1. We had an extended period of excess increase in money supply, loan growth, leverage, and below normal interest rates.
2. This combined with a remarkably lucky global economic environment that we described as “near perfect” to produce a bubble in asset classes, as such a combination has done without exception according to our research. Since all these factors were global, the combination produced what we have called “the fi rst truly global bubble” in all assets everywhere with only a few modest exceptions.
3. While these asset bubbles were infl ating, facilitated by easy money, the authorities – the Fed, the SEC, the Treasury, and Congress – rather than tightening existing regulations, partially ismantled them.
4. The combination of favorable conditions and irrationally exuberant encouragement from the
authorities produced an even more poisonous bubble – that in risk-taking itself. Everybody, and I mean everybody, got the point that risk-taking was asymmetrical and reached to take more risk. The asymmetry here was that if things worked out badly they would help you out (this sounds very familiar!), but if all went well you were on your own, poor thing. Ah, the joys of pure capitalism!
We have had a bloated financial industry feeding off the real world and a breach of the social contract with the increasing maldistribution of income (encouraged by tax changes!) in favor of the very rich at the expense of ordinary people. We also had unnecessary fl aunting of this new great wealth. To cap it off, we had blinkered, narrow-minded leadership by the government and financial corporations. Well, much of this is ending. Some undesirable elements will disappear for a long time and some will just be moderated, but it is truly the end of an era and a rather disgusting one in my opinion[...]
We have collectively had a touching faith that capitalism – just because it’s the only effective driving force behind economic growth – is basically fl awless, and any controls are bound to be counter-productive. Pure Ayn Rand capitalism obviously cannot deal with social issues of the tragedy of the commons variety, such as climate change. It cannot turn corruptible and greedy types into the reasonable and honest types that our readers represent. It cannot begin to address social justice. [...]
Still at the meta level, I would like to bring up the hope that as a result of our current misfortunes we will re-examine how we pick our leaders. It would seem for starters that a lack of prejudicial bias would be helpful. If you’re looking for an open mind, why would you pick Robert Rubin or Hank Paulson for a job at Treasury that might, just might, involve decisions on the life and death of their beloved Goldman Sachs? And in the case of Paulson, why pick one of the fi ve leaders of fi nancial fi rms who lobbied hard at the SEC against increased reserves for investment banks? Why would you pick an Ayn Rand extremist like Alan Greenspan to be the Fed Boss when he openly deplored increased regulation in almost any form and thought untrammeled capitalism was the bee’s knees? Wouldn’t an open mind be better? Or Ben B, whose refl ex is so
clearly to believe in market effi ciency? He believes it so profoundly that he prejudged important data such as the very dangerous housing bubble of the last few years. He seemed to believe that since no such extreme ineffi ciency should exist, then it did not exist.[...]
And as for Alan! He had a proven record. It was proven for years that he was a very mediocre, lightweight commercial economist. He sat on a few politically connected committees, met the right people a lot, and, hey presto, had the second most important job in the land. Lower down on the pecking order, I think we have learned not to value CEOs so highly. We have seen their limitations when under novel stresses, and we have examined how their reward system was out of kilter with the ordinariness of their talents. The boss of Lehman did an honorable and long service in my opinion, and I have no doubt he tried hard. But frankly, Lehman even in its heyday was a B player and, in its last few months, a D player. It is probably unfair to weigh too heavily his lack of skill down the home stretch and the pain he infl icted on many by holding out too long. He was obviously very unlucky to be picked out as a sacrifi cial lamb. But even before the unraveling, did he really deserve to have accumulated a $650 million holding in Lehman – all wealth that would otherwise have accrued to stockholders – in addition to immense annual rewards for basically doing an average job?[...]
The research science world is no doubt sighing with relief at their silver lining: the prospect of once again recruiting some of the best PhDs who had been lining up to work for Goldman or a hedge fund (and even, I must admit, a few for GMO). There they designed the cleverly epackaged mortgage paper so admired by Greenspan, or developed quant equity models and “stat arb.” Now they will have to waste their time once again designing nuclear facilities and second generation biomass projects. Oh well. [...]
The fl ood of money also allowed for over-funding of fi rst-rate hedge funds and the start-up of
thousands of second-rate funds. Real investment talent has always been scarce, and does not jump out of the ground just because there’s a massive demand. Nuclear physicists do not immediately become investment talents even with IQs of 150. The hedge fund industry is just an extension of our larger zero sum game. It adds collectively no value, it just reshuffl es the existing pool of wealth minus the higher fees. Last year, in its prime, it offered mainly in place of real value added, or alpha, a simulated alpha that was dependent on rising asset prices, falling interest rates, or easy credit. All three in many cases.
Voice of Wisdom: Jeremy Grantham
I have been reading Jeremy Grantham's letters for quite some time, and I share almost all his opinions. I found in his last letter many ideas and opinions that I have been having for some time now, but which I never had the time to write down. So I am really happy that he did! Here are some quotes that are more related to our world than to markets: