Days of Yesteryear: Newspaper Edition

In high school, I eagerly awaited Sunday's newspaper so I could read syndicated columns by Dave Barry, Mike Royko, Thomas Sowell, and Charles Krauthammer, as well as the Calvin & Hobbes comic strip. I didn't care about anyone's political affiliation. Most writers who made it into the Sunday paper were undeniably authentic and had in-depth personal knowledge. I was interested because each of them cared about the topic discussed and provided relevant research, even if only anecdotal. If any journalist had a chip on his or her shoulder, I couldn't feel it on my ink-stained fingers. I would save articles I loved in my cabinet, a shrine to the many words of wisdom I felt lucky to read. 

A few days ago, when a newspaper--from the same publisher--unexpectedly arrived on my parents' porch, I went to throw it in the recycling bin, asking my mom along the way whether she wanted it. She demurred, and off to the bin it went, unopened. How times have changed. But why? 

Despite more information publicly available than ever before, I learn more about a scientific topic by speaking to my sister, a PhD scientist, for 5 minutes than anything online. Writers can fit only so much context in a short article, but they don't have much competition--the number of experts able to provide "big picture" context is extremely limited. As the always interesting Nassim Taleb might say, oftentimes, it's not what you say, but what you leave out. 

A lawyer/analyst recently published an article arguing record consumer debt wasn't a cataclysmic problem but missed an issue: are his numbers and data based on organic, sustainable growth--such as steady, predictable tax receipts--or artificial, unsustainable catalysts, such as government borrowing at ever-increasing interest rates? Without knowing the answer to the aforementioned question, the entire article as well as its research is useless. This author, the editor of the blog, The Big Picture, somehow missed the big picture--despite doing considerable research and using diverse data sets. 

I emailed him, saying, "You... failed to list overall liabilities, such as pension and other local gov obligations. If local and state govs borrow more and transfer their debt/revenue to local residents, of course the overall picture will appear better." 

He responded, "These are current, not future liabilities." 

This expert accepts an analytical approach where if 100 people owe 1 million dollars now and have jobs that can reasonably cover the interest on their debts now, it doesn't matter if their government--local, state, and federal--or their private sector employer owes 100 billion in bond or other payments due tomorrow. 

But without knowing present and future liabilities, one cannot determine whether last year's tax receipts and accompanying job growth are sustainable. If governments or private employers owe 100 billion tomorrow, they might require higher taxes, fewer new hires, and more debt (presumably at different interest rates, impacting present-day revenue). 

If the debt is pension-related, then more revenue would be needed to replace the retired workers as well as to pay ongoing pensions unless the pension fund was 100% funded. In short, future liabilities can dramatically change the assumed rates of job growth, tax revenue, consumer demand and inflation, rendering prior data almost useless. It's as if there's a Black Swan event we can actually predict, but no one wants to do the additional math because it's too complicated. 

So I wrote Barry Ritholtz back: "[I]f we have a bill due tomorrow, analyzing only today's liabilities and GDP makes no sense if the entire structure depends on rolling over massive debt and other financial engineering." 

That's when it got interesting--and slightly snippy: 

My response: 

The value you were trying to provide was context, not knocking down a strawman, I hope. 

If since 2007, govs have borrowed more money and transferred that money to their residents on local, state, and fed levels while doing little to resolve systemic issues such as lowering pension obligation interest rates, etc., then the result won't be the same. It'll be different, of course, but serious problems will remain, meaning your article promotes complacency rather than true context.  You want the "big picture"? So do I. 

Barry: "See how it's totally not the same because of a lack of defaults and overall population and other changes that I'm going to examine without trying to see if the growth is merely because govs borrowed more money?" 

Skeptical Guy: "Dude, analyzing only today's data makes no sense if you're unable to determine that consumer/mortgage borrowing wasn't merely replaced by gov borrowing, which then was transferred to residents, leaving systemic issues alive and well, but with a larger fuse and more dependence on low interest rates."  

Barry: "Dude, I was just analyzing why it ain't exactly the same." 

Guy: "What value is that if your goal is to analyze the big picture?"

And that's where the conversation ended.  

When I opened my newspaper in the 1990s, I never once suspected Mike Royko wasn't an expert on everything Chicago. When Peggy Noonan taught me politics is all about "Whose ox is being gored," I knew she was speaking from a reservoir of personal experience. Today, in contrast, when I click on content, I sense people consider themselves experts after one-hit wonders or because they know the "right" people. Worse, I sense journalists and experts no longer have power behind their pen. Even if they manage to capture eyeballs, the public's threshold for outrage has risen so high, nothing will be done unless an army of paid meme creators and politically-connected groups manufacture simplistic slogans that fail to capture any complexity. 

Maybe that should be the modern journalist's motto (and epitaph): "So simple, you'll be outraged and demand change without really understanding a damn thing." 

Book Review: Barry Ritholtz's Bailout Nation

I'm a huge fan of Barry Ritholtz. His blog, The Big Picture, accurately predicted the most recent stock market collapse; as a result, Mr. Ritholtz gained millions of fans. Not being content with blogging and television appearances, Mr. Ritholtz published a book, Bailout Nation. His thesis is that excessive financial leverage, lax regulation, and government incompetence and cronyism caused our current economic crisis.

Bailout Nation is geared towards the general public, i.e., non-experts. If you have been waiting for an easy-to-read, thorough explanation about how we reached our current economic crisis, Bailout Nation is for you.

The flip side of making Bailout Nation so accessible is that long-time market followers will not be surprised by most of book's substantive content. In addition, I was disappointed that Mr. Ritholtz used a more formal writing style for his book. On his blog, Mr. Ritholtz brings an irreverent tone that makes him a delight to read. In fact, I've called Mr. Ritholtz the "Anthony Bourdain of Wall Street" because of his intelligent, devil-may-care style. (Jim Cramer would be Rachael Ray, of course.) Fans of The Big Picture, where curse words are used on a semi-regular basis, will be disappointed to know that I found only one curse word (on page 165).

Perhaps Mr. Ritholtz sanitized his writing style to reach a broader audience. (Either that, or Aaron Task, his editor, had a heavy hand in the book.) Whoever decided to sanitize Mr. Ritholtz made a mistake. As anyone who's read his blog posts can tell you, one reason people love Mr. Ritholtz is because he's the opposite of uptight. In fact, if there was ever such a thing as a "blue-collar" banker, Mr. Ritholtz would be it. There are too few people on Wall Street who have inside knowledge of the business and who are willing to take on the big boys (like Goldman Sachs) with panache. When you are one of the very few people on Wall Street who told people to get out of the market before it collapsed, your record speaks for itself--you don't need a dry, Utah-esque writing style to gain anyone's credibility. Even though readers won't see much of Mr. Ritholtz's normally informal style, don't let it stop you from reading the book--it's not quintessential Barry, but it's still pretty darn good.

Mr. Ritholtz starts out by telling us the "modern era of finance is now defined by the bailout...Perhaps what the government should be doing is acting to prevent systemic risk before it threatens to destabilize the world's economy, rather than merely cleaning it up and bailing out out afterward." (page 5) He then distinguishes between corporate welfare--bailing out individual companies--and broad-based stimulus plans, noting that the "public works programs of the Depression era were designed to impact the entire economy," not a few politically-connected groups. (page 11)

Although Mr. Ritholtz singles out the government's 1971 Lockheed Martin bailout, which he believes paved the way for other taxpayer-backed boondoggles, he places much of the blame on the banking sector and the Federal Reserve. His scorn for former Federal Reserve chairman Alan Greenspan is palpable. Mr. Ritholtz believes Greenspan actively aided and abetted the financial and housing bubbles when his job was to prevent bubbles, not make them. (As Charlie Munger once said, "Greenspan overdosed on Ayn Rand.") Given the ripple effects of the banking sector's collapse on the general economy, Thomas Jefferson's quote--that "Banking establishments are more dangerous than standing armies"--seems all too prescient today. (page 15)

Mr. Ritholtz then surveys the financial damage, and it is heartbreaking. "[A]s of March 2009, the S&P 500 was back at levels below where it was [in] 1996...If you bought the broad index [in 1996] some 13 years later you would have nothing to show for it." (page 66) The market's reversion to 1996 levels makes sense, because so much perceived wealth creation was based on false housing valuations. Most of us know that consumers used their homes as piggy banks, but I was unaware of the extent to which this occurred. Mr. Ritholtz says that "the impact of mortgage equity withdrawal [MEW] has been nothing short of breathtaking: MEW was responsible for more than 75 percent of GDP growth from 2003 to 2006." (page 96)

It doesn't get better, unfortunately. Mr. Ritholtz slams us with another shocking statistic: "From 2001 to 2008, the [American] greenback lost nearly 40 percent of its purchasing power." (page 106)

One reason Mr. Ritholtz may have seen the crisis coming was because of the unreasonable yield spread between U.S. Treasuries and mortgage-backed CDOs. He points out the absurdity in having mortgage-backed CDOs rated the same as U.S. Treasuries but paying a much higher interest rate: "These CDOs rewrote the laws of economics. They promised to be as safe as U.S. Treasuries, but paid out a significantly higher yield. In other words, for the same exact risk, the reward was much greater. This should have been recognized as an impossibility...Someone would either be winning a Nobel Prize in economics--or going to jail." (page 113)

Mid-way through the book, Mr. Ritholtz mentions the "net capital rule." "From 1975 to 2004, this was the primary tool used to prevent investment banks from taking on too much leverage. The rule limited their ratio of debt to net capital to 12 to 1; in other words, $12 was the maximum they could borrow for every $1 in capital." (page 143) After 2004, however, the net capital rule did not apply to major investment banks.

After reading about the SEC's relaxation of the net capital rule, I made up my mind--the economic collapse occurred because the SEC allowed a small number of investment banks to take on an unholy amount of leverage. How much more leverage? Well, in 2004, the SEC exempted investment firms with a market capitalization of over $5 billion from the net capital rule. Thus, Goldman, Lehman, Bear Stearns, and Morgan Stanley were no longer governed by the 12 to 1 limit. These investment firms promptly increased leverage dramatically, sometimes up to a 40 to 1 ratio. Welcome to Wall Street on steroids. Initially, the growth looks good to you and everyone else, but the shrinkage is inevitable. Or, as Mr. Ritholtz writes,

Thus we learn that the tragic financial events of 2008 and 2009 are not an unfortunate accident. Rather, they are the results of a conscious SEC decision to allow these firms to legally violate net capital rules that had existed for decades, limiting broker-dealers' debt-to-net-capital ratio to 12-to-1. You couldn't make this stuff up if you tried. (page 144)

The paragraph above sums up the book for me, but Mr. Ritholtz isn't done. He talks about the fact that "We in the United States have lived beyond our means for many years. " (page 210) As a result, we are dependent on the kindness of foreigners willing to fund our spendthrift ways, and once "you begin to depend on the kindness of strangers, it's best not to make those strangers too angry." (Id.) So, "Why bail out overseas counterparties and debt holders? One gets the sense Uncle Sam had little choice in the matter." (Id.) I echoed Mr. Ritholtz's conclusion here in September 2008:

The money belongs mostly to the Japanese and Chinese, who have lent us trillions of dollars by buying up U.S. debt, bonds, and preferred shares. If we want them to continue financing our lifestyle—-which they will do, because few other places contain citizens so willing to spend—-they set the terms of the bailouts, not us...In large part, international investors are willing to forgive our transgressions because of the bailouts.

Or, as the joke goes, "I just took out a dollar bill to buy coffee and the bill had the inscription, 'Made in China.' Is this going to be a problem?" It's funny, in a Weimar Republic sort of way.

Lest you think Mr. Ritholtz favors bailouts, don't worry--he later writes, "We cannot have privatized profits and socialized risks." (page 227) I wholeheartedly concur. If you're interested in reading about the seeds of the current economic crisis, you'll enjoy Barry Ritholtz's book.

English Majors Unite: on page 199, "tax deferred" is spelled "tax defered."

Note: page numbers refer to the 2009 hardcover edition, published by John Wiley & Sons, Inc.

Disclosures: the publisher provided me with a complimentary copy of Bailout Nation. I do not currently have a financial stake with the author or the publishing company.