A decade of financial frustration has just ended with US equity returns negative for the entire period. This is the first time this has occurred, and that includes the 1930’s America’s Great Depression. A grim statistic indeed; what went wrong?
The United States began and thrived as a nation of ideas, imagination, hard work and grit. Its hallmark has been a population that saved and produced. Contrary to these admirable national character traits, Alan Greenspan and his protégé Ben Bernanke utilized low interest rates and a “fire hose” of liquidity to solve financial crises. From this folly, we now suffer negative consequences detrimental to the very fabric of American Society. See Shredding the Social Fabric.
The Age of Get Rich Quick Schemes
America has always had a history of “get rich quick schemes:” the California Gold Rush, the Florida land boom and the “roaring”1920’s stock market. These booms and inevitable busts were damaging, but did not change America’s basic character. Even the Great Depression did not change our basic values of thrift and hard work. But the toxic combination of Greenspan’s easy money, and ubiquitous information and spin disseminated via the internet and financial television elevated “get rich quick schemes” to national obsessions.
- The Internet Boom – A poster child and pitiful example for the boom and bust was MicroStrategy. From its initial offering in June 1998 it rose to a market cap of $26b. The founder was found guilty of numerous SEC violations. Still in business 11 years later the company has a market cap of $1.1b.See Search for Redemption.
- Day Trading – Closely allied to the internet boom was the wave of day traders who quit their jobs to spend full time trading stocks. Many achieved temporary riches only to suffer huge losses after the internet boom turned to bust. See Downfall of a Day Trader.
- House Flipping – To offset the internet stock market crash, the Fed adopted a policy of ultra low interest rates. In the ensuing housing frenzy from 2002-2007, speculators flipped houses and even raw land. The disastrous results are now obvious.
- Credit Derivatives – Experts from Myron Scholes, the Nobel Prize winner for his work on valuing credit derivatives (Black-Scholes model) to Warren Buffet view credit derivatives as financial weapons of mass destruction. These esoteric instruments were key factors in the recent financial crisis and many believe the problem has not been fixed. Indeed derivatives became a source of large profits for Wall Street firms, often at the expense of their own clients. See Banks Bundled Debt, Bet Against It and Won.
- Ponzi Schemes – Disregarding obvious warning signs, sophisticated investors lured by consistent above market returns were ultimately defrauded by Ponzi schemers like Bernie Madoff, Allen Stanford and others.
- Wall Street Bonuses – Instead of holding capital in reserve in anticipation of the next financial crisis, Wall Street firms are paying record bonuses this year equal to fifty percent or more of revenue. This easy money is even more galling as we used taxpayer money to stave off bankruptcy in these same firms. The lure of easy money trumped prudent financial strategy. See Wall Street on Track to Award Record Pay.
Disconnecting Effort and Reward
The last decade has made fools out of the average working person. Why work at a $50,000 a year job, stay out of debt and try to save 10% of your income while others reap outsized rewards with seemingly little effort? Low cost, virtually unlimited lending enticed many to “day trade”, “house flip” and engage in a consumer orgy.
I have chronicled the obvious problems of too much debt. We will take a long time, if ever, to work our way out of this morass. More damaging was the disconnect between effort and reward. Financial schemes replaced production. We invested scarce societal savings in these get rich schemes which make economic recovery even more difficult.
And too, our precious human capital has been compromised, as resources were diverted from teaching, engineering and management programs into MBA’s in finance. A prestigious job on Wall Street became way more attractive than teaching, engineering, entry into a manufacturing company or even law or medicine. This was not just a financial crisis, but a crisis of American character. I hope it does not take ten years to return to fundamentals and our core national values.
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Related posts:
- Freedom to Fail
- It is All a Derivative of Productive Enterprise
- The Macroeconomic Picture or Connecting the Dots
- Citigroup, Branch Rickey and the Theater of the Absurd
- War on Prudence
Tags: Allen Stanford, day trading, house flipping, Madoff, MicroStrategy, Myron Scholes, Ponzi scheme
