America Invested in a Madoff Economy

The Federal Reserve Flow of Funds Z1 table makes clear that America invested in a Madoff economy. In the 12 months between 4Q2007 and 4Q2008 American households and Non-Profits experienced an $11.3trillion decline in asset value. In one year 15% of the consumer wealth of this country was destroyed. The last three months of 2008 saw $5.4 trillion in asset losses in US households and nonprofit organizations, 8% of wealth. These are mind boggling numbers.

In the last 3 months of 2008 GDP was $3.55 trillion. More asset wealth was destroyed than total income generated in the 4th quarter of 2008. The US economy performed like a giant financial institution with asset write downs exceeding income. Like a grand Ponzi scheme, global imbalance was revealed by the receding credit tide. Everyone hates the banks and screams for Madoff blood. I fully understand the sentiments. However, the greater issue should be the tens of trillions lost not by Bernard Madoff. Lost in the shuffle seems to be that our macro economy looks suspiciously similar to a giant bank balance sheet or a portfolio run by Bernie. Thus, we are mad and off in our narrow anger.

It’s a Madoffed world. The Asian Development Bank (ADB) estimates that global asset losses sit at approximately $50trillion. 2008 global asset losses exceeded 2008 total global product. $50 trillion in asset deflation amounts to losses of nearly $7,150 for every person on living earth. While we are laser like focused on Bernie Madoff, his vile scheme amounts to little more than tears in the ocean. Developing Asia, the engine of global economic growth, was particularly hard hit. ADB estimates suggest that the $7 trillion developing Asia GDP took a $9.5 trillion asset hit. China, a particularly vital growth engine, persists in maintaining 8% growth targets that seem absurd. Electric power demand in China appears to have been falling since June/July2008. This week China’s premiere made headlines talking down China’s trillion dollar US Treasury position and casting doubt on the American stimulus his country badly needs. In a rare departure from sage commentary, Chinese officials seem to have Madoffed into being mad and off this week.

Beyond calls for vengeance and a sudden interest in blaming banks, the real lessons of the last decades sit and wait to be discovered. Transferring bad assets and blame has been the order of the American and global day. This is a serious mistake. Some clamor for nationalization, others blame banks and America. Some still claim markets are functioning acceptably. A passing glance at the opening paragraph should make clear this is a global, structural failure. Nationalizing now makes sense only to save vital firms, sectors and jobs.

There is no reason to believe that government ownership, alone, will radically alter the course of firm or national fortune. True, global disasters always implicate state and enterprise alike. Saving vital social function, jobs and political stability is almost always sage. Games of toxic asset hot potato, firm to state, don’t transform fundamental value. This game is a recipe for drawn out crisis and public anger. Strategic receivership and regulatory reform are pressing essentials. Exchanging blind faith in markets for blind faith in government policy is mad and it is off.

Madoff has become the face of the global crisis- particularly in America. He is a poor choice. His grotesque and larcenous behavior has stripped many worthy causes, individuals and institutions of funds. He richly deserves all the asset seizure and jail time he gets. What the episode teaches is only allegorical. Trust in wealth and power is always dangerous. Massive losses require failures by state and enterprise- think multiple SEC investigations netting no action. When markets were soaring and banks reporting huge profits, we showered them with praise and allowance. Now that markets and banks are laid waste, we rush to castigate and punish. For years we engaged shallow theories that all state intervention was costly and counterproductive.

Now many believe that state intervention can transform asset water into rich wine. So long as we indulge bi-polar oscillation we elide real systemic rebuilding. Excess celebration and condemnation drive some to conjure false triumph to garner great praise and evade hatred. Their frauds may offer precious warning. We have been Madoffed but we don’t have to be mad and off moving forward.

Comments

[John Lounsbury:]

Prof. Wolff - - -

I watch for your posts with anticipation. I find them filled with thought provoking stateements.

Here are five statements I highlighted:

1. "Beyond calls for vengeance and a sudden interest in blaming banks, the real lessons of the last decades sit and wait to be discovered."

2. "Transferring bad assets and blame has been the order of the American and global day. This is a serious mistake."

3. "...this is a global, structural failure. Nationalizing now makes sense only to save vital firms, sectors and jobs."

4. "Saving vital social function, jobs and political stability is almost always sage."

5. "Games of toxic asset hot potato, firm to state, don’t transform fundamental value. This game is a recipe for drawn out crisis and public anger. Strategic receivership and regulatory reform are pressing essentials. Exchanging blind faith in markets for blind faith in government policy is mad and it is off."

I want to expand on statement #1, which is very fundamental. So many authors and commenters fail to recognize that we still have so much to learn about the causes of our current crisis. We (I include myself) are still confusing causes and symptoms of the financial collapse. Let me list some points of confusion:

A. "Toxic" assets are a symptoms, not a causes.
B. Mark-to-market failures are symptoms, not causes.
C. Outrageous compensation packages for in failing concerns are symptoms, not causes.
D. "Too Big to Fail" is a symptom, not a cause.
E. Lack of regulation is a symptom, not a cause.
F. High debt burdens (private and government) are symptoms, not causes.
G. Financial system structure is a cause.

Steve Waldman has a good Seeking Alpha article (March 15) discussing financial system structure. seekingalpha.com/artic...

Once we can focus on causes and get them defined from several perspectives, we will start to define a box. Only then can we start to think outside the box and debate real long-term solutions instead of band-aides. So far everything on the table is a band-aide.

Mar 16 01:40 PM

[Sober Realist:]

John and Prof Wolff.
"Financial system structure is a cause."

Did we begin to destabalize our financial system when we unpegged the dollar from gold, a finite resource? Wasn't this act a departure from the real world and a flight into fantasy where our economy could seemingly continue to grow into infinity in a finite world which has restraining boundaries and bites back when those boundaries are crossed. Overshoot in nature results in a precipitous collapse. This financial meltdown was caused by rampant hallow growth, backed up by nothing more than worthless paper.

Mar 16 04:11 PM

[morph366:]

I am intrigued by your comment:
So long as we indulge bi-polar oscillation we elide real systemic rebuilding.
Perhaps human nature has a fundamental ambivalence and bi-polarity at its core.
Hence we talk about seeing a glass half full and then half empty
In order to have functioning markets we need differences of opinion about values and outlooks about the future etc. This may mean that markets are inherently unstable as some economists (not the mainstream majority) have proposed. The real challenge is to clarify and then redress the asymmetry of the risk/reward payoff which underlies a private gain/public pain system.

Mar 17 09:49 AM

[zagrebzagreb:]

This is a fine article... always love to find a piece that is not afraid to speak directly. Good numbers too, so that we have a few facts to chew on.

However, I would frankly direct more criticism at so called conservative fiscal policy, and the incompetents who implement it. The results are in. It is a disaster.

Mar 17 10:57 AM

[John Lounsbury:]

Morph - - -

You wrote:

"Perhaps human nature has a fundamental ambivalence and bi-polarity at its core.
Hence we talk about seeing a glass half full and then half empty
In order to have functioning markets we need differences of opinion about values and outlooks about the future etc. This may mean that markets are inherently unstable as some economists (not the mainstream majority) have proposed."

This an excellent philosophical statement which contradicts The Efficient Market Hypothesis. There has been anecdotal evidence for some time about "anomalies" that can not be explained within the context of efficient markets. I have thought for some time that The Efficient Market Hypothesis was fundamentally flawed in many of the ways it was interpretted.

Broadly applied, The Efficient Market Hypothesis requires that bubbles and crashes can not occur, individual investors can not outperform the market averages over decades, and the average investor can not do better than buy and hold market indices. The truth of the matter is that the average investor is an average of those who outperform and those who underperform the market.

"This may mean that markets are inherently unstable" is the counter premise to the supposition of an efficient market. It is dangerous to apply a simple theory (as efficiency) to such a complex beast as investment markets. Morph, you may not have expected to encourage such a discourse as this, but you stated such a complex truth that I could not resist expanding on it.

Mar 17 01:44 PM

[hug g:]

John, I greatly enjoy your commentary on SA (more than many of the articles!). Last fall I had the opportunity to hear Leon Panetta speak (before he became CIA Director). Something he said during the speech really stuck with me- "When leaders continually fail to make difficult decisions- that require sacrifice and compromise- then all we end up doing is managing from one crisis to the next." I think you are correct to view our current financial crisis and all the dominoes that lead to it (deregulation, low rates, excess leverage etc.) as symptoms of a larger problem. Analysis along these lines got me thinking about longstanding fundamental challenges such as- energy policy, entitlements, current account deficit, Military/ Industrial Complex... do these point to a failure of leadership a` la Panetta? I wonder if the failure to address these is attributable to one thing- the intersection of money (influence) and politics (leadership)? Would public financing of elections give us more "honest brokers" in Washington, more capable of "making difficult decisions- that require sacrifice and compromise" and have helped us to avoid the (far more expensive) "public financing" of the current crisis?


On Mar 16 01:40 PM John Lounsbury wrote:

> Prof. Wolff - - -
>
> I watch for your posts with anticipation. I find them filled with
> thought provoking stateements.
>
> Here are five statements I highlighted:
>
> 1. "Beyond calls for vengeance and a sudden interest in blaming banks,
> the real lessons of the last decades sit and wait to be discovered."
>
>
> 2. "Transferring bad assets and blame has been the order of the American
> and global day. This is a serious mistake."
>
> 3. "...this is a global, structural failure. Nationalizing now makes
> sense only to save vital firms, sectors and jobs."
>
> 4. "Saving vital social function, jobs and political stability is
> almost always sage."
>
> 5. "Games of toxic asset hot potato, firm to state, don’t transform
> fundamental value. This game is a recipe for drawn out crisis and
> public anger. Strategic receivership and regulatory reform are pressing
> essentials. Exchanging blind faith in markets for blind faith in
> government policy is mad and it is off."
>
> I want to expand on statement #1, which is very fundamental. So
> many authors and commenters fail to recognize that we still have
> so much to learn about the causes of our current crisis. We (I include
> myself) are still confusing causes and symptoms of the financial
> collapse. Let me list some points of confusion:
>
> A. "Toxic" assets are a symptoms, not a causes.
> B. Mark-to-market failures are symptoms, not causes.
> C. Outrageous compensation packages for in failing concerns are
> symptoms, not causes.
> D. "Too Big to Fail" is a symptom, not a cause.
> E. Lack of regulation is a symptom, not a cause.
> F. High debt burdens (private and government) are symptoms, not
> causes.
> G. Financial system structure is a cause.
>
> Steve Waldman has a good Seeking Alpha article (March 15) discussing
> financial system structure. seekingalpha.com/artic...
>
>
> Once we can focus on causes and get them defined from several perspectives,
> we will start to define a box. Only then can we start to think outside
> the box and debate real long-term solutions instead of band-aides.
> So far everything on the table is a band-aide.
>
>
>

Mar 21 09:49 PM