What Difference?

There have been a number of good books written about the crisis we are embroiled in. Depending on what you want to learn and what perspective you want to take the shelves are groaning with tomes each presenting a credible view. From what I can tell they all triangulate on one simple fact: that our elites, the media, the politicians, business leaders, and academics, failed us horribly. They failed to realize the consequences of their social engineering – the extraordinary emphasis on home ownership as opposed to home renting – and their unabashed commitment to free market ideology. They genuinely thought that markets resolve problems. They never considered that markets may also cause problems.

Group think permeated the US from the late 1970’s through until 2008. Every aspect of our lives was exposed to the rawness of unfettered market power. Regulations were stripped away because “government was the problem”. That meant protections were also stripped away, a fact that voters less committed to the ideology failed to grasp.

So when Katrina roared through we watched as our government was helpless – rendered that way by the deliberate reduction in its capacity. It was government, so it was bad. Likewise when tainted products arrived from China we were exposed to their dangers because the “bad government” had been reduced and could not cover the vast territory of inspection we still expected it to. And finally we all were forced to watch as our government caved in meekly to the banking industry as it imploded and asked peremptorily for our help. This after having been deregulated and allowed to pile up the disaster from which it sought relief.

Our elites failed us.

So the question we should ask, naturally, is: will that failure continue?

Sadly yes.

Getting back to those books.

What most stands out for me is the extraordinary analysis in “This Time Is Different” by Reinhart and Rogoff.

The one message that they hammer home is that it is never different. Crises have time worn similarities. Symptoms do exist. It is possible to tell whether an asset bubble is brewing. We are quite capable of seeing the problems arise and before they reach catastrophic levels of urgency.

Our one problem is that we keep convincing ourselves that ‘this time is different’.

We heard that endlessly about the rise of the internet and that somehow the internet had changed, irrevocably, the basics of economics. We heard it about the rise of the insanity in the financial markets, where ‘risk management’ techniques had eliminated, forever, the chance that risk would destroy a bank.

The point is that while the innovation of the internet may alter the way in which business is done – and that is something I am completely convinced of – those changes do not alter the more basic relationships of profit and loss. Profits my be sourced in different ways, and losses may crop up in different guises, but the economy, in aggregate, is still subject to the same forces that have always buffeted it.

The insanity of the ‘dot com’ era was that profit was not as important as revenue growth. So money poured into speculative projects that had no reason for being. Most of that money was lost. Yes, many great companies emerged from the debris, but only after they embraced the fundamentals of finance and economics. Old fashioned fundamentals allowed them to survive and flourish. As for the rest: they disappeared and took a ton of very valuable capital with them. Capital that could have been employed rebuilding our infrastructure, or our manufacturing industries.

The insanity of the financial boom and bust was that people came to believe in magic. They believed risk could be neutralized – eliminated rather than simply managed – by deploying endless layers of increasingly opaque rigamarole and legal hocus-pocus. It was a profitable illusion for a while and the main players all made personal fortunes. But they robbed the economy at large of its vibrancy and debilitated one of our great assets: our healthy banking system.

In retrospect, which is the perspective of all the books now flooding us with their 20/20 hindsight, the staggering fact is the we did this to ourselves. We allowed ourselves to suspend our better judgement because the dreamy ‘city on a hill’ was sufficiently gaudy that we took our focus off reality.

We fell for saccharin, old wives tales, and ‘this time is different’.

Why am I repeating this?

Because, already, the next bubble is growing. The financial media, for which my contempt is unbounded, is already touting our recovery and is breathlessly talking of new highs in the Dow just a few months from now.

And the energy, determination, and simple brute fortitude needed to fix the structural mess that underlay the crisis is fading from our legislators daily.

The case in point is bank reform.

We will witness the passage of bank reform. My guess sooner rather than later. The new law will have a glossy edge to it and will be filled with well meaning and tough sounding jargon. But it will not fix the big problems.

Our biggest banks will remain too-big-to-fail. They will thrive off our subsidy. They will pay egregious bonuses. They will continue to ‘innovate’. They will syphon capital into their paychecks rather than channel into our businesses. And they will assuredly fail again.

We all have a tendency to avoid the big decisions. Politicians more so than the rest of us because they are so exposed to our vanities. Now is not a time to fail by such avoidance. The pall cast across the world by the Euro crisis should warn us not to postpone action. The failure of the Euro was predictable. It was a matter of time. It was a classic case of ‘this time is different’. The failure is now obvious: without a full integration at the political level, and the fiscal integration that would have implied, each Euro member has only limited choices in policy. Europe’s problem can be boiled down to this: wages are too high in some parts when compared to the wages of the other parts. This means that Greek and Spanish workers need to deflate their incomes – by about 30% – in order to compete with Germany. Other ways to accomplish a re-balancing of purchasing power – local inflation or local currency devaluation – do not exist. So the original weakness to seek the bold solution, political integration, has left a legacy for which today’s workers will pay a terrible price.

This time is never different.

Boldness, clarity, and direct action will always be preferable to limp explanations that, somehow, we have discovered the magic that enables us to ignore reality.

So beware the financial media’s triumphal headlines about the next big thing.

Ask: what difference?