I am faced with an internal conflict regarding our present state of affairs. A part of me is “cautiously” optimistic that America will emerge from this financial and economic crisis better and stronger than before. Another part of me says the way we’re addressing this crisis could set us back for years, many years. While the current situation is hitting most of us upside the head, there are some bright spots for certain of us like um, er – the people in the Financial Products group at AIG; or the traders and execs at Merrill Lynch this last December; or the manufacturer selling the $45 million jet to Citi – oh wait, that order was canceled. I digress. There are three scenarios I see unfolding over the next 24 months.
The Good
First, the “good.” American entrepreneurialism and ingenuity, in my opinion, is second to none. It is our great pillar of strength. Our country has seen crises in the past and done more than just live to tell about them. We have reinvented ourselves economically, politically and socially time and again following periods of great challenge. What is at the root of our adaptability? A number of things, but chief among them is our willingness to take creative risk in search of financial benefit. Taking risk created Google, Boeing, Hollywood, Pfizer and countless companies and industries that consistently keep America at the top of the international heap. Our $14+ trillion annual GDP outpaces the next four highest producers combined (Japan, Germany, China and the U.K., in case you’re interested). That’s a phenomenal factoid for a country of only 300 million people.
As Gordon Gecko said so eloquently, “Greed is good.” The opportunity to make it big, to produce a product or service that people want to buy, to simply get rich, has lured millions of immigrants to our shores going back to the days when my relatives made the trip from Europe many, many moons ago. Now don’t get me wrong on this point GonzoBankers. I have zero respect for the “greed” of individuals in our financial services industry who, with little to no regard for risk, created esoteric financial instruments that brought a world economy to its knees. Those CDOs and swaps benefitted the creators of those instruments – not you and me. But our culture has historically celebrated the men and women who typified commercial ambition, and I think that?s a good thing. While every economic crisis has caused us to question our cultural “celebration of wealth,” thankfully we return to our roots. We work more hours, relocate for a new job, and spend more on “stuff” than any other country in the world.
A comparison to Europe in the midst of this global meltdown is instructive. For all its rich cultural history, most Europeans simply don’t posses the innate American “pick yourself up by the bootstraps” attitude that makes us so scrappy. Europe has followed a much more patriarchal, dare I say socialist, path that I believe will embroil the EU in a longer, tougher battle with this economic quagmire than America. Europe for decades has been suffering higher unemployment, lower per capita income, decreasing growth and longer sustained bouts of inflation than the United States. A front page article in the Wall Street Journal last week discussed France’s $3.9 billion bailout of Renault. As part of the deal, the French government forbade Renault from closing any French factories or resorting to layoffs for at least a year. Many of these factories are running at less than 50% of capacity. While I may not agree with our bailout of the auto industry in principle, at least we are not guilty of tunnel vision on job protection since the U.S. plans involve job cuts, reduced pay and decreased benefits. Why do I raise this “coddling” European approach? Because of what could happen. Read on, GonzoBankers.
The Bad
“Bad” can be characterized most obviously as the absence of “good,” or in this case losing faith in our ability to innovate, take risk, get rich and live the American dream. And right now, folks, I’m scared that there’s a little too much bad going around. Even worse than our dour national mood is that Washington is now at the center of our economic discourse when the public should be talking about what our next transformative industry will be, whether it’s biotechnology, green energy, nanotechnology, or the way we educate our children. This administration, or any administration for that matter, is not the panacea to our ills. It can be part of a solution but it is not the solution.
A case in point is our current, European-style rescue plan for the nation’s banks. Right now we need to fix the largest banks (the top four hold 55% of our deposits). If they get fixed, our mid-size banks, community banks and credit unions will be able to breathe much more easily. How do we do this? I would venture to say not the way the administration and Treasury are approaching the problem.
Let me simplify the situation. Banks take deposits and make loans and investments. Over the past several years, many of the largest banks made stupid investments, the losses on which now exceed their capital. Back in the old days when I had my business courses we called that insolvency. What we should be discussing now is how much of that loss should be shouldered by you and me as taxpayers and how much the bondholders pony up. The “equity” holders (i.e. stockholders) should be wiped clean -there is no equity in an insolvent company. They rolled the dice and took their chances – snake eyes came up.
The “too big to fail mantra” has it backwards. What we’re seeing today is the reality of “Too Big Will Likely Fail.” Big banks aren’t like Boeing with an international focus on one thing – making airplanes. Big banks have an international focus on 50 things. It stands to reason that a diversified financial services company with a trillion dollars in assets that is involved in banking across the globe, wealth management, insurance, investment banking, brokerage and myriad other lines of business simply isn’t manageable by an eight person executive team (and a board that meets quarterly) – no matter how smart they are.
In the 1930s we created the Reconstruction Finance Corp, which, at its height, held one-third of all bank stocks in the country. Guess what? Taxpayers ultimately came out not losing a penny. We should create a modern day RFC run by business people and entrepreneurs – people who have actually succeeded in the market place (the type of people lacking in Treasury and the administration). The new RFC should decide which banks have solid management and can succeed (audit them with a stress test) and which to put into receivership. Putting the insolvent banks into receivership in an RFC structure makes the most sense since it can be done quickly, transparently, and simply without the involvement of middlemen. When the banks return to solvency, turn them back to private ownership. RFC had the power to take these actions, Treasury does not. Treasury lends money, audits later, vacillates between micro-management and hands-off, and then sounds the alarm when AIG pays bonuses.
As we face the very real prospect that we’ll burn through hundreds of billions more without fixing the problem (what did the first $350 billion do?), Geithner’s plan doesn?t accept the reality that Citi and others should be put into receivership – quickly. Geithner hopes private equity firms and hedge funds will purchase bonds from banks. How will they do that? Well, with loans and loan guarantees from the Treasury and the Federal Reserve. In other words, let’s prop up the very institutions that failed in the first place without implementing the fundamental fixes that receivership would address. This is bail out European style. What really scares me about this approach is using taxpayer money to subsidize the least transparent and least regulated financial institutions we have today – hedge funds and PE firms.
The simple fact is this: an RFC type of structure can fix the banks. The Geithner/Summers plan pours taxpayer money into a hoped for miracle to give a boost to the stock prices of these failing banks. Propping up their stock prices will not fix the situation we’re in.
The Ugly
To me, the “ugly” is characterized by Japan’s lost decade. American ingenuity and capitalism don?t win the day. A poorly thought out and executed bailout plan that sends the economy into deep recession (possibly depression) from which we emerge stronger and more feisty four or five years down the road doesn’t materialize either. Instead, we’re burdened with a heavy cloak of stagnation that lasts for 10 or 12 years. The thought of this is just too awful to contemplate.
Unlike Rush, I don’t want to see Obama and his administration fail. Too much is at stake to elevate politics over the financial wellbeing of our nation. At the same time, I don’t want to see Obama follow a plan that could burn through his financial and political capital in the first year of office, leaving us with a three year lame duck presidency.
What will it be?
Which of the “good, bad and ugly” scenarios will play out over the next two years? How will the final standoff between Blondie, Angel Eyes and Tuco turn out?
Not an easy question to answer, but as Blondie said so appropriately to Tuco in the graveyard, “In this world there’s two kinds of people, my friend. Those with loaded guns and those who dig. You dig.” As for me, hell, I’m a GonzoBanker, a member of the elite Cornerstone Advisors team, an eternal optimist, an American, and a lover of spaghetti Westerns. I’m casting my vote with Blondie. I’m casting my vote with the ingenuity, the creativity, the drive of the American people. I think we have the loaded guns.
All for now.
–SAS
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