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.