Ever since the housing bubble burst and the market crashed for financial derivatives tied to home mortgages, it has been a mystery to me how citizens and politicians could have let this happen. My theory to-date is this – the citizens who fell into this trap were financially illiterate, and the financiers who engineered the trap were financially hyperliterate. That is – ordinary people abandoned their common sense and felt they had to buy a home because prices would keep going up – accepting mortgage obligations no financially literate person would tolerate, and elite financiers were similarly unable to see the forest for the trees because they knew so much they lost their perspective – their hyperliterate quantitative models gave them a false sense of security.
No wonder the science of economics is not only dismal these days, but in the grip of a well deserved intellectual crisis. But there is another theory that is taking hold among a sorely disgruntled American population, a theory that if it spreads, will abruptly and severely rearrange the American political balance of power - hopefully for the better. That theory holds that this crisis was caused by a decade or more of bipartisan, elitist abandonment of the interests of hard working American citizens in favor of big government, big labor, and big finance.
A commentator of extraordinary lucidity who provides useful insights on this topic not always available in the American press can be found at Asia Times Online. Writing under the pseudonym “Spengler,” he offers a perspective on the world, and the United States in particular, that is stripped of hyperliteracy – financial or otherwise – and cuts to the chase. Here is how he characterizes what happened, and is happening, in Washington today:
The one-trick wizards of Wall Street had one idea, which was to ride the trend and pile on as much leverage as credulous investors and crony regulators would allow. It has gone pear-shaped, and those who didn’t cash out early along with the cynics are poor. Fortunately for them, Obama will let them play with the budget of the US federal government for the next four years.
Failed financiers run the Obama transition team. It used to be that the heads of great industrial companies got the top Cabinet posts. Now it is the one-trick wizards. After George W Bush fired former Treasury Secretary Paul O’Neill, who had run Alcoa, the last survivor of the species was Vice President Dick Cheney, the former CEO of Halliburton. Obama’s bevy of talent comes from finance. American industrialists have become figures of ridicule, like the pathetic chief executive of General Motors, Rick Wagoner, begging for a government loan.
America, and Americans, have been accumulating debt for 40 years. Back in 2007, in a post on EcoWorld entitled “Inflation or Deflation,” I attempted to quantify this debt, quoting Paul Rubino from www.dollarcollapse.com, who said “the past two decades of low inflation and steady expansion have been purchased with ever-greater amounts of debt. In the 1960s it took about a buck-fifty of new debt to produce a new dollar of GDP. Today it takes about six bucks…” and “Total debt in the U.S. economy grew at a seasonally-adjusted annual rate of $3.7 trillion, and now stands at $46 trillion, up from $29 trillion in 2001…”
Now our Obama administration is well on their way to more than doubling our federal debt before the end of the first term – projections now put federal debt at 17 trillion by then. This will trigger inflation – indeed the painful reality is despite the fact that failed (but hyperliterate) financial foxes are guarding the nation’s economic henhouse in Washington, this massive spending is the only way to avoid deflation, which would be far worse. Let’s return to Spengler for more on this:
For a quarter of a century, the inbred products of the Ivy League puppy mills have known nothing but a rising trend in asset prices. About the origin of this trend, they were incurious. The Reagan administration had encountered a stock market in 1981 trading 50% below its the long-term trend. Reagan restored the equity market to trend by cutting taxes, suppressing inflation and easing some regulations. The private equity sharps were fleas traveling on Reagan’s dog. They simply rode the trend with the maximum of leverage.
Now that the stock market has collapsed, the private equity strategies cannot repay their debt, and their returns have evaporated. Note that equity investors spent a decade in the cold, from 1973 to 1983; it may be even worse this time. The maturities on debt issued to finance private equity deals will come due long before the recovery.
Over the long term, we know that the average investment cannot grow faster than the economy, for investments ultimately are valued according to cash flows, and cash flows stem from economic growth. Real American gross domestic product grew by 2% a year on average between 1929 and 2007. Whence came the enormous returns to the Ivy League? Some of them surely came from betting on the right horses, but most came from privileged access to leverage.
For all Obama’s bashing of the rich, it is arguable that Obama’s administration is a product of public sector labor union power married with Wall Street power. Look no further than our public sector employee pension funds, who invested hundreds of billions – in aggregate, trillions – with hyperliterate Wall Street brokers – and all of them actually believed they could earn double-digit real returns on trillion dollar funds for generations.
For much more, read “Obama’s One Trick Wizards,” or anything by Spengler.