Seven Forewarnings of the Current Credit Crisis

I was going through some old notes and books searching for some information when I stumbled upon a copy of Anthony Sampson’s The Midas Touch. Browsing, I found a number of 1987-89 interviews he had used to make his points. And what do I find? Some of these gentlemen interviewed had not only foreseen the current environment but warned against what was to come. There are great takeaways. Sample this:

I always feel that the Gods in some sense are laughing at us up there: because we have become a captive of our own definitions of and our sort of processes…We define professionals as being those who produce statistically desirable results. We certainly don’t include in that definition a broader, more textured definition of results. We don’t have the long-term loyalty to problems and solutions that a less numerically oriented set of investors would have.

I often sit around with leaders of major corporate entities who tear their hair at the fact that they have to become very short term oriented in terms of their financial results, quarterly earnings and so forth because of the pressures on their stock…of course the pools of money that are making that concern are their own pension funds which insist on quarterly performance.

---John Reed (then Citicorp) – 1989

(Soon to be called First Nationalized Citibank (group) – as mentioned in one of the columns I read recently.)

I think the root of the problem is addressed. It is the dog eat dog competition and performance pressures that investors created (hefty bonuses as a by-product) that led to creation of esoteric instruments, high risk taking, overextended rewards - and here we are. It has come back to the investors themselves. This is an area that needs to be addressed not only from the executive compensation point of view, but also the demand investors put on corporations.

It’s a constant conflict between greed & fear. Sometimes the fear is greater and you don’t have financial excesses: I grew up in an atmosphere after the depression when in financial markets the fears engendered by depression had made everybody pretty conservative. Now, we’ve gone through about forty years of really unparalleled growth and prosperity. People take a quite different view towards risk than they did in 1950, and it’s been a gradually cumulative process [emphasis added]. Now the interesting question is whether we are not getting off on the deep end and borrowing & leveraging again, with very great difficulties as the excesses are corrected.”

---Paul Volcker (former Chairman Federal Reserve) – 1988

Well, he seems to have hit the nail on the head back then. But the circus went on for another couple of decades plus before s*** hit the roof. The gradually cumulative process of risk taking hit the tilting point and so we are in for a conservative era where the excesses get corrected again. How long is anybody’s guess as no one knows how much of excess risk remains and how much the risk appetite is likely to go down.

The whole turbulence of the inter-war period, with the enormous fluctuations in the exchange rates and the high unemployment and the protectionism, was due to the fact that the United Kingdom was no longer strong enough to be the top nation, and the United States hadn’t realized that it had to be. And I think you see the same things since the beginning of the seventies, exactly parallel between the United States and now Japan – the same symptoms of fluctuation of exchange rates, high unemployment and protectionism.

The world was very deeply unbalanced, with this very large US deficit that would need to be financed mostly by the Japanese, week after week, month after month, and year after year. There was uncertainty as to how that would happen and whether the exchange rates or the interest rates would have to move. It looked as if the world’s leaders were not addressing the problem…

---Sir Kit McMahon (former Deputy Governor Bank of England) - 1988

China and others joined in in a big way and boy, did we have exchange and interest rates moving! This borrowing binge does appear coming to an end as the US comes full circle. In fact, the infrastructure funding needs of China, India and other emerging markets are so high that surpluses might be pulled back. We are likely to see a much higher savings rate in the US in the coming decade, which, while reducing consumption, will help reduce this deficit. The sad part is that if the advice were heeded, this could have been done without such a hard landing.

According to the National Intelligence Council analysis 'Global Trends 2025- A Transformed World', China and India are likely to emerge atop a multipolar international system as the US economic and political clout declines over the next two decades, according to the US intelligence agencies projections. Not only will new players - Brazil, Russia, India and China - have a seat at the international high table, but they will also bring new stakes and rules of the game.

There is a willingness to buy now and pay later, whether you are public or private…driven partly I think by the feeling the economy is going to grow, because it’s been growing so there’ll always be something out there in the future to pay with…

It’s not the government itself – by world standards – that is in such big deficit. It’s the combination of the deficit with a very low savings rate. We are at the bottom of the world league among industrialized countries and probably among almost any kind of country and our rate of savings has unfortunately been declining instead of increasing.

---Paul Volcker (former Chairman Federal Reserve) – 1988

It is not just the government, but also the consumers who were led to believe in profligacy and are also a part of the problem. But unfortunately nobody did anything about it including the government. Now with their backs to the walls, remedies are being worked out which nobody knows if they will work or not. US citizens have to take the future into their hands and start saving. The middle class of course will bear the brunt as the lower end and the upper end (those who remain there) generally are immune.

We have been consuming much more than we’ve been producing, we’ve been borrowing more than we’ve been saving and we’ve been brought up to believe in an ethic of entitlement rather than a work ethic. And the government has been a very willing co-conspirator in this concept through the pressures of certain specialist interest groups, who thought of our economy as a kind of vending machine that turns out goods. Who produces these goods, who creates the wealth, was somehow left to others. The result of it all is, I think, that we have been led into a wonderful land of Oz in which all our dreams come true…to a large extent we were doing this on borrowed money from foreign bankers and foreign lenders who were quite willing to lend us all kinds of money in record amounts.

---Peter Peterson (former Secretary of Commerce) – 1988

While buttressing the point made above, it also puts the onus on consumers now to change their behavior and expectations. It brings home the point that work ethics have to change and probably Saturdays off may be off. The payoff will come when this saving goes to fund infrastructure and other projects in the emerging world, create new markets, bring back profits, and help reduce deficit - both internal and external. This could be a painful and long drawn change but a necessary one I think, to restart the cycle.

There is a correlation between personal debt and the national debt here in the US. The runaway inflation of the late seventies encouraged people to buy now and to repay with cheaper dollars…The mental set that permits the individual to spend excessively permits his or her government to spend excessively as well. We think there’s going to be a correction not only in the US but worldwide [emphasis added].

---Peter Hart (former Chief Executive MasterCard (MA)) – 1989

A warning coming from the CEO of a credit card company putting his own interest at stake is something that should have been heeded. Of course he must have foreseen credit card companies getting into trouble with this trend continuing. Maybe cards of the future should come with a statutory warning a la cigarettes – ‘Overspending is injurious to your financial health.’

Whether you talk of a family or a city or a state or a nation there are certain economic rules that govern all of us. None of us can live beyond our means for too long a period of time without getting into deep, deep trouble [emphasis added]. This is what worries me about the United States. We have lived beyond our means, we have run up an incredible debt now, of about 2.8 trillion dollars…the largest debt that’s ever been incurred by any nation on earth.

I think the future generations will feel that the 1980s was a time of easy living for the United States, that we lived beyond our means, we failed to live up to our responsibilities and we failed to be realistic in facing up to our economic problems…We complain about the third world countries and the amount of debt that they have; but in one decade United States of America went from the largest creditor nation to the largest debtor nation in the world. That’s an enormous swing, and I think it forebodes ill for us, and for the stability of the international monetary system [emphasis added], because the dollar is reserve currency of the world.

---John Connally (former Secretary of Treasury who personally went bankrupt) – 1988

That was almost prophetic, and it came from his personal experience too. That future generations have been affected is no secret now. The question is how long will it be until a new approach, a middle path, will be taken for long term stability of not only the US but the world at large - or will it want to thrive in chaos?

I can calculate the motions of heavenly bodies, but not the madness of people – Sir Isaac Newton -1720.

Disclosure: No stocks discussed – No Positions.

Comments

[john s. gordon:]

a lot of good insight here.

pay heed.
> jack

2008 Nov 24 08:14 AM

[Asbytec:]

October 2007, Ben bernanke testifying before congress. "Shore up the GSEs."

Why is it congress does not listen?

With all these warnings and current pain, we have to come out of this crisis a different animal than we went in. If not, we'll lose all credibility.

2008 Nov 25 12:42 AM

[Midas Inter...:]

That is spot on. Too bad it took 20 years for their point to have any serious consequences. Like my granny used to say: After the steed is stolen, the stable-door gets locked...

2008 Nov 25 01:05 AM

[neutrino23:]

Color me skeptical. It sounds like they are talking about symptoms or results and not causes. Why is there such pressure to have people borrow and spend? Why don't people save? Why such pressure for quarterly results? Seems like there should be an underlying cause or two or three.

A couple of suggestions. One is that the way our Fed creates money requires increasing amounts of debt.

Second is that every time we've had large cuts in the marginal tax rates for those with high incomes then we've had a bubble and a crash. High marginal tax rates above some amount (say a couple million a year) discourages the frenzy of buying companies and breaking them up and encourages long term investments and steady growth. High marginal tax rates contributed to a steady economy from about 1940 to the mid 1980s. Large tax cuts led to bubbles and crashes in the 1920s, 1980s and our current time.

Third might be our asymmetrical trade policy that allows manufacturing jobs to move overseas. This pushed down wages such that few people had enough money to put aside savings.

These kinds of long term pressures could explain the changes in peoples saving and buying behavior. No one sat down and said it would be a good idea if we ran high trade deficits for years on end. Rather it was the cumulation of individual decisions where participants did what they thought was good for them. Possibly including and certainly not limited to lenders pushing easy loans, consumers treating their homes like ATMs, businesses making individual decisions about how to survive in competition with cheap Asian labor and all in an environment of lax regulation and little transparency regarding financial transactions.

I'm not claiming to have the answer, just that this sort of thing makes more sense to me than to say that the consumers and executives suddenly started making bad decisions on a massive scale since 1980.

2008 Nov 27 04:05 AM