Mr. Galbraith notes that the speculative bubble in America in the late 1920's did not go unnoticed around the world. In fact, the demand to borrow for stock purchases was so great that the whole world got into the act. Galbraith writes:
This cost was being assumed, in the first instance, by the New York banks, but they, in turn, were rapidly becoming agents for lenders the country over and even the world around. There is no mystery as to why so many wished to lend so much in New York. One of the paradoxes of speculation in securities is that the loans that underwrite it are among the safest of all investments... At the beginning of 1928 this admirably liquid and exceptionally secure outlet for non-risk capital was paying around 5 per cent. While 5 per cent is an excellent gilt-edged return, the rate rose steadily through 1928, and during the last week of the year it reached 12 per cent. This was still with complete safety.
In Montreal, London, Shanghai, and Hong Kong there was talk of these rates.... A great river of gold began to converge on Wall Street, all of it to help Americans hold common stocks on margin. Corporations also found these rates attractive. At 12 per cent Wall Street might even provide a more profitable use for the working capital of a firm than additional production. A few firms made this decision: instead of trying to produce goods with its manifold headaches and inconveniences, they confined themselves to financing speculation. Many more companies started lending their surplus funds on Wall Street.
There were still better ways of making money. In principle, New York banks could borrow money from the Federal Reserve bank for 5 per cent and re-lend it in the call market for 12 per cent. In practice they did. This was, possibly, the most profitable arbitrage operation of all time.
Heh, the rhymes are almost drowning out my laughter at Mr. Galbraith's uber-cool writing! Complete safety...
For one, it seems to be accepted in the popular press that our global economy is a new phenomenon. It is not. Our great-grandparents lived in a global economy. They use telegraph instead of email, and steamship and railroad instead of planes and cars, and they read newspapers instead of blogs, but as Mr. Galbraith points out the speculative party in New York in the 1920's was an open one --- just as the wild securitization of crappy US home loans, and then of everything else that could be securitized, drew in partygoers from around the globe.
Secondly, the presumed bullet-proof quality of the collateral underlying our stew of CDOs, CLOs, CDSs, etc parallels the assumptions back then about the money-good nature of stock-margin loans. The Joe Cassano's of the world --- he being the magnificently remunerated mastermind of AIG Financial Products, the biggest pigeon at the poker table if ever there was one --- were not mindless idiots. They really felt they were dealing based on solid collateral, just as Mr. Cassano must have been certain the CDS insurance he sold would never face claims. (Or was he?)
Thirdly, finance in the late 20's became so attractive that companies dropped production to engage in it. Why does that sound familiar? GE, anyone? In general the premium for clever finance operations grew rapidly in their era and ours --- why be a loser and operate a low-margin manufacturing business when you could hit a home-run on Wall Street, especially if you can develop a reputation riding the tide inside a respected franchise, say Goldman or Merrill, and then cash in with a 2-and-20 deal?
Thinking of global, here comes a random comment. The current generation of Chinese government leadership is largely composed of people who were trained as engineers. It is widely presumed that the next generation will be lawyers and MBAs, as this is understood to be a self-evident and natural evolutionary progression for a successful modern society. Might they want to investigate that self-evident truth?
Tuesday, December 2, 2008
Crimes far worse than murder
Galbraith writes:
Hoover was elected in a landslide. This, were the speculators privy to Mr. Hoover's mind, should have cause a heavy fall in the market. In his memoirs Mr. Hoover states that as early as 1925 he became concerned over the "growing tide of speculation." During the months and years that followed this concern gradually changed to alarm, and then to something only slightly less than a premonition of total disaster. "There are crimes," Mr. Hoover said of speculation, "far worse than murder for which men should be reviled and punished." As Secretary of Commerce [under President Coolidge] he had sought nothing so much as to get the market under control.
Mr. Hoover's attitude toward the market was, however, an exceptionally well-kept secret. People did not know of his efforts, uniformly frustrated by Coolidge and the Federal Reserve Board, to translate his thoughts into action. The news of his election, so far from causing a panic, set off the greatest increase in buying [ of stocks ] to date.
Who will be our Hoover, our secretly-frustrated woulda' been unsung hero, who instead of being tarred with supposedly helping to cause the Panic should have been enabled to prevent the bubble(s) that led to the Panic and downturn? Only time will tell, although we can surely cross a few names off the list now, like those of Greenspan, Bernanke, Rubin, Summers, and Paulson, Cox, Pitt, and, sadly because he strikes me as a man of great decency and generally superb judgement, Arthur Leavitt. I'm not sure about Paul O'Neill or Bill Donaldson. Certainly on the surface O'Neill may merit some consideration for his robust ability to annoy his bosses during the early years of the Bush II regime.
And what about speculation and 'crimes far worse than murder? ' Did Hoover have a point, or was he just dramatically evincing the bitterness that comes with looking back in deep sorrow and frustration at one's own failures? I think Hoover had a legitimate point: you can kill people in many ways, say, by starving them to death instead of shooting them, as Mr. Stalin and henchmen demonstrated so tragically in the Ukraine during the 1930s. (Hoover knew this better than most --- prior to serving Coolidge as Secretary of Commerce he led the US famine relief effort in Russia in the early 1920s.) And there is no doubt too the Great Depression did in more than just the few broken speculators who jumped during the Crash of '29. If this Panic of 2008 spins out of control --- and no one in their right mind wants it to do so --- people will starve to death, somewhere, as a direct result of economic activity needlessly reduced by the modern-day equivalent of the speculation Hoover so detested.
Hoover was elected in a landslide. This, were the speculators privy to Mr. Hoover's mind, should have cause a heavy fall in the market. In his memoirs Mr. Hoover states that as early as 1925 he became concerned over the "growing tide of speculation." During the months and years that followed this concern gradually changed to alarm, and then to something only slightly less than a premonition of total disaster. "There are crimes," Mr. Hoover said of speculation, "far worse than murder for which men should be reviled and punished." As Secretary of Commerce [under President Coolidge] he had sought nothing so much as to get the market under control.
Mr. Hoover's attitude toward the market was, however, an exceptionally well-kept secret. People did not know of his efforts, uniformly frustrated by Coolidge and the Federal Reserve Board, to translate his thoughts into action. The news of his election, so far from causing a panic, set off the greatest increase in buying [ of stocks ] to date.
Who will be our Hoover, our secretly-frustrated woulda' been unsung hero, who instead of being tarred with supposedly helping to cause the Panic should have been enabled to prevent the bubble(s) that led to the Panic and downturn? Only time will tell, although we can surely cross a few names off the list now, like those of Greenspan, Bernanke, Rubin, Summers, and Paulson, Cox, Pitt, and, sadly because he strikes me as a man of great decency and generally superb judgement, Arthur Leavitt. I'm not sure about Paul O'Neill or Bill Donaldson. Certainly on the surface O'Neill may merit some consideration for his robust ability to annoy his bosses during the early years of the Bush II regime.
And what about speculation and 'crimes far worse than murder? ' Did Hoover have a point, or was he just dramatically evincing the bitterness that comes with looking back in deep sorrow and frustration at one's own failures? I think Hoover had a legitimate point: you can kill people in many ways, say, by starving them to death instead of shooting them, as Mr. Stalin and henchmen demonstrated so tragically in the Ukraine during the 1930s. (Hoover knew this better than most --- prior to serving Coolidge as Secretary of Commerce he led the US famine relief effort in Russia in the early 1920s.) And there is no doubt too the Great Depression did in more than just the few broken speculators who jumped during the Crash of '29. If this Panic of 2008 spins out of control --- and no one in their right mind wants it to do so --- people will starve to death, somewhere, as a direct result of economic activity needlessly reduced by the modern-day equivalent of the speculation Hoover so detested.
Glimpsing the Genius of Capitalism, and Leverage
Galbraith writes:
As noted, at some point in the growth of a boom all aspects of property ownership become irrelevant except the prospect for an early rise in prices. Income from the property, or enjoyment of its use, or even its long-run worth is now academic....
Such is the genius of capitalism that where a real demand exists it does not go long unfilled...
The machinery by which Wall Street separates the opportunity to speculate from the unwanted returns and burdens of ownership is ingenious, precise, and almost beautiful. Banks supply fund to brokers, brokers to customers, and the collateral goes back to banks in a smooth and all but automatic flow...
Wall Street, however, has never been able to express its pride in these arrangements...
Wall Street, in these matters, is like a lovely and accomplished woman who must wear black cotton stockings, heavy woolen underwear, and parade her knowledge as a cook because, unhappily, her supreme accomplishment is as a harlot.
Whoa! Where do we, in the midst of the Panic of 2008, start looking for rhymes? Somehow the Time Magazine cover of February 15, 1999, comes to mind when I think of Mr. Galbraith's stunning harlot metaphor. It shows a happy troika of Messrs. Rubin, Greenspan, and Summers, looking for all the world like true financial statesmen with the utmost gravitas. Time Magazine does not reveal that less than a year earlier these three had concocted, along with Arthur Leavitt of the SEC, to prevent Congress and the CFTC from seriously considering applying some kind of regulatory oversight to the budding Credit Default Swap business. Instead it applauds them for pulling together a temporary coalition of self-interested banks to prevent the 1998 collapse of Long Term Capital Management from toppling many other banks and financial companies.
Natural are analogies to a similar effort by JP Morgan himself to staunch the panic in 1907. But sadly missing in the 1999 Time paean to the troika's genius is an awareness that these gentlemen had put a band-aid on the problem at hand while aggressively sawing off the only limb in the body politic that might have saved the patient -- they killed regulation of OTC derivatives so decisively that no one could stop Enron, and then AIG and the banks, from their appointed rounds with destiny.
And Mr. Galbraith's admiration for the beautiful flow of collateral in support of speculation, written in 1954 about the rather simple stock-margin machinery of 1929, could with almost no adjustment apply happily to the CDO, CDS, CLO, ABCP, MBS, CMBS etc. machinery of our time. Was Mr. Galbraith so prescient? Were our financial leaders and regulators so dumb? Or is it just a matter of finding ourselves, once again and this time with a real pounding hangover that won't go away, to have been charmed by the harlots in the black cotton stockings?
As noted, at some point in the growth of a boom all aspects of property ownership become irrelevant except the prospect for an early rise in prices. Income from the property, or enjoyment of its use, or even its long-run worth is now academic....
Such is the genius of capitalism that where a real demand exists it does not go long unfilled...
The machinery by which Wall Street separates the opportunity to speculate from the unwanted returns and burdens of ownership is ingenious, precise, and almost beautiful. Banks supply fund to brokers, brokers to customers, and the collateral goes back to banks in a smooth and all but automatic flow...
Wall Street, however, has never been able to express its pride in these arrangements...
Wall Street, in these matters, is like a lovely and accomplished woman who must wear black cotton stockings, heavy woolen underwear, and parade her knowledge as a cook because, unhappily, her supreme accomplishment is as a harlot.
Whoa! Where do we, in the midst of the Panic of 2008, start looking for rhymes? Somehow the Time Magazine cover of February 15, 1999, comes to mind when I think of Mr. Galbraith's stunning harlot metaphor. It shows a happy troika of Messrs. Rubin, Greenspan, and Summers, looking for all the world like true financial statesmen with the utmost gravitas. Time Magazine does not reveal that less than a year earlier these three had concocted, along with Arthur Leavitt of the SEC, to prevent Congress and the CFTC from seriously considering applying some kind of regulatory oversight to the budding Credit Default Swap business. Instead it applauds them for pulling together a temporary coalition of self-interested banks to prevent the 1998 collapse of Long Term Capital Management from toppling many other banks and financial companies.
Natural are analogies to a similar effort by JP Morgan himself to staunch the panic in 1907. But sadly missing in the 1999 Time paean to the troika's genius is an awareness that these gentlemen had put a band-aid on the problem at hand while aggressively sawing off the only limb in the body politic that might have saved the patient -- they killed regulation of OTC derivatives so decisively that no one could stop Enron, and then AIG and the banks, from their appointed rounds with destiny.
And Mr. Galbraith's admiration for the beautiful flow of collateral in support of speculation, written in 1954 about the rather simple stock-margin machinery of 1929, could with almost no adjustment apply happily to the CDO, CDS, CLO, ABCP, MBS, CMBS etc. machinery of our time. Was Mr. Galbraith so prescient? Were our financial leaders and regulators so dumb? Or is it just a matter of finding ourselves, once again and this time with a real pounding hangover that won't go away, to have been charmed by the harlots in the black cotton stockings?
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