Nostalgic For ‘Morganization’ in Today's Market

The American Industrial revolution began in earnest at the end of the Civil War. The build-out of long tentacles of railroad tracks rapidly connected cities and towns over a landscape of endless ribbons of unpaved roads.

There was an immediate effect to this new, efficient transit and freight haulage system. It propelled the growth of even more infrastructure; the telegraph, new methods of steel production, a banking system and two world changing industries that would arrive later in the century, oil and electricity.

These sectors all had two common facets; a never-ending need for capital and an infestation of wildcat operators and speculators. Each industry had its unique cyclicality due to cutthroat competition, misrepresentations and fraud. Financial ruin was an accepted feature of the economy.

The United States relied at the time on British, Scottish, and Dutch capital for its enormous capital requirements. As any investor anywhere, those of late 19th century Europe required, above all, a reasonable expectation that their risks were well defined. That, at the time, was difficult to assess from across the Atlantic Ocean.

Enter J. P. Morgan and his London-based father, head of the family investment banking company. It was their carefully crafted, solid reputation that provided assurances to Europeans anxious to invest in this new frontier but reluctant to be blindsided by the chaotic nature of the United States infrastructure build-out.

J. P. Morgan rationalized the railroads, buying out small, competing, and often under financed, companies; merging them, building monopolies that made future entry into the industry and speculation difficult.

Then the Morgans moved into steel, electricity, and banking, rationalizing those sectors using the same "Morganization" strategies. The larger newly created entities assured the steady stream of earnings and growth required by the European investment community.

Above all it was the Morgans' personal integrity that helped attract foreign investment. Their simple philosophy could best be described as "always keep your hands on the table;" transparency, and accountability, in loftier finance terms.

As we all know, until World War I the United States was a debtor nation. But it was a solid, predictable provider of dividends, interest, and capital gains to their overseas investors throughout this crucial period of economic growth.

Now we must sadly confront the past decade of huge trade and budget deficits. Once again the US is a debtor nation. In debt to the overseas holders of US treasuries and cash accumulated from the ever-growing trade imbalances.

The difference in the two eras of US debtor status is striking. Little of the recently accumulated debt has been allocated to a new, sorely needed infrastructure build-out, but rather to finance personal consumption.

Complicating this situation has been the peddling of our debt in forms of ever-growing, ever more cleverly packaged financially engineered instruments. CDOs, SIVs, TOPS, SNAPS. Trendy initials proliferate. These packages proved to be incomprehensible to the foreign buyers who relied on the ratings agencies to define their risk exposure. These ratings agencies, as we now know, defaulted on this responsibility by affording AAA ratings which are now perceived as having been bought or manipulated by the peddlers.

Not a shard of responsibility to a longer term building of confidence or transparency was assumed by the sellers of these financial instruments. Their only outlook was to a short –term trading profit based on ever more complicated devices.

Now we are faced with the fallout from the lack of faith in our financial system, with many foreign sources of credit evaporating, except for those that will require huge risk-adjusted premiums due to the now perceived wildcat nature of our financial system.

Arguably J. P. Morgan presided over an era of great human misery in the working classes of that era. Strike breaking, racism, and wide spread usage of child labor were all attendant to the growth of the trusts that he created.

But the absence now of any figure or institution in the United States who commands comparable confidence in foreign capital markets will be paid for dearly…….. and probably very soon.

Disclosure: Short the S&P 500 (SDS), home builders (SRS), Beazer Homes (BZH), Centex (CTX), Countrywide (CFC), and Mohawk (MHK).

Comments

[Doug Roberts:]

This little history could do without the dig at the end against the Morgans: that they presided "over an era of great human misery in the working classes". Wow. What history book did that come from? The history has not begun to be written about our time. The old folks from my young years were from that time - they just shook their heads at our generation's spendthrift ways.

2007 Nov 27 10:52 PM

[abelardo:]

Hi Doug,

You ask "what history book did that come from?"
In fact there is a whole genre of writing from that era that exposed the often inhumane working conditions. The writers were known as "muckrakers," and including both fictional and non fiction accounts. These writings, by arousing public opinion, led to extensive state and federal legislation to correct these conditions.

Google that word (muckraker) and you may be surprised to find that my "dig" is no secret. It is generally accepted that these conditions existed, the same as they apparently do in China and elsewhere today.

thanks for your response to my article.

2008 Jan 22 11:45 PM

[overtaxed42...:]

I've long held the position that GAAP is the cornerstone that needs to be destroyed. Generally accepted accounting principals. By who are these principals accepted by? The number manipulation that takes place with GAAP misleads to extents not imagined. Until now. With the way these principals are used to show worth in anything related to money, we are in for bad times I fear. When a business can be broke, get a bailout and not hold any assets, the writing should be on the wall. Not with GAAP though. It is obcure and misleading.
Two cures
1.FairTax ammendment
2.Gold standard to return accountability to govt. and value to our currency

Jan 05 07:04 PM