Bailout Nation (2 page)

However much we dislike the predicament we are in, the only way it can be remedied is if people learn in some detail what has transpired and so, armed with knowledge, demand change. Reading this book will prepare you to be able to do just that.

 

BILL FLECKENSTEIN
March 2009

A
ll books are collaborative efforts, and
Bailout Nation
was more so than most. There were many people whose contributions were crucial to getting this project off the ground, and keeping it going when things started to falter.

Over the course of the past year, I wrote this book while working in an asset management firm, heading a research shop, all the while running a very active blog. This book was possible only thanks to the many helping hands involved.

Much of the book was written in real time, and early versions of parts of this appeared on
The Big Picture
(
www.ritholtz.com
). I would post ideas a few hundred words at a time, and readers would critique, poke, and prod my thought process along. These brave souls have my everlasting gratitude. Many of the insights, quotes, obscure references, and artworks within the book come courtesy of them.

There were many professional journalists and writers who selflessly shared sources, ideas, and insights with me. In particular, Dan Gross, Jesse Eisinger, Randall Forsyth, and Herb Greenberg all greatly impacted my process. If there are any parallels between my book and Dan's, it's because we batted more than a few ideas off of each other. Special thanks go to Thomas Donlan of
Barron's
, who took my disjointed ramblings in
A Memo Found in the Street
(“Dear D.C.”) and turned them into a concise thing of beauty.

Numerous other authors were helpful with the process of writing a book, as well as influencing my own research and writing. I owe special thanks to Nouriel Roubini, Bill Fleckenstein, and Michael Panzner for advice and comfort. Various fund managers and analysts generously shared their insights, most notably Doug Kass, James Bianco, Scott Frew, Chris Whalen, and David Kotok.

I grew up in a household where stocks and real estate were fodder for dinner-table conversations. My now-retired mother was a successful real estate agent, and used to regale us with dark tales of corruption and criminality in the real estate business (especially about C1 and C2). Her subversive view of the industry she worked in definitely rubbed off on me. (Thanks, Mom!)

The artwork in the book came to me courtesy of a few fantastic artists: John Sherffius of the
Boulder Daily Camera
is the creator of the fabulous jacket illustration to
Bailout Nation
. His political cartoons are also at the beginning of each of the five parts of the book. His dry wit and deft pen strokes communicate more with one picture that I can with thousands of words. J. C. Champredonde is the wicked mind behind the investment banks as casinos illustrations. You will find his work toward the end of the casino capitalism chapter and on the Web at
www.stereohell.com
. His art perfectly captures the past decade of casino capitalism. Jess Bachman of
WallStats.com
did amazing work on the Anatomy of a Crisis. R. J. Matson lent us a cartoon—corporate welfare.

Special thanks also go to Bill McBride of Calculated Risk for his informative real estate charts, and to Ron Griess of The Chart Store for the historical market charts.

Few writers particularly enjoy being edited. I was fortunate at
TheStreet.com
to work with Aaron Task—a rare editor who genuinely makes your work better (as opposed to merely different). When McGraw-Hill first approached me about doing this book (more about them later), I knew without question who I was willing to entrust my words to. Aaron's contributions, organization, and constant urgings forward are the prime reason this book got to the publisher on time in December 2008. It's been said a book is done when the manuscript is torn from its writer's hands, and Aaron made sure that when that date came, what was being torn was something readable.

Much of this book involves dollar amounts, dates, data, and numbers. Staying on top of that would not have been possible without a crack research team, and I was fortunate to have worked with three of the best: Eugene Ashton-Gonzalez and William J. Miller were terrific, and my research intern, Ariel Katz, deserves special praise for her insights. She graduates from business school in May 2010, and some lucky company should snag her right away. Special thanks also go to Marion Maneker, for his gentle shoves in the right direction and his insights into the world of publishing.

Jeanne Glasser at McGraw-Hill was uniquely patient in dealing with writing a book about live events as they happened. When that publisher took issue with my criticisms of Standard & Poor's (a division of McGraw-Hill), Jeanne fought hard for the book. That the book in your hands ended up at John Wiley & Sons—and Jeanne at FT Press and Wharton School Publishing—tells you something about character. And I would be remiss if I did not add that Lloyd Jassin, my literary agent, went above and beyond the call of duty throughout. As you might imagine, this was not the typical book deal.

Speaking of which: I am thrilled to be published by Wiley. The people there were especially excited about this project. It was a pleasure working with Kevin Commins and Meg Freeborn and the rest of the Wiley crew.

Perhaps this is an acknowledgment first, but I have to give a shout out to Google Docs—the collaborative editing process would have been a bear without it. We had so many different versions of each chapter floating around before we started using it. G-Docs made staying on top of the latest changes and edits a breeze. Chalk one up for cloud computing.

On a personal note, my wife showed infinite patience during this lost year of writing
Bailout Nation
. If it wasn't for her, this book would never have been finished. (
Go for a walk! You're babbling again! Stop procrastinating! And for goodness' sake, will you take a shower already!
)

I must also express my gratitude to my partners at FusionIQ, Kevin Lane and Mike Conte, who gracefully allowed me to take many days off to finish this beast and to close the door to my office to bang out a few more pages during the workweek.

Many additional authors colored my worldview, and much of what you read is due to the prior work of Roger Lowenstein, Richard Bookstaber, Tom Metz, Paul Desmond, Stephan Mihm, Satyajit Das, Robert J. Shiller, Robert F. Bruner and Sean D. Carr, Reginald Stuart, and Ed Gramlich. Their writings influenced what you now hold in your hands, and if it's any good, it's because I stole only from the very best.

—J. P. Getty

 

 

 

 

 

W
e like to think of the United States as a rugged country of determined, self-reliant individuals. The iconic image is the American cowboy. You can picture him on a cattle drive, watching warily over his herd. All he needed to get by were his wits, his horse—and his trusty Winchester.

This idealized vision of America is fading fast, rendered moot by present-day cattle rustlers. The new gauchos ride not on the range, but on the financial vistas. Instead of herding cattle, they rope derivatives, wrangle financial instruments, and round up paper wealth. The differences between the modern-day cowboy/bankers and the ranch hands of the old West are many, not the least of which is monetary—today's banker/rustler makes a whole lot more money than the frontiersmen did in the past.

But there is another crucial difference between the two—the “individualist” part. The newfangled herdsman may look rugged, but he sure as hell ain't independent. The modern cowpoke has become way too reliant on a different sort of cavalry: Uncle Sam—and all the taxpayers that support him.

How did we go from being a nation that revered the idea of the self-reliant broncobuster into something else entirely? What turned us into a nanny state for well-paid bankers?

How did the good ole U.S. of A. turn into a Bailout Nation? That is what this book is about.

It's easy to understand why
bailout
is such a dirty word in the American financial vernacular. There are many reasons, but I want to focus on the three biggest ones.

First, there is something inherently unjust about some people getting a free ride when everyone else has to pay his or her own way. We Americans are always willing to lend a hand to someone down on their luck, but that is not what the current crop of bailouts is about. This is the government financially rescuing people despite—or perhaps because of—their own enormous recklessness and incompetence.

This inequity is especially galling to those of us who work in the financial markets. Wall Street has long been a brutal meritocracy. Success is based on skills and smarts and the relentless ability to identify opportunity while simultaneously managing risk. All of the people I know who work on the Street—whether in stocks, bonds, options, or commodities—have a strong sense of fair play. “Eat what you kill” is the classic Wall Street attitude toward risk and reward, profit and loss.

There are, however, those market players who fail to live or die by their own swords—but then expect to be rescued by others from their own folly. They embody a fair-weather belief in the free market system, somehow thinking it applies only during the good times. This is a high form of moral cowardice, and it is rightly despised by those who play fairly and by the rules.

Since the turn of the twenty-first century, well-connected, moneyed interests have managed to keep all of their profits and bonuses during good times, but have somehow thrown off their risk and the results of their own bad decision making onto the public taxpayers. “Privatized gains and socialized losses” is hardly what capitalism is supposed to be.

Second, the process of how some groups get rescued by the government, while others are left to flounder, is in and of itself suspect. The cliché that “no one should see how laws or sausages get made” is especially true when it comes to bailouts. The political mechanisms—and the dollar amounts involved—are especially egregious. Why? In all modern cases, they are done quickly, on an emergency footing. There is often little or no debate. Transparency has been nonexistent. Many observers not only object philosophically to the concept of bailouts, but are particularly offended by the ham-fisted way they are foisted upon the public. Nearly everything has been done on an ad hoc basis, with little thought and less planning. Who has time for strategy or long-term thinking when we have trillions of dollars to spend?

Third, and finally, there are the costs. If we have learned anything about bailouts over the past hundred years, it is that each rescue attempt is more costly than the one that preceded it. This is usually true in terms of the immediate expenditure, but even more so in terms of the long-term damage done to the financial system. As of February 2009, the costs have raced past $14 trillion. That is an unprecedented sum of money, greater than any other single government expenditure in the nation's history (see
Table I.1
).

Table I.1
Cheaper to Clean Up After?

SOURCE: Data courtesy of Bianco Research

Beyond the actual out-of-pocket expenses lies the dangerous hazard of corporate bailouts. The government's largesse encourages greater and greater reckless speculation. The ordinary liability and risk that is supposed to go with investing and business ventures seem to have disappeared. A grotesque distortion of normal capitalist incentives is formed. When a sector of the economy expects to be rescued by the government, it loses the healthy fear of financial failure. This leads directly to excessive speculation and reckless behavior—a condition known as moral hazard.