Don't Drink the Kool-Aid

“Heads we win, tails you lose.”

Mark’s First Maxim for Wall Street Denizens

My apologies friends. I have started this blog several times in the last few weeks or so. But every time I began outlining its content, my WIFF (Whitmore’s Indignation and Fulmination Factor) began to escalate uncontrollably. Since I have lived in a virtual 24/7 state of outrage since the government bailouts began last Fall, this was not a good thing. And unlike Dr. Evil, I do not have a Mr. Bigglesworth to stroke in order to reduce my frustration level.

But this missive could not be delayed any further, regardless of its health implications for moi. Maybe it was Citigroup having the audacity to tell its employees that the bank was actually profitable thus far this year (assuming of course you do not factor in the $300+ billion in toxic assets still on its books, the $45 billions in government funds it has received, its tax liabilities, and a variety of other trifling details). Perhaps it was the laser like focus upon which the public has directed its attention to the AIG bonus fiasco. At least $450 million (when properly characterized) in extra compensation appears to have been given to the geniuses that managed to put the company in a position in which it needed $160 billion in government aid simply to remain solvent. It also could have been the adroit display of verbal pugilism (even if some of it was below the belt) by Jon Stewart when CNBC personality/buffoon Jim Cramer came on his show last week.

Whatever the impetus, I am going to eschew my traditional outline (lest my WIFF go red-line), and let this be more of a stream of consciousness endeavor. Please bear with me.

Separating Wheat from Chaff

Back when I practiced law, I learned to make an important distinction. While I generally disdained the field, some of the most diligent, scrupulous and upstanding individuals I knew were attorneys. I have great respect and admiration for these people, and many are among my closest friends.

Similarly, I have family members and friends who are in both the financial services industry and real estate. While I have heaped great scorn upon these sectors as a whole, obviously there are really talented, earnest and hard-working individuals employed in these fields. I am fortunate enough to know many such people. Indeed, the long run health of our economy largely depends upon folks such as these transforming their industries. So please do not mistake my vitriol directed at the boneheads, scoundrels, loafers, scofflaws and boorish know-nothings who generally compose the financial sector of our economy as applying to any specific individuals who are employed therein (other than those I specify).

When Doing Something is Worse than Doing Nothing

When the financial crisis really began to pick up steam last Fall, a huge lie was perpetuated by policy-makers, pundits and financial executives alike: What was good for Wall Street was good for Main Street. This simple little deception allowed all manner of shenanigans, tom-foolery and hood-winking to take place.

The logic of this great lie was superficially sound. The financial sector of our economy had grown substantially over the last two decades. A greater percentage of stock market wealth was concentrated in that sector than had ever been the case in our history. A huge percentage of the population was employed in financial services, and many others were dependent upon the health of this industry.

So in comes Henry Paulson, scion of the Wall Street elite, and proposes that there might be some loose change in the sofas of the Treasury Department, say to the tune of $800 billion or so, that should be used to bail out all the poor financial institutions in tatters. Of course he argued that circumstances were so exigent that this massive program must be implemented immediately. There was no time for dispassionate reflection upon the specific merits of TARP, or worrying about how the money was going to be earmarked. No, action must be taken, as confidence was ebbing, and the credit markets desperately needed greasing. Moreover, Mr. Paulson represented that this money was actually an investment, or at worse a loan to Wall Street (in reality, funds used for TARP have already seen 30-35% losses that do not expect to be recouped according to Barron’s).

You see dear old Henry and most of the Wall Street executives continued to maintain that their impaired assets were artificially undervalued by a marketplace that had just gone crazy. Once the marketplace returned to normal, and asset prices resumed their lofty levels, the crisis would pass and the government could recoup its money.

But this was only part of a unified effort by republicans and democrats alike to save the likes of AIG, Bear Stearns, Citigroup, Fannie Mae/Freddie Mac, Goldman Sachs, etc.

Hypocrisy, Moral Hazards and Social Injustices

I have discussed at length why I think it is bad policy-making to spend trillions of dollars trying to avert an unavoidable, and indeed necessary, recession (see Save (for) Yourself, Save the World). But let me focus my acrimony on how the bailouts for the financial sector are pure and simple just ethically repugnant.

First, for the financial services sector to aver that it is deserving of any government assistance is the height of hypocrisy. Without boring the reader ad nauseum with history, the titans of finance lobbied Congress tirelessly throughout the last 25 years for Congress to remove government oversight and regulations (many of which had been imposed as safeguards in the wake of the financial crisis which caused the Depression). Throughout this time period, the constant justification was that if government would simply “unshackle” the industry and let free markets work, the financial sector would be more efficient and everyone would make more money. And boy, did it work. Between 1981-2003 the financial services portion of the S&P 500 index grew three times more quickly than the rest of the index (which itself appreciated hugely). People were making more money than many ever thought possible (recall the priceless ETRADE commercial during the 2000 Superbowl – “he’s got money coming out the wazoo.”) For Wall Street, laissez-faire capitalism was the greatest thing ever.

Well, until it was not. Apparently the vaporization of mid-six figure plus bonuses cause investment bankers and their ilk to bust out their Marx-Engels readers and become rabid socialists! Wall Street executives went from being Masters of the Universe to hat-in-their-hand mendicants. But instead of seeking nickels and dimes, they begged for hundreds of billions of dollars collectively. They have been hoisted on their own petard, as the very oversights and regulations they removed could have prevented these idiots from taking speculative and leveraged positions that ultimately proved their undoing. But now, they ask, nay expect, you and me via Uncle Sam and all their chums in DC to bail them out by taking on all their bad investments and impaired assets. Needless to say, they are not getting much sympathy from yours truly.

Second, the bail out of financial institutions is beyond outrageous due to the moral hazard that is perpetuated in the marketplace. I have previously discussed the notion of the “Greenspan put” and its deleterious impact on asset markets and the economy (see From Whence We Came Part II). In brief, for almost a full decade now, the Fed via Mr. Magoo (aka Alan Greenspan) and “Helicopter Ben” Bernanke have been moving heaven and earth monetarily in an effort to keep their game of musical chairs going.

Wall Street figured out how to master this game very early on. They would speculate recklessly with all kinds of overpriced, often highly leveraged assets that were still going up in price (first tech stocks, then mortgage backed securities and credit derivatives). Wall Street firms would make billions and billions of dollars for themselves, their clients and their shareholders. Then these kooky, inflated assets would, as is always the case, decrease in price.

Now in a functioning capitalist economy, this is where the notion of “market discipline” would come into play. You see if someone in the late 90’s speculated that Beannie Babies would keep appreciating, they would have lost a lot of money. Hopefully they would have learned something about imprudence and act differently in the future. If not, they would eventually go bankrupt, while other economic actors survived. This is economic Darwinism, and I embrace it. The smart never lost money. The adaptable learn from their mistakes and avoid making the same ones in the future. The incompetent make the same mistakes and eventually do not have the resources to recklessly and foolishly speculate.

But in his sage-like wisdom, Greenspan determined that nobody on Wall Street, no matter how dim-witted, should have to suffer the consequences on their incompetence! Hence, whenever these over-priced assets in which Wall Street idiots had substantial investments began to deflate, Greenspan was there to artificially cut interest rates to zero, thereby insuring other assets would inflate absurdly. Wall Street was thus always bailed out from its own stupidity.

At least until last year. As I have said before, you can only keep stimulating an economy artificially before it no longer responds (the law of diminishing returns). This is where the game of musical chairs ends and everyone realizes that all the seats are taken. First Bear Stearns needs help. But by bailing out Bear Stearns, the government sent two very clear messages to Wall Street and its owners/investors: 1) we will shield you from your own past stupidity; and 2) as a precedent for the future, certain enterprises will be deemed to be too important to fail. Somehow Lehman must have been on the outs with DC insiders, as it was the only entity of any significance that was allowed to go bankrupt.

But instead of Bear Stearns being the precedent, it should have been Lehman. Companies fail all the time. People lose jobs. While it is justifiable for the government to provide need-based assistance to those affected individuals and families who are having difficulty sustaining themselves, it is not justifiable to extend corporate welfare to enterprises whose mean incomes oftentimes exceeded $300,000. The message sent simply encourages future speculation, as now there is virtual certainty that no matter how moronic/reckless their actions, financial institutions will be able to siphon tax dollars ad infinitum to cover up their losses.

Finally, any concept of social justice is done great violence by these bailouts. This is almost so obvious that it does not warrant elaboration. This is evident by the way in which the AIG bonus issue has sparked the collective ire of the nation with such ferocity (just today AIG’s CEO stated that some of its employees were receiving death threats).

But one thing makes my blood virtually boil. Thousands of individuals making six, seven, and even eight figure incomes will receive more in income that is attributable from taxpayer sponsored bailouts than they will pay in taxes. Think about that. Or maybe you should not, as I would hate to spread an offshoot of the WIFF virus. But seriously, how can any society in good conscious create the most expensive bailout program ever seen on earth in which its most wealthy citizens benefit so disproportionately???

This is among the most massive wealth redistribution plans ever seen on earth, yet until recently, no one seemed to give the fairness issues much attention. The spin-masters were initially successful in making this a program deemed necessary to save the economy. But now reality is beginning to hit. Namely, that the economy will not likely be saved by this, and that in the process we are providing the greatest degree of assistance to those who are most able to care for themselves financially.

I had one discussion with an extremely bright investment banker a couple of months ago in which my WIFF reached what may be heretofore unsurpassed levels. Our a wide-ranging debate related to the state of the economy and government actions in the face of our economic crisis. Now this is someone who is quite vocal in their opposition to most government support programs for welfare recipients, mentally ill individuals and the like. Yet he was arguing for the TARP program that doled out money to troubled financial institutions. When confronted with the apparent contradiction, he conceded that he had a “soft spot” for the bailout program. Well, few things warm my heart like knowing there will not be investment bankers deprived of purchasing Patek Phillippes as gifts to themselves for a year of great work!

Concerning Weak Retorts

Oh, you may hear nonsense like these bailouts and bonuses are needed to keep bright capable people that are the only ones that can get us out of this mess. I doubt if I am not the only one that realizes that these are the people that got us into this mess. Needless to say, I am not overly optimistic that they will deftly navigate financial waters going forward.

Moreover, this sounds like the most hollow threat I can imagine. I mean the implication of this counter argument is that if we do not continue to employ these morons in the financial services industry they will take their impressive skill sets elsewhere. Let’s think about this. Resumes noting one’s experience at: losing billions of dollars through idiotic, leveraged trades; managing a division that earned a -75% return; running a company that required more than $100 billion in government bailouts. These people will clearly be in high demand everywhere.

In fact, the only compelling thing I have read arguing for the TARP program and the Wall Street bailouts that have accompanied it has come from Barron’s gifted columnist Alan Abelson. He noted that hundreds of billions of dollars is actually a small price to pay in order to prevent the thousands of investment bankers and other financial service professionals from entering the workplace as teachers, nurses, engineers, or a wide variety of other occupations that really matter. We may be dodging a bullet there.

The Worst Investment Advice Ever

When a wise man gives thee better counsel, give me mine again.

Shakespeare, King Lear

I am convinced that 99.9% of reported financial news/analysis is at best a waste of time. Investors tend to be focus upon “noise,” such as a drop in some particular economic indicator, and risk losing sight of the forest through the trees. But once in a while I come across something in the financial media so much more abominable that it warrants special opprobrium.

Let’s travel back in time together nine years, to the halcyon days of early 2000. Ahhh, doesn’t everyone feel better already? Y2K was perhaps the biggest non-event of our lives. Asset prices everywhere were buoyant. Jobs were plentiful. The government actually had a budget surplus, and was thereby reducing the national debt!! Sorry, I am a little dizzy here from the disorientation . . . . Ok, better now.

Of course everyone was happy other than yours truly. My delicate psyche was already troubled by disturbing trends in both personal spending and overall debt levels, as well as what appeared to be unsustainable increases in the stock market. And no sector had experienced greater gains than the tech sector. Now I am just a naïve simpleton; technology largely eludes my ken of understanding. I have to be tutored in the use of Excel. But as an investor, I simply could not see how companies that employed really smart, tech-savvy individuals, yet operated businesses with no track records, tiny customer bases and paltry revenue streams could be valued at billions and billions of dollars.

So while this Chicken Little was warning of the impending sky-earth collision in March 2000, I stumbled across an investment advice column online. In it, the “advisor” recounted the content of a letter he received from a reader seeking guidance. The poor fellow was in a very common situation. He was in his mid-late 50’s and was employed in a lower management position with some company. So here he was in the twilight years of his working life, yet had never gotten around to putting away much money in his retirement account. He had begun to do some back-of-the-napkin calculations one day and realized that his projected financial needs/wants upon retirement would exceed his social security payments. This epiphany suddenly made him a very motivated saver/investor. So he was going to max out his retirement contributions to try and “catch up.” But even at a maximum level, he was concerned about falling short of his retirement needs. He thus asked for this advisor’s portfolio allocation suggestions, both for what relatively small amount he had in his 401(k) at the time, as well as for future contributions.

The advisor began by making some general observations about how in younger years, investors should generally be invested heavily in equities, since stocks have higher long-term returns. These investors can also handle short-term losses given their long investing horizon. Conversely, older investors should start to funnel an increasing amount of their investments into more stable, fixed-income securities, even if they have less up-side. This percentage for someone like the reader might be 40% stocks and 60% bonds if he were an individual with a large sum in his 401(k). Even though I was advising that people have little or no money in the US stock markets at that time, I cannot take issue with the fact that this is good generic advice for any time equity markets are not at bubble levels.

The advisor went on to talk about the reader’s specific situation. Since this investor was way behind in saving for retirement, he would have to take on greater risk with his 401(k) allocation (my eyes began to widen). Specifically, the investor should be putting 80%+ into the stock market (my jaw dropped). And within the stock market he should put most of the money into the tech-laden NASDAQ due to its expected “higher returns” (incredulous, I was in a virtual apoplectic trance)!

This advice was imbecilic and deleterious on three levels. First, if someone has inadequate funds to maintain a desired lifestyle, the most important goal should be capital preservation, not capital appreciation. As such, advising this poor gentleman to place most of his saved income into the riskiest asset class at the time that was not a start up was utterly negligent, and placed the investor in financial harm’s way.

To understand the need to emphasize capital preservation better in this case, let’s imagine that after saving and scrimping all year, this fellow is able to sock away $10,000. Should he make 30%, he banks $3000 and feels good. But in the event his investment goes South 30%, he is now down to only $7000 in savings. But importantly, in order to get back to his initial $10,000 level, he must now obtain returns of 40%+. So volatility to the downside is much worse to his financial health that a commensurate gain is beneficial.

Economic behaviorism is a school of thought to which I adhere. Studies by economic behavioralists have shown that individuals suffer a greater magnitude of displeasure when an investment goes down x% that they receive satisfaction from the investment going up x%. This makes sense intuitively. When you receive something you have not had, you are generally pleased, but not necessarily ecstatic. But when you lose something that you have had, the sting can be very great indeed.

From a pragmatic perspective, it was even more important to prevent significant losses in this man’s retirement account. Assume he wanted to retire at 65 and then take a couple of trips a year with his wife and enjoy life. He figures out how much he needs to have saved to do all that, and then concludes that his investments would have to go up a total of 70% to make that happen. So he eschews bonds and safer equities, and plunks down his hard earned savings in high-flying tech stocks. But instead of gaining 70%, they lose the same amount. The effect? Now it is not an issue of trying to fit in that second trip each year. Rather, he may be unable to make his mortgage payments (more older Americans owe significant amounts on their houses than ever before, so this is not an unrealistic problem). Similarly, the man may conclude that he cannot retire until he is much older.

The second way in which this ranks as the worst investment advice I have seen in the financial media is that this counsel was provided on the eve of the great tech implosion of 2000. Now many financial advisors/professionals at the time claimed that they could not be blamed for being caught unawares, as most of their colleagues we similarly blind-sided by the precipitous fall in stock prices. Rubbish! The same reason the current housing crash should not have surprised people who claim to be real estate experts applies to tech crash of 2000: anytime there is an unprecedented increase in the magnitude of returns for a particular asset class, investors (as opposed to speculators) should generally run for the hills.

Stocks are like any other asset. There is some notion of intrinsic value that applies to companies. Those of us who invest based upon fundamentals look at a variety of metrics to determine how attractive stocks are priced. This method can be applied to individual companies, or markets as a whole. And while its application is far from scientific or fool-proof, it can give one a general idea of whether the stocks in question are investment worthy. When applying these analytical tools to the NASDAQ in the early part of 2000, it was apparent that the market was over-valued to an extent never seen before. So for this advisor to justify his recommendation of tech stocks based upon very recent, ephemeral and unsustainable gains in the NASDAQ was appalling by any standard of responsible financial advising. But this was not unique. I talked to dozens of people that were getting similar advice from their financial professionals as well.

Finally, the advisor made the mistake of treating stock market returns like an actuarial table. Sure, if one charts out the last 80 years or so, average returns in the stock market look pretty impressive (although a lot less impressive than they did back in 2000!) And in 2000, even ten year returns for tech stocks looked remarkable. But this is like driving by looking at nothing else but the rear-view mirror. Generally when one sees such complacency in the markets, danger is lurking around the corner. Of course even being able to see the corner and adjust one’s direction assumes that one is looking at the road. In this case, investors and their advisors en masse drove right through the barrier and off a cliff. One should never forget that asset markets make very quick and violent reversals. Expected returns can be dashed in the process.

I periodically think of the poor gentleman and the terrible advice he received from the investment "professional." I hope he got a second opinion that was remotely sensible given his situation. You see, the 70%+ loss scenario I outlined above was not arbitrary. In the nine years since March of 2000, that is the magnitude of losses in the NASDAQ index. It would have been far better advice to have told the reader to go to a roulette table once a year and put his entire annual savings on black. The total expected losses would have been much less than buying tech stocks in early 2000.

This topic came to mind due to the fact that I have had numerous inquiries from friends who are trying to assist their parents, many of whom have suffered huge losses in retirement funds, manage the money that is left. Since many older individuals rely upon these accounts for a stream of income, the relevant question is usually whether they should cut their losses in stocks and get out, or stick it out expecting some imminent rebound. However, without doing a painstaking analysis of someone’s entire finances, it is impossible to proffer general advice on this topic responsibly.

But it is possible for me to implore folks, whether you are managing your own personal finances, or those of your parents, to determine what level of income is needed to support a minimally accepted lifestyle. Frankly we in this country are blessed, as no one will ever be in a position of starving, and few will be unable to find long-term shelter. Social security and other state programs alone address these needs. But once the investor determines one's future acceptable standard of living, the savings that will support that level should be in very secure investments. Generally this would be something like Treasury Inflation Protected Securities, short-term fixed income instruments, and possibly certain investment grade corporate bonds.

Reader Appreciation

I began this enterprise in a rather sputtering manner last July. While always having a passion for assisting people who might not be otherwise financially inclined make smart decisions concerning their money (or at least avoid making poor ones), I am not by nature a self-promoter. However, after a close friend told me that a “blog unread is simply a diary,” I realized I hate diaries and needed to do something about that. Accordingly, I started to let people know this personal endeavor exists, mostly through contacting Facebook friends.

In the month that I have spread the word, this is now the most tracked blog dealing with either investing or personal finance that is networked through Facebook, with 100 individuals who have signed on as followers. It is also the most followed blog under the topic of “ranting.” I am not sure how I should feel about that.

Since letting folks know about this blog, I have received excellent and supportive comments, as well as ideas to make it better. All of the input is greatly appreciated, and please keep it coming.

I would encourage any of you that are reading this to pass along my blog link to friends who may also find it of interest or use. The more people who follow this, the less likely I am to feel like these entries are akin to those of a 13 year-old girl.

The Abyss Deepens

A trillion here and a trillion there, and pretty soon you are talking about real money

Me

Since my last fulmination, government intervention in the economy continues to escalate. The new administration announced Friday that taxpayer ownership stake in Citigroup is now greater than 35%. Citigroup used to be the most highly valued bank in the world, worth in excess of $300 billion. Now you can buy two shares of the formerly storied financial institution for less than the price of a morning latte. Absent government intervention, Citi would have been forced into bankruptcy months ago (by way of full disclosure, I had been short Citigroup for over a year until recently covering my position).

Just this morning the Treasury and Fed threw another $30 billion of taxpayer money at what used to be the most highly valued insurance company in the world – AIG. Total government support for this hapless corporation has thus increased to a mind-numbing $160 billion. This is more than $500 in support for every man, woman and child in the US. The government calls its bailout an “investment.” I do not know about you, but I would rather take my $500 and choose how I will invest it myself.

In my last blog, I mentioned that there were plans in the works for a massive $50 billion federal mortgage bailout program for “homeowners.” Actually, that is a bit of a misnomer, as the problem is that the people being bailed out generally own very little, if any, of their homes. But apparently $50 billion seemed too inconsequential of a sum, so the Obama administration upped it to a $75 billion program in a futile effort to arrest falling home prices, as well as spare Americans from rising foreclosures.

Oh, and late last week the new administration announced it will be setting aside an additional $250 billion to purchase “toxic assets” from banks in its budget proposal for Congress. This is on top of the $700+ billion set aside by the Bush administration for the same purposes. For taxpayers this is great news of course. We get to have almost $1 trillion of our hard-earned dollars buy assets that are deemed by financial institutions to be so impaired that they cannot sell them on the free market to anyone else. This will clearly be a fantastic government investment. In the meantime financial institutions and their owners can breathe a collective sigh of relief that H.L. Mencken was literally correct: “No one ever went broke underestimating the intelligence of the American public.” This is particularly true when that intelligence is channeled through its politicians. Financial institutions throughout the country will have foisted upon us poor saps “assets” which are in actuality liabilities. This will undoubtedly cost the American taxpayers billions and billions in losses.

Some people are doing the math as to what the price tag of all this spending will cost this coming year should Obama’s budget get approved: $3.6 trillion dollars!! This constitutes more than one quarter of the entire economic output of the nation. By way of a minor detail, the government will be coming up just a tiny bit short in terms of balancing the budget under the proposed spending plan. The shortfall? Let’s see, add this, multiply that, carry the one. Ah, a mere $1.75 trillion dollars. That will add more than 15% to our existing national debt of almost $11 trillion dollars, which is already increasing at a rate of almost $25,000 per second. It took the federal government until the second Reagan administration, or almost 200 years, for the national debt to reach $1.75 trillion. But if the administration has its druthers, fiscal year 2010 alone will rack that up.

The government is clearly pouring money into the economy at a heretofore unprecedented scale. So how is that working out for us thus far? Hmmm. This morning the overall stock market officially pierced the previous lows of last November. The S&P 500 (a market-weighted index of the largest 500 companies in the nation) had its worst opening two months for a calendar year ever (depression era included). The index is actually at a lower level than it was at the end of Clinton’s first term twelve years ago!!

But twelve years ago is nothing when it comes to the fall in national output as measured by the fourth quarter gross domestic product (GDP) numbers. The economy shrank at an annual rate of 6.8%. This was the worst contraction since 1982, harkening me back to the day when I was blithely listening to Duran Duran and reeling from the fact that my new nickname at middle school was “Zitmore.” Consumers certainly do not appear to be taking much stock in the government’s efforts to jump-start the economy. At no time in the last 50 years have so many people polled voiced concerns over a deepening recession and rising unemployment.

"Economic developments in recent months have been consistently worse than the worst-case scenarios," noted Stephen Stanley, chief economist for RBS Greenwich Capital, on Friday. Well, that is not true. There were a small minority of us Nervous Nellies who thought that the logical result of the biggest credit bubble in history would be the worst economic fallout since at least the Great Depression. I will say that most of us who were in that camp have been stunned at the rapidity with which things have unraveled in the last several months, without any signs of a meaningful short-term bounce along the way.

Even Warren Buffet, the richest man in the world and one of its greatest investors, is struggling. Berkshire Hathaway lost 11.5 billion in net worth during 2008, the worst performance in Buffet’s 35 years of running the company, even accounting for inflation. Since peaking with the rest of the US stock market in the Fall of 2007, Berkshire’s share price is down 45%, sending it to the same level it was almost ten years ago.

Unlike 99% of CEOs or investment professional, Buffet issued a very forthright mea cupla: “During 2008 I did some dumb things in investments.” Wow. What a breath of fresh air. Unlike most of the logic-impaired (I am trying to be diplomatic for once) financial company executives that have been grilled by shareholders, the media and Congress alike, Buffet shouldered responsibility for making bad decisions that cost real people very real sums of money (although at $74,000 for a single A share in Berkshire Hathaway, one can safely assume that widows and orphans were not the primary victims of Warren’s lapses in judgment).

While 2008 was not a year of excellence for the Oracle of Omaha, I would not count Mr. Buffet out. He has proven himself to be one of the shrewdest, most canny investors ever. So unlike my contrarian babble, we should all sit up and take notice about what he thinks concerning the economy: “We're certain, for example, that the economy will be in shambles throughout 2009 -- and, for that matter, probably well beyond” (emphasis added).

Something about “all the king’s horses and all the king’s men” seems fitting when it comes to the Obama administration’s colossal fiscal efforts to revive the economy.

There is a noticeable trend for my blogs to be getting longer. In an effort to spare my readers eye strain, I will try to post shorter blogs more frequently. This will mean some will be more current events driven like today. The next one will relate to a more practical financial advising matter, which I will post by Wednesday. Social justice and government programs will have to wait. Cheers!

Save (for) Yourself, Save the World

’Tis true that we are in great danger;
The greater therefore should our courage be.

Shakespeare, Henry V


I hope everyone had a great Valentine’s Day weekend. And what connotes love better than a meandering missive on personal finance, the economy and government policies? In an effort to spread the love, I am going to try an experiment with my blog. I know there are those who may not be enthralled with following my various diatribes about flawed fiscal plans, corporate greed, housing busts, misguided monetary policies, etc., and are simply looking for some practical advice. Alternatively, there are those that may already be well-versed in the basic elements of sound financial planning and even portfolio management. These people may only be interested in economic analysis and disquisitive ranting. So for a while I will try to cast a wider net – the first part of my blog will be dedicated to some (hopefully) practical household finance issues, while the latter section will be focused upon broader policy/investment issues. Hopefully, everyone will be able to find something of use or interest.

Our new president is also trying to spread the love, $787 billion worth of love to be precise. Upon signing the massive stimulus package into law today, President Obama said the occasion marked “the beginning of the end” to our nation’s economic troubles.

I really like President Obama. He is smart, earnest and hard-working. In many ways Obama represents the very best of our nation, and the principles upon which our country was built. He inspires hope and admiration. I would happily have him as a two-on-two basketball teammate (although I think I might choose a different bowling partner). Moreover, outside of Rain and Stephen Colbert, I can think of few more fearsome competitors in a dance-off. And while my political views may be to the right of his in several areas, unlike some conservative buffoons, I genuinely wish him great success.

Having said that, Obama may as well have been posing in front of the Hoover dam with his finger shoved in a noticeably growing crack while making that statement. Similarly apropos, he could have filed a five-story office building with hundred dollar bills and blown it up. Clearly Wall Street was unimpressed with the fact the Stimulus Plan is now law; the stock markets were savaged to the tune of 4% today.

Obama’s bold proclamation is not nearly as much of a blunder as the infamous “Mission Accomplished” banner above Bush’s head aboard the USS Abraham Lincoln. But it is certainly in the same vein. By raising the prospects that our economic woes may soon be a thing of the past, President Obama risks over-promising and under-delivering.

Rather than seeing this as the beginning of the end, I would argue that we may just now be seeing the end of the beginning. To me, there will be middle and end phases to our economic troubles yet to come. But more about this below.


Of Dead Car Batteries and Moribund Economies

Not long ago I was ready to leave the house to meet some friends for lunch. Upon trying to start my car though, I discovered the engine would not turn over. Marshalling every iota of my meager automotive skills, I attempted to jump the battery. Much to my chagrin, the battery would not even hold a charge.

After postponing what was sure to be a tasty Malaysian meal with excellent company, I called AAA (thanks to my better half’s preparedness/membership). Shortly thereafter a familiar looking gentleman arrived at our house prepared to assist.

“Nice to see you again!” exclaimed a gregarious man with a noticeable Ethiopian accent.

It then occurred to me that he had helped my wife and me before when her car would not start while we were downtown. He proceeded to attach cables to the battery and had me start up the car so it could idle for several minutes.

“How is business for you?” He apparently recalled my occupation as an investor.

“Oh, great! Thanks for asking.”

“Can I ask you a question?”

“Of course.”

“I came to this country years ago with my wife. We worked very hard. Eventually I bought this truck and started a business. We now have a house and children.”

“Congratulations! You have a great deal about which to be proud.”

“Thank you. I look around today and talk to people, and there is nothing but gloom. Nobody wants to start any business. People do not want to spend money. But by refusing to spend money or take risks, does that not just make everything worse?”

“Hmmmm. You are correct in that as people spend less that causes the economy to contract even more. And it is true that jobs are not created if people are not starting businesses.”

“Exactly! And with interest rates so low, does it not make sense to borrow money to do something?”

“Like what?”

“We were thinking about buying another house, or maybe starting another business.”

“Well, I tell people the first goal of investing is not to make money, it is to avoid losing money. The danger is that the economy will worsen, and you will not only lose your own money, but also the money you borrowed, while still owing interest on the loan.”

“But did you not say that the economy is deteriorating because people have these very fears? Isn’t it just these negative attitudes that make the economy worse? Is it not hope and positive thinking that will make things better?”

By this time, we were ready to see if the battery could maintain a charge on its own, and I was pondering the very good questions and observations posed to me. Upon removing the jumper cables and checking the battery with a variety of probes, my new friend said the battery needed to be replaced. While he sprung into action, two points sprung to my mind. But I only felt comfortable sharing one of them.

“What you describe is akin to something known as ‘prisoner’s dilemma’ in the social sciences?”

“Prisoner’s dilemma?”

“Imagine a band of ten criminals in cahoots with one another are all rounded up. The police know, but cannot prove, they are responsible for a serious armed robbery in which several people were assaulted. However, they were all caught having broken into a warehouse. Let us say that should they all be convicted of burglarizing the warehouse, they would each receive a three-year sentence. However, if they were convicted of armed robbery and assault, they would each receive ten-year sentences. The police decide to separate and interrogate all of them. Each is made an offer: Rat out your crew and you will be given immunity from prosecution as well as witness protection.

“Interesting. So what happens?”

“Well based upon social science modeling and experiments, most people would choose to ‘defect,’ or rat out the gang. This, despite the fact that in that scenario, the group as a whole is worse off, serving a total of ninety-years in prison. If everybody stayed quiet, the group as a whole would be three times better off, serving only thirty-years of collective time.

“So let us apply that to the economy. It is true that in the short-term, everyone would be better off if we all began borrowing money and spending once again, as this would certainly stimulate the economy. But the individual will likely be better off saving money and avoiding debt during bad times. So it is safe to assume that households will do what is in their own best interests, even if they know that their actions, if imitated throughout the economy, will cause further economic deterioration. Should you borrow and spend in an effort to do your part to turn things around, you risk financially over-extending yourself at precisely the time when things will probably get worse.”

By this time a new battery was installed and it was time to test it. My engine turned over without hesitation.

“I see. So I should do nothing?”

“Have you started saving for your children’s higher education?”

“Hmmmm. No. Not really.”

“I suspect that will be an investment that will pay dividends far in excess of any stock, bond or piece of property.”

After a warm handshake we parted ways. I had a new battery. I am not sure with what my new friend left.

So what was the second point I did not want to bring up at the time? A concept that is probably heretical to most readers, and is certainly unconscionable to every policy-maker:

What this Country Needs is a Good Old-Fashioned Recession

Throughout the polemic debates raging on Capital Hill about what should be done about the financial crisis, there is one point upon which there is utter and complete consensus: the government must do something to bail out people and businesses who have buried themselves in debt and bad investments. This is a most grave misconception, and one that I am convinced will make things much worse in the long-run. I will make three points this week as to why the approach taken in DC is disasterous policy-making.

1. Capitalism is “creative destruction.” The primary advantage of capitalism is the way in which it efficiently and quickly allocates capital throughout and economy. Adam Smith called this the “invisible hand.” Essentially the market, left to its own devices, naturally adjusts to any economic circumstance based upon supply and demand. As we discovered 20+ years ago when communism collapsed under its own waste and inefficiencies, capitalism is the greatest system in the world when it comes to generating wealth. However, this system is not one without its costs. One of the great economists, Joseph Schumpeter, noted that capitalism's very essence is "creative destruction."

With very few exceptions, when the government intervenes in the marketplace, it does so at the cost of reducing overall wealth. This is not to say that such intervention is never justified (a topic that will have to wait until next week). But to do so to save businesses or people from bankruptcy based upon their own decision-making is horrific policy-making.

I grew up in an era of stereo 8 tapes (for those younger readers, please consult your resident octogenarian for information about this archaic audio format). Back in the day I felt quite cool popping in my Captain and Tennille eight-track tape and turning up the volume (did I mention I was a very pathetic child?) At some point in the late 70’s, people stopped buying these tapes and players. First cassette tapes, and then later CDs, were viewed by the marketplace to be superior formats (for instance, both actually had rewind capabilities). Stereo 8 accordingly died an ignominious death.

I am sure that there were thousands of people whose jobs were tied to the manufacture and distribution of eight-track tapes. The government could have stepped in to stave off corporate and personal bankruptcies by extending loans or subsidies to this industry. But intervention would have extended the production of goods the marketplace no longer wanted, and employed people in positions that would only continue so long as the government maintained its largess.

Moving ahead to the present, by stepping in to "bail out" those industries/market sectors that would otherwise go bankrupt, the government prevents the natural winnowing process inherent in efficient markets. So instead of our economy receiving the proper signals that we need a lot fewer investment bankers, mortgage lenders, auto assembly-line workers and the like, huge quantities of capital continue to be misallocated when Uncle Sam saves jobs/businesses that should go away.

2. A serious recession is both inevitable, and ultimately necessary. The Holy Grail of both economics and government policy-making is ending the business cycle. Actually, let me clarify. It is to eliminate the “bust” portion of the business cycle. Who does not like a boom after all? Booms are like attending weddings with open bars.

But let us return to the dreams of those hoping to make recessions a thing of the past. Somewhat ironically, the greatest hope on this front has occurred when the economy has been poised at the edge of great financial precipices. On the eve of the great stock market crash of 1929, noted economist of his day, Irving Fisher, proclaimed, “stocks have reached what looks like a permanently high plateau." I suppose from ground level, cliffs can occasionally be mistaken for plateaus.

As recently as 2007, Fed and Treasury officials were confident that economic fundamentals were “sound” and future growth prospects looked bright. Once cracks began to emerge in the very foundations of the world economic order, these same officials offered assurances that the government stood ready to act in a way to minimize any slowing of the economy. Now that a full-blown economic catastrophe is upon us, we are promised that ultimately trillions of dollars with be spent in a herculean effort by the government to revive the economy. Moreover, it is taken for granted that such action is necessary given the circumstances. Balderdash!

While I am skeptical that there will ever be an end to the boom-bust cycle inherent in market economies, of this I am certain: A bust cannot be avoided after the most pronounced and unsustainable boom the US economy has ever seen. Marc Faber likens the need for a recession to the human body needing sleep. In an expansive phase of an economic cycle all kinds of frenetic activity and growth takes place. In this euphoric time, companies expand business operations, consumers buy more goods, and everyone takes on more debt. But just as the body needs its time of inactivity and rest, so economies need times of contraction to purge excesses and repair balance sheets.

To push this analogy further, it is possible for the body to stay awake longer than is natural. Initially this can be done by sheer will power. Eventually artificial stimulants are required. Being an inveterate crammer throughout college and grad/law school, I recall the drill quite vividly. Determination was enough through about 2:00 a.m. A candy bar could take me through 3:00 a.m. at which point I started brewing coffee. By 4:00 a.m. I was double-fisting Mountain Dew. Anything beyond 6:00 a.m. and I was looking for a Red Bull IV drip. The later I pushed my body to stay awake, the worse the repercussions. After one grueling 38 hour stint without sleep, I did not stir for 14 hours. It took me a week to feel like myself.

So it is with the economy. Yet the Fed has for years been artificially stimulating the economy through below-market overnight interest rates (see blogs below). This is the economic equivalent of mainlining NoDoz. It should be no surprise that our economy soared to heights not previously achieved. But just as there is a law of diminishing returns when it comes to taking stimulants to stay awake, the current zero-interest rate environment appears to be doing little to revive our economy that has already begun to slumber.

By preventing a serious recession at all costs in the futile attempt at staving off inevitable, and painful, economic adjustments the economy must make (reducing debt and consumption), the government simply prolongs and intensifies the pain. Moreover, thanks to its massive non-market based intervention in the economy, it reduces the overall net wealth of the nation by untold billions. It is truly execrable.

3. The government’s solution to drunkenness? More alcohol! Listening to politicians, pundits and policy advisors alike, the one message that gets through is the need to “stimulate” the economy so we can get back to the business of our nation. What is that business? Why, it is getting the consumer confident enough again to consume! It is getting the banks stable enough to resume loaning money. And above all, it is getting everyone, individuals and businesses alike, secure enough about the future to start borrowing again. We are constantly bombarded with talk of the “credit crunch.” The solution, taken for granted by one and all, is to inject hundreds of billions of dollars into the banking system to make credit easier for all to obtain. Indeed, a particularly important and popular element of the of the stimulus plan passed last week are tax incentives and rebates for first time home-buyers as well as new car purchasers.

Am I the only one that thinks this entire plan will not just be ineffectual, but counter-productive? Just prior to the financial crisis, household debt relative to income soared to unprecedented levels, while at the same time net personal saving in the US went below zero for the first time in 80 years! Consumption as a percentage of the overall economy reached 70%, far exceeding its historical norm. The ratio of household debt to assets had soared more than 50% in less than a decade. According to a recent research report by Merrill Lynch, overall private sector debt exceeded $15 trillion by the end of 2007, reaching a new high even as a percentage of national income.

In the brief period of time since the financial crisis started, 10% of mortgage borrowers are either behind on their payments, or in a state of foreclosure (and indeed the new administration is proposing a $50 billion plan in an effort to arrest further foreclosures). And while savings rates have climbed to a paltry 2% of national income, this is almost 85% lower than the level it was at the beginning of the 80’s.

So let me get this straight, the uniform consensus on Capitol Hill is that the solution to the financial crisis is to do everything possible to encourage further consumption and borrowing? Does it even make sense to anyone that long-lasting economic growth can be achieved by consuming more and more consumer goods that eventually depreciate in value to zero? Or borrowing ad infinitum? As I have argued before, whether we are talking at the household or macroeconomic level, I have never heard of spending one’s way into prosperity. Nor can one borrow their way to riches (at least riches that will not have to be paid back with interest).

Real economic strength is based upon savings and investment, not borrowing and consumption. More than anything else, we need to encourage Americans to rebuild their balance sheets, eliminate debt and set aside money that can be invested. This is in the long-term best interests of the US.

But far from encouraging and fostering this transition, policy-makers are adamant in their efforts to eliminate the short-term pain that inevitably comes with such a paradigm shift for our economy. In so doing, I am convinced they will retard the very processes already naturally and necessarily at work in the economy.

Adam Smith had it right. This is obviously a sprawling, dissertation-worthy topic, and I have not done justice to any of the points above. But I will attempt to sum up my simple-minded perspectives.

Whether it has been from my closest and smartest friends, or new friends that know how to replace a car battery, I often get questioned about the “savings paradox.” This is the concept that during economic crises individuals who look out for their best interests by saving more actually do harm to the economy as a whole, and hence ultimately themselves, since they are not spending as much. And once this behavior is replicated, the economic damage spreads.

My response: By saving money you are actually helping the economy make what will inevitably be a painful, but necessary, transition towards sustainable growth. This process would occur naturally, thanks to the “invisible hand” at work in the marketplace. But allowing this process to unfold in the least destructive manner possible would require courage, and lots of it. Americans must be courageous enough to suffer through a painful period of economic dislocation. Moreover, courageous politicians must emerge to tell Americans what they need to hear, not what they want to hear. Sadly, courage appears to be in short supply, and no where is this more evident that in DC.

So the main danger is that in a desperate attempt to prevent exactly the contraction process the economy needs to purge the excesses that have built up as a result of a rampant and malignant credit bubble, the government will waste hundreds of billions of dollars and prolong the recession/depression.

This is not to say that the government should stand idly by and allow the effects of economic dislocation ravage the members of society already living at the margin. But that discussion, along with the ways in which the current government policies violate basic tenets of social justice, will have to wait until next week.

Portfolio Reclamations Project

"We haven't the money, so we have to think"
-Lord Rutherford


Times change so very quickly. Fifteen months ago the US stock market was scaling new all-time peaks. Unemployment was comfortably under 5%. Consumer confidence was near six year highs. Goldman Sachs was paying its average employee in excess of $660,000 a year. Banks were, well, solvent. Home prices in my region (Seattle) were very close to their all-time highs. In short, life was good. People were feeling ebullient, at least when it came to the economy.

Fast forward to the present. The overall stock market is down almost 45%. Unemployment is over 7% with many (myself included) thinking it is headed towards 9%. Consumer confidence readings are at record lows (and they have been charted since before I was born!) Home prices have declined between 20-25% nationally, with some markets being savaged even more brutally. Hundreds of billions of dollars have been needed to prop up a banking system that would otherwise be insolvent. On Monday of last week alone, IBM, Texas Instruments, Pfizer, Sprint, Phillips, Home Depot, Caterpillar and ING announced layoffs totaling over 50,000. Here in Seattle, Boeing, Starbucks and (gasp!) Microsoft have all announced layoffs as well.

Even the poor suffering souls at Goldman have had to tighten their Italian belts and figure out a way to get by on average salaries that barely exceed $360,000. Oh, the horror! By the way, we the taxpayers paid for about 91% of those salaries thanks to the $10 billion bailout package the former investment bank received from Uncle Sam (find your happy place Mark, find your happy place)!!!

I do not bring up these sobering statistics to boost the sales of anti-depressants. Rather, given the regular influx of inquiries I receive from people about what in the world one should do in this catastrophic economic climate, I am breaking with my general policy to avoid providing specific investment advice. These are very dire times. Individuals in this country have collectively lost trillions of dollars, largely based upon the actions and recommendations by the very financial service professionals that either directly caused the present crisis, or failed to see it coming.

Let me provide a few provisos and one general observation before proceeding. First, each household has unique financial needs. Hence, one should not simply apply these thoughts without first determining what your unique financial circumstances are, and which of these investment ideas are appropriate for you and your household.

Second, as an investor I simply try to find assets that in my estimation have the best risk-reward profile. But there is no investment of which I am aware that has no risk in the long-term (including US Treasury bonds). And usually the investments that offer the greatest opportunity for reward carry some of the largest risks. Hence do not take any of these thoughts to be the equivalent of "sure things."

Third, I believe in long-term investing. This means I am using at least a ten-year horizon. I do not attempt to divine the direction of any asset class in the short-term. Indeed, I am probably the world's worst market timer. I am used to purchasing assets and seeing them decline in value for months, and in some instances years. So there is a real possibility that even if some of these ideas are successful in the long-term, one may see ongoing short-term losses.

As for the general observation - act defensively when it comes to financial matters. If given the opportunity, savings should be favored over spending (even more than would be the case in normal economic times). Debt reduction should be one's highest priority (particularly consumer and other high interest debt). The main reason for the economic crisis we are in is debt (see blogs below). There are those (whose glasses are generally roseate) who think that we will see the economy come roaring back to life sometime this year. I do not fall in that camp. The problems we face economically are systemic and chronic. While assets markets may rebound significantly in the short-term as news becomes "less bad" (again, I am not the person to ask), there is not any easy fix for our broken economy.

So, in light of all of that, the investments I like:

Treasury Inflation Protected Securities (TIPS). Never heard of them? Well do not feel bad, you are not alone. In essence, these are US Treasury bonds (considered by many to be the safest investment in the world) that pay two types of interest. The first is a base amount that is guaranteed to be paid every year. It is typically quite small, a handful of percentage points. Not very exciting or interesting so far. But the second is based upon what the Consumer Price Index is each year. So in effect, you receive back your money, plus the rate of inflation, AND the base interest rate. In times where preservation of capital is paramount, I can think of no better place to have money parked where it is both secure, and is assured of providing positive after-inflation returns (the only returns that should matter for any investor).

Gold. I know gold is neither considered a traditional asset class, nor is it recommended by the vast majority of investment professionals. It is after all, a "non-performing asset." It is not like investing in a business, where one can at least hope for/expect revenue growth. Nope. Gold just sits there. But that is sort of the point. You see gold will buy you roughly the same amount of food and other basic necessities as it did back in the times of Christ. There is not much gold. The entire world's supply of gold would occupy a cube 60 feet by 60 feet by 60 feet (granted it would weigh 160,000 tons). It is a storehouse of value. And in today's environment, where "Helicopter Ben" Bernanke (see below Looking Ahead to 2009) promises to litter the landscape with increasingly worthless dollar bills, having a tangible storehouse of value whose supply is not subject to any electronic printing presses is a nice thing. Furthermore, it is one of the few assets that is not someone else's liability. Other tangible assets potentially worth having some interests in are silver, platinum and oil, along with those companies that dig the stuff up.

High Quality Stocks. Now this is not a recommendation that I expect will yield the kind of returns to which people have grown accustomed. Again, I am pretty bearish on the future state of the US economy. And if the economy is not zipping along, it is hard for corporations, and their stock prices, to excel. Having said that, I think there is some upside, and not a ton of downside, in stocks that meet at least four of the following five criteria: 1) have little to no debt; 2) pay solid dividends; 3) are "wide moat" businesses (dominate an industry or area of business in such a way so as to make entry by competitors difficult, if not impossible); 4) trade at very cheap valuation multiples (such as price-to-earnings, price-to-book, price-to-cash flow); and 5) are not in the financial services industry. Frankly, there are not a lot of those companies around (although I understand one of them has some campus in Redmond).

As for investments to be avoided:

Residential Real Estate. I do not expect houses to be a good investment as an asset class for the rest of my life. Seriously. My favorite question I posed to housing market bulls during the heady earlier years of this decade was: For the 105 years prior to 1997, what was the average annual after-inflation returns for residential real estate in the US? I typically had guesses as low as 5%, and as high as 10%, or even 15%. The answer: -.5%. That is not a typo (forgive the others). Houses, as an investment, did not even keep pace with inflation for over a century. And when one thinks about it, this should not be surprising. Like gold, a home is a non-performing asset. Unlike gold, it actually falls into a state of disrepair over time. Roofs must be replaced, paint reapplied, pipes fixed, etc., etc. I always encourage people to view their home as a way of avoiding paying rent, not as an asset likely to intrinsically appreciate beyond the cost of living. Unlike stocks, I will be shocked if housing prices rebound in the near term. In addition to all the bad news regarding prices well known by one and all, the following should be a sobering fact for those expecting an imminent upturn in the housing market: according to the Census Bureau, a record 19 million homes were uninhabited at the end of 2008. Think we might have some more over-supply to work through?

Long-Term Treasury Bonds. I have already written about the basis for thinking these are terrible investments below (see Looking Ahead to 2009), so I will not rehash. Suffice it to say that since I wrote that blog, long-term treasury bonds have declined in excess of 15% in value. There should be considerable downside yet to come.

US Financial Institutions. This is the call that has the biggest chance of going awry. Indeed, the wise, hoary Warren Buffet is on the opposite side of the trade with me on this one. The argument for investing in these companies is two-fold: 1) they have been absolutely bludgeoned senseless, and have to be cheap at these levels; and 2) the big ones now have the express backing of the US Government, and are thus not going under. As a deep contrarian, I am quite sympathetic to the first point. And I do not rule out the possibility that there are well-run banks out there that have been taken to the woodshed and smacked silly by the market along with all the culpable/incompetent financial institutions. But as a whole, I still think the risks for the sector exceed the potential rewards. As a nation, we are still choking on debt. Banking bulls pin some of their hopes on the scuttlebutt concerning the creation of a US "Bad Bank" that would pool all or many of the toxic assets held by US banks and transfer the losses to . . . (any guesses?) the US taxpayer. Well, in addition to being yet another "Bad Idea" that has come from DC in its handling of this financial crisis, I do not think that will be enough. As long as the housing market languishes (and we know my thoughts on that), more impaired assets will find themselves on the balance sheets of many US banks. And while bondholders get bailed out when the US government takes over a failed bank, the stockholders generally do not.

There you have it. As things stand now, you could do a lot worse than simply squirreling money away in a low-interest bearing account. And again, I think being cautious and defensive at this time makes a great deal of sense. Nevertheless, there are always opportunities to judiciously put money to work.

In an effort to address the specific interests and concerns of those of you who follow these periodically penned meandering thoughts, please feel free to pass along any question, comments or suggestions.

From Whence We Came Part II

"I don't have to tell you things are bad. Everybody knows things are bad. It's a depression. Everybody's . . . scared of losing their job. The dollar buys a nickel's work, banks are going bust, . . . and there's nobody anywhere who seems to know what to do, and there's no end to it."


Any guesses as to where the quote above is from? Perhaps an Op-Ed piece in the New York Times last week? Maybe some talking head on This Week's roundtable discussion last Sunday? A recent speech by some politician criticizing the manner in which the financial crisis has been handled?

Nope. None of the above. This is from an on-air monologue/rant delivered by the newscaster Howard Beale in the acclaimed 1976 movie Network (a fine flick if you have not already seen it). One of the reasons why the movie won four Oscars, including best screenplay, is that it adroitly captured the Zeitgeist of the mid-70's in the US. I am old enough to remember the era (although I was admittedly more concerned with cartoons, baseball cards and comic books than unemployment, inflation and poor stock market returns). Times were tough. Jobs were hard to come by. People worried about the future. What little extra money that did come into a household was oftentimes saved for an even rainier day.

Why dredge up a quote from a movie that is over thirty years old? To highlight the fact that up until about twenty years ago it was taken as a fact, albeit a sad one, that economies regularly experience busts. Accordingly, people acted a lot more responsibly, more cautiously, when it came to matters of personal finance. Debt was taken on only when necessary, and was paid off promptly. There was more fear about insolvency and potential unemployment, and less greed. Stocks were viewed as assets whose value could just as easily decline substantially as they could rise to the sky.

But something began to change, at first subtly and almost imperceptibly. I put the genesis of this around 1988. By then the economy had grown without interruption for six straight years. Perhaps even more importantly, the stock market had gone up dramatically since bottoming out in 1981. And despite "crashing" in October of 1987, it had already scaled new highs just months later. Indeed, people who panicked and sold were about 25-35% poorer than those who kept their heads and stuck it out. By this time communism had also been handily defeated. America was now the world hegemonic power, both militarily and, to a large degree, economically.

The movie Wall Street had also been released the previous year. The angst and despair of Howard Beale was replaced by the uber-confident and audacious Gordon Gekko. Fear? Doubt? Caution? No, no, no. Conquest, acquisition, and, above all, greed. Mr. Gekko, with all of his consumate charm and demure nature, made the case that "greed is good." This began to resonate with the masses, and became a new sign of the times.

For the next 20 years people were actually rewarded for "bad" behavior in the economy. Debt was not even called debt. It was "leverage." And the prevailing wisdom was that assets (which were taken for granted would appreciate) must be leveraged for maximum return. I mean even a society like ours in which 8th grade math skills are the norm could figure out the arithmetic. $1000 invested in an asset that increases 10% yields a $100 return after one year. The same asset using one's own $1000 plus $1000 of borrowed money yields $200. And with $9000 borrowed, the original $1000 of your own would fetch $1000 profit (minus interest on the borrowed money).

With banks and all forms of financial institutions being deregulated (see "From Whence We Came Part I below), and interests rates falling throughout this time, borrowing money was never easier, or cheaper. Remarkably, there were virtually no consequences for "bad" behavior on the part of corporations or individuals. The nervous Nellies, their portfolios comprising 60% bonds and living in apartments until they could scrape together a 20% down payment for a home, were left in the financial dust by those who bought their stocks on margin and their houses with little to nothing down.

Oh sure, there were minor hiccups along the way. Some regions experienced short-lived slumps, and there were two very shallow recessions in 92 and 2001. But even the tech crash of 2000 did not cause much of a stir; for most Americans, whatever losses they suffered in the stock market were more than offset by gains in the home prices.

And for this 20 year neo-gilded age, one man towered above all others in esteem and respect: Alan Greenspan, or the "Maestro" as Bob Woodward prefers to call him. Whenever the economy began to hit sour notes, the Maestro was there, baton in hand, to get it in tune once again. Shrewd and smart people on both Wall Street and Main Street began to take their cues from the respected economist turned central banker. He believed in confidence above all else. And he never met a bubble he did not love. People realized that here was the most powerful man in the world (really) prepared to do their bidding to keep the economy zooming along.

Hence the term "Greenspan put" entered the financial lexicon. A put is a particular type of option that pays off only if an asset goes down in value. The concept was that should any significant asset in the economy (homes and stocks being the two most important) go down in value, Greenspan would be there lowering interest rates to whatever level necessary to stimulate borrowing and spending enough to get the economy growing again. Hence asset prices would return to their previous levels and keep going higher. That was the theory at least.

In this environment, fear was seen less frequently than investment bankers dining at McDonald's. Money had never been easier to make. With interest rates cut to levels below inflation for a good portion of the new millennium, leverage increased to levels heretofore never seen. Greed was ever more pervasive.

Bob Woodward's moniker for Mr. Greenspan was indeed apropos, but for a reason not contemplated by the revered journalist/author. In reality, the Maestro was conducting a national symphony serving as the source of a grand game of financial musical chairs. As long as Greenspan could his orchestra playing ad infinitum, the party would continue.

But alas, just as no musician can play without rest, and no reveler can imbibe forever, neither can any economy pile on ever mounting debt without it eventually choking. And that, dear reader, is where we find ourselves presently.

And it will have to be next time (sorry Matt), that I take up the savings paradox. Simply put, it is the fact that when individuals do the right thing in a bad economy (save more, spend less), it actually further weakens the economy, and thus all the individuals who are acting in their own best interests.

My So-Called Life (as a Contrarian)

Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference

Robert Frost


Life is hard enough. But some of us seem to magnify its difficulty in a variety of ways. Me? I have held views about the markets and the economy that were/are not only in the minority, they were/are deeply unpopular. Being a contrarian inherently means that a (usually vast) majority of other people think you are stupid. As if that were not bad enough, when you are a contrarian during good economic times (and particularly economic bubbles), people can actually be hostile to the content of what one has to say.

Accordingly, I am used to being a social pariah by now. During the late 90's through the turn of the millennium I would attend a variety of casual parties and social events. While most people would prattle on excitedly about XYZ.com and the dramatic gains they were realizing, I would be the dour-faced attendee warning people of a crash that was quite likely in the offing.

Flash forward five years. The same cocktail parties and the like. Now it is ebullient discourse concerning the real estate market. Oh, the glory of zero-down payments, retirement homes, vacation properties, remodeling, buying up, flipping, etc. It was all so intoxicating. Money had never been so easy to make (and the quantity of cash-out home-equity loans evidenced that). But morose Mark was there trying to take away the punch bowl, worrying about such inconvenient things as household indebtedness, variable-rate mortgages readjusting at higher levels, unsustainable price gains, and overinvestment in residential housing. It was the social kiss of death. Indeed, one woman stopped seeing me after we had a tiff over whether her planned condo purchase would be a good investment.

But this social phenomenon actually speaks to a very important investment principle - one must not let emotion cloud analysis and judgment when it comes to investing. I think it is a basic tendency in most human beings to be generally optimistic. I actually view myself to be of this ilk. Accordingly, when presented with the same bullish drivel that has been rife in the financial and popular media for roughly the last 20 years, or analysis that warns of bad economic tidings, it is more comfortable to focus on the former and write off the latter.

Great investors simply perform risk/reward analysis. It is very similar to seeing somebody with an umbrella under there arm on a cloudy, yet presently dry, day in Seattle. It is safe to say that the typical person in that situation is not hoping it will rain. Rather, it is more likely that the person checked the forecast and discovered that rain was likely.

Similarly, I cannot imagine any investor that actually hopes for an economic crisis such as one we find ourselves in today. After all, it is far easier to make money when asset prices are increasing. However, if rigorous analysis indicates such a crisis is coming, it is simple prudence to manage one's portfolio in a manner so as to profit from such an event (or at least lose as little money as possible).

I bring all of this up because I remain convinced that the only was an investor is able to achieve exceptional returns is by being a contrarian during times of extreme optimism or pessimism. Indeed, I look forward to the day when not only is there caution in the marketplace, but something more akin to revulsion (a point I do not believe we have yet reached). From a long-term investing perspective, that will be a great time to be a bull.