soon do the same in economic circles. If we do more than talk, that could bring back a lot of trust, the lubricant of capitalism, in both China and America. That could set the stage for much better times.

Let me close with something Peter Bernstein, author of Against the Gods just wrote in his newsletter: “This extended period of difficulty is going to bring about a new economic regime, different in many aspects from the experience of most people alive today. Along the way, we will have to pass through a transitional period that harks back to an unfamiliar past in both the financial system and in the household sector. But this too shall pass.”

Readings & Reflections is an email publication of The Financial Seminary, a non-profit whose sole interest is to encourage the reintegration of spirit and ethics into political economy and personal finances. While R&R is written by an investment professional who gladly submits this newsletter to officials trained in the intricacies of securities regulations, nothing in it should be construed as counsel to consider any particular investment opportunity. R&R is also posted on www.financialseminary.org, along with other articles and speeches by Gary Moore, the Seminary’s founder, and other contributors .Gary Moore offers securities through NPC of America (NPCOA), Member FINRA/SIPC. Gary Moore & Company, The Financial Seminary and NPCOA are separate and unrelated companies. The political, religious and ethical opinions contained are not endorsed by NPCOA. Opinions are not intended to provide specific investment advice and should not be construed as recommendations for any individual. To determine which investments and investment strategies may be appropriate for you, consult your financial, tax or legal professional. Please remember that investment decisions should be based on an individual’s objectives, goals, time horizon, and tolerance for risk. Furthermore, any listing of a vendor or product does not constitute an endorsement or warranty of the vendor or product by NPCOA. NPCOA is not to be held responsible for, and not be held liable for, the adequacy of the information contained herein. International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and differences in accounting methods. Past performance cannot guarantee future results.