How the Wall Street Boom Went Kablooey

Reading Barbara Ehrenreich’s new book Bright-Sided recently, I became aware of Michael Lewis’s November 2008 article for Portfolio, “The End of Wall Street’s Boom,” which offers a fascinating inside look at how bubbles develop, sustain themselves, and then collapse.

Lewis makes an interesting connection with the delusional “positive thinking” mode that seems to be an important component of economic bubbles. This is the source of Ehrenreich’s interest in what Lewis has to say.

The main character of Lewis’s story is Steve Eisman, who built a busines toward the end of the bubble short-selling mortgage originators and homebuilders riding the subprime boom, as well as Wall Street firms and even rating agencies that were complicit.

Lewis relates that Eisman said something both interesting and funny to Brad Hintz, a prominent financial analyst at a conference in spring of 2007. Eisman told Hintz that his group had just shorted Merrill Lynch. Hintz wanted to know why.

“We have a simple thesis,” Eisman explained. “There is going to be a calamity, and whenever there is a calamity, Merrill is there.” When it came time to bankrupt Orange County with bad advice, Merrill was there. When the internet went bust, Merrill was there. Way back in the 1980s, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit. That was Eisman’s logic—the logic of Wall Street’s pecking order. Goldman Sachs was the big kid who ran the games in this neighborhood. Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be a part of things. The game, as Eisman saw it, was Crack the Whip. He assumed Merrill Lynch had taken its assigned place at the end of the chain.

Lewis is a former Wall Street hack who wrote the 1989 expose Liar’s Poker about his experiences in the industry in the 1980s.

His 2008 article ends on a curiously touching note as he recounts his recent lunch meeting with John Gutfreund, the ex-CEO of Salomon Brothers who took the company public and then led it during its period of prominence in the 1980s.

In relating his meeting with Gutfreund, Lewis offers an interesting analysis of the shift that took place in the 1980s, led by figures such as Gutfreund:

You can’t really tell someone that you asked him to lunch to let him know that you don’t think of him as evil.

Nor can you tell him that you asked him to lunch because you thought that you could trace the biggest financial crisis in the history of the world back to a decision he had made. John Gutfreund did violence to the Wall Street social order—and got himself dubbed the King of Wall Street—when he turned Salomon Brothers from a private partnership into Wall Street’s first public corporation.

… From that moment … the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished.

The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith.

AB — 15 January 2010

Simon Johnson: ‘What kind of catastrophe would you like?’

Economist Simon JohnsonOn CNBC’s “Squawk on the Street” on 7 January, MIT economist Simon Johnson delivered a perky, upbeat prediction of economic catastrophe in the next year due to the megalomania of banks that have drunk the too-big-to-fail Koolaid — see “Crisis Just Beginning: Economist“.

You’ll get a kick out of Johnson’s collegial banter with CNBC’s Erin Burnett and Mark Haines — for example:

Johnson: “The next 12 months could really be exciting. People could be very positive. But we are setting ourselves up for an enormous catastrophe.”

Haines: “Aw, man! Here we go again! Isn’t there anybody who comes on this show and doesn’t see storm clouds on the horizon? What kind of catastrophe?”

Johnson: “Ah, well, what kind of catastrophe would you like?”

Enjoy the full five minutes of comradely back-and-forth in this video linked from YouTube:

AB — 8 January 2010

Ditching the GDP: Report from Sarkozy/Stiglitz commission

The Commission on the Measurement of Economic Performance and Social Progress, a group initiated by French president Nicolas Sarkozy, has released a set of recommendations for a more sophisticated set of indicators to replace the concept of GDP (gross domestic product). Columbia economist Joseph Stiglitz is chair of the commission.

The draft of the report dated June 2, 2009, is available at this address.

In an article for The Guardian (see “The Great GDP Swindle,” Stiglitz emphasizes the need for a new regime for the measurement of economic progress:

If we have poor measures, what we strive to do (say, increase GDP) may actually contribute to a worsening of living standards. We may also be confronted with false choices, seeing trade-offs between output and environmental protection that don’t exist. By contrast, a better measure of economic performance might show that steps taken to improve the environment are good for the economy.

An article by Saamah Abdallah, researcher at the New Economics Foundation (nef), calls the new report “bold. (See “Sarkozy and Stiglitz challenge GDP ‘fetish.'”)

However, Abdallah sees a danger if policy leaders decide to take only partial measures to correct the current GDP mindset:

The report carries many recommendations, and there’s a risk that politicians will latch onto the easier ones, without really taking home the big message: namely, that we need to radically shake up our understanding of progress and success.

Abdallah’s organization has created a “Happy Planet Index” designed to measure humanity’s progress in a more holistic fashion.

AB — 14 Sept. 2009

Energy Economist Says Oil Will Peak Sooner Than Expected

In an interview with The Independent, Dr. Fatih Birol of the International Energy Agency (IEA) says that most of the world’s major oil fields are already past their peak production — see today’s article, “Warning: Oil supplies are running out fast,” by Steve O’Connor.

When O’Connor asked Birol to explain the concept of “peak oil,” Birol replied:

This is the point when the maximum rate at which oil is extracted reaches a peak because of technical and geological constraints, with global production going into decline from then on.

The UK Government, along with many other governments, has believed that peak oil will not occur until well into the 21st Century, at least not until after 2030. The International Energy Agency believes peak oil will come perhaps by 2020. But it also believes that we are heading for an even earlier “oil crunch” because demand after 2010 is likely to exceed dwindling supplies.

For more information on peak oil, see my previous blog post “Peak Oil Notes.”

AB — 3 August 2009

‘Life Inc.’ author Douglas Rushkoff on Colbert Report

Douglas Rushkoff, who writes about media and popular culture, appeared July 15, 2009, on The Colbert Report. Rushkoff is currently promoting his new book, Life Inc.: How the World Became a Corporation and How to Take it Back.

Rushkoff does a great job explaining the premise of his book, which is that corporations are only happy when individuals are contributing to the GDP, which is why they are always bugging us to do something productive rather than something useless like, for example, going out and watching birds.

As always, Colbert does a great job of helping Rushkoff explain his book by pretending not to like it. Here’s a link to the video — it’s a great six minutes.

AB — 17 July 2009

The Grandest Ponzi Scheme and The Great Disruption

In his recent column “The Inflection Is Near?,” New York Times columnist Thomas Friedman raises the question:

What if the crisis of 2008 represents something much more fundamental than a deep recession? What if it’s telling us that the whole growth model we created over the last 50 years is simply unsustainable economically and ecologically and that 2008 was when we hit the wall — when Mother Nature and the market both said: “No more.”

Friedman references physicist and researcher Joseph Romm, who writes at www.climateprogress.org. In “Is the global economy a Ponzi scheme, are we all Bernie Madoffs, and what comes next?,” Romm describes the global economy as “the grandest of Ponzi schemes, whereby current generations have figured out how to live off the wealth of future generations.”

If that’s not sufficiently gloomy for you, Friedman also references environmental activist Paul Gilding’s article “The Great Disruption,” in which he maintains that in 2008 the world entered a period that he calls The Great Disruption:

Our whole global political and economic system has been built on incessant growth, so this crisis will strike at the heart of society. Growth is the underpinning policy focus and strategic assumption of all governments, central banks, corporations and investment funds. It is never questioned and anything less leads to intervention to restart it. So when growth stops, things get very difficult. People throw out governments, shareholders throw out Boards and Boards throw out CEOs. So we can expect all that before we face up to reality – we have a system design problem.

However, Gilding refers to himself as an optimist. Although the crisis will “herald an unparalleled era of system stress, economic stagnation and social tension,” he believes that during that time “we’ll evolve a new economic model and then rebuild”:

This disruption will drive a transformation of extraordinary speed and scale. It will leave in the dust all other major global changes we’ve faced – those driven by war, technology or globalising markets. It will be an exciting and ultimately positive transformation, with great innovation and change in technology, business and economic models alongside a parallel shift in human development. It could well be, in a non-biological sense, a “great leap forward” for humanity with a move to a higher stage of evolution and consciousness.

AB — 18 March 2009

Is higher GDP a good thing?

Today’s news that the U.S. GDP shrank by 6.2 percent in fourth quarter 2008 got me thinking about the question whether a growing GDP is actually a good thing.

Some people would say I must be crazy (or even evil) to even ask that question. Growth is an important assumption behind the prevailing economic model — the economy must grow so more people can live at a higher level materially.

The Wikipedia entry for gross domestic product (GDP) defines and explains GDP.

Wikipedia also has an entry for an interesting alternative measure, the Happy Planet Index (HPI), advocated by an organization called the New Economics Foundation (nef).

The nef says it is creating “a new framework for real wealth creation by redefining wealth to focus on increased well-being and environmental sustainability rather than on just having and consuming more things.”

AB — 27 February 2009