Dear Prudence, won’t you come out to play
Dear Prudence, greet the brand new day
“Dear Prudence” – The Beatles
Lately, “prudence” is a virtue which has been in short supply. Prudence is defined as “care, caution, and good judgment, as well as wisdom in looking ahead….” This virtue has fallen into such disrepute that the American political and financial establishment have undertaken a war on prudence. Closely allied to prudence are the virtues of thrift and savings. Alas, these two handmaidens have also fallen on hard times.
Ignoring this virtue will only prolong the recession and economic malaise.
How We Got Into the Current Mess
Economic policy makers have exceptionally short memories. We are in financial crisis because Americans took on too much debt and over consumed housing, autos, plasma televisions and stocks. Americans also failed to save. Wall Street behavior made the crisis worse though reckless lending, highly leveraged trading and esoteric derivatives.
In short, we spent and borrowed too much and did not have the incomes to support the residual debt load. We entered into what the late economist Hyman Minsky referred to as Stage 3 Ponzi finance. That is, lenders knew that the debt could not be repaid based on the borrower’s income, yet they speculated on being repaid from presumed, ever increasing asset appreciation. For a longer discussion see Hoisington Investment Management, Quarterly Review and Outlook, 3rd Quarter 2009
Have the past two years ended the Ponzi finance system?
Back Doing Business at the Same Old Stand
The Obama and Bush administrations faced clear policy choices. Government could have encouraged savings, debt repayment and reductions in consumption. Un-payable debts would have defaulted and yielded whatever the market would bear in negotiated settlements or bankrupt proceedings. The choice would have been painful. But markets and the economy would have reset. Prudence on a personal and national level would have been restored.
Government’s alternate choice is now clear: reflate the bubble economy so we can party again as if it were 2005. Mark to market accounting was suspended. The Fed bought mortgage backed securities and other dubious debts at or near full value. The large banks, credit card companies, GMAC, AIG and others were bailed out. Where was Prudence? Nowhere to be found!
Keeping interest rates at near zero punished the thrifty and encouraged an ill-equipped public to return to an overvalued stock market and speculate in commodities or high yield debt instruments. On the consumption side the government encouraged home purchases through tax credits for new homes and cash for clunkers.
Prudence in Hiding on Wall Street
Prudence remains in hiding on Wall Street. After accepting (and we now learn needing) government funds and guarantees, Wall Street is back to high risk, highly leveraged trading. Goldman Sachs lost money on only one day in the last quarter. Instead of thanking taxpayers by demonstrating proportionality and humility in compensation practices, Wall Street will pay itself record bonuses this year. Perhaps the prudent course would be for these firms to reduce compensation levels and retain some of these record profits before the next storm. In addition, why not force executives to have some personal risk through mandatory deferrals of compensation to incent more prudent long term behaviors.
Sometimes it is Characterological
Prudence is one of those old-fashioned values that have fallen out of favor. Prudence requires delayed gratification, the acceptance of occasional loss and the accumulation of wealth slowly based on hard work and careful consumption. But our current government policy is a reflection of us: wanting a “quick fix” and a “do over” for the imprudent who lent and invested recklessly. In sparing Wall Street pain, we have managed to inflict pain on the entire American economy: barely any growth in GDP, unemployment still at 10% and ever growing deficits which will tax future generations.
Maybe when the current course of action totally fails, we can get Dear Prudence to come out and play.
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Related posts:
- Trust Once Lost
- Goldman and the Winner Take All Society
- Faux Powerlessness Part Deux
- Uncomfortable Questions
- Faux Powerlessness
Tags: bankers, derivatives, Minsky, prudence, The Beatles, Wall Street
