While the nearly-over earnings season has had a very salubrious effect on share valuations, this week has certainly reminded us that, however spindled and mutilated, those of the bearish persuasion are still very much among us. Company results have been almost uniformly encouraging, driving yet another set of nails into the coffin of “double dip recession”. One has had to scratch hard to find exceptions. Tuesday’s swoon was triggered by rating agencies having finally caught on that the dysfunctionality of certain Euro-backwaters is more or less as persistent as it was a century or so ago. This air pocket was really not all that surprising, considering how frenetically some swathes of the Market (e.g., the Russell 2000) have been trading over the past few weeks. It also seems that those money pools who thrive on exacerbating disappointment seem to have less clout than they did a quarter ago, as if a more optimistic conviction has hardened in the minds of the unwashed masses their depredations are intended to intimidate. There is clearly a wolf pack of opportunists running screens each morning for anything resembling a “miss”, then gang banging the bids in hopes of jump starting a stint of negative momentum, but it rarely seems to be good for more than a few hours of high jinx. There is simply too much evidence of an on-the-mend global economy, and more to the point, too much money, badly in need of a greater than “risk-free” return, finding its way into US equities. This is a very tough time to be a bear, even if you didn’t bet that “Palm will go out at $1”.
As vivid as the earnings fireworks have been, we have been distracted by what amounts to a Potemkin (as in, put-up fakery) show trial (as in, politicians raking their cronies over the coals) on the Senate floor. What a surprise that the SEC serves up the staggering revelation that sharpies sometimes get hosed down by other sharpies just as the D.C. Power Grab turns its sights on the financial markets. All that’s really going on here is an effort to make something gamey even gamier (as in, advantage accrues to those politically connected enough to game the system.) Wall Street will become that much more a cash cow for funding Permanent campaigns. The occasional public floggings will continue, but with even more winking acknowledgement that such debasement is a small price to pay to have everyone think of you as a Master of the Universe. I suspect that whatever rules get crafted will make it harder for non-financial enterprises to extend credit. It will probably have some impact on marginal predators well down the financial services food chain. The “too big to fail” predators will take up the slack. Expect to what might be regarded as piranhas (e.g., small time finance companies) lose share to the Great White Sharks (GSC, et al).
All this is being foisted on us to prevent something that is very unlikely to happen anyway. We are being told that future panics/meltdowns, whatever are inevitable if we don’t “do something!”. This is true enough in the sense that as long as there is at least a modicum of freedom, and fear and greed are still part of human nature, there will be accidents, bad days for those who didn’t see it coming. What is misleading, though, is the implied likelihood that such inevitable upsets will be of a magnitude of what we just lived through. I would submit that “the black swan” flew due to conditions that were decades in the making. 2008 was “once in a generation” because it takes decades to aggregate widespread credulity into overripe systemic delusion. The scariest part of the scariest part of that episode was that nobody, even those of us who had lived through some pretty scary patches, had seen anything quite like it. It fell as hard as it did because the delusion of “real estate as impregnable in the aggregate” that underpinned it all was largely the result of policies that had been metastasizing for decades. However appropriate these policies started out (increasing home ownership was undeniably a worthy aspiration in the 1920s, by 2000, have succeeded so wildly, not so much), they were thoroughly corrupted by the time real estate became the designated engine to pull us out of the 2002 recession. The good news is that these blowups are a lot like forest fires. If the woods have been growing for a very long time without a fire, there is lots of “fuel” lying about. No one is expecting it, and so when it happens, it burns out of control. In doing so, however, it makes it much more difficult for a fire of any consequence to happen any time soon. In the financial world, the same thing happens. Lending standards swing from practically non-existent to CYA tight. The suspect mortgages of a few years back run off or are refinanced, and are replaced, bit by bit, day by day, with much more scrupulously sourced cash flows. The “fuel” for the next conflagration simply is not there like it was in 2006, nor is the complacency wrought by a rating system that had never really been tested. So yes, there will be failures, headline grabbing, day ruining upsets, but nothing with the sort of systemic risk that calls for handing more power over to those who would game the system.
“Too big to fail” seems to be one of the most intractable challenges we face, but it really doesn’t have to be. It could all be sorted out with a simple policy that if you get the guarantee that comes with FDIC, you don’t do take casino bets. Enterprises that want to be hedge funds can be hedge funds. Those who want to take deposits can act like banks in the sense that “bank” is akin to “bunker”, a putting safety ahead of opportunity. To the degree that what constitutes a casino bet is difficult to sort out (so many derivatives being rather benign ways that companies dial down their commodity or forex risk), a bit of behavior modification might be called for. How awful would it be to have a policy where if the government has to facilitate a change of control to protect depositors or prevent systemic shock waves, the hurt goes beyond the equity holders and reaches the ones who made it happen? We could fix this problem if, in the event of such failure, any compensation above some nominal threshold, say $90K/year, in the five years leading up to the event gets clawed back to help pay for the redeployment. This would include former as well as current employees, no exceptions. It would includes salary as well as bonuses, deferred or long since spent. Skin in the game, just like the share holders and, it would seem, many of the bondholders. There would seem to be a lot of unfairness in such an outcome, but one suspects that such a prospect would change an awful lot of behavior, and it would likely be a very long time before “risk taking with other people’s money” brings us to such a pass.
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