Critiques & Commentary

Three Little Words Tell You Civilization Is Collapsing

We frequently identify the shaping forces of human affairs as “isms”: communism, fascism, capitalism, mercantilism, socialism and so on. In looking over the wreckage-strewn landscape of global finance, however, it seems to me that words ending in “ity” should have their turn at bat. “Rapacity” and “duplicity” are too easy, too obvious. “Timidity” works, but my inner jury is still out on Geithner, so I’m going to let it pass. The three little “ity” words that spring foremost to mind are stupidity, obesity and nudity. Let’s look at these in no particular order.

Obesity occurs in financial institutions—look at Citigroup—as much as in teenagers, brought on by junk finance rather than junk food; there’s as much water-bloat on our balance sheets as in our waistlines. The artery-clogging qualities of junk finance can be as threatening to our overall health as a nation as those of junk food. Mayor Bloomberg should have required the securities firms he has courted so assiduously with stay-in-Manhattan subsidies to post trans-fat warnings on their deal documents.

Whether we’re speaking of Wall Street or Main Street, fast food is rapidly prepared and even more rapidly consumed. Gobble gobble, slurp, slurp—the way teenagers blow through Value Meals, but then, Wall Street has always displayed a penchant for adolescent behavior. For confirmation, you need only have visited any of Manhattan’s reigning steakhouses during the pre-bust boom; no place on earth is as vile at the height of a traders’ bull market than one of those places that dishes up 20-ounce porterhouses slathered in Black-Scholes testosterone, where the behavior of the crowd at the bar, the louts with street voices, big cigars and bumpers of $50 per glass Barolo, perfectly fits what John Dos Passos wrote about Veblen: “… the last grabbing urges of the profit system taking on, as he put it, the systematized delusions of dementia praecox.” (The Big Money, 1936)

Next: stupidity. Here we need only look at the uproar over the AIG bonuses. To be sure, this is an issue that’s a specific proxy for a widespread, generalized, confused anger, but in a situation like this, more than mere catharsis is called for. Emotional distractedness never solved anything. What you end up with is this idiotic movement toward one-size-fits-all compensation controls in a situation that calls for careful case-by-case analysis.

This is a situation that involves two enablers and one enablee:  the press and the Congress being the parties of the first part, and the public/electorate the party of the second. Anyone who has ever observed the average citizen at a fast-food counter, a supermarket checkout point or boarding an airliner knows that, as a people, we don’t have an instinctive or intuitive grasp of process. We need instruction and protection: The former is the job of the press, the latter of the Congress. Both have failed miserably. The media suddenly rediscovered the bonus “scandal”—which was known about last fall, as Michael Kinsley has pointed out—and whipped up a froth that has drowned out the real horror show: the AIG “pass-through,” whereby billions of bailout money has ended up in the hands of Goldman, Sachs, foreign banks and assorted other derivatives counterparties. As for the Congress … well, five minutes of TV exposure to Nancy Pelosi tells all that need be said.

Of course, solutions confected under intense, emotional PSI seldom work, which brings me to “nudity,” as in “naked,” as in naked derivatives and naked short sales. Start with the latter. In the good old days, if you didn’t like a stock and wished to short it, you had to fulfill two requirements: Your short sale had to be made on an “uptick,” at a price higher than the last previous recorded sale, and you had to deliver the shares sold short, which could be borrowed for a small fee.

That ceased to be the case quite a while back. The “uptick” rule was revoked. The requirement to deliver just seems to have vanished. What this leads to, as a Bloomberg report puts it, are “… unlimited sell orders, overwhelming buyers and driving down prices.” There seems to be clear evidence, in the form of unsettled short sales where the seller failed to deliver the stock, that this is what happened to Bear Stearns and Lehman Brothers, even as those firms writhed in their death agonies, and it’s probably what herded Merrill Lynch into the embrace of Bank of America. What this also accentuates is the folly of the various Paulson working groups in trying to devise crisis solutions under the gun of a market in which they must have known this was taking place.

The way I work out the nudity in the derivatives market is this: The amount of debt notionally covered by credit default swaps (CDS) comes to three to four times the amount of debt actually ever issued. How can this be? Simple. The global CDS book breaks down into two categories: insurance, and bets.

Insurance is easy. I own $1 million of X’s debt. I want to sleep easy, so—for a modest monthly premium—AIG sells me insurance, promising to pay off any shortfall if X can’t come up with principal and interest when due. There’s the easy part. But then the ironclad precept that Wall Street steers by kicked in: As more people try to get in on the game, the game itself degenerates, the players start to reach. In this case, the players started to buy protection on debt they didn’t own; basically, all they were doing was betting that Bear or Lehman or whoever would fail, would default or be downgraded, whatever. AIG was happy to book these bets, so enticing was the vigorish. The result? A naked global CDS book that probably runs to $30 trillion.

Normally, when a bookie loses big, he skips town. He doesn’t go to City Hall pleading that the Steelers didn’t cover and he’s tap city and the municipal coffers need to be hit up to make him whole. Yet that’s what happened at AIG. And, by gum, City Hall seems ready to pay.

I don’t think that should happen. I think naked transactions—short or CDS—should be left out of any bailout. Legitimate bets, such as Buffett’s been making on future levels of stock prices and indices, can be left on the books. But for the most part, I don’t think We the Taxpayers should be obligated to strip down to cover someone else’s nudity. We’re up to our hocks in naked emperors as it is.

Panic in Detroit

Originally published 06/18/09 in the New York Observer

Let’s talk Detroit for just a minute.

Forget the brouhaha the media have blown up around the head of “car czar” Steven Rattner. It doesn’t bother me and shouldn’t bother you.  He happens to be one of those people it’s too easy to dislike on principle: (a) because he’s so obviously on the make it makes one’s teeth hurt, and (b) he seems to have delivered performance sufficient to substantiate his flagrant ambition. The latter will be much more irritating to many people than the former (a good portrait of Rattner, especially his rivalry at Lazard with Felix Rohatyn—they were sort of  the Nadal and Federer, respectively, of the firm—can be found in William Cohan’s The Last Tycoons). But he won’t be the difference, any more than the U.A.W. will.

A couple of weeks ago, The Washington Post carried a story, based on information fed to the paper by government insiders, that the reconstituted GM is expected to be so successful that the government will recoup its $50 billion investment, along with uncountable dividends, in five years. Perhaps. But has it occurred to no one that this is exactly the thinking, precisely the same investment rationale,  that underpinned Cerberus’s disastrous buyout of Chrysler? It would be interesting to compare Uncle Sam’s plan for GM with Cerberus’s plan for Chrysler, which postulated an identical return to profitability. Can alchemical schemes to remake two large automobile companies really vary that much? Aren’t the problems the same company-to-company? And are there really any steps that can be taken virtually overnight that can reverse 20 years of engineering, manufacturing and marketing stupidity?

Sure, GM will have certain advantages that are outright discriminatory (take this, June 4, from The Wall Street Journal: “On Wednesday, GM got even more help. GMAC, which funds dealers and car buyers, began issuing $3.5 billion in three-year debt backed by the federal government. This should cost GMAC about 2.2% annually. Ford Motor Credit just priced a five-year bond. It’s paying 8%.” Perhaps if GM could revert to its last business model, which was essentially to manufacture loans with cars inside them, the future would brighten, but I don’t think that’s going to happen. There keeps lighting up in my mind this extraordinary statistic: At the height of credit bubble, 20 percent of new automobiles purchased in California and Florida were financed with home equity loans. If the latter no longer exist, can the former?

As far as I’m concerned, it’s time to put aside the pipe dreams and “Hamilton Project”–style blah blah blah and concentrate on the kind of economy we can have—and then to work back from there to see how that scheme of things might be attained. Let’s start with where I think any reasonable person will come out as regards the dominant chords in our economy.

Our wage and cost-of-living levels will continue to make this a consumption-based economy. Nothing wrong with that, provided we consume within our means at every meaningful level of the political economy. And I define “within our means” to include a realistic likelihood of discharging our debts, public and private, individual and institutional.

We simply cannot make stuff itself in a free global economy at prices competitive with China or Brazil or Costa Rica. The U.S.”goods” economy must inevitably consist in the main of the assembly, delivery, retailing and financing of stuff mainly made overseas and sold here, including complex commercial and military systems and equipment fashioned from componentry and technology developed both here and overseas, and it will function alongside a much larger economy consisting of agriculture, and personal and institutional services ranging from TV repair to health care to transportation.

O.K. That’s the hand it looks like we’ve been dealt. What’s the smartest way to play it? Isn’t it basically a matter of working back from the likelihood to the fact? From there to here? A consumption-based economy requires a vigorous base of consumers. The base is a shambles today; it needs to be rebuilt psychologically and fiscally. And how is that to be done? Well, perhaps for openers, it would be nice to see public and private wholesalers-retailers of consumer-homeowner credit—the creditor class—treating ordinary people—the debtor class—with something approaching the same respect and generosity with which our government has treated them.

I accept that it’s become a given that if there’s any free money to be handed out by Uncle Sam, Goldman Sachs has a kind of droit de cochon that entitles it to automatic first dibs, but maybe we can find a way to squeeze a bit for the rest of us at a rate that doesn’t make Dante’s flame-stricken usurers grow icy with envy.

Here’s one suggestion. Most average debtors’ problems have to do with fixed monthly payments that comprise an interest and a principal component. Why not defer 50 percent to 75 percent of the interest component of those payments? Let the credit-card issuers and auto-loan mulchers run the deferred interest through their profit statements onto their balance sheets; we’re well into the age of federally sanctioned phony accounting in which capital is what someone says it is, so that can’t be a big deal. This deferral can then be amortized over time. A long time. Since monthly payments would now go mainly against principal, consumer debt levels should come down steadily, preferably accompanied by a simultaneous, judicious lowering of individual credit limits—and a million wolves will retreat over time from a million doors.

I don’t think any of this can happen until we starting taking people who’ve met a payroll—and by that I mean a real, honest, business payroll—into government. Those are the sort of men incoming administrations used to seek out.

And here’s the sort of people to whom we shouldn’t entrust a scintilla of our destiny. In the current New Republic , there’s a passel of blather under the byline Amitai Etzioni (a name achingly familiar to all connoisseurs of crypto-academic bien-pensant bullbleep) that sets forth a plan by which America will transform itself into a nation of savers. At the heart of this plan will be a series of “megalogues” by which we will talk our problems out of existence.

In laying out the process, the author puts forth what is perhaps the single most witless and stupid proposition I can recall. “Public intellectuals, pundits, and politicians,” he writes, “are those best-positioned to focus a megalogue on this subject and, above all, to set the proper scope for the discussion.”

Ah yes: turn our future over to a chatterati of public intellectuals who are self-serving nostrum peddlers, of pundits who are usually wrong, and of politicians who are corrupt.

As Ronald Reagan liked to say: “Where did we find such men?’