‘Dr. Doom’ Might Have Spared Bear, Saved $34 Trillion

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‘Dr. Doom’ Might Have Spared Bear, Saved $34 Trillion: Books

Sept. 10 (Bloomberg) -- If only we had heeded the other Dr. Doom, Henry Kaufman.

Bear Stearns Cos. might still be standing. Americans wouldn’t have run up some $34 trillion in domestic nonfinancial debt. And Ben Bernanke could have kept his dollar-spewing helicopter in the hangar.

The nickname Dr. Doom was hung on Kaufman long before it became synonymous with Nouriel Roubini, the New York University gloom meister. Kaufman, a former Salomon Brothers Inc. managing director and economist, has spent decades telling anyone who would listen about the dangers of ballooning debt, deregulation, excessive risk-taking, and the rise of financial conglomerates such as Citigroup Inc.

In “The Road to Financial Reformation,” he recapitulates his past predictions, discusses the consequences for free markets and lays out a blueprint for fixing our broken regulatory machinery. The book makes for painful reading at a time when bailed-out bankers are again scooping up tens of millions in compensation dollars.

“The shabby events of the recent past demonstrate that people in finance cannot and should not escape public scrutiny,” Kaufman, 81, writes in this scorching indictment.

Nobody listens to Cassandra, of course, and everybody hates hearing “I told you so,” especially from someone who calls his own old comments “prophetic.”

Salomon, Lehman Jobs

Some may also rankle because Kaufman was inside Salomon when the firm embraced two factors that he fingers in the crisis, securitization and outsized risk-taking. This was, after all, the firm where Lewis Ranieri pioneered the packaging of mortgages as securities and John Meriwether ran the Arbitrage Group, which Kaufman himself calls the precursor of Long-Term Capital Management LP. Others will recall that he was a director at Lehman Brothers Holdings Inc. as it careened toward disaster.

Yet Kaufman’s insider status is the very reason why you should read this book. Here is a withering critique of the follies of deregulation from one of Wall Street’s own.

At the core of his criticism lies our failure to study, let alone learn from, the past. Yes, we know we’re slogging through our worst financial crisis since the Great Depression. Yet how many people realize that the U.S. has suffered no fewer than 15 credit crises since 1966? Kaufman shows how we marched -- eyes wide shut -- toward the Great Credit Crackup, bubble by bubble, bailout by bailout.

“The excessive use of leverage,” he writes, is “an ongoing theme throughout financial history,” from 14th-century Florence to the near collapse of Barings Brothers under massive loans to Argentina in 1890.

‘Super Bubble’

For centuries, Kaufman reminds us, credit bubbles were popped by “financial crises and panics, which induced large debt liquidations through bankruptcies and reorganizations.” In more recent times, we have softened the blow with deposit insurance, bailouts and ultra-low Federal Reserve interest rates. No regulator dared prick what George Soros has called a “super bubble” that began ballooning in the 1980s.

“One feature that distinguished this time from earlier periods was the rapid and large growth of debt, without intervening periods of debt rollbacks,” Kaufman writes.

And so it was that we wound up freeing financial institutions from regulation yet protecting them from failure, spreading what Kaufman calls “an official safety net” under many financial activities. This is both illogical and dangerous.

From Adam Smith to Milton Friedman, “no reputable economist argued for both deregulation and the too-big-to-fail doctrine, because the two views are logically incompatible,” Kaufman writes.

Past Predictions

Much of the material presented here amounts to a selection of warnings that Kaufman presented in papers year after year at gatherings such as the Fed’s annual symposium in Jackson Hole, Wyoming. It’s worth revisiting.

In a talk in 1986, for example, he sounded an alarm about swelling credit creation, which would cause U.S. nonfinancial debt to exceed its nominal gross domestic product by almost $19 trillion in early 2008, up from $500 billion in 1979, he writes.

Books on financial regulation are by definition dry, and Kaufman often sinks into yawn-inducing paragraphs of numbered points. (First, second, third and finally.) If the prose gets you down, flip to the telling tables and charts.

My favorite is Exhibit 12.1, which lists 15 major credit crises since 1945, starting with a credit crunch in 1966 and running through the various bank failures, crashes, bailouts and bubbles that led inexorably to our own mess.

Keep that timeline handy for the next banker, senator or Fed governor who says the financial sector doesn’t need re- regulation.

To contact the writer on the story: James Pressley in Brussels at jpressley@bloomberg.net.
Last Updated: September 9, 2009 19:00 EDT