The Federal Reserve chairman, by law, is required to report twice a year to Congress on the Fed’s monetary policy and is called to testify on numerous other issues at various times. I heard Bernanke testifying on one of these occasions—I was in a hotel room somewhere, and the television was on—and when asked to comment on the decline of the dollar, he answered that it was of absolutely no consequence except to Americans traveling abroad. I stopped what I was doing and looked very closely at the man on the TV screen, to see whether he was lying, or if he really did not know. Making a statement like that is a little bit like saying that whether the sun comes up in the east is of no consequence to the average American unless he or she happens to be looking east.
Say you own IBM, and it goes from $100 to $200. You have made money in US dollars, but if the value of the US dollar declines by 50 percent, you have not made any money at all—you cannot afford any more Scotch whiskey than you could before, you are no better-off in terms of your ability to buy a Toyota, both of which imports have effectively doubled in price. You are no better-off in terms of purchasing anything from abroad. Including things like petroleum. Even if the value of everything else stays the same, the fact that your dollar has declined means your standard of living has declined.
If the dollar goes down, imported tires go up in price, and that affects you as an American even if you do not buy your tires from Michelin, because Goodyear is going to raise its prices, if for no other reason than to cover the increased cost of imported rubber. If the dollar declines, Saudi Arabia, which sells oil denominated internationally in US dollars, is receiving less value. How long do you think that is going to be allowed to happen? For every sheik, the price of a Mercedes goes higher. Just to maintain their standard of living, the Saudis are going to have to raise the price of oil, and the smart and most effective way to do so is to cut the supply.
This is the nightmare of inflation. You may think you are better-off because your IBM shares have doubled in price—or maybe your salary has gone up—but then when you look around, you see that you are paying more for everything. You are paying more for gasoline. You are paying more for food. Your dollar is worth less and less against everything … against other currencies, against rice, against gold …
If the dollar goes down, the decline has a widespread effect on everything you as an American buy, everything you do, and pretty much everything that goes on in the rest of the world. It is Economics 101. Bernanke, testifying before Congress that the dollar’s decline is inconsequential, did not look like he was lying, and one would have to assume that being under oath he would be a little bit constrained. So I came away with a realization that he knew even less than I thought.
Look back at the numerous pronouncements, the numerous projections Bernanke has made over the years, and it quickly becomes evident that he has seldom been right about anything. He knows little about economics or finance, he has no idea how markets work, and the only thing he truly understands about currency is how to print it. He has yet to figure out that the present crisis is one not of liquidity, but of solvency. There is plenty of liquidity around. Part of the reason for the crisis, in fact, is that American and European central banks, for ten or fifteen years, supplied too much liquidity to the market. There was too much cheap money available. It led to the housing and consumption bubbles, and when those bubbles burst, the world was left with a credit problem. Overextending themselves financially, people, institutions, and governments could not pay their obligations, an explosion of which resulted while the banks were taking all that garbage paper and turning it into subprime bonds. Loans today are not unavailable to people who are reasonably solvent; liquidity is not the problem. The problem is that too many people are bankrupt.
Bernanke does not seem to understand this. During the Great Depression, liquidity was indeed the problem. Thanks to misguided government policies, trade began to dry up, there was no liquidity to support the banks, and the whole system collapsed. Unable to distinguish between liquidity and solvency, Bernanke sees the current crisis as the 1930s all over again. It is the moment he has been waiting for all his life. His entire intellectual career has been devoted to the study of printing money. Give the guy a printing press, and he is going to run it as fast as he can, just as a guy with a hammer sees everything as a nail. But you do not solve the problem of too much debt with more debt. If printing money led to prosperity, Zimbabwe would be the most prosperous country in the world.
With Bernanke at the helm, nobody fails. Everybody gets a big bonus next year. Everybody keeps his Lamborghini, while our poor dental assistant in Colorado Springs is losing her job and her house because the government is pumping enormous amounts of money, collected from her and her fellow taxpayers, into the financial system to prop up bad assets at the banks. Rewarding failure, incompetence, and, in some cases, illegality, the government is buying bonds on what have already proved to be losing ventures run by mediocre people. It is throwing good money after bad, and thereby discouraging growth. All the competent people see all those bad assets sitting there, waiting to make a claim on the good, and are inevitably scared off, along with their money, leaving behind a stagnant economy with no new, dynamic forces at work.
In the early 1990s, Sweden, with a similar real estate bubble, faced its own collapse. But the government resisted bailing everyone out. A lot of people went bankrupt; it was a terrible two- or three-year period. But since then Sweden has boomed and is now one of the soundest economies in the world. Its currency today is much stronger than most, partly due to the country’s suffering through that difficult period. The same thing happened in Mexico in 1994 and in Russia and Asia in the late 1990s. All these nations went through the wringer. People went bankrupt. And all emerged through the horrible pain thriving: sound, solid, and growing.
In the early 1990s, Japan experienced a big bubble in real estate and stocks. When I was traveling through the country by motorcycle on my first trip around the world, the price of a country club membership in Japan exceeded the price of a house. It was awe inspiring what people in Japan were willing to pay to play golf. The bubble was just peaking. The bubble eventually popped, and everything collapsed. And the government refused to let anyone fail. What resulted were what we now call “zombie” banks and “zombie” companies, institutions we identify as among “the walking dead.” When I passed through Japan on my second trip around the world, ten years later, its suicide rate was higher than that of any developed country. Everyone was despondent, looking for security. Government jobs were highly sought after. The Japanese were referring to the 1990s as “the lost decade.”
And now the lost decade has become two. Today, more than twenty years after the crash, the Japanese stock market is 75 percent below where it was in 1990. The suicide rate is still high, and the birthrate is among the lowest in the developed world. The sense of insecurity and lack of confidence going forward have not abated. Even in the depths of the Great Depression, the American stock market, dropping 90 percent, bottomed out only for a few months. In Japan, it has been over twenty years. In propping up the country’s failing entities, the Japanese government extended the crisis. And this is the approach the United States has chosen to take.
America has had great collapses before. In 1907, the whole financial system went under. And yet in the twentieth century we came back strong. You can go back through American history and find examples of banks and insurance companies collapsing and states, counties, and municipalities going broke. After World War I, the United States had a serious economic setback, but the government balanced its budget while the Federal Reserve raised interest rates to curb inflation. We took our pain for several months but were then rewarded with the Roaring Twenties. Perhaps if people in Washington, D.C., read history or understood economics, we would stop using taxpayer money to prop up failure.
The world has suffered financial panics, financial disasters, since the beginning of time. It is not fun. It happens. And the world survives. Let us look at Japan again. In 1966, Japan experienced a staggering collapse. Every stockbroker in Japan went bankrupt. Every broker. Was it the end of the world? No. Every broker and every investment bank was allowed to go bankrupt. Over the next twenty-five years, Japan enjoyed phenomenal success, unexceeded by that of any nation in the second half of the twentieth century.
But the United States has chosen to follow in Japan’s more recent footsteps. Politicians, worried about the next election, and pleading bankers, worried about the next bonus, carry the day. Like every entitled interest group in what is now the largest debtor nation in history, where everyone has his hand out and the federal government operates like Tammany Hall, the rich deserve payouts too. There will be no recession. There is no such thing as failure. There will be welfare for the rich. The Lamborghini and that house in the Hamptons are yours to keep—our firefighter in Omaha and a hardworking dental technician in Colorado Springs will happily see to that, even if they have to take second jobs to do so. Rather than force you to liquidate unsound assets, we will pay you to carry them on your books, or better yet, we will buy them. You will be compensated for your failure.
The Japanese talk of their two lost decades. We in America will have at least two, possibly more.
BEFORE THE SUBPRIME MELTDOWN, I was having lunch in Washington with Republican senator Richard Shelby, from my home state of Alabama, who at the time was chairman of the Senate Committee on Banking, Housing, and Urban Affairs, which supervises Fannie Mae. I said, “Dick, I hope this doesn’t blow up on your watch,” explaining that I was short Fannie Mae and that I believed the company was using phony bookkeeping and perpetrating a fraud. He thought about it for a minute, then said, “Well, you might be right,” but he wanted me to understand that Fannie Mae and Freddie Mac made more political contributions to the people “in this town” than did any vested interest in the country. It was unlikely that the government would call them to account, much less that the guys cooking the books would go to prison, I was led to believe, for the simple reason that they were in everybody’s pocket. Senator Shelby was and is a smart observer.
But while I know that examples of fraud can be found, I do not buy the fact that the crash was largely the result of criminal behavior. Much more widespread, and in the end even more infuriating, was the level of incompetence. I had far too many arguments back then, trying to convince others that it was a fraud—saying it was going to collapse, explaining why it was going to collapse—and having what appeared to be perfectly intelligent, ambitious, well-intentioned people telling me I was nuts. Everybody was taking the fast money, the easy money, and those who warned that it was not going to work were considered ridiculous. It was a wild time; there were staggering amounts of easy money around, thanks to the central bank, and just about anything you did would make you more of it, if you were fast enough and smart enough.
Few people realized that the house was built on sand. I do not think the people at Moody’s who were putting out these AAA ratings really thought that some kind of evil conspiracy was at play. Most had their jobs on the line. People at the highest levels supported what they were doing. The chairman of the Fed, the secretary of the Treasury, everybody told them housing was safe. Greenspan urged Americans to take out loans, encouraged banks to create derivatives. He saw it as a way to get more money into the system; he convinced everybody it was good for the country. Fannie Mae said this stuff is sound. Wall Street really believed that the traders at Fannie Mae were smarter than everybody else. And the whole thing fed on itself. Alan Greenspan was getting his information from CNBC, which was getting it from some government bureaucracy, which was presumably getting it from him.
Chuck Prince, the head of Citibank, told the Financial Times in 2007, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.” I do not think Chuck Prince had a clue what the guys were doing down in his basement.
Yes, some people should have been sent to jail. It is difficult to see how Franklin Raines at Fannie Mae could not have known that what he was doing was crooked. He reported a rise in earnings of 15 percent every quarter, year after year. I know enough about the investment business to know that justifying those numbers is impossible. And yet Wall Street, making vast amounts of money selling the company’s bonds, never questioned the claim. The people who did question it probably lost their jobs. If it were up to me, Raines would have been doing time in 2008, when instead, in defiance of all reason, his opinion was being solicited by the Obama campaign. If it were up to me, the guy running Merrill Lynch, Stan O’Neal, would have drawn a stretch at Leavenworth instead of the $160 million in severance he drew when Merrill threw him out the door of the company he helped to bring down.
It has been going on for thousands of years; history is replete with examples. The fact is people get greedy … bankers, clergymen, academics, politicians … especially when times are exceptionally good. People cut corners, do things they might not do under normal conditions, and because times are good, because there is so much prosperity, they are not held to account. Stocks go up. Investments pay off. The corners that are cut actually make people a lot of money. No one questions, or even cares, what happened—they are so happy with all the money they have made.
Manias cover a multitude of sins.
“You only find out who is swimming naked when the tide goes out,” says Warren Buffett.
Following the Great Depression, Richard Whitney, president of the New York Stock Exchange, scion of the venerable family for which the Whitney Museum is named, was arrested and charged with embezzlement. He pleaded guilty and spent more than three years in Sing Sing. Had stocks continued to boom, nobody would have noticed or cared, because everybody would have made so much money. The same thing happened at Enron in 2001. Chief Financial Officer Andrew Fastow earned the praise of his colleagues for coming up with creative devices designed to hide the company’s losses. He was a corporate hero until things started getting shaky on Wall Street, at which time the SEC discovered that he and his colleagues at Enron were defrauding the public (and that Fastow at the same time was defrauding his colleagues). He pleaded guilty to wire and securities fraud and, along with his coconspirators at the company, whom he immediately ratted out, he was shipped off to federal prison.
It happens not just in business. In the 1960s, in the America that I knew, it would have been inconceivable that one might accuse a Catholic priest of any kind of misbehavior. In doing so, one could expect to be ignored, if not actively held in contempt. But eventually, as the church became less powerful, people grew receptive to the idea that one might ask questions of the clergy and, furthermore, expect real answers. As the secular world intruded on the power of the priesthood, as times got tough and parishes dried up, only then did people come to identify the church hierarchy as an active sanctuary for criminal sex offenders; only then were they unafraid to say, “Yeah, these guys really are scumbags.”
Misfeasance is not limited to business, nor is it anything new. It has been with us forever. And so too has incompetence. Neither should be rewarded. Economic slowdowns are inevitable. They have occurred regularly since the founding of the republic. We had one of the regular slowdowns in 2002. The one that began in 2007–2008 was much worse because the debt was up by a staggering amount. What will America do next time? We cannot quadruple our debt again. We cannot print reams of money again. Can we get away with it one more time? I doubt it. Certainly not two more times. Sometime in this decade the whole system is going to collapse. In 1907, when it collapsed, it could be saved because the United States was a rising nation. It was going from debtor to creditor status; it was on an ascending curve. It is now a debtor on a descending curve. In 2008, had the government allowed the losers to go broke, certain safety nets would have come into play—the government was then solvent enough. There would have been three horrible years, but by now we would have recovered. But that opportunity has passed. The next time it happens, there will not be enough money, and not nearly enough faith in government. Adam Smith said it takes a lot to bankrupt a country, but we are well along the path.
The Fed before 2008 had $800 billion on its books, mainly in government bonds. Since then that number has nearly quadrupled, and most of what appears on the balance sheet consists of garbage. Somebody has to pay for it. And who better than the American taxpayer? Bernanke says he will continue to buy bad assets. In doing so he is ensuring the demise of the central bank. If things get bad enough soon enough, we may abolish the Federal Reserve before it collapses. The United States has had three central banks in its history. The first two disappeared. This one will undoubtedly fail too.
Capital is agnostic. That is one of the truisms of the system under which we live. All capital cares about are security and getting the best return. Some raise this as a criticism, as evidence of the evils of capitalism. OK, fine, maybe it is. But it is also the way the world has worked for thousands of years. And nobody knows this better, or appreciates it more, than the capitalists who made fortunes riding the recent bull market over the edge. All should have been allowed to fail. The more of them that shared the fate of Lehman Brothers, the better-off the system would be.
As former astronaut Frank Borman, then CEO of Eastern Airlines, said, “Capitalism without bankruptcy is like Christianity without hell.”