“This notion that great misadventures are the work of great and devious adventurers, and the latter can and must be found if we are to be saved, is a popular one of our time. Since the search for the architect of the Wall Street debacle, we have had a hue and cry for the man who let the Russians into Western Europe, the man who lost China, and the man who thwarted MacArthur in Korea. While this may be a harmless avocation, it does not suggest an especially good view of historical processes. No one was responsible for the great Wall Street Crash. No one engineered the speculation that preceded it. Both were the product of the free choice and decisions of thousands of individuals. The latter were not led to the slaughter. They were impelled to it by the seminal lunacy which has always seized people who are seized in turn with the notion that they can become very rich. There were many Wall Streeters who helped foster this insanity, and some of them will appear among the heroes of these pages. There was none who caused it.”
- From ‘The Great Crash: 1929’ by John Kenneth Galbraith
“Senator Couzens: “Did Goldman Sachs organize the Goldman Sachs Trading Corp. ?”
Mr. Sachs: “Yes, sir.”
Senator Couzens: “And sold its stock to the public ?”
Mr. Sachs: “Yes, sir.”
Senator Couzens: “At what price ?”
Mr. Sachs: “At $104. The stock was split 2-for-1.”
Senator Couzens: “And what is the price of the stock now ?”
Mr. Sachs: “Approximately $1 ¾.””
- From Senate hearings in 1932, and cited in ‘The Great Crash’.
Perhaps the biggest mistake Goldman Sachs (GS) ever made – other than launching its eponymous investment trust in 1929 – was its decision to go public in 1999. That enabled the former partnership to retain employees otherwise then being enticed by the prospect of dotcom riches, by means of share options and restricted stock. But it also turned a tightly focused private partnership into a public company. That involves a loss of independence. And as Chris Dillow recently suggested in a Times article (“Why aren’t hedge funds failing as fast as banks ?”), the current crisis is as much one of ownership as of finance.
It is not markets that have failed, but a peculiar form of ownership that we have taken for granted for decades – stock market-listed companies with dispersed shareholders.
As Chris points out, the succession of hammer blows to the market this year have come from stock market-quoted companies, not from hedge funds – which, despite the misplaced mudslinging from the more wilfully ignorant members of the financial press, are largely blameless bystanders in this colossal drive-by shooting. That is not to say that hedge funds will be immune to the ferocious deleveraging gale blowing wildly round the world, not least as the implosion of investment banks and reining in of credit provision may prove terminal to more highly leveraged strategies and funds. But in Chris’ opinion (which I very much share), the principal-agent problem is at the heart of the crisis:
Big, quoted companies have been unable to solve this problem. Shareholders – often, ordinary people with pensions – have little control over fund managers. Fund managers have little control over chief executives. And chief executives have had little control over trading desks, partly because they just didn’t understand the complexities of mortgage derivatives.. In hedge funds [for example] things have been very different. Very often hedge fund managers invest their own money and take key decisions themselves, or at least closely watch those who do. Their incentives to take huge risks have been smaller. So these have at least survived [in general].. What we’re seeing, then, is the cost of separating ownership and control. In private firms, or partnerships – even limited liability ones – the two are closely aligned. In stock market-quoted firms, they are not.
Maybe Goldman Sachs (which by now seems to have become a placement agency for the US administration) and Morgan Stanley (MS) survive as the last remaining former investment banks. Maybe they don’t. But if they don’t make it through this crisis, expect an orchestra of the world’s smallest violins to play to their demise. The taxpayers of the world are in no mood to indulge the whims of (what’s left of) Wall Street any further.
But the search for scapegoats has to be relegated behind the urgency of shoring up confidence in the financial system. By all accounts the UK’s bailout plan, revealed this week, takes the right tack. It seems increasingly likely that other countries will follow a similar interventionist model. What is needed is coordinated action as opposed to piecemeal band-aid flinging. This weekend’s G7 meeting is an opportunity to prepare such action.
As Redburn Partners point out, the Dow Jones has now racked up the worst 12 month performance since 1932. The MSCI World Index has recorded its worst weekly fall since records began. When does it end ? There have been plenty of false dawns throughout the crisis but the UK rescue plan has ignited a glimmering of light at the end of the tunnel. However, it needs bold and international follow-through.
We will know that the low is in when the market stops going down after being hit by new bad news. For investors with some semblance of a balanced portfolio, it seems late in the day to be capitulating now and fleeing the stock market. Die-hard contrarians would be selectively buying (pharmaceuticals; consumer staples; the more solvent banks; telecoms; utilities). Gold still makes sense. Gilts still make sense in a big way as inflationary pressure subsides and the likelihood of slashed interest rates builds. Taking the longer view, the ‘BRIC’ countries – notwithstanding the likely hit to the global economy over the next few years – are still better positioned to deliver growth; G7 economies will be close to exhaustion for some while yet. “The only thing we have to fear,” says ‘The Onion’s re-imagined 1933 US President in his inaugural address, “is a crippling, decade-long depression”. By all means, have the witch-hunt. But do the triage first.
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This article has 13 comments:
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User 270430
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54 Comments
Oct 10 11:52 PM-
john s. gordon
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707 Comments
Oct 11 08:37 AM1929 correction was preceded by collapse of agricultural commodities in 1927. the war ravaged economies of europe were finally able to feed their own people. nobody paid attention to the warning.
in 1930 the federal reserve shrank the money supply (dumb idea but keynes had not yet published his book explaining why it wa a dumb idea) and hoobert heever raised taxes because a federal deficit was occurring. it was not yet a depression. then in 1930 the creditanstalt in vienna collapsed & the world depression is on.
clearly hedgie funds if they are permitted to operate at all need to be limited by law to no more than 3/1 leverage.
> jack
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Groundhog
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10 Comments
Oct 11 09:48 AM-
Paul Revere
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4 Comments
Oct 11 10:20 AMFebruary 14, 2008 Washington Post
Several years ago, state attorneys general and others involved in consumer protection began to notice a marked increase in a range of predatory lending practices by mortgage lenders. Some were misrepresenting the terms of loans, making loans without regard to consumers' ability to repay, making loans with deceptive "teaser" rates that later ballooned astronomically, packing loans with undisclosed charges and fees, or even paying illegal kickbacks. These and other practices, we noticed, were having a devastating effect on home buyers. In addition, the widespread nature of these practices, if left unchecked, threatened our financial markets.
Even though predatory lending was becoming a national problem, the Bush administration looked the other way and did nothing to protect American homeowners. In fact, the government chose instead to align itself with the banks that were victimizing consumers.
Predatory lending was widely understood to present a looming national crisis. This threat was so clear that as New York attorney general, I joined with colleagues in the other 49 states in attempting to fill the void left by the federal government. Individually, and together, state attorneys general of both parties brought litigation or entered into settlements with many subprime lenders that were engaged in predatory lending practices. Several state legislatures, including New York's, enacted laws aimed at curbing such practices.
What did the Bush administration do in response? Did it reverse course and decide to take action to halt this burgeoning scourge? As Americans are now painfully aware, with hundreds of thousands of homeowners facing foreclosure and our markets reeling, the answer is a resounding no.
Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye.
Let me explain: The administration accomplished this feat through an obscure federal agency called the Office of the Comptroller of the Currency (OCC). The OCC has been in existence since the Civil War. Its mission is to ensure the fiscal soundness of national banks. For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.
In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government's actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.
But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation.
Throughout our battles with the OCC and the banks, the mantra of the banks and their defenders was that efforts to curb predatory lending would deny access to credit to the very consumers the states were trying to protect. But the curbs we sought on predatory and unfair lending would have in no way jeopardized access to the legitimate credit market for appropriately priced loans. Instead, they would have stopped the scourge of predatory lending practices that have resulted in countless thousands of consumers losing their homes and put our economy in a precarious position.
When history tells the story of the subprime lending crisis and recounts its devastating effects on the lives of so many innocent homeowners, the Bush administration will not be judged favorably. The tale is still unfolding, but when the dust settles, it will be judged as a willing accomplice to the lenders who went to any lengths in their quest for profits. So willing, in fact, that it used the power of the federal government in an unprecedented assault on state legislatures, as well as on state attorneys general and anyone else on the side of consumers."
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Danny L. Newton
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47 Comments
My Website
Oct 11 11:12 AM-
pockyclips 2020
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154 Comments
Oct 11 11:35 AMThe witch hunts are necessary because the witches keep getting away with it. Ever since the '87 Crash, Fed intervention has prevented the market forces from regaining balance, encouraging the witches to keep taking bigger risks. Sad as it may be, bloodletting may be the best cure.
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notsosmart
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1251 Comments
Oct 11 11:42 AM-
Roy M.
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355 Comments
Oct 11 01:13 PM-
getlost
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4 Comments
Oct 11 04:54 PM-
SB-tiger
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76 Comments
Oct 11 07:24 PMEveryone is to blame - Home buyers, lenders, securitizers (Wall Street), rating agencies (major culprit), Fonie/Fraudie (a Ponzi scheme), Congress (promoting housing – we are not a socialist country).
* Rating agencies must be disbanded
* Fonie/Fraudie –already are in conservatorship – but still continue the dubious “mission”
* Wall Street – the ill gotten bonuses must be clawed back – what they did was accounting fraud. Paulson- he got away with $ 600Mi.
* Congress – vote these fools out – replace them with a new set of fools
* Regulators – Fed/SEC/FDIC – first sleeping at the switch, then lying under oath “All is well” – heads must roll.
Take the first step vote your Congressman out.
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Roy M.
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355 Comments
Oct 12 01:27 AM-
woodsey
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146 Comments
Oct 12 01:57 AM-
Jimmy Lathrop
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269 Comments
My Website
Oct 12 11:14 AMListen, if you overleveraged your house, you gambled and lost. Lo siento.
If you were a hedge fund or money manager and you leveraged yourself out on commodity plays, and got killed with margin calls and forced selloffs of your holdings because your clients realized you were too risky, you gambled and lost. Lo siento.
If you were close to retirement age and you had your money in stocks when bonds are the more prudent choice, you gambled and lost. Lo siento.
I am neither of the above three. I am a renter. I am not a day trader nor does the market make or break me. I have many moons to go before I retire. More importantly, I don't have Mercedes calling me at work asking me when my next payment will come, and my summer home is not on the market. Because LIKE 99 PERCENT OF AMERICANS I COULDN'T AFFORD EITHER OF THOSE THINGS IN THE FIRST PLACE.
Witch hunt? Blame game? As forced selling causes overpriced stocks to fall to normal P/E levels, indeed, overshoot into single digit P/E levels, I just want to know whose hand I need to shake! Lo siento.