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     Aug 16, 2011


The people's Ponzi scheme
By Spengler

"What happened to Obama?," asks a psychology professor in an August 6 op-ed in the New York Times. Our brains, he avers, require stories to make sense of things, and in 2009, "Americans needed their president to tell them a story that made sense of what they had just been through, what caused it, and how it was going to end."

The story the country awaited from Barack Obama, according to Professor Drew Westen, went like this: "This was a disaster, but it was not a natural disaster. It was made by Wall Street gamblers who speculated with your lives and futures. It was made by conservative extremists who told us that if we just eliminated regulations and rewarded greed and recklessness, it would all work out."

The trouble is that "Wall Street gamblers" didn't do the

 
speculating. The American public did. This was a Ponzi scheme by the people, of the people and for the people, the most democratic crony-capitalist scam in the history of humankind. Households made more money than the bankers during every year of the bubble, and ended up better off than they were before the bubble, while the bankers got wiped.

Take two gauges of wealth: real estate assets owned by American households, against the value of bank stocks (using the KBW index of American bank equities). The price of bank stocks measures the value of institutions as well as the net worth of the highest-paid bankers, who take most of their bonuses in equity.


Source: Federal Reserve Flow of Funds; Yahoo Finance.

Household real estate assets rose nearly two-and-a-half times from around $9 trillion in 1998 to $23 trillion at the peak of the bubble in 2006. Bank stocks had a smaller bounce, from around 80 on the KBW index to a 2006 peak of 117, a gain of less than 50%.

That's not surprising, for households could buy a house with 5% or 10% down, and deduct the mortgage interest from their taxable income. A homeowner who bought a US$100,000 home with a $5,000 down payment doubled his original stake every year as home prices rose 10% per annum. Return on equity of 100% to 200% was common for homeowners; Goldman Sachs' return on equity never made it above the mid-30% range.

The contrast is clearer if we index 1998 to 100 in order to put the two gauges on the same scale.

Bank stocks vs household real estate assets, index 1998 = 100

Source: Federal Reserve Flow of Funds, Yahoo Finance.


Household real estate wealth remains 70% higher than it was in 1998, even after the crash in home prices. Bank stocks, by contrast, are worth half of what they were in 1998. Many of the big banks are much worse off. Bank of America is trading at less than a third of its 1998 price, and Citigroup is at barely a tenth of its 1998 level.

By no means do I excuse the banks. Until 2005, I headed fixed-income research for Bank of America, and resigned for what the bank and I agreed to call "philosophical differences". On leaving, I sold every share I owned. Years before (1993-1996) I worked for Bear Stearns, and stayed in touch with such old colleagues as Ralph Cioffi. He ran the firm's mortgage head fund. The July 2007 failure signaled the crisis to come. The federal government charged Ralph with malfeasance in the hedge fund's demise, but a jury rightly acquitted him; from what I could tell, he was guilty of nothing more than being wrong about the market.

In July 2007, I warned Larry Kudlow's national audience on CNBC about a "trillion-dollar AAA asset bubble". Even though I left the financial industry because I disagreed with its direction, and alerted the public early on, one admits such past affiliations with trepidation. Before the likes of Professor Westen, an ex-banker feels like Charles Darnay explaining his pedigree to Madame Desfarges.

In general, Wall Street remained stolidly sanguine about the bubble until it was too late. There were exceptions - Goldman Sachs and the John Paulson hedge fund, among others - who took short positions on subprime. But there had to be a long position on the other side, and the destruction of institutional and personal wealth among the top tier of bankers exceeded the balance-sheet damage to American households.

Wall Street was the enabler, but Main Street was the addict. Americans stopped saving as long as home prices rose; when home prices started to fall, they started saving again.

Household real estate assets vs personal savings rate




That is why the national narrative that Westen proposes is ill-informed, innumerate, vituperous, malicious and false. American households levered a $6 trillion net inflow of foreign savings during the decade 1998 through 2007 into a bubble that benefited them far more than it did Wall Street. The impact of the bubble on the household balance sheet exceeds the growth in real-estate assets, moreover, because most small business expansion followed the housing bubble.

Americans, as I argued on August 2 (The collapse of America's middle class Asia Times Online, August 2) must adapted to a technology-driven global economy, after a decade and a half of riding the crest of the savings tsunami that flooded American markets during the bubble years. Whatever they do, it will not be easy. The bankers got no more than they deserved, to be sure, but there is not much left to beat up in the exsanguinated financial industry. To propose a national witch-hunt against "Wall Street gamblers" is a stupid and wicked thing to do.

Spengler is channeled by David P Goldman. Comment on this article in Spengler's Expat Bar forum.

(Copyright 2011 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)


Destabilizing speculation
(Aug 9, '11)

End of the road for hedge funds
(Aug 8, '11)

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