Michael Lewis: 'There's a Real Chance There's Going to Be an Uprising Against Bankers

http://www.huffingtonpost.com/terrence-mcnally/qa-with-michael-lewis-par_b_249538.html


Terrence McNally

Radio host, communications consultant
Posted: August 2, 2009 02:55 PM

Q and A with Michael Lewis (Part 2): There's a Real Chance There's Going to Be an Uprising

I recently interviewed Liar's Poker author Michael Lewis. After talking about his new book, Home Game: An Accidental Guide to Fatherhood, we discussed the financial meltdown and the bailout. This is Part 2 of some excerpts. You can hear the full podcast at terrencemcnally.net.

In Part 1, we talked about how the rules of the game were "totally screwed up" - for individual traders, firms, and ratings agencies. In Part 2, we look at some implications for American society at large.

TM: In 1970 only about 5% of men graduating from Harvard went into finance. By 1990, 15%, and by the class of 2007, 20% of the men and 10% of the women planned to go into investment banking.

ML: And half of the other ones applied, they just didn't get jobs. This is a radical misallocation of human talent. You can say it's faith in the free markets, but it's caused by the huge growth of a culture of financial manipulation.

TM: For years people have been saying that the U.S. was shifting from a manufacturing to a service economy. I suspect people thought of services as fast food, IT, health care, maybe lawyers. I don't think many really saw the huge role played by the financial sector.

ML: That's right. And let me draw an analogy. With the sub-prime mortgage racket generating lots of fees, the people within each big Wall Street firm who create that business acquire enormous power. So when the business gets decreasingly sane, when the loans get shakier and shakier, and the leverage gets bigger and bigger, they're the ones who say we've got to keep doing this. Even though people not directly implicated in the business might have said, "No, it's time to stop."

TM: So there were people within the firms who were sane and conservative ...

ML: There were, and they got driven out.

The plot thickens. Lewis sees the same dynamic at play among our country's leadership.

ML: I want to draw an analogy between what happens inside Merrill Lynch and what happens inside the United States. Here we have our little company, the United States of America. For thirty years the people who have had the most money to throw around were engaged in financial manipulation. Now they have outsized influence over the way the company is run.

TM: The company being the United States, the U.S. government...

ML: We are at a point right now where we should be radically reforming the financial system, and no Wall Street person with an actual interest should have a great deal of influence on that reform. Instead, the Obama administration is sort of half-heartedly reforming things, with little radical change -- and Wall Street people are instrumental in designing the new rules.

I think they think nobody's going to say anything to them about it, but I think it's politically risky. There's a real chance that there's going to be an uprising about this, and they're going to have trouble controlling the process.

TM: Do you mean they'll face trouble when what they pass doesn't work?

ML: Right. It won't work, and the mess they've created is going to have slow-burning economic consequences. We're going to be living in a very soft economy for a long time, and it's going to create disillusionment and anger. I expect there's going to be a crashing down of Wall Street's influence. It's just amazing it hasn't happened yet. And it hasn't happened yet because for thirty years their influence has become part of the air we breathe.

TM: It doesn't look like it's due simply to financial contributions to political candidates -- although there's certainly plenty of that -- but it's more that the best and the brightest...

ML: -- want to go work on Wall Street. That's the out.

If you're in Washington right now and you're engaged in public policy around Wall Street, if you're a regulator at the SEC, or you're at the Federal Reserve or the U.S. Treasury, and you're thinking what do I do next -- after I stop doing my poorly paying public service job -- there is an out. You get paid millions of dollars a year to go work at Goldman Sachs.

I don't think people engaged in trying to fix the problem are necessarily conscious of this, of how corrupt it all is. It's just in the air they breathe.

The existing institutional structure rewards those who are making the decisions, so they don't want to change it. In fact, they can't imagine a different institutional structure. They can't imagine a completely tamed financial sector that actually exists to serve the productive economy.

TM: They never ask, "How do we save the folks?" They never get past, "How do we save the banks?"

ML: The premise of the bailouts wasn't even really "How do we save the banks?" There are lots of banks, not all of them were involved in sub-prime mortgages. If you were going to start giving money to banks, you'd think you'd give it to the ones who didn't do dumb things. But instead the money goes to bankers who did do dumb things, because they're the ones who are about to go out of business.

What's even more interesting, the starting point for dealing with this problem - for both the Bush and Obama administrations -- was to say, one, we can't nationalize these banks, and two, the creditors of these banks can't take any sort of haircut, they can't take any losses.

TM: -- for making these terrible investments.

ML: So it leaves you, as a matter of public policy, with only one solution: to give money to the banks until they "earn their way out of it". Congress wrote a check for 700 billion dollars six or seven months ago. Then they lost the appetite for giving money to the banks, so now the banks are being gifted money, kind of sneakily, in the form of zero interest rate loans from the Federal Reserve. They can reinvest it in government securities, continue to run their high leverage, and keep the spread.

You take a step back and say, "What kind of society is this, where you have socialism for careless bankers and capitalism for everybody else?" Capitalism for everybody but the capitalists. That's not sustainable.

I think people generally don't completely understand what's going on, but it's a political issue.

TM: People say to themselves, "This is too complex for me..."

ML: -- and "They must know what they're doing."

But the fact is, they haven't known what they were doing, so there's no reason to suspect they know what they're doing now.

They're trying, I guess, but with a double standard that in these places alone, profits are privatized, and losses are socialized. That's a disaster. That they have not taken a more punitive approach to Wall Street amazes me, but I think the Obama administration is going to be forced to.

TM: When?

ML: Couple of years out.

It's hard to guess what's happening, but Obama probably looked at the problem and said, "If I do what actually needs to be done right now, it would consume the first two years of my administration. I could get one thing done -- radical reform of the financial industry, but I wouldn't get healthcare, climate change, anything else. So I'm going to put a band-aid on that problem, and do the other things I want to do. Then we'll come back to it.

TM: You're giving him the benefit of the doubt.

ML: Maybe. I think he deserves the benefit of a lot of doubt. He's earned it with me. That's the only thing I can think.

TM: You do see a day of reckoning...?

ML: Yes I do.

TM: And the question is, "Will society get really ugly before that happens?"

ML: Yes, that's the problem.

If you accept that what caused the financial crisis was totally screwed up rules of the road, totally screwed up incentives...then you claim you're reforming things, but you don't change those rules, you're just going to get the same problem all over again. I think that's the issue. Eventually we're going to have to change the rules of the game.

 

http://seekingalpha.com/article/157589-markets-aren-t-as-benign-as-they-look

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Markets Aren't as Benign as They Look
by: Tim Price
August 21, 2009 | about: SPY / XLF

“Remember, that credit is money.”
- Benjamin Franklin.

About 15 years ago, an older relative who enjoyed considerable status and influence within her local community expressed some surprise about how her bank account operated. She had always assumed that the banknotes that she deposited within her account would literally be kept in some kind of vault for safe keeping and left untouched. She fully expected to see the very same notes whenever she made a withdrawal. The idea that her money would be reused and lent on by the bank – and that the bank notes that returned would not likely be “hers” – came as something of a revelation to her. (Quite how bank depositors manage to earn interest was evidently not something that she unduly worried about. But given that current savers now earn essentially nothing, perhaps her lack of concern on the topic is more widely shared.)

Banks and banking are certainly poorly understood. Given the severity of the crisis, we can say with some confidence that banking is poorly understood even by bankers. The widespread unfamiliarity with the workings of the banking system may even be a good thing, for a while. For as Henry Ford once said,

It is well enough that people or the nation do not understand our banking and monetary system for if they did, I believe that there would be a revolution before morning.

Someone else who believes that the prospect of a revolt against the bankers is entirely conceivable is Michael Lewis, author of Liar's Poker (the definitive account of investment banker atavism – in this case, at Salomon Brothers in the mid-1980s) and former bond salesman, who knows something of the nature of the Wall Street beast. You can read the transcript of this podcast here. Among the pertinent highlights: in 1970, roughly 5% of male Harvard graduates went into finance. By 1990 the figure had risen to 15%; by 2007, 20% of the men and 10% of the women planned to head to Wall Street. Lewis suggests that half of the remainder also applied and just didn't get jobs:

...a radical misallocation of human talent. You can say it's faith in the free markets, but it's caused by the huge growth of a culture of financial manipulation... With the sub-prime mortgage racket generating lots of fees, the people within each big Wall Street firm who create that business acquire enormous power. So when the business gets decreasingly sane [gorgeous phrase], when the loans get shakier and shakier, and the leverage gets bigger and bigger, they're the ones who say we've got to keep doing this. Even though people not directly implicated in the business might have said, “No, it's time to stop.”... For thirty years the people who have had the most money to throw around were engaged in financial manipulation. Now they have outsized influence over the way the company [and country] is run.. I think it's politically risky. There’s a real chance that there’s going to be an uprising about this, and they're going to have trouble controlling the process. (Emphasis mine.)

Future generations will rightly wonder how taxpayers stood by while their present and future earnings were essentially redirected into the pockets of bankers who messed up, not trivially, but in a way that threatened the integrity and working of the entire financial system. Chief executives at banks have defended the ludicrous continuation of the bonus culture on the basis that talent needs to be rewarded at free market rates. This is, of course, absurd. If there were any talent out there in banking to create social value as opposed to leaching off the taxpayer and shareholder, it would be leaving the banks and setting up new entrepreneurial ventures to provide capital to those individuals and businesses most worthy of receiving it. As it is, banks are being stuffed with money from the government purse and sitting on it – or, as Luke Johnson suggested a couple of weeks ago, putting it to work perpetuating the misallocation of capital to the property sector.

The ongoing unavailability of bank finance, despite governments cramming capital down the throat of the banking sector goose, can be seen in the figures for corporate bond issuance, which on a global basis broke through the $1 trillion mark this year with four months still to go. This reflects the credit drought for the corporate sector and the difficulty companies face in securing bank loans. It also points to the income drought facing investors, who are otherwise caught between the rock of artificially low government bond yields and the hard place of quasi-zero deposit rates from those same pesky banks. Ironically, on exactly the same day that the corporate bond issuance figures were released, Standard & Poor's announced that the number of companies defaulting on their debts had risen to record levels this year – even as returns for the most speculative corporate bonds had soared since January.

Such is life when governments and their ostensibly independent central banks are allowed to muck about with interest rates, thus distorting market values all the way through the capital market chain. Quantitative easing manipulates government bond yields lower on the dubious premise of stimulating the broader economy. Coordinated monetary policy drives down base rates toward zero, and forces bank depositors into higher risk assets simply to keep their head above water. Some of this micro meddling would be justified if the banks were passing on the liquidity so generously supplied to them, but they are not. Those investors not lured by the siren-like returns of speculative quality assets are left to ponder whether or when the tidal wave of easy money sloshing round banks and asset markets will trigger real inflationary pressure. (That inflation is at work in financial asset prices is hard to deny – an over-supply of money chasing ultimately finite resources.)

Meanwhile, risk assets continue to surge higher. How durable the rally is remains, of course, to be seen. But those chasing equity markets ever higher should consider the following question: how can the world return to pre-2007 levels of economic growth when the supply of credit is being hopelessly constrained? And those brave investors buying bank stocks might wish to consider the report "Small Lessons from a Big Crisis" by Andrew Haldane, Executive Director for Financial Stability at the Bank of England, presented to the Federal Reserve Bank of Chicago Annual Conference in May this year. Haldane suggests the following hypothetical trade. Imagine placing a hedged bet in 1900: a £100 long investment on UK financial sector equities versus a £100 short bet against general UK equities (i.e., a bet on UK banks outperforming the rest of the market). How would that bet have performed?

Continued

 

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The chart below shows the results.



For the first 85 years, the bet looks like a rather unexciting trade. By 1985 it would have delivered £500, the equivalent of 2% per annum. And then comes the period 1986 to 2006. By the end of 2006 (note: before the credit crisis gets truly into gear), our once unexciting bet would have delivered £10,000, or the equivalent of over 16% per annum. As Haldane observes,

There is no period in recent UK financial history which bears comparison.

And then, of course, it all went horribly wrong. The cumulative fall in UK banking stocks up to the low point (so far) in March is the largest in history at over 80%, “outstripping the fall following the first oil price shock in 1973/4 and the stock market crash of 1929”. By the end of 2008, our century-old gamble would have delivered a capital sum of £2,200, or the annualised equivalent of less than 3% - reversion, in other words, back to the mean.

Just how did UK banks manage to generate such spectacular recent returns? Haldane points below to the obvious answer: leverage. “Movements in leverage have clearly been the dominant driver. Since 2000, rising leverage fully accounts for movements in UK banks' return on equity – both the rise to around 24% in 2007 and the subsequent fall into negative territory in 2008”.



Haldane also points out that those banks unable to deliver sufficiently high returns on assets to meet their return on equity targets resorted instead to gearing up their balance sheets. The rest is history (as, probably, are many of the banks, at least as far as mark-to-market accounting is concerned).

Where does this leave us now? 2009 has seen an extraordinary rally by more speculative assets, leaving “value” behind in the dirt. As Rob Arnott suggested two weeks ago, the gulf between “value” and “growth” stocks, for example, has only been more marked once in history – at the height of the dotcom boom. The rally may persist – and the outperformance of junky assets over high quality ones might persist alongside it. But the rally is taking valuations back toward those that pertained when the world was rolling orgiastically in credit. The credit is gone. We will not see its like again for years to come.

You do not have to understand the precise workings of banks to know that buying their equity now – or for that matter the equity of speculative quality companies – represents unusual risk. The world has changed and the financial world in particular now looks radically different from the ill considered credit spree that dominated until western property markets and the associated banks started to creak and then collapse in the summer of 2007. The seemingly benign market environment is dangerously misleading. Those investors chasing the momentum of the most speculative cyclical stocks – and debt of comparable quality – are incurring exceptional levels of risk. Perhaps, like bankers shovelling other people's capital toward essentially unproductive uses, they simply don't care.

 

From what I'm seeing/hearing, Bankers/Inv. Bankers/Brokers are now considered to be LOWER than Lawyers. That's saying something!!!

(Yes, I'm a Broker and IAR I know... It's truly sad, but I can also understand why...)

Thanks to a large group of what I consider "scumbags," I'm on the road to being a broke Broker with a Wife, three Sons, and Clients I truly care for. Wait, I'm already broke. Nevermind.

 

If things get bad enough, banks will be burned to the ground;yes, in the U.S.ofA.

People who deny the possibility of this are on the wrong side of history, and in denial of the basic premise that history can and does repeat itself.

 

Here's a recent article about Goldman's CEO, where he tells his entire company to "play it down" and talks about his "humble roots coming out of Brooklyn".

Link

I find it to be absolutely amazing that their dealing with the government have not be investigated more fully! :eek:

 

In the 1960's, it was civil rights. This time around it will be Mr.
middle class america. Sounds like he is getting pissed.

 

ByLo, thanks for posting the Michael Lewis, damn he's good.

Comments regarding any revolution such as burning banks, etc. I just don't see it, who would do it? People under 25 just don't have the initiative, people over 50 who may have good reasons are burnt out, no energy for something that may or may not happen, taking care of both their kids and the elderly parents.

The able bodied people are in the military, or some type of law enforcement/ security, sworn to uphold the law.

Who's left, Wall Mart shoppers, minorities, illegal immigrants, the homeless?

Maybe the unemployed once their bene's run out. I really can't think of a large group of people that would pull this off.

 

History can repeat itself, however in this case, what demographic will burn down the banks? The gen x/yers? No way in hell. The boomers?

 

People may not burn the banks, but they don't have to.

DoS attacks, viruses, etc, could cause the desired dissruption w/o the potential bloodshed.