Wednesday, November 4, 2009

Party Like It's 2007 - Ari Paul

If you’ve misplaced your calendar, you could be forgiven for thinking it’s the fall of 2007. Big banks are again paying out record bonuses to speculating traders. I’m again receiving letters from banks begging me to borrow money for 0% in special promotional offers. We’re again offering 0% down mortgage loans to people with poor credit (and like last time, it’s being encouraged by congress). There is again widespread talk of how the US dollar must eventually collapse and endless optimism about commodities.

What’s going on? Are investors/citizens/congress really that shortsighted? Ah, the remarkable power of liquidity. When the fed (and central banks around the world) throw enough money at people, those people are given tremendous incentives to gamble. Now, the gamblers don’t see themselves as gamblers. Rather, they rationalize that this or that asset market is cheap. They find convincing analysis by smart economists to justify stockpiling commodities or buying corporate bonds on margin. Similarly, when congress writes a blank check to a construction company, they’ll always find a highway that needs fixing.

The harder thing to explain is the near complete lack of response by the president and congress to the rising populist anger. For better or worse, responding to public sentiment is usually what politicians do best. So why is the modus operandi of the financial sector almost completely unchanged? After every major banking collapse in history (and there have been many), there was a period of conservatism when banks went back to the basic business of taking deposits and making loans. I think the answer is that Congress has just moved slowly, but the regulation is coming, and it will be very heavy. The financial firms donate a lot of money, but every person still only gets one vote. The main street narrative is clear – the financial sector was at least partly responsible for getting us into this mess and they haven’t taken their fair share of the pain. Over the next year, we’ll see that narrative translated into heavy handed legislation.

Aside from the additional regulation, I think we’re in for a repeat of many of the other changes that followed 2007. Just as the speculative bubble in 2007 was largely caused by excess credit, the recent rallies in “risky assets” have the same source. There’s no limit to how much money the fed can print, but I believe the tide is turning politically and we’ll start seeing credit tighten over the next 6 months. For example, today the front page of the WSJ featured an article about how economists and government officials worldwide believe bubbles are forming ( As I wrote 3 months ago, I expect the catalyst for a broad sell off to be the withdrawal of liquidity by central banks. It looks like the credit tightening is growing nearer.

An interesting social trend that's gaining steam is a push towards isolationism. In the last couple months, both liberal and conservative pundits have started calling for us to pull out of both Iraq and Afghanistan (e.g. Fareed Zakaria, Thomas Friedman, George Will). Another trend just starting is "age warfare." People under 40 are asking, "hasn't my generation's future been mortgaged enough to support the overspending of our parents and grandparents? Why are we taking on yet more debt to mail seniors checks?" We're only beginning to see the economic and social fallout from last year's crisis.

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