Thank The Designer

The week of Thanksgiving Holiday, 2009, finds us in a thankful frame of mind indeed. What started out as a year to just get through: the Financial Panic of a lifetime doing a not-atypical number on our retirement nest egg, the loss of a job   at the very nadir of that crisis, a regime change at the seat of federal power that promised Change in the direction of profligate collectivism, and by some measures the worst drought ever here in South Central Texas. It ended being an opportunity to stand among those investors who were financially and emotionally prepared to make the proverbial bet against the end of the world and profit accordingly. Financial independence is within reach, if not quite firmly grasped. A semblance of gainful employment has, in fits and starts, started to take shape. The once ominous HopeNChange Express barely made it out of the garage before the engine started smoking and sputtering, the wheels started coming off and the pit crew started making like to slit each others’ throats. The drought has recently given way to a series of rainstorms which in turn unleashed a torrent of photosynthesis and concomitant vegetative activity. So gratitude towards whoever or whatever might be keeping things from collapsing into a cosmic scrap heap, that wellspring of Love that seemingly countervails ubiquitous Entropy, comes easily to mind.

With this in mind, it should not be surprising that this week’s meditation came to be. I had been working on a new investment idea. It is a company that holds the high ground with respect to the technology of controlling heat, pressure and so ultimately rates of flow for large scale processes like oil refining. This company designs and manufactures highly engineered equipment, which is to say that while there may be a certainly simplicity to the designs, each system has to be attuned to local conditions in order to achieve consistent and optimal performance. What struck me was that it is also designed to operate for upwards of twenty years, not unlike the aviation equipment that has been such a focus over so much of my working life. In both instances, a very large installed base has been put in place, to the degree that the need to replace equipment reaching the end of its economic life is a big part of what drives prospective demand. As I pondered what that might look like over the next few years and started putting dates to things, it occurred to me that this “replacement demand” will be driven by the retirement of equipment that was being installed or even designed early in my working life. Indeed, I can remember when the aircraft whose looming retirement is expected to drive demand for “next generation” models like the Boeing 787 was the “next generation”. Now, part of this apparent obsolescence is due to design advances. We also know the outliers as to how long well-engineered equipment can be kept running, but we also know that it takes a great deal of special, and often expensive, care and attention to do so. We see some evidence to the contrary, but they tend to be relatively simple, though still marvelously engineered, piles of stone, like pyramids and aqueducts. Even a modicum of complexity in a pile of stone will eventuate in the need for a great deal of expensive attention to  keep it from falling down, such as the cathedral we were able to visit in Cologne early this year. Equipment might be made with the most durable of materials, but however well designed it is, operating in any but the most hermetically benign environment, it still eventually wears out. And it does so at a rate which does not compare favorably with human beings.

Here I am at the midpoint of my sixth decade, certainly not made of the most durable of materials and fully aware that in another 55+ years my frame will be dust. In at least a few respects, this seemingly highly engineered system is not operating at that peak efficiency denoted by youth, but compared to the aforementioned examples which are at the apex of humanity’s best efforts, it is doing quite well. The idea of clocking an unbroken string of sub-6- minute miles is certainly a thing of the distant past (Hell, just having to run a mile is not something I want even think about), but I can still from time to time get to a tennis ball that everyone else on the court thought was gone. My eyes certainly need a lot of help, but can still make out amazing things when they know what to look for, like that whiteness on the inside of the mouth of a feeding trout that is otherwise marvelously well camouflaged. The list of things that still work but not quite like they used to could go on, but let’s not go there! What is amazing, if you stop and think about it, is that we were designed to operate as well as we do for as long as so many of us have. 

It is miraculous that we are as self-repairing as we are. Many of us enjoy seeing antique equipment, planes, cars, locomotives, etc. being operated. In many cases, even with antiques houses, these remarkable testaments to craftsmanship are very nearly devoid of their original material. With us, a similar process takes place without our even thinking about. Wound repair, immune systems that continue to provide scientists with more questions than answers, memory and especially that prosaic miracle we call sleep, all designed into a system to keep it running even longer than a KC-135 (which certainly doesn’t repair itself!) This is not to say that a disregard, willful or imposed by circumstance, for basic preventative maintenance (i.e., calories consumed should approximate calories burned, sleep when needed) or any number of manifestations of evil will not preclude an expectation that which attributed to Moses over 3000 years ago: “The length of our days is seventy years, or eighty if we have the strength.” (Psalm 90:10). It should, however, remind us that we are fearfully and wonderfully made. 

This ancient observation bespeaks yet another layer to the beneficence of Providence in our day. Not only do we seem to be designed for 50+ years of relatively low maintenance functionality, we have also been blessed with an unlocking of knowledge which is pushing the envelope on that Psalmist’s observation. For example, the pain management provided by opiates and variously rendered ethanol concoctions was only supplanted about 100 years ago by mass produced salicylic acid (a.k.a, aspirin), which has in turn been supplanted by a host of successor compounds. But more to the point, the technology to provide “repair” against all manner of upsets, even as our designed=in repair sub-systems wear down, has exploded in our lifetimes. Case in point, the immediate progenitors of the fearfully and wonderfully made system that has been the object of this meditation, i.e., my parents. Both of them are nearing the end of their ninth decade, and both have been in for repairs. But one still drives all over the country to look at birds through eyes that had cataracts several years ago, helped along by a remarkably unobtrusive hearing aid. The other maintains airplanes and flies one of them almost every week, when he is not busy growing grapes to make outstanding (i.e., Best of Show at the Western Washington State Fair more than once) wine. This workload is easier to bear than it was a decade ago, thanks to a pair of titanium knee-joints. What a blessing to live in a time when access to such life extending technology is scarcely remarked (although the prospect of placing more of the dead hand of government on this body of innovation is deservedly being remarked upon!). 

2009 was a year of great suffering and setback. The Psalmist goes on, “ ...yet their span is but trouble and sorrow, for they quickly pass, and we fly away.” Trouble and sorrow have been more in evidence of late than many of us have been accustomed. Yet there is so much to ameliorate that, so much to be grateful for. A look at History, just about anywhere you choose to peek behind its curtain and into what troubled our ancestors, should make you thankful for the troubles we have as opposed to the troubles we could be having. Happy Thanksgiving! 

And the Walls Came Tumbling Down

This week finds us observing the anniversaries of when two walls came tumbling down. Twenty years ago, the wall purportedly erected to protect the socialist revolution in East Berlin was torn asunder. Ten years later, on November 12, 1999 , that "wall" that had for two generations divided commercial from investment banking was dissolved by the repeal of the Glass-Steagall Act. The former was perhaps only the most emblematic of a whole series of actions which brought an end to the Cold War era, when something called Communism loomed menacingly against what in more self-confident times was called Western Civilization. For a decade or so (two months shy of 12 years, to be exact), it became fashionable to presume an "end of history", that titanic struggles between disparate worldviews had been rendered a thing of the unseemly past. The dissolution of that other wall came at a moment when faith in markets had been inflated by widespread animal spirits to what was arguably an all-time high (NAZ was going to see to it that we all retired early and rich!) 

A decade or two later, I am struck by what the passage of time has done to enervate moral clarity and its concomitant courage to decide and then act. We have been reminded in the run-up to the Berlin Wall anniversary of Ronald Reagan's resolve in this matter. The Wall was but one element of the whole "evil empire" that he found so repugnant. However timely its seems in retrospect, his "Tear down this wall!" demand was delivered over the strenuous objections of the State Department and members of its staff. He set his sights on freeing millions of oppressed people and ending the doctrine of mutually assured destruction. Did any of us not think of these as farfetched aspirations at the time? But by golly it happened, peacefully and in a few short years, thanks to the unwavering moral insight of a few leaders. 

That this end to the Cold War did not mark the end of history really should be no surprise. For a thousand years, attempts to spread Islam at the point of a sword ranged as far west as the Pyrenees and Vienna (1683), simmering down just as its Western nemesis was being transformed by ideas from the likes of Newton, Calvin, Jefferson and Smith. For three centuries following Ottoman failure outside Vienna, the West enjoyed an energizing transformation which made it rich and powerful, while the Islamic world devolved into sclerotic impotence, a radical departure from the preceding ten centuries. How surprising should it be then that when a perverse ideology like Marxism came along that it would seem like public enemy number one, civilization-wise? Contrary to what seemed so obvious when we were growing up, it turned out to be not much more than a two generation distraction from a much more timeless struggle.

Something "laughable if it weren't so damning" about that more enduring conflict has been brought out by the tragic murders which took place at Fort Hood. I am not as appalled by the murders themselves (hate-fueled mass murder is always tragic, always wrong, but always happening in one venue or another) so much as to much of the reaction to it. We see pundits and politicians tying themselves up in knots, utter moral confusion that is a polar opposite of what we saw in Reagan, Thatcher and a certain Polish pontiff. We hear a lot of babbling about our inability to understand this murderer and his motive. Well, duh. Of course we will never "understand" exactly why he did it, but how often is exact understanding of heinous acts ever forthcoming? I think a large part of the moral confusion which has set in here can be attributed the way the very word "hate" has lost its meaning. When the subjective element of definition is allowed to run amok, words eventually lose their power. This act was committed out of hatred, as classically understood. As such, hatred is a motive that transcends intellect and even emotion. It is what motivated  Hutus against Tutsis, Iroquois against Algonquin, Nazis against anyone they thought weak enough to dominate, etc, etc. It is murderous and implacable by its very nature, and so demands an effective response. Thus defined, "hate" has the power to explain and so provide a focus for an appropriate response. But as we have witnessed the definition of this word expand to include any action or even perceived attitude which a subject perceives as hurtful, the definition is effectively gelded, "hate" explains nothing, and the chances of coming to any kind of consensus as to how to respond to it go to about zero. It would seem that over the course of the past twenty years, we have been diminished in our ability even to think and talk about the evils which must be resisted if not overcome.

A similar erosion of moral certitude seems to be in play in the dance around financial regulation. We have in the last year gone through the financial-near-death-experience of a lifetime, and are still picking our way through the wreckage. It is pretty obvious, in my estimation, that the repeal of Glass Steagall (G-S) in 1999 was a key ingredient in setting this conflagration in motion. I remember hearing it said that when one decides to tear down a wall, its a good idea to make sure you know why it was put up in the first place. Chances are, there were circumstances "back then" that have changed, but there might also things that haven't changed. In this case, these would include the human propensity to greed, the seeming inability of most of the players in "alpha" positions within financial organizations to comprehend the idea of "enough". It was also fallacious to assume that just because a moderate amount of deregulation had been beneficial that further deregulation would be without unintended consequences. 

The consequences we reaped were in large part due to the powers that be having been seemingly oblivious to the fact that the post 1999 model was subsidizing any and all manner of risk taking. The game was redefined, and the sharpies did what the sharp always do. They ran with it, reaping what they could before the not-so-sharp figure it out. I would submit that the aspect of G-S that made sense and served us well comes down, once again, to the meaning of words as classically understood. On this basis, commercial banks and investment banks serve fundamentally different purposes, and we should not pretend that whatever similarities they have outweigh their essential difference. As classically understood, banks existed for the same reason as bunkers (note the etymological similarity), to provide safe haven; to protect what its depositors already have. This was easier to understand when money was more tangible and what we call law enforcement was spotty at best. That such entities should assume a moderate degree of risk by lending against its depositors' assets was a reasonable development. The same can be said for a scheme to insure against such risks, funded by the member banks and administered by the government. 

Exactly what we mean by "investment bank" has always been a much slipperier term. Opportunistic by nature, their ability to succeed rests in large part on their ability to evolve with changing circumstances. However nebulous a classic understanding of the term might be, though, what we have today is something synonymous with "casino", a venue for gambling. Why, pray tell, if we were starting from scratch, would we want to put the imprimatur of the taxpayers' dime anywhere close to what investment banking has come to mean? As it is, this government sanctioned backstop to unbridled risk has fueled the consolidation, initially wrought by technology having all but eliminated the friction of distance in matters financial, that has brought us entities deemed "too large to fail". Policy makers face a Gordian knot of a problem as to how to implement reforms which reduce the chances of a repeat of what we just went through at some point in the future. Until they summon the moral clarity to recognize that what started out as a government administered insurance scheme to restore the confidence of savers has transmogrified into a seemingly limitless backstop to all manner of risk taking, the "too big to fail" problem will just keep getting worse.

The governing class probably likes it that way. By raising the stakes (i.e., how much those with the best seats in the casino can potentially take home), they increase the value of having influence on what the rules will be. This goes a long way in explaining why political contributions by casinos and their best patrons (e.g. hedge fund operators, private equity funds) have grown in lockstep with the size of the prize. Regulation has become a way of facilitating the flow of campaign funds rivaling if not surpassing Tort Inc. The ability to influence changes in regulation (i.e., the rules of the game) or at least understand them and adapt a step ahead of the crowd comes at a price, but it is also the price of admission to the best seats in the house. Combine this unholy alliance with the attenuated moral fiber which I have alluded to, and the chances of "too big to fail" going away any time soon look remarkably slim.

That said, bear in mind that crashes are all about wholesale rottenness and delusion, which takes time to build up, being flushed out in a hurry. An awful lot of this just got flushed, and more is trickling out. Crashes like we just endured are years if not decades in the making. The issues I have touched on are if grave concern in considering what we will leave to our children and grandchildren, but are unlikely to bear on how the economy and the Market will unfold in the months ahead. With the caveat that the consequences of diminished moral clarity in the face of sudden emergency cannot be anticipated, optimism remains the more prudent and profitable attitude for facing what investors refer to as the "foreseeable" future. But if in thinking about 2019 or 2029, we are any more confident than we were about an "end of history" right after 1989, or our faith in markets is anything like it was in 1999, we will be surprised in ways that I frankly don't like to think about. 

 

 

A Turning Tide Beckons

The last big slug of Q3 earnings releases are behind us. A few hours ago, the polls closed. The people, or at least some of the people, have spoken. They have spoken up for the rest of us who cling to the notion that the government is there to serve and not to re-define every little detail of our lives. Damage has been done, and will continue to be done, but thus it ever is, but the system is showing every sign of working. America is still a center-right country, not yet willing to forfeit principles based on the dignity and worth of the individual over to the soul of the hive. As the political class will now be operating with a high degree of re-election anxiety for the foreseeable future, they will be less inclined to meddle with and otherwise burden their Producing class. All but a scant few of them are not so obtuse as to not be able to read what the folks in NJ and VA have scrawled on the wall for the rest of us. We just might have another sustained economic recovery in us after all. 

Meanwhile, here in South Central Texas, it looks like the tide will be all the way out in about four hours and then start racing back in. The red tide recently brushed some of the outer beaches but stayed out of the bays behind North Padre. The winds are remarkable calm and it looks to stay that way until late Saturday. If I leave now, I can have my yak in the water before the reds know to follow the tide in. It sure would be nice to not be plugged into this silly Market for a few days. I'm out of here.