Sunday, April 19, 2009

Boom and Bust



My good friend John Wander and I debated the causes of the current mess among financial institutions. He kicked it off by sending me a link to an editorial that contrasted bubbles past (railroads, internet) with today's credit crunch. You will notice my snotty tone in the correspondence. Maybe that had something to do with the half million dollars I lost in the markets (and by the way, the fact that I outperformed the markets was skinny solace). Anyway, I was grumpy.

Me: He's a ninny in this article. The contrast is very weak. The parallel is very strong. The burstings of the railroad and internet bubbles were associated with excess capacity in railroads and bandwidth. The bursting of the housing bubble is associated with excess capacity in housing. Exactly the same. He tosses off the parallel offhandedly by suggesting that the excess in housing is condos in Florida that "should never have been built". He implies that the current bust is different, worse, more evil, because it did not relate to the creation of useful assets. But a condo in Florida can be quite useful. In their day, you could find a lot of railroads and optical fiber networks that "should never have been built" too. So, in conclusion, stupid. Journalism is in a pitiful state.

He: Do think that housing's not the problem, nor subprime, nor greed? We need to take the inflation out of many markets and I'm not sure how easy that is. If an $8 loan on a $10 house generates $40 in credits through structured products and a $10 or 11 loan on the same house does the same the rising tide will lift all boats until at one point no one's afloat.

Me: The problem is the proliferation of mortgage loans that were undersecured and made to borrowers who could not afford them. Freddy and Fannie made many of these loans and encouraged the making of many more. You can call much of this phenomenon "subprime." Why do you think that happened? I know why. Do you?

Greed is not a "problem" in the financial markets or in any business. Greed is a very common vice. Any system that does not function well in the presence of much greed is perverse. For greed, the cobbler wants to raise his prices. For greed, the banker wants to raise interest rates. Most businesses make exactly as much as they can. Most businesses are not subsidized by Freddie or Fannie. Most businesses do not enjoy federal guaranties of their debtors' debts. By the way, your hypothetical "an $8 loan on a $10 house generates $40 in credits..." never happened, and nothing like it ever happened in the US mortgage market.

He: I don't think it was those loans alone, and I thought a lot of them were written to enable mortgage brokers to get paid up-front origination fees with little concern as to whether they'd be paid, and bankers to insure them with derivative products. I'd be interested to know why you think it happened. I've seen figures suggesting the sub-prime tranche of bank portfolios insufficient to bring them to their knees, though the derivative backwash gamed their asset ratios. Of course greed (a vice) is not a problem but it's a word bandied about by candidates and congressmen, incorrectly attributing the blame, which ensures the solution will be wrong. The way the political decision to encourage home ownership gamed the market. What I meant by the $10 to $40 figure, based on interviewing bankers who dealt in swaps, cdo's, cmo's, cds's is that an initial fixed-rate loan could be swapped with a variable one, packaged before or after into a CMO, that was then protected by a CDS. This enabled banks to maintain 'assets' that weren't assets, all based on a shaky initial instrument, whose failure multiplied its way through the system.

Me: Ultimately the bad assets currently coming home to roost are indeed the mortgage loans. (Credit card debt and car loans, also securitized, may be next; because much consumer debt was supported by cash from second mortgages and refinancings of home loans.) Banks and non-bank mortgage companies typically get origination fees. Nothing wrong with that. But why did they have little concern as to whether they would be paid? -Because they sold the loans to other institutions who had little concern or who could get them guarantied by other institutions who had little concern.

By dollar volume, by far, the biggest buyers and guarantors of bad mortgage loans were Fannie and Freddie. That outlet for risk (that vast moral hazard) quite simply caused the current problems. Full stop. It provided a large, strong incentive to gin-up liquidity for these loans. The liquidity came in part from securitization. In other words, selling securities that were backed by mortgage obligations. Some of these securities were also guarantied by Fannie and Freddie. Some were guarantied by AIG. But importantly, securitization is just a way to raise more cash to make more loans that could then be sold on to Fannie or Freddie or guarantied by Fannie or Freddie.

Meanwhile, there was of course an asset price bubble in real estate. That bubble helped banks and other mortgage lenders make loans that appeared to be sufficiently secured but weren't. It also promoted expansive consumer debt in the form of second mortgages, mortgage-backed credit cards, and mortgage-backed lines of credit.

The unwashed masses were parading around saying things like, "ya gotta unlock the equity in your home." In my neighborhood, these stupid jerks were zipping by me in their new BMWs. Little education and lousy jobs. In fact, a lot of them were manning the phones in boiler rooms dedicated to selling second mortgages to other jerks who couldn't afford their debts or their expenses. Now the Republican president and Democratic congress want me to bail those guys out.

Let 'em shine my goddamned shoes.

The rest of what I said was unprintable, so I'll stop there. My main point is that, despite the apparent complexity of securitization, credit swaps, options, and other derivative securities, the root of the problem is clear--lenders did exactly what the U.S. government and its monstrous public-private chartered bastards (Freddy and Fannie) asked them to do and encouraged them to do and payed them to do. I don't much blame them. I blame both the government and the borrowers who took out unaffordable loans just because they could.


Thursday, April 02, 2009

Living In The Age of Porcelain and Skateboarding

"No grown-up hierarchy." "No ambition." "No responsibility." "The new super-prosperity." "Forty-something is the new eight." For a couple of years these words and ideas have been tugging at a loose thread in the fabric of my mind. They are part of a phenomenon that I'm trying to identify.

I and most of my friends don't feel like real adults. In our forties now, we still feel like impostors, children in adult bodies. Indeed, even some of the adult bodies are looking pretty youthful, having avoided hardships and physical labor. Our age is supposed to slow us down. It hasn't happened yet. I'm cycling 200 miles per week, often with state champion bike racers. One of my friends is an amateur bullfighter and a good one. My friend from junior high school, now pushing 50, recently ran the Boston marathon, nearly beating his 25-year-old personal record. But it's our lack of responsibility, not our fitness, that most makes us childlike.

No grown-up hierarchy

Where Los Angeles goes, other cities follow. When I moved to Los Angeles in the mid-80s, I had just spent three years in Boston, a city that I found to be socially regimented. It had college kids and townies and bankers and Brahmins. The hierarchies seemed to have been reliably defined for a long time. It had grown-up industries, like insurance and banking. It was a grown-up town.

Los Angeles was different. I worked downtown in a big law firm. I lived downtown. My law firm had plenty of serious business to work on -- billion-dollar deals. And yet it had nothing at all to do with what many Angelinos think their town is all about: "the industry." You had to go to the west side for that. Many people living on the west side of Los Angeles never went downtown, ever. They didn't even know what happened downtown. From the Hollywood perspective, I didn't really live in L.A. Plenty of other industries had nothing to do with "the industry" -- computer businesses, small manufacturing, the garment district, Korea town. Even on the fringes of the movie industry, many of the participants didn't give a fig for the industry hierarchy.

Think about the hierarchies of earlier generations. When I was a child in age, not just in mind and spirit, a successful adult man was probably a "company man." I never saw any of those in Los Angeles.

In L.A., nobody rules the roost. I like that. There are so many hierarchies running in parallel that there may as well be no hierarchy at all. Los Angeles is a city that heeds the hippie directive: do your own thing! Of course most people end up doing things that the hippies would not have approved of.

No ambition

One of my law firm's clients was a very young business man, a boy really. A few years before I met this fellow, his father was at wit's end. The boy had no ambition and no job. To inspire the boy, his father bought a little bottling plant. I think it was somewhere in or near New York. The boy began to bottle and brand alternatives to popular sugary, sweet, carbonated beverages. His beverages too were sugary, sweet, and carbonated, and they were called, "Original New York Seltzer." Dad, who used to be in the beer business, helped with distribution. The brand took off. After capturing close to five percent of the soda pop market nationwide, father and son sold the business for several tens of millions of dollars. The boy threw a huge party with his pet mountain lion on display along with a busload of breast-enhanced female humans.

But the phenomenon that I'm trying to identify goes well beyond what I saw in Los Angeles in the late eighties. It involves dropping out more convincingly. I believe that a certain meaningful minority of the U.S. population has realized, consciously or not, that work (at least serious, staid, consistent work) is no longer necessary. I myself became one of those people in the most cowardly and backward way: I worked diligently until I had enough to retire early. I still get honors for being a half-assed slacker, because I was never a careerist or company man, and when I thought I had enough to retire, I retired. Without some slacker bones in your body, you would just keep working and spending more or saving more.

Along the way, before retiring, I took baby steps towards this new slacker attitude. After law school, I dramatically and irresponsibly changed jobs two or three times, badly injuring my career. The wounds to my career were real enough. Unlike so many of my classmates, I did not become a partner in a big law firm. I expected the wounds to affect my prosperity too, but they never did. I prospered. In the short run, I prospered more than they. And then I just stopped. I cashed in my chips. I had enough prosperity to try something else.

No Responsibility

My generation takes comfort for granted. We didn't get drafted. We didn't go to war. We didn't have an economic depression. We didn't have civil war. We didn't have a revolution or a plague. Many of us didn't get married or have children. I don't even have a mortgage or a dog. This lack of responsibility combined with prosperity leaves us free to ponder deeper things such as what movie to rent tonight.

Forty-something is the new eight

Here's an idea: given the opportunity to persist in childhood, most folks will do just that. More and more people are living in a perpetual childhood. They don't knuckle down. They goof off. They develop deep hobbies. My and my wife's closest friends are: an under-employed actress, an unemployed former schoolteacher, a bullfighting instructor, and a law professor -- all middle-aged, all goofing off (no, "law professor" is not a real job). That's why I say, "forty-something is the new eight."

Youth need not be wasted on the young. As a boy I spent my time reading, dreaming, riding my bicycle, and playing with my chemistry set. Now, at forty-six, I spend my time reading, writing, dreaming, riding my bicycle, and fermenting wine in my garage.

The new, super-prosperity

In the eighteenth century, John Adams prophesied, "I must study politics and war, that my sons may have the liberty to study mathematics and philosophy, geography, natural history, and naval architecture, navigation, commerce, and agriculture, in order to give their children a right to study painting, poetry, music, architecture, statuary, tapestry and porcelain." We live in the age of porcelain and skateboarding.

There is a lot of prosperity going around. And you don't have to be prosperous to benefit from it. Fool.com says, "Certainly, we have more money to spend. From 1970 to 2000, real household income rose by more than 50%, according to the authors of Trading Up: The New American Luxury. Today, there are 15 million households that take in more than $100,000 a year. Our paychecks and portfolios are fatter than ever, and thanks to mass-manufacturing and merchandising (think Wal-Mart, Kohl's, Circuit City), our everyday necessities can be had at a fraction of what our parents and grandparents paid." http://www.fool.com/news/commentary/2006/commentary06071003.htm.

In simple, material terms, being poor today can include having a car, three televisions, a refrigerator, a DVD player, stereo, and computer. I think that's a symptom of a super-affluent society. As far as I can tell, the trickle-down theory proved out. Our economic freedoms and the energy and innovations that they release have produced so much material wealth that it doesn't just trickle down; it spills over.

If the poor live rich, what does it mean to be rich? Past generations would have accumulated wealth for security, power, and status. Whereas a growing, childish minority of my generation doesn't seek power or status in a conventional hierarchy. And this group of people seems not to worry about security, never having suffered privations.

My brother-in-law has a very young client with a problem. The client is a skate punk. All he ever did was ride his skateboard. Most of the guys in my brother-in-law's firm have a hard time communicating with the skate punk. They are too buttoned-down. They make him nervous. My brother-in-law's profession? Money manager. The skate punk's problem? What to do with the great wealth that he earned by riding his skateboard. To help solve this problem, my brother-in-law has to remove his tie and say "dude" a lot.

My nephew is a good student and a fine young man. Rock and roll is his thing. At 14, he is already making money playing in a band. His parents don't mind. They aren't pushing him to be a doctor or a lawyer. My sister manages his band. I'm convinced he will make a fortune in music. He'll be like the skate punk, just doing what feels good, and the wealth will pour in.

However, you don't have to make any money at all to enjoy the new super-prosperity. My unemployed friend is impecunious and has been for more than a decade. He lives among millionaires in a beautiful cottage a block from the beach in La Jolla, California. There he spends his time wondering where he went wrong and what it's all about and which diet is right for the human organism (macrobiotic? vegetarian? sugar-free? low glycemic index?) and whether his upbringing is the cause of his frequent physical malaises and what to do next, if anything.

I know that some of this high living involves other people's money and resources -- friends and relatives. But the friends and relatives are volunteers. These aren't forced redistributions.

Look at the trends and follow my speculations. How far can this go? In material terms, our poor are richer than everyone in earlier generations except for a wealthy minority. Productivity continues to rise. It takes less and less to earn more and more. Sure a lot of people work long, hard hours, but their motive is more likely to be power and wealth rather than food and shelter.

Does the average, middle-class worker like work that much? What will he do if ten hours of work a week will earn a comfortable living? Will he still work 40 hours? If we get prosperous enough, will many more people drop out? Will they conclude that working hard at jobs they don't like is a bad bargain when the consequences of quitting are so comfortable? Will they work only jobs they like or none at all? Will they take long, frequent sabbaticals?

Prosperity took me too much work and time. I got to be 44 years old. That's 25 years of hard work without goofing off! Well, okay, I did take more than a year off, twice, before retiring. Was I a fool to prosper at all before walking away from the table and cashing in my chips? Perhaps the ambient prosperity is enough. I'm not talking about being on the dole; I'm talking about being a slacker, a layabout, navel-gazing, perpetual student (without, of course, taking any courses).

Classes turned upside down

Is this in fact new? In 1906, William Jennings Bryan complained: "The theory that idleness is more honorable than toil -- that it is more respectable to consume what others have produced than to be a producer of wealth -- has not only robbed society of an enormous sum, but it has created an almost impassable gulf between the leisure classes and those who support them." But then and before, the leisure classes were always the rich and privileged classes. Now most of the rich are the working rich. They have, or give themselves, less leisure than almost anybody else. They work all the time -- in their cars, at their offices, in airports, at home. From them the spill-over economy flows.

These are the new serfs. Our economy feeds on their labor and creativity and risk-taking and taxes. I have seen it close up. The new serfs are the company executives who work longer and harder than their own employees. Thirty years ago, that was not typical. Today, it is the rule in new businesses. In every high-technology company that I know, the bosses are the slaves. And when the labor market is tight, they must coddle their employees just to keep them working 9:00-5:00.

So, many of the exploited masses have become the new leisure class. I admit that most of the new leisure class have some advantages (my description of the world will seem all wrong to some working-class people), but they are not just the wealthy or even mostly the wealthy. That's what's new. It's a middle-class revolt against middle-class values, and it has never happened before. Aristocrats, artists, and intellectuals have done it, but now the successors of the company man are doing it.

The Wikipedia entry for the word, "slacker" includes this: "...but philosophers such as Plato and Aristotle made it clear that the purpose for which the majority of men labored was 'in order that the minority, the elite, might engage in pure exercises of the mind -- art, philosophy, and politics.'" In our upside-down world, the apparent elite work miserably hard so that the enlightened bums of my generation and the next can engage in pure exercises of the mind and body -- writing screenplays, skateboarding, playing guitar, aimless speculation (like this essay), and bicycle races.

Or perhaps these childlike, unambitious people are simply petty and blind to the challenges that could make them more worthy. Perhaps the very opportunity to be a slacker is an illusion, a brief calm before a storm. Maybe war and pandemic and depression loom just over our close horizons.

Or, even if our prosperity and stability continue, maybe man is not made for the age of porcelain and skateboarding. I'm already seeing symptoms of a revolt against slackerdom among the slackers themselves. I feel it in my own heart. Something in me needs an existential challenge. I have apocalyptic dreams, dreams of war and violence. They are euphoric. I feel a sort of allergic reaction to the obvious question: "Is this all there is?" The more I ask myself that question, the more I tend to break out in a rash of crazy ideas -- I'll walk across the entire Indian sub-continent or move to Spain or climb Everest or take LSD or join the CIA or get a job. It's the urge to awaken the inner zombie. It's the next step in societal evolution. And it's the topic of my next essay.