After the 2007-09 financial crisis, the imbalances and risks pervading the global economy were exacerbated by policy mistakes. So, rather than address the structural problems that the financial collapse and ensuing recession revealed, governments mostly kicked the can down the road, creating major downside risks that made another crisis inevitable. And now that it has arrived, the risks are growing even more acute. Unfortunately, even if the Greater Recession leads to a lacklustre U-shaped recovery this year, an L-shaped “Greater Depression” will follow later in this decade, owing to 10 ominous and risky trends.
The first trend concerns deficits and their corollary risks: debts and defaults. The policy response to the Covid-19 crisis entails a massive increase in fiscal deficits – on the order of 10% of GDP or more – at a time when public debt levels in many countries were already high, if not unsustainable.
Worse, the loss of income for many households and firms means that private-sector debt levels will become unsustainable, too, potentially leading to mass defaults and bankruptcies. Together with soaring levels of public debt, this all but ensures a more anaemic recovery than the one that followed the Great Recession a decade ago.
A second factor is the demographic timebomb in advanced economies. The Covid-19 crisis shows that much more public spending must be allocated to health systems, and that universal healthcare and other relevant public goods are necessities, not luxuries. Yet, because most developed countries have ageing societies, funding such outlays in the future will make the implicit debts from today’s unfunded healthcare and social security systems even larger.
A third issue is the growing risk of deflation. In addition to causing a deep recession, the crisis is also creating a massive slack in goods (unused machines and capacity) and labour markets (mass unemployment), as well as driving a price collapse in commodities such as oil and industrial metals. That makes debt deflation likely, increasing the risk of insolvency.
A fourth (related) factor will be currency debasement. As central banks try to fight deflation and head off the risk of surging interest rates (following from the massive debt build-up), monetary policies will become even more unconventional and far-reaching. In the short run, governments will need to run monetised fiscal deficits to avoid depression and deflation. Yet, over time, the permanent negative supply shocks from accelerated de-globalisation and renewed protectionism will make stagflation all but inevitable.
A fifth issue is the broader digital disruption of the economy. With millions of people losing their jobs or working and earning less, the income and wealth gaps of the 21st-century economy will widen further. To guard against future supply-chain shocks, companies in advanced economies will re-shore production from low-cost regions to higher-cost domestic markets. But rather than helping workers at home, this trend will accelerate the pace of automation, putting downward pressure on wages and further fanning the flames of populism, nationalism, and xenophobia.
This points to the sixth major factor: deglobalisation. The pandemic is accelerating trends toward balkanisation and fragmentation that were already well underway. The US and China will decouple faster, and most countries will respond by adopting still more protectionist policies to shield domestic firms and workers from global disruptions. The post-pandemic world will be marked by tighter restrictions on the movement of goods, services, capital, labour, technology, data, and information. This is already happening in the pharmaceutical, medical-equipment, and food sectors, where governments are imposing export restrictions and other protectionist measures in response to the crisis.
The backlash against democracy will reinforce this trend. Populist leaders often benefit from economic weakness, mass unemployment, and rising inequality. Under conditions of heightened economic insecurity, there will be a strong impulse to scapegoat foreigners for the crisis. Blue-collar workers and broad cohorts of the middle class will become more susceptible to populist rhetoric, particularly proposals to restrict migration and trade.
This points to an eighth factor: the geostrategic standoff between the US and China. With the Trump administration making every effort to blame China for the pandemic, Chinese President Xi Jinping’s regime will double down on its claim that the US is conspiring to prevent China’s peaceful rise. The Sino-American decoupling in trade, technology, investment, data, and monetary arrangements will intensify.
Worse, this diplomatic breakup will set the stage for a new cold war between the US and its rivals – not just China, but also Russia, Iran, and North Korea. With a US presidential election approaching, there is every reason to expect an upsurge in clandestine cyber warfare, potentially leading even to conventional military clashes. And because technology is the key weapon in the fight for control of the industries of the future and in combating pandemics, the US private tech sector will become increasingly integrated into the national-security-industrial complex.
A final risk that cannot be ignored is environmental disruption, which, as the Covid-19 crisis has shown, can wreak far more economic havoc than a financial crisis. Recurring epidemics (HIV since the 1980s, Sars in 2003, H1N1 in 2009, Mers in 2011, Ebola in 2014-16) are, like climate change, essentially manmade disasters, born of poor health and sanitary standards, the abuse of natural systems, and the growing interconnectivity of a globalised world. Pandemics and the many morbid symptoms of climate change will become more frequent, severe, and costly in the years ahead.
These 10 risks, already looming large before Covid-19 struck, now threaten to fuel a perfect storm that sweeps the entire global economy into a decade of despair. By the 2030s, technology and more competent political leadership may be able to reduce, resolve, or minimise many of these problems, giving rise to a more inclusive, cooperative, and stable international order. But any happy ending assumes that we find a way to survive the coming Greater Depression.
• Nouriel Roubini is professor of economics at New York University’s Stern School of Business. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.
Everybody seems to be in debt, this is sort of puzzling in a way.”
And I would say, no, and one reason why is because there seems to be this feeling since
the 70’s that basically all social problems can be solved through debt.
One theory I saw, which is kind of interesting, it’s the autonomist reading, Midnight Notes
Collective, it’s a group of Italian autonomist Marxists.
But they had this very interesting reading of the two phases of post-war capitalism.
What they basically said is that after World War II they kinda gave a deal to the North
Atlantic white working class and they said, “Okay, if you guys don’t become commies we’ll
give you free education, free health care in most places anyway, we’ll give you social
benefits of various kinds.”
And social struggles between 1945 and 1975 where more and more people asking in on the
And there is a tie between productivity and wages.
So whenever, and the lines go up together, increases of productivity are met with increases
Since the 70’s the deal is clearly off and one reason is because they reached kind of
crisis of inclusion that you can’t actually give that deal to everybody without fundamentally
changing the nature of the system.
So first minorities, so you have the Civil Rights Movement, other people who’ve been
left out of the deal want in, people in the Global South want in, women want in, feminist
It reaches a point where it just sort of snaps and you have this fiscal crisis, oil crunch,
ecological crisis and they say, “Alright, deal off, we’ll give you another deal.
No longer will wages be connected with productivity, you can all have political rights because
political rights don’t necessarily give you any economic benefits, but you can have credit.”
So the credit solves everything, everybody’s being, that’s why you have microcredit saves
the Third World, why you have 401k’s and mortgages and there’s this huge extension of credit.
And you could say the same thing happened, right?
More and more people want in on the deal and more and more people are getting credit to
the point where people they’re just doing these crazy sub-prime scams and things like
that are beginning to run the system.
And when it cracks it looks almost exactly the same, you get the oil shock, you get the
financial crisis, you get the visions of ecological catastrophe.
It’s the same thing all over again except at this point it’s not clear what they’re
[chuckles] gonna come up with next.
So, in that sense, yeah, you have this unprecedented series of bubbles, built on bubbles, built
And I’m speaking as someone who’s working the Global Justice Movement and we were like
doing our studies for the G20 as part of like several intellectual collectives where they
kind of, the activists kind of told us, “Alright, well, they’re all meeting to come up with
their evil plan and tell us what their evil plan is likely to do so we can oppose it.”
And so we figure it and I guess they’re gonna have to do green capitalism, declare an emergency,
we had various ideas for what would be a viable solution.
And they kept not doing it; they just fight each other.
In fact one of the reasons why the Global Justice Movement fell into such a problem
is, like, at least in 2000 we knew what their evil plan was [laughs] and we could oppose
And now they don’t seem to be able to come up with one, we had better ideas for their
evil plan than they did.
So we were sitting around and saying, “Well, come on guys come up with your formula and
we can fight you.”
And they wouldn’t so they were sort of stuck on this credit like bubble system that fell
apart and they haven’t quite come up with what they’re gonna do next.
Why the bulls are wrong
Equity markets have bounced well over 20% since the lows just over a month ago, so technically we are already back in a new bull market. With peak new cases now behind us in Australia, business is agitating to reopen and governments are starting to ease restrictions. With the biggest fiscal programs since WW2 and huge monetary stimulus in the pipes, are the bulls about to be proven spectacularly right? No. Not even close, according to Jerome Lander who manages the Lucerne Alternative Investments Fund.
In this 25-minute outdoor video interview, Jerome first set the stage by giving three reasons the bulls are wrong before then saying the bottom for the market could be more than 40% below where it is now:
“… it’s very easy to come up with figures around, 1600 or 1800 on the S&P 500. Obviously we’re up at 2800 on the S&P at the moment”.
Citing the risks of ongoing virus infestations, credit defaults, geopolitical risks, poor consumption and investment spending going forward, he paints a picture of a future that is vastly different from the past.
In this new paradigm, he argues, investors face the very real prospect of long-term asset price deflation as fundamentals reassert themselves, and that in this environment investors will require a completely different approach to the one that has worked for the last 40 years.
Discussion points through the interview
– Three reasons the bulls are wrong
– What could drive the bear market and how low it could go
– What the most imminent risks are, including conflict
– What ‘the new normal’ might look like
– The biggest mistakes most investors are making
– The lens investors should now view the market through
– Investment styles that reduce market risk
– A message for all anxious investors out there
You can access the full transcript here: https://www.livewiremarkets.com/wires/why-the-bulls-are-wrong
I think firstly the Bulls are pretending
this virus itself the problems gone away
and the problem hasn’t been solved so
although we’ve reached a peak in daily
new cases we we still haven’t got an
effective treatment or an effective
vaccine for the virus firstly secondly
we have valuations at all-time record
for earnings levels not with saying the
economic settings we have had we have
and thirdly I think the Bulls really
ignore the overall picture which is that
we have unsustainable and unsustainable
amounts of debt driving our economic
growth for many years now and that we
may well be becoming to the end of a
long term debt cycle which makes it
really very difficult to be optimistic
about the returns that you’re going to
get from traditional asset classes
there’s a lot of people out there who
just seem overly optimistic to me given
the the the settings we have at the
moment for investment markets so we
think about where we’re at we have
economies which are really operating
unsustainably still we keep on putting
on more and more debt we have
unsustainable situation whereby we we
keep trying to pretend that we can just
layer and layer upon layer of extra
extra debt and create some sort of
nominal growth the low amount of growth
given the amount of debt we’re putting
on and that somehow we’re going to we’re
going to be able to continue doing that
forever and I think the balls really
ignore those things so the Bulls often
focus on very short term short term sort
of settings and they’re overly
optimistic by Nature
I suspect so I think when you’re
investing it’s ideal to be flexible so
you want to be bullish sometimes very
sometimes neutral at other times and be
able to adjust yourself to the settings
and the opportunities that you have if
you think about where we’re at now we’re
in a position where valuations are
expensive you know we actually when you
price what markets are going to deliver
just normally based on historical
context given how they’re being priced
you come up with very low returns from
traditional asset markets
if you then layer on top of that you
know we’re at economically we’re really
we really look to be coming towards the
end of the long term debt cycle whereby
it’s becoming increasingly obvious and
increasingly challenging to actually
keep economic growth going given the
type of economic settings we have we
have a very imbalanced economy so we
have a lot of wealth in the hands of
relatively few parties and we have a lot
of people living unsustainably on the
basis of the fact they can keep on
borrowing money to to buy what they need
and that doesn’t really create a
virtuous circle in the long run or a
situation which can really resolve
itself favorably I think sure so if you
look at a traditional bear market you
know it sort of takes place over many
months so you don’t suddenly you don’t
see the bear market over in a one-month
period of time so if we are in a bear
market there would be strong reason to
suspect that it will take many months
for it to play out we might for example
see a significant default cycle over
time we might see further waves of virus
infestations should we not be in a
fortunate position to come across you
know better treatments or were
unfortunate with mutations or whatever
we might see all sorts of ramifications
further shocks to the system from
geopolitical risks there’s lots of X
factors that can still occur to mean
that shocks the system that mean that
people really re reassess whether their
prices they’re paying at the moment in
this rally actually are supported by the
fundamentals at the moment the the rally
the bear market rally you know is
supported by by the fact that that we
have got you know daily new cases piki
have piqued by optimism around that but
mainly really by massive central bank
liquidity and that central bank
liquidity there is a fight between bulls
based which the bull case is really
based upon central bank liquidity and
bears based on fundamentals and the
strong possibility of a high default
cycle and poor consumption and poor
investment spending etc going forward
and so you know that’s gonna be the
tussle back and forth now this this bear
market doesn’t have to be like any other
bear market we’ve seen before it can
definitely be different so I think while
history can inform
what we might expect going forward it
could equally be very very different the
thing that’s of concern to me I guess is
that many investors are assuming that
we’re going to go back to normal or that
although the asset prices are justified
and I think that I think that they’re
not there’s been lots of work done on
this to say well what is this support
what is a supported evaluation for these
markets and if we think about what what
earnings are doing this year and where
bear markets historically sort of get to
you know historically we’ve seen
valuations you know bottom at much lower
multiples and what we see now we’ve
obviously got earnings coming off a long
way this year so it’s very easy to come
up with figures around you know 1600 or
1800 on the SP obviously we’re up at you
know 2800 on the SP at the moment so
that would be a fall around circa 50%
plus to get to what you might argue is a
fair valuation level for the market now
clearly we’re not in a situation where
central banks have any interest or
wanting to allow valuations to fall to a
normal valuation level or experience
that sort of situation so they’re
fighting very hard to keep the bubbles
alive and they’re providing massive
amounts of liquidity and stimulus to to
to keep that secured basic prices afloat
now at the end of the day will that be
successful we don’t know you know how
long will they be able to do that for we
don’t know but there’s clearly a lot of
risk to the downside should for any
reason central bank’s not be successful
at continuing to stimulate stimulate
asset prices and support our set prices
one of the things I raised concerns
about was the valuations of commercial
property unlisted property and and where
that would go to going forward so you
think about the situation now with
everybody having you know a lot of
people being at home working from home
and a lot of people actually saying we
can actually work at home effectively
and employers saying well actually we
can have our employees and working from
home and they’re more productive you
simply aren’t going to have the same
sort of demand or need for office space
coming out of this coming out of this
crisis they needed before not to mention
the fact that you know unemployment
levels will be higher probably a
substantially higher so the demand for
property won’t be what it was and that
means that a lot of those you know those
evaluations probably are not sustainable
and you’re likely to see a lot of
pressures on on property property
evaluations moving forward also with
respect to you know residential property
we have to ask ourselves you know
depending upon what the unemployment
picture does and and how ugly this gets
are those valuations justified you know
can we can we really support valuations
purely on the basis of cheap money or do
we have to have people in employment
with good employment prospects being
able to grow their incomes over time and
people with the confidence to be able to
take out big loans banks with the
willingness to lend people in those
situations lots of money so they can
continue to pay the the high prices that
we have on on property more generally I
think one other issues I raised was the
valuations that are that you know that
are being used of unlisted assets within
super funds and so forth and there’s now
been more published on that whereby
people have raised the fact that you
know that valuations arguably weren’t
being priced fairly such that if you
think take the bottom of the market the
the short-term bottom in the market back
in March and the recovery since that
time a lot of super funds haven’t
actually recovered with the markets over
that period of time so if you had
actually invested at that time thinking
you were getting the bottom one of the
markets all had a been fortuitous enough
just to just to be in that situation and
you had of invested in one of these
super funds you were actually buying
into unlisted property prices unlisted
infrastructure price unlisted private
equity prices at at prices which were
inflated which didn’t really reflect
reality your fair valuation and those
valuations will need to now gradually
come back to what they really worth and
and that means is that there’s an
inequity in the way those those
investors are actually being treated
there is actually a much higher risk of
conflict post post two pandemic
interestingly enough and certainly when
you start doing funny things with your
money then also there’s a high risk of
conflict when you look at political
cycles and you think about people trying
to retain power there’s also an
incentive incentive there for them to
you know try and remove trying to move
the the attention of the populace onto
some external focus because they know
that if you’re at war with someone
you’re much more likely to vote in ink
to be conservative in that regard so you
can certainly come up with situations
whereby the likelihood of conflict you
know you can certainly assess the like
little conflict as being higher now than
what we’ve seen before now of course we
already have a lot of conflict in the
world we have we have we have trade war
you know that’s been going on for some
time between China and us you know fight
for supremacy there we have cyber war
going on this is not something that
people necessarily focus on I talk about
but we have lots of that going on at the
moment already so the war doesn’t have
to necessarily be in the in terms of
physical confrontation we have economic
war going on at the moment and and that
can certainly be you know exaggerated
there’s a lot of focus in the media
recently on you know what was the real
cause of this forest did China you know
did China handle this appropriately when
they did certain things and certainly
you can point to those things very
easily and and be quite upset about the
fact that that maybe this problem should
have been contained a lot of earlier
than it was and it shouldn’t have been
the problem shouldn’t become the problem
that it did if certain state actors had
it behaved very differently than what
they had ever had that then they’d have
done so you know there might be a focus
of attention turned towards that and and
that might create you know D
globalization terms of people looking to
there’s a need that in fact for people’s
supply chains become much more resilient
out of this to move to move certain
industries which are strategic and
necessary or at least diversify them but
move some of them back to to kind of
more familiar territory and more home
territory in order to ensure they have
supplies of essential goods and services
for their economy so there’s a lot of
things that can happen out of this and
there is certainly a much higher risk of
conflict and I think he’s being
appreciated it’s one of those X factors
that’s out there in terms it’s not just
China there’s obviously the possibility
of conflict in the Middle East again all
prices have dropped very significantly
that’s going to be putting a lot of
pressure on those budgets and a lot of
those a lot of those those those
countries there’s obviously the the
tensions with Iran
there’s tensions with Venezuela there’s
lots of Powder Keg some places around
the world where
this can go wrong I think it’s some
things are definitely going to change as
a result of of this shock to the system
I think certainly we’re not going to go
back in a hurry to the levels of
unemployment that we had previous to
this shock very easily so we now have in
the US unemployment fast approaching
about 20% of the population and although
we may on the other side of this once we
do and if we do get to a solution to the
coronavirus have a rapid sort of
comeback in unemployment
it won’t quickly come back at all to
where it was before so we’re going to
come out of this with a lot more
unemployment and certainly a much more
challenged consumer than what we had
before and that will mean that will come
back with a lot of people much more
hesitant in the way they go about their
daily business and the way they choose
to interact with the world is it safe to
go and do the things you did before do I
you are you are you willing to sort of
travel overseas and go to exotic places
like you were before are you in a
situation financially where you can even
afford to do that will you be confident
in your ability to take on long term
debt and your ability to pay pay off
that debt given the fragility that
you’ve just learned with respect to your
employment prospects there’s a lot of
there’s a lot of reason to think things
will some things will change permanently
as a result of this crisis one of the
concerns I have is that when you look at
the big picture we have an economy
that’s operating it
you know that’s this size say you know
we’ve got an economy sort of this size
and we have asset prices which are this
size so there’s a massive misalignment
between the size of our asset prices and
the size of our markets and the size of
our real economy and furthermore we’re
not really growing this real economy you
know we don’t have and and this crisis
is really going to accentuate that even
further we’ve got a kind of low
productivity economy we haven’t actually
got the right settings to grow the
economy strongly and it’s laden with
debt you know basically and with the
debts been used to boost asset prices to
these levels and that’s just not a
sustainable picture long-term so
investors really should be conscious of
that in the back of their heads they
should be thinking and
really safe if I just go and buy you
know a broad basket of equities so I
just invest in a traditional way
am I really safer I’m really taking the
risk that one day this big these asset
prices that are all the way out here
this massive on the back of this massive
financialization and massive easy money
on that central banks have provided gets
collapse towards the size of the real
economy alternately do I really believe
with the way we’re operating the
economies today are we going to grow
those economies rapidly so they ask they
grow you know they grow the asset
they’re going to be asset prices so to
speak I think if you look at either
those situations there’s strong reason
to think that there’s going to be at
some stage you know you know there’s a
there’s a gravity that’s pulling asset
prices down there’s a force there that
asset prices actually naturally want to
collapse and the settings were right now
we have massive deflationary forces
operating on our set prices they want to
collapse the only thing that’s keeping
them up is really central bank easy
money and and that’s that’s becoming
harder and harder to do the real
question mark out of this is whether we
gonna get one more bubble you know
whether they manage to float those I set
prices higher again into one more even
bigger bubble how long will that last if
they manage to do that or whether this
is it this is the end of the long term
debt cycle and we have to change the way
we everything will change basically all
the things will change to mean that you
know the the returns you get from being
invested in a traditional way
long equities long property all along
all these long debt basically lot read
through an assets gets collapsed down
and so you know for me I can’t go to I
can’t I can’t sleep at night if I was
operating under that paradigm with that
with what I know now I wouldn’t I
couldn’t sit there and look at that
setting and say I should put all my
investors into that sort of risk in a
very concentrated fashion and just hope
it’s all okay because I think there’s no
reason when you look at it I think that
it will be okay in the long run so you
have to operate on the assumption that
that can collapse and therefore you have
to do things very differently from the
way most people are actually doing it
most investors are really operating
under a traditional or historic paradigm
so they’re really they’re really you
know they’ve got their equity dominant
portfolios and they really operate under
the assumption that this is a strategic
asset allocation type framework which is
based on historical returns and they’re
basically assuming that
the portfolio’s ahead for the last 40
years are the right portfolios are run
with going forward now I don’t believe
that is the case I think they’re quite
clearly we can mount a very very strong
case for why real returns will be very
low from here looking forward on the
basis of valuations or pond on the basis
of the unsustainable economic settings
we have and on the basis of all the
risks that are out there that were that
the world’s facing that investors are
facing that just aren’t being priced
into markets and and on the basis of
that I think you really need to you know
if you’re really assessing the world or
thinking about how risk it really is and
also thinking about what investors
really want for their money
you know this is don’t want a roller
coaster ride they don’t want to go up
and down like a yo-yo and end up going
nowhere at the end of that they want to
actually have absolute returns with low
risk of large you know substantial
losses and have their money protected
and genuinely diversified and if you’re
just running a portfolio which depends
purely upon you know interest rates
moving from very high to very low and
upon debt levels continuing to expand at
extraordinary and unsustainable rates
you’re not really running running a
portfolio that’s suited for what we’re
facing the next five or ten years I
think one of the things investors often
underappreciated as well is that you
know it’s geometric returns that matter
to most investors over time it’s not
arithmetic ones so if you return ten
percent this year ten percent next year
and ten percent the year after that but
then you do you do minus 30% you know
you’ve actually you’ve actually lost
investors a lot of money overall and
achieve nothing so the whole the whole
name of the game investing for the long
term is to make sure you avoid large
losses because if you have if you
experience large losses and you exposing
vistas to large losses and you’re not
you’re not giving them what they need or
want and you’re not really doing a good
job for them and I think our industry
really at the moment under the
traditional paradigm it’s it’s operating
under is really giving investors that
experience and it’s it’s really
necessary for a lot of people to sit
back and think you know given what given
what you know from operate from first
principles is this the way it would
design a portfolio for today or is this
the way the portfolio has been designed
a long time ago on a very with very very
different investment settings you’ve got
to assume that that asset prices are
going to be very low in the long run
you’ve got to assume that you know
crises are a normal part of the way
you know you manage money you have to be
your portfolio has to be resilient to
crises basically because this isn’t
gonna be the last crisis we face we
can’t just sit here and say this is a
one in a hundred year event and it’s
gonna go away even if we do somehow
manage to go over the coronavirus very
soon which as we’ve talked about there’s
no strong reason to think that will be
the case but let’s let’s say that we do
they’ll still be further crisis because
of the way we’ve set everything out and
because of the risks that there are in
the real world so we have to build a
portfolio that’s resilient to Christ as
it can still make us money and still
meet the objectives that we have now to
do that unfortunately we can’t all do
we can all do that by just investing in
a traditional way so we can’t say let’s
go and invest in a risky way let’s go
and chase equity risk and property risk
it inflated valuations and which is what
by the way think just about the entire
industry does so what I’m saying is that
the way the entire industry operates is
is flawed that’s what I’m basically
saying and in terms of what the
individual investor actually needs it’s
based on historical paradigm that
probably isn’t going to work very well
so we have to think how do we get away
from those risks you know if the stove’s
gonna be really hot and really dangerous
to touch how do i how do i trying to
avoid touch that i have to think very
differently you have to do something
very differently to what to what they’re
doing have to expose myself I have to
minimize that risk basically so you need
to have a lot less risk exposed to the
traditional long-only type of investing
and you have to move much more into a
more conservative more active more more
sort of long-short way of looking at the
so more skill-based
strategies basically so a lot of so a
lot of what I focus on is you know
finding skilled strategies that I can
use combined combined in a portfolio to
mean that I can get a return which is
along with what investors actually won
which isn’t as dependent upon
traditional asset process and
traditional asset Marcus remaining
inflated because that’s a very binary
risk so if you really want to build a
diversified or balanced portfolio you
need to think about how do i how do I
minimize the exposure to interest rate
risk you know how do I minimize the
exposure this asset price inflation risk
how do I make sure the portfolio can
survive the cry
SIB again face going forward so with
life basically what we do is we look at
we look for skills underlying
investments managers and strategies that
really bring something different to the
portfolio there’s not heavily dependent
upon you know markets so you want to
find sources of return that don’t depend
upon the markets basically going up to
achieve a good result for investors and
that’s why we’ve had such resilient
returns assess resilient results put
part whose have managed to find those
returns and we’ve managed to combine
them in a way such that we manage a lot
of the risks that are that are out there
and ensure that you know investors have
a have a have a true to label type
experience now investors in life you
know are basically looking for absolute
returns we have low risk of large
capital losses I mean one of the things
are published on as an example of
something we have used in the portfolio
which is a more traditional sort of type
of exposure in a sense but which you
know even other investors could could be
using a lot more of is precious metals
precious metals have been in a bull
market for some time now there’s still
strong reason to expect that bull market
might continue it’s amazing when you
look at you know your every Superfund or
average large institutional investor out
there how little if anything for having
precious metals it’s incredible giving
the settings we actually have at the
moment and it’s just an example of what
I was talking about before that most
investors really aren’t thinking outside
the square and aren’t really trying to
adjust their portfolios from a
historical paradigm to one which is
better suited to the sort of situation
we face today if you actually looked
under the hood of the way a lot of these
these investors operate you would
realize that bringing in an idea that’s
kind of considered you know
non-consensus is getting it into the
portfolio is actually quite difficult so
there might be in individual investors
within large institutions who actually
believe and who are themselves investing
in gold but they won’t be able to get it
in past Syria their investment
communities or their investment boards
and get it into the portfolio in any
meaningful degree I mean I saw a study
recently suggesting that even though
historically institutions had a couple
of percent of their portfolio in gold
more recently was only half a percent
which is incredible in this massive bull
market that were actually been on for
some time now
it’s amazing so some of the long short
exposures we have for example there’s
that one of the strategies that’s that’s
worked for a long period of time is in a
long short land it’s basically being
long you know higher quality companies
and low you know lower quality companies
there’s a generic sort of buckets so we
think about that there are a lot of
companies on the stock exchange which
really aren’t good companies you know
you shouldn’t be investing in them so
when you buy an index fund you’ve got an
exposure automatically to all these
crappy companies you’ve got exposure to
you know actually differentiating
between the good companies and the bad
companies people are actually adding
economic value of creating value over
time and people who aren’t so the
benefit of being long short is that you
can you can you can actually say look
these are these are good companies these
are actually adding you know creating
value for their shareholders over time
and on the other hand here we have a
whole bunch of let’s call them bad
companies in and sometimes these bad
companies are really are really bad
companies they’re fraudulent for example
there’s a lot of frauds fraudulent
companies that are on stock exchanges
around the world and in the long run
they’re going to burn their investors so
if you’re able to create a basket of of
shorts to sort of fraudulent companies
or mismanage companies or highly
indebted companies at a time when the
economy’s turning south all sorts of
different strategies you can use as a
longshore manager to to have that bucket
of low quality companies and over time
the strong reason to expect you get a
you get a relative return out of that
that the good companies will actually
outperform the poor quality companies
and you’ll be able to extract a return
that’s not depend upon whether the
markets go up or down but it’s dependent
upon whether those good companies
outperform those bad companies over time
and and that sort of strategy is one of
the strategies we use if you think about
traditional asset assets if you like the
original asset classes are things like
you know equities bonds cash property
you know these are all considered sort
of traditional asset classes the ones
that make people feel most comfortable
most familiar with the ones that are
most mainstream and most you know used
in a traditional sort of paradigm you
think about alternate eternities they’re
really everything else so alternatives
can can be alternative asset classes so
things like precious metals often
considered alternatives some people even
unlisted versions of of listed asset
classes as being alternative I don’t
really see them as alternatives I see
them as unlisted
unlisted versions of the listed version
but they still expose the underlying
similar economic risks for me but when I
think about alternatives I’m thinking
more about liquid alternatives so ways
of taking traditional asset classes but
operating with them very differently so
for example you know market neutral so
your long one company your short another
company against it you’re taking out the
market that you you you you taking it
down to another level and saying you
know within that within that asset class
what is there that I want to own what is
there that I don’t want to own what can
i what is going to outperform something
else so you totally getting a different
return stream out of it and that’s
that’s an alternative strategy in my
book it’s understandable that investors
are confused because lots of things are
changing and it’s important that your
investment approach also changes will be
if investment markets if you don’t
believe investment markets are going to
offer strong returns going forward if
you don’t believe like I do that
economies are well set up to encourage
high productivity growth that the
valuations are attractive that settings
are sustainable that we don’t have a
debt bubble that’s a big problem in this
sort of thing like if you if you believe
everything is okay and you can continue
to invest in a traditional way and have
your portfolio or your your wealth and
your future dependent upon that but if
you think things that you know if you
think things aren’t like that and think
the world’s different place from that
now I think you really need to think
have I got the right investment approach
at all haven’t got the right investment
partners do I need to do something very
differently than what the industry at
large offers me and I think you do I
think people absolutely need to think
differently about how they manage money
and what’s a line with what they’re you
know not knowing that the way the world
is but what they are trying to achieve
for their portfolios the truth is most
of us don’t want a rollercoaster ride we
don’t want to be on this you know seesaw
and end up going nowhere we want to
actually have you know steady more
reliable more skill-based returns for
investment managers that aren’t depend
upon everything being okay and I don’t
expose us to so much crisis risks that’s
out there so my message to investors
will be just that you know really think
about whether you’ve got the right
alignment for what you’re trying to
achieve and is there a better way is
there a different way and do I need to
do I need to make sure I’ve got the
right investment partners for that
National Securities’ Art Hogan believes the consensus view that stocks must retest the March low is wrong.
According to Hogan, there are too many unprecedented factors, including an intentional decision to freeze the economy, to suggest the market will follow a preset course based on historical trends.
“That pace at which we got to the correction here is the fastest that we’ve ever seen,” the firm’s chief market strategist told CNBC’s ″Trading Nation” on Friday. “Usually it takes the Fed and certainly Congress a much longer time to adjust to the here and now and to find the corporate polices to support the economy, and they did that in record time.”
Hogan’s view may be on the more optimistic side, but he’s not expecting a sharp, sustainable rally.
“We’re in a middle ground where we’re a little bit more than 20% off the lows [and] a little bit less than 20% from the highs,” he said. “This is going to be a place we churn through for most of the first half.”
The rebound doesn’t surprise Hogan.
Five days before the S&P 500 and Dow hit their lows, Hogan predicted on “Trading Nation” stocks would bottom before coronavirus cases peak in the United States.
Now, he’s seeing some progress on the virus front.
“If new cases continue to plateau, then 2021 is certainly going to look a whole lot better than 2020,” he added. “I would argue that the second half looks way better than the first half of this year.”
Hogan, who has $15 billion in assets under management, speculates a slow and deliberate reopening of the economy will likely be successful and spark a demand frenzy.
“There has been a lot of delayed consumption,” he said. “There is going to be maybe some pent up economic energy that explodes into the fourth quarter and certainly into 2021.”
It’s a scenario, according to Hogan, that should put Wall Street and Main Street firmly back into the green.
“Corporate America has the ability to get back into place relatively quickly. This is not a great financial crisis,” Hogan said. “Going into this, the U.S. economy was in pretty good darn shape, and so was corporate America’s balance sheets.”
Steve Eisman: Quantitative Easing was a failure: it didn’t get corporations to borrow and invest. Rather, they borrowed and bought up their own stock.
Steve Eisman: Inequality was cause of Financial Crisis (10:17)
Steve Eisman: They made money because of their leverage (debt ratio) and they mistook their leverage for genius (12:19)
Steve Eisman was one of the few who predicted the 2008 financial crisis, and he made his name by foreseeing the collapse of subprime mortgage market.
Michael Lewis portrays him as one of the heroes in the bestselling book The Big Short and Steve Carrell plays an outspoken version of him in the Oscar-winning movie of the same name.
EFN:s Katrine Marçal meets Steve Eisman at Claridges hotel in London.
they’re all getting screwed you know you
know if they care about they care about
the ballgame or they care about what
actresses went into rehab I think you
should try medication no no we agreed if
it interferes with work you hate Wall
Street maybe it’s time to quit I love my
job you hate your job I love my job
you’re miserable I love my job I love my
mark Steve Iseman welcome to the offense
I’m glad to be here so you’ve been
portrayed in a book and in a film what
did you prefer I would say they were
both fairly accurate as the way I was
back then and let’s just leave it at
that okay okay so I’ve heard that some
Brad Pitt’s almost caladium in the film
it’s not true I got a phone call from
Adam McKay who was the author director
of the movie in November of 2015 to say
that he was writing the movie and that
there was a possibility that Brad Pitt
would play me to which I responded that
the only thing Brad Pitt and I have in
common is that we both have really good
so being one a few people who sold the
financial crash coming how did it feel
to have see this big disaster unfold and
not being able to do anything about it
the analogy I use it’s a little bit like
Noah in the ark yeah so you know Noah’s
on the ark he’s okay and that he saved
his family but he’s not exactly happy
hearing everybody screaming outside
that’s was sort of my experience all
right did you think the financial market
potential market from the financial
sector would get back get back to
business and get back to some kind of
normal as quickly as it did no I didn’t
expect it would it would happen that
quickly you know a lot of that was the
fact that the government backstop the
system and once the become a backstop
the system it was what the financial
markets did come back but the banking
system has been changed so in the book
and the film it becomes very clear that
you’re you betting against the subprime
mortgage market is not
just a trade but it’s kind of a moral
crusade are you still on this moral
crusade I’m not because a lot has
you know dodd-frank I think really fixed
a lot of things leverage has come down
enormous ly the Consumer Financial
Protection Board has been put in place
to protect consumers I the world’s very
different from what it was pre-crisis
hmm but now many of these things are
threatening I mean Donald Trump has
promised to repeal vast parts of the
dodd-frank act for example it’s not
something I’m in favor of I think that
will be a big fight you know it’s
possible the industry is going to get
deregulated to a degree we’re not going
to go back to what we where it was so
for example you know Citigroup used to
be levered 35 to 1 today its levered 10
to 1 I feel if we go into some type of
deregulation maybe you get 2 to 3 turns
more leverage it’s not something that
I’m personally in favor of but I don’t
think it’s a calamity hmm so do you
think with Donald Trump be president
today if more than one banker had gone
to jail for the financial crisis it’s an
excellent question and the answer is I
don’t know you know I don’t know
I’m cold about it I’ve thought about it
I think there’s a definite very strong
sentiment that it was wrong that nobody
went to jail I’m not going to say if
that sentiment is right or not but
there’s definitely a very strong
sentiment in the country that that’s the
case and I think people are very angry
that nobody did go to jail again I’m not
going to say whether that’s right or
wrong and if people had gone to jail I
think that would have soothed some of
the hangar that was seen in the election
so it’s possible that impact of the
election but it’s impossible it’s
impossible to say right so now taxes are
going to be can’t and Finance regulators
because the populace to campaign against
Wall Street 1 correct correct okay so
what do you do with investment then I
hear you you are investing quite a lot
in bank stocks well I mean there’s
there’s two issues there’s what I think
about finance the financial system and
what I think about financial stocks and
the two don’t necessarily
correlate so with respect to the
financial system I think that what’s
been done has been a good thing but it’s
been very intense bank the dodd-frank
act and the Fed forcing people to
de-lever to de-risk etc so from a
financial system I’m very happy I could
say very strongly the United States
financial system has never been held
this healthy in my lifetime but it’s
been very painful for financial stocks
because as you de-lever and do risk you
make less money and therefore it hurts
your stock price so the last six years
or so have been extremely painful for
financial stocks especially banks as
they’ve de-levered and dearest well if
we’re going to go into world where we’re
going to deregulate and leverage is
going to go up at least some just
reverse the story
so therefore financial stocks should do
well right okay
like I said financial system financial
stocks but you are not necessarily the
same an interest rates in America are
going up yes that’s very good for banks
so America is kind of moving from a
monetary stimulus to a fiscal stimulus
with something but it’s like that’s
something I’m in favor of yes I think
it’s a good thing the infrastructure
investment yeah that’s right until not
believe that quantitative easing is a
successful strategy why not there are
too many negative impacts for from it to
I mean look it was a noble experiment
there was no fiscal expansion there was
no other game in town so I don’t blame
the Fed for doing it the idea was that
lowering rates would cause people to go
up or out on the risk curve and vest in
the economy and really the other thing
happened was they went out on the risk
curve by buying back their own stock
they didn’t really invest in the economy
and with lower rates that hurts consumer
because they makes us money we pay the
money in the bank so I haven’t you know
when we started the monetary policy of
us growth was one-and-a-half to two
percent and after we did it it’s one and
a half to two percent so in my view
quantitative easing is a failure
alright so in November you said to the
Guardian in Europe but Europe is screwed
you guys are still screwed referring to
their non-performing loans in the
Italian depends of the country yes
are we in Europe still screwed well my
wife wish I hadn’t said that
yes so okay oh we in big trouble not big
it depends on the country you know Italy
has a very large non-performing loan
problem I don’t see the Italian
government doing anything to really
solve that problem if they like before
Christmas that was a nasty suppose that
was just monte de Paz yeah and you never
like to say monte de Partie because it’s
such a great name and the world’s oldest
bank as the world’s oldest bank correct
and I don’t you know you could try and
Simmel to deposit ten times fast it’s
very hard but it’s not really solving
the problem I mean this is something
called a Texas ratio which is a ratio
that bank analyst Achon myself compute
which is non-performing loans divided by
tangible book value plus reserves
basically the numerators all the bad
stuff divided by the money you have to
pay for the bad stuff and one of the
great lessons about bank analysis is
that one in Texas ratio gets over a
hundred percent the bank is done and in
Italy the two largest banks are in paisa
and you credit and their Texas ratios
are at ninety percent and every other
Bank in Italy is over 100 percent so I
don’t envy Italy the problem ok famous
ahma is the country there’s the bigger
than I think it won’t come and I think
the problem with the banks generally in
Europe is that they are still under
capitalized and they they are they do
not make enough money per dollar
employed basically European banks don’t
charge enough for this
services they never have and they’ve
tried to make up the difference with
leverage and in a world where you have
to use less leverage that model doesn’t
what about Deutsche Bank quite the same
well don’t you make sort of the poster
child for that let’s think about this
this way so today if a bank has a 1%
return on asset and is loved or ten to
one the return on equity is 10% that’s
the simple formula so you know Citigroup
for example doesn’t even have a 1% ROA
but they’re not that far off but
Deutsche Bank today has a 30 basis point
ROA they need to improve their
profitability by more than three times
there’s no way Georgia Bank on its own
can improve its profitability three
times the entire European banking system
has to be price you know how that’s
going to ever happen I don’t know but
until it does your paint banks it could
be a problem
they’re going to be a problem so you’ve
been in here in London for a few hours
now and you must have realized already
that the only thing people talk about
here with breakfast yes
so what financial risks do you see
coming from brexit big question is a big
okay what will happen in March I have no
idea you have no I really have no idea
honestly I don’t think and more
importantly anybody else has any idea
that it’s going to be an adventure a not
so it’s going to be a fun adventure but
it’s going to be an adventure so you
said that we’re very bad at dealing with
crises that develop very slowly and you
put the blame on the big financial
crisis of 2007-2008 on income
distribution really do you see that
changing at all I mean let me explain
that yes because it’s not intuitively
obvious how the two are connected so you
know my thesis is that one of the
underlying causes of the financial
crisis it was bad income distribution so
you know when I say that people’s eyes
generally clays are like you know what
are you talking about
but I think that there’s a
cause-and-effect relationship in that
you know starting in the 90s when income
distribution started to get really poor
in the United States rather than focus
on that and what the solutions worth of
that problem let credit get democratized
that was the euphemism for will will
make loans to people that we didn’t make
loans to before so rather than get
people’s incomes up they let them lever
themselves [take out more debt] and one of the ways people
lever themselves was by taking out loans
on their homes and loving themselves
that way and so I think one of the
causes of the subprime mortgage crisis
is that you know post dodd-frank hard to
get a mortgage loan yeah you know
incomes have only started to start
growing again we’ll have to see what it
does the new administration can do
so it don’t Frank it’s harder to get a
loan but well it’s hard to get a
mortgage why although I don’t think that
I caused a defect of dodd-frank I think
it’s more of an effect of all the fines
that were imposed on the banks for the
mortgage crisis and so the banks I think
not unjustifiably are kind of worried
about making mortgage loans that they
might they might not should or should
not make so the financial crisis what he
said the main problem was the products
the tools available or the culture ah I
would say is one of the unsung aspects
of the financial crisis that people have
definitely not written that up about
which is psychology yes and what I mean
by psychology is you have an entire
generation of Wall Street executives who
grew up in the 90s in the early aughts
who really only had one experience which
is they made more money every single
year now what they didn’t really notice
was that as they were making more money
every single year the leverage of their
various institutions was increasing
every single year
now they thought they were making more
money because it was them but really
what was happening as they were making
more money because their institution was
becoming more levered and really what
happened was they mistook leverage for
I wrote that sentence by the way I read
that I do it’s a good son it’s a good
sentence I don’t write a lot of good
sentences but that’s definitely one of
them tweetable yes it’s very good right
if I tweeted I would tweet listen I am
so let’s imagine you went to a Wall
Street executive in circa 2006 and you
said to the CEO of you know pick the
name of your institution and you’d say
dude listen the entire paradigm of your
career is wrong you have to de-lever so
did you ever have a conversation like
that I did I’ve never told this story
before there’s like AI now it can be
told story okay um so the day is
February 2008 and I have a meeting with
the head of Risk Management and one of
the big Wall Street firms we won’t name
them anyone else today but it wouldn’t
matter because I would have had the same
it would have been the same conversation
with any of them
given what was discussion one so I sit
down with a head of risk management of
one of the big farms it’s one month
before Bear Stearns almost to the day
and I say to him you have got to de-lever
and you’ve got to de-lever now because
Armageddon is coming the point of it is
the direct that’s almost a direct quote
I used the word Armageddon and he looks
at me and he says you know I hear what
you’re saying but you know we at X we
can be much more levered to the bank now
back then there was a bank based in
Detroit called net city it was a
medium-sized regional bank and it had a
lot of subprime mortgages so it was a
bit of the topic of the day and so I
said to him you know do you know what
happens if knacks City goes down and he
says no what happens I said nothing the
regulator’s come in they seize the bank
they pay off the depositors they fix the
bank they sell the bank the government
takes something of a loss end of story
do you know what happens if your firm
goes down planet earth burns who should
be more levered and he looked at me like
I was speaking ancient Greek like he
just it was so outside his paradigm it’s
like he didn’t know I was talking about
and I realized it was over that there
was no way these guys were going to do
what needed to be done before the world
blew up but I think we’re going to see
someone to go to jail right
I mean you can have to break up the bank
partido I don’t know I don’t know I have
a feeling in a few years people are
going to be doing what they always do in
the economy tanks they would be blaming
immigrants and poor people it’s not X
equate from you is that Hollywood’s a
great quote it’s a great mark it’s not
yellow it was written by Adam McKay with
the author and director and but did you
think in those terms back then oh I
always think in those times always
thinks in terms of disaster yes why is
that just I have a very strange DNA do
you see this paradigm changing at all
this culture I was told check it steady
change they’ve been beaten to a pulp
you know the dodd-frank gave much more
power to the Fed to regulate the banks
that power was put in the hand of
Governor Daniel Tarullo and I think he’s
done a tremendous job of de-levering the
banks in the United States you know I
would say the CEOs of the bank’s fought
him kicking and screaming but I’d say in
the last year or two they gave up and I
know you said before that Europe’s done
not as good of a job with that that’s
correct why well it’s what your starting
point so you know just pre-crisis
Citigroup is levered thirty five to one
deutsche bank is lowered over 50 to one
so today’s Citigroup is levered ten to
one and deutsche bank depending on how
you calculate is probably levered twenty
five to one so everybody’s leverage is
lower European banks have always been
much more levered than US banks so
they’re still more levered they just
left levered than they were right not
they’re not de-levered enough to my taste
but that again we gets back to the Paula
Mills they’re not profitable enough per
dollar employed so the regulator’s in
Europe let them be more levered I think
it’s a mistake but that’s the way the
systems it works okay and everyone’s
asking you what the next one of the
crisis is going to be so I don’t have a
dick I know I’m not going to ask you
money I will ask you that question I say
you know everybody’s trying to pick the
next big short and I’ve done that
already I’m in no rush
okay thanks a lot Steve Eisman thank you
Yves here. Get a cup of coffee. Another meaty chat with Michael Hudson, who focuses here on the role of finance in rent extraction.
An important theme here that Hudson has stressed before is the mistaken perception of home “ownership”. Only about 1/3 of homes in America are owned free and clear. For the rest, the banks, or mortgage trusts, hold a senior position as mortgage lenders. And over the decades, they have become far less accommodating when homeowners are late even on a single payment. Even worse, insiders have reported that mortgage servicers will even hold payments to assure that they are late, which typically leads to compounding charges that virtually assure a foreclosure. Borrowers also face Kafkaesque obstacles to clearing up errors when they unquestionably paid on time.
To put it another way, as Josh Rosner put it in the early 2000s. “A home with no equity is a rental with debt.” That can be generalized to homes with little equity.
Radical Imagination host Jim Vrettos interviews Professor Michael Hudson, Economist, Wall St. Analyst, Political Consultant, Commentator and Journalist; who offers his views in the way finance works
Welcome, welcome once again to the Radical imagination. I’m your host, Jim Vrettos. I’m a sociologist who’s talked at John Jay College of Criminal justice and Yeshiva University here in New York. Our guest today, on the Radical Imagination, is one of only eight economists named by the Financial Times who foresaw the credit crisis and ensuing great recession erupting in 2008. It was conventional wisdom at the time to say that no one saw the gravity of the crisis coming, including almost every leading economist and financier in the world.
In fact, many had seen it coming. It was seen by everyone except economists from Wall Street; as our guest put it. They were ignored by an establishment according to then, the Federal Reserve chairman Alan Greenspan that watched with innocent quote-unquote shock disbelief as its whole intellectual edifice collapsed in the summer of 2007.
Official models missed the crisis not because the conditions were so shockingly unusual, they missed it by design because the world they lived in was not a world of how finance really works. They missed it because their mathematical models made it impossible to warn against a debt-deflation recession.
Their innocent model worlds were worlds where debt simply did not exist. It’s a world that most of our economic policymakers still live in, and it’s no wonder that everyday people see most economists far removed from their practical economic concerns and interests their everyday concrete reality. Our guest today is an internationally renowned economist who’s followed a much different path of interest and concern.
Michael Hudson is a distinguished research professor of economics at the University of Missouri, Kansas City, a researcher at the Levy Economics Institute at Bard College, a former Wall Street analyst; political consultant to governments on finance and tax policy, a popular commentator sought after speaker and journalist.
He identifies himself as a Marxist economist. But his interpretation of Karl Marx that differs in most other major Marxists. He believes parasitical forms of finance have warped the political economy of modern capitalism. History has regressed back to a neo- feudal system. He’s also a contributor to the Hudson report, a weekly economic and financial news podcast produced by Left Out.
His many books include Killing the Host, J is for Junk Economics,The Bubble and Beyond, Super Imperialism, and “… and Forgive Them Their Debts.” Michael has devoted his entire scientific career to the study of debt —both domestic and foreign, loans and mortgages, and interest payments.
In 2006 he argued that debt deflation would shrink the real economy, drive down real wages and push our debt-ridden economy into a Japan-style stagnation or worse. And just for reference, the typical American household now carries an average debt of over $137,000 up from $50,000 or so in 2000. The average American has about $38,000 in personal debt, excluding home mortgages.
The average credit card debt per U.S. household is $8,500, and outstanding student loans are at an all-time high, in 2019, of $1.41 trillion, a 33 percent spike since 2014, and a 6 percent increase from 2018. Only 23 percent of the population say they carry no debt. As Hudson presciently puts it, debts grow and grow, and the more they grow, the more they shrink the economy.
When you shrink the economy, you shrink the ability to pay the debts. So, it’s an illusion that the system can be saved. The question is, how long are people going to be willing to live in this illusion? Every day people have to face reality. Our economic policymakers urgently need to get it too.
So welcome Michael to The Radical Imagination. Thank you very, very much for coming here and being with us. Your work is so interesting; it’s so new and different. You’re a Marxist economist and yet…
[Michael] I’m a classical economist…
[Jim] You are classical, ok.
[Michael] Marx was the last great classical economist. Classical economics basically runs from the French Physiocrats through Adam Smith via John Stuart Mill to Marx.
[Jim] Along with Ricardo.
[Michael] Yes, they were all talking about the rentiers. In their time the landed aristocracy were the main rent recipients. But Adam Smith also talked about monopoly rent. And finance was the major monopoly. And today, the role of the landlords played in the 19th century of stifling industrial capitalism is being played by the banks and the rest of the financial sector. Right now the collectors of land rent, which was the main focus of the labor theory of value to isolate what was unnecessary, is being paid to the banks as mortgage interest.
[Michael] So, we no longer have a small privileged private landlord class when you have 80 percent of the European population and two thirds of the American population being homeowners. However, they have to pay the equivalent of the rental value of their housing to the bank, in the form of mortgage interest.
[Jim] To the banks, right!
[Michael] My analysis follows from classical economics, as did Marx’s analysis. So Marx is simply the last great classical economist. They were all talking about how industrial capitalism sought to free itself from unnecessary costs of production, and hence how its political fight was against the landlord class and other rent extractors. Where Marx went beyond his predecessors was in looking at the laws of motion of industrial capitalism. He saw these as leading toward socialism. Later, Rosa Luxemburg said that if it’s not towards socialism, it will be toward barbarism.
[Jim] So capitalism would evolve into the possibility of socialism.
[Jim] Did he foresee the sort of predatory financial system that you worked out?
[Michael] No one described it better in his time than Marx, in Volume III of Capital.
[Jim] Volume III. Ok!
[Michael] Marx analyzed the “real” economy’s circular flow between employers and wage labor buying the products they produced. But then, in Volume III, he said that rentier debt claims by the financial sector was a separate dynamic, independent from the economy of production and consumption. This industrial capitalist economy is wrapped in a financial sector composed of debt and property claims. These are external to the economy. They slow it and ultimately cause a crash. Marx was one of the first to talk about business cycles of about 11 years and the internal contradictions that led to a market collapse. He pointed out that the financial sector had different mathematics of growth – the mathematics of compound interest. These are exponential and inherently unsustainable. In Volume III of Capital and also of his Theories of Surplus Value– which was Marx’s history of economic thought and the theories leading up to him – he collected everything from Martin Luther to other analyses pointing out that debts grew so rapidly at compound interest that it is impossible to pay them.
[Jim] You have a great chart where you talk about compound interest, a penny that was invested at 5% interest from Christ’s time to 1776.
[Michael] Richard Price was an actuarial accountant. He calculated that a penny saved that at the time of Jesus’s birth at 5% interest would become a solid sphere of gold extending from the sun out to the planet of Jupiter.
[Michael] Obviously, many people did save pennies at the time of Christ, and the annual interest rate then in Rome was 8 1/3%, one twelfth per year. But of course nobody has a sphere of gold extending out to Jupiter. That’s because debts that can’t be paid, won’t be.
That’s basically my motto: Debts, that can’t be paid, won’t be paid, because there’s no way of paying out of current income that grows much more slowly, tapering off.
[Michael] So debts have to be written down. It usually takes the form of a financial crash. Nobody before Marx explained crashes in terms of the financial claims growing and causing a break in the chain of payments. The actual break could be a result of fraud or embezzlement, or a bad crop, because crashes happened in the autumn when the crops were moved and there was a drain of money from the banks to pay for moving the crop and paying the harvesters. But at least a crash wiped out debts, and then the debt buildup could begin all over again.
[Jim] But in pre-industrial civilizations that didn’t occur did it? We want to play a short little clip from your book, “… and Forgive Them Their Debts,” in which you talk about the debt phenomenon in primitive or pre-industrial civilizations, very different than what we’ve experiencing today, correct?
[Michael] That’s right. You mentioned the Financial Times report of the economists who did see the crash coming. I was the only one who actually made a chart showing why the break had to come. The Financial Time review was by Dirk Bezemer, who showed the chart that I published in a Harper’s magazine, based on an earlier paper I’d given at the University of Missouri at Kansas City for one of our Minsky Conferences.
[Jim] Let’s play this. It’s a two-minute clip on what you talking about, and debt within pre-industrial societies.
[Michael] Economists don’t talk much about religion or society, or how these concerns shape markets. Theologians for their part act as if religion is all about heaven and sex, so debt is left out. Yet it used to be at the core of Judaism, Christianity, and earlier Near Eastern religion.
[Host] Why is that? If religious leaders are interested in social justice, as Jesus was, it you have to talk about economics.
[Michael] I think part of the reason is that when they translated the Bible into English, German and the vernacular, they didn’t know what many of the words originally meant, like deror (for the Jubilee Year), or how to distinguish between “sin” and “debt” as originally a reparations payment for sin. They didn’t understand that most of the Bible was redacted by the returnees from the Babylonian captivity, who brought back this concept of debt cancellation, “andurarum” – Clean Slate. The Hebrew word was “deror.” In the Bible, you’ll have other words or terms for the Clean Slate, the Jubilee year of Leviticus 25, such as “Year of the Lord” in Jesus’s first sermon.
They didn’t realize that the word “gospel” was the “good news.” That good news was that there was going to be a debt cancellation. They didn’t realize that the Ten Commandments were very largely about debt; that “one shall not covet the neighbor’s wife,” that means you don’t make a loan to the guy so he has to pledge his wife as a debt slave to her so that you can have your way with her.
[Jim] But ordinarily that just gets translated as adultery.
[Michael] Yes, but they didn’t realize that the vehicle for this immorality was largely debt bondage. “Thou shalt not take the Lord’s name in vain” meant that a creditor couldn’t swear that so-and-so owes you money if he didn’t. All of this had to do with fact that the great destabilizing factor in society in the first millennium BC was debt beyond the ability to be paid, leading to bondage of the debtor, and ultimately forfeiture of land to wealthy creditors eager to grab it and do as Isaiah accused, join plot to plot and house to house until there were no more people left in the land.
[Jim] “No more people left in the land.” This is an incredible narrative. Please flesh out the narrative so that we can understand what was going on at that time.
[Michael] In order to explain the dynamics of debt in early times, you have to explain how the overall economic system worked as part of the social system. Most people ran into debt not by borrowing, but simply by not being able to pay the taxes or other payment obligations that accrued. These debts weren’t the result of loans. Most personal debts in Sumer and Babylonia were owed to the palace, so when the crops failed or there was a military fighting they couldn’t pay what they owed to the bureaucracy of tax collectors or for public services.
[Jim] Who were working for the palace.
[Michael] Yes. The rulers had a choice at this point: Either they could let the debtor fall into bondage when he couldn’t pay the tax collectors or the palace. If that happened, he’d owe the crop surplus to the creditor, not the palace.
He owed his payment in labor. That was the scarce resource in antiquity. He’d owe his labor to the creditor, so he couldn’t serve in the army, or do corvee work to build infrastructure or palace walls.
So rulers canceled these personal debts to regain control over agrarian labor and its crop surplus. Every new ruler who took the throne in Sumer and Babylonia started the reign with an amnesty, a Clean Slate to start from a position of balance in Year One. During their subsequent reign, if the crops failed or if there was a military conflict, the ruler would cancel consumer debts (but not commercial debts among businessmen for foreign trade or similar enterprise). That’s in the laws of Hammurabi, cancelled Babylonian debts four times. It’s obvious that if you’re at war or if the crops are hurt, cultivators can’t pay the loans.
What early modern scholars could not believe, until our Harvard group began to compile the economic history of antiquity, that canceling such debts actually was what maintained stability. We began our Harvard group in the 1990’s , and we’ve published five colloquia volumes of the origins of economic enterprise in the ancient Near East, on land tenure, urbanization, debt, and debt cancellation.
Our researches showed that as soon as you had interest-bearing debts (mainly in the commercial sphere), you had debt cancellation for the personal agrarian debts. Business debts were not canceled because the merchants were also citizens, so no matter what, all citizens had their designated self-support land. So only the barley debts were canceled; not the personal debts. We showed that rulers canceled the debts because number one, they were canceling debts owed to themselves. It’s politically easy to forgive a debt if it’s owed to you. But it’s more difficult if there is an oligarchy and debts are owed to private creditors.
Canceling crop debts was what maintained economic stability without mass bankruptcy, which would have meant that a lot of debtors would have ended up as bond servants to their creditors. It also maintained demographic staility, because otherwise, debtors would have run away and joined another community. Many did run away after Babylonia fell in 1600 BC. Four centuries later we find them joining the hapiru, which many people connected to the Hebrews. They were sort of gangs of laborers who also would do a little bit of piracy or serve as mercenaries. Their own groups were very egalitarian, just as pirates were egalitarian in their own ranks in the 18thcentury West.
With the hapiru you find for the first time an ideology saying that they were not going to let themselves fall into debt to the rich or to landlords. Their ranks were joined by fugitives walking out. Of course, that’s how Rome came to be settled under its “kings,” and what the Roman commoners did 594 BC after the kings were overthrown. The oligarchy took over, and tried to reduce the Roman population to bondage. You had numerous Secessions of the Plebs, for instance, again when the oligarchy broke its word by 449 BC.
[Jim] the aim was to forgive all the debts, just as in the Bible, right?
[Michael] When the Bible really was edited and put together by the Jews who were coming back from Babylonia, they brought back with them many Babylonian practices.
[Jim] So, they had learned from that experience . . .
[Michael] At that time all the Near Eastern kingdoms, even the Neo-Assyrian and Neo-Babylonian empires had rulers who continued to proclaim Clean Slates.
[Jim] The Persians and so on. But that tradition didn’t survive into modern times, although it became a tradition within the old Judaism.
[Michael] And also the original preachings of Jesus. Leviticus 25 projected the practice all the way back to the commandments of Moses. But there’s not very much documentation of Judaism after the compilation of the Jewish Bible, because the Judeans didn’t write on clay tablets, they wrote on perishable materials that haven’t survived. The little that did survive was the sacred library of Jerusalem, which became the Dead Sea Scrolls. When the Romans came, they took the library and they put it in pots. We now have many of these scrolls. One was a midrash, a collection of all of the biblical passages about debt cancellation, including those of the prophets.
[Michael] So we know that by the time of Jesus, there was an active popular demand for another Jubilee. But meanwhile, within Judaism itself, the wealthiest families became the rabbinical school. Luke’s description of Jesus in the New Testament said that the Pharisees loved money. They became the rabbinical school of Hillel. Luke said that Jesus went back to the temple in his hometown to give a sermon, and unrolled the scroll of Isaiah to read the passage about the Year of the Lord – meaning the Jubilee Year – and said, that he had come to proclaim this year. That was his destiny.
Early translators of the Bible just read “the Year of the Lord” without realizing that this meant the Jubilee Year, deror, a debt cancellation. Luke immediately says a lot of families got very angry and chased Jesus out of town. They didn’t like his message. The Pharisees in particular got upset, and complained to the Roman that Jesus wanted to be King. Well, the reason they said was that they knew that Rome hated kingship. Roman tradition as written by Livy and by Dionysius and Halicarnassus described Servius as cancelling the debts, and most other kings of trying to keep the oligarchy in its place. Rome grew by making itself a haven for immigrants, whom they attracted precisely by keeping the oligarchy in its place.
[Jim] But they also had an empire. . .
[Michael] We are talking before the eighth to sixth centuries BC. But then the oligarchs took over and throughout the rest of Roman history down to the empire, the great fear was that somebody would do what the kings did: cancel the debts and redistribute the land to the poor. Julius Caesar was killed for “seeking kingship,” meaning that the Senate worried that he was going to cancel the debts after decades of civil warfare over this issue and the assassination of Catiline and other advocates of debt cancellation.
[Jim] And people will be free from their economic bondage
[Michael] Yes. Even many rich people were behind Catiline, who led the revolt a generation before Caesar, who actually seems to have been an early sponsor of Catiline. We’re talking about 62 to 64 BC; Caesar was killed in 44 BC.
So to make a long story short, what made the West “Western” was that it was the first society notto cancel the debts. It was to prevent this that oligarchies opposed a central authority. We don’t find any sign of debt in Greece and Rome until about 750 B.C. It was brought by near Eastern traders, along with standardized calendrically based weights and measures, ritual and religious practices. They set up temples as trading vehicles. For thousands of years, traders had set up local temples to act as a sort of Chamber of Commerce, to negotiate trade. In Greece, and Rome at that time there were chieftainships, which began to adopt the patronage practices of extending loans to the population, and then taking the payment and labor.
These dependency relationships are what made Western civilization different from what went before. There was no palatial economy, no state authority to override the oligarchy, cancel debts, redistribute land or liberate citizens who had been reduced to bondage as a result of their debt.
[Jim] You’re talking about the Middle Ages as well, feudalism?
[Michael] No, I’m talking about Greece and Rome in contrast to the Near Eastern mixed economies that were palatial as well as private. There was much private mercantile enterprise in Sumer. Its foreign trade was largely left to private enterprise (with the palace being a major customer, to be sure), so, these were mixed economies, as the five volumes that our Harvard group published have shown.
[Jim] This is all contained in your book “… and Forgive Their Debts.”
[Jim] So this is what is crucial to understanding lending, foreclosure and redemption from the Bronze Age finance to the Jubilee.
[Jim] This is a fascinating history. Can we bring it up to date, including issues of militarization and empire and imperialism in the 20thcentury, World Wars I and II? What are some of the things that occurred, the inception of the World Bank and the IMF? How did America control and attempt to defend its empire by using debt leverage?
[Michael] Already in Greece and Rome there was a linkage between debt and militarization. A Greek general, Tacticus in the third century BC, wrote a book of military tactics. He said that if you want to conquer a town, the way to take it over is to promise to cancel the debts. The population will come over to your side. And conversely, he said, if you’re defending a town, cancel the debts and they’ll support you against the attacker. So that was one of the reasons that debts tended to be canceled by one group or another. It’s what Coriolanus did, and then he went back on his word in Rome. That’s what Zedekiah did in Judea. Well, today it’s different. Here you have the imposition of a military force – really NATO – to enforce debt collection, not only from individuals but on debt entire countries. The job of the World Bank and IMF is to impose such heavy debt service on countries, and indeed to impose it in dollars, that countries have to earn these dollars to pay their debts. They can’t simply print the money to pay these debts like America can do. They have to obtain dollars by steadily lowering the price of their labor. But as yet there is no debt revolt.
[Jim] Because, when we went off the gold standard the American dollar became all powerful.
[Jim] And we control 75% of the gold reserves?
[Michael] By the end of World War II, we controlled 75%, right.
[Jim] These are tremendous transformations in the world economy. The IMF and World Bank have supposedly developed through the UN for development, but as you argue, it’s more to create dependency.
[Michael] The World Bank is effectively part of the Defense Department. Their heads are usually former Secretaries of Defense, from John J McCloy, the first president, to McNamara and subsequent heads. What the United States discovered is that you don’t need to go to war to control other countries. If you can have them accept the assumption that all debts should be paid, they will voluntarily submit to austerity, which is class warfare against their own labor force. They will continue to devalue their currency …
[Jim] And create puppet governments that will support that as surrogates.
[Michael] Yes. What the free market boys at the University of Chicago discovered is that you can’t have a pro-financial free market – free of government regulation and its own public infrastructure and credit system – unless you’re prepared to assassinate everyone who wants a strong government. When they went to Chile and supported Pinochet, U.S. officials provided a list of who had to be killed –
- land reformers,
- labor leaders,
- socialists, and
- especially economics professors.
They closed down every Economics Department in the country, except for the one at Catholic University, the right wing economics department teaching Chicago School neoliberalism. So, you have to be totalitarian in order to impose a free market pro-financial style – which, under today’s circumstances, means pro-US.
[Jim] It’s occurring across Latin America, right?
[Michael] Yes. A free market means libertarianism and totalitarian government. What the Chicago boys and the so-called New Institutional Economics school calls the rule of contracts. You have the history of Western civilization now being taught almost everywhere as if what created civilization was the rule of contracts, not canceling the debts. So, you’ve created an inside-out view of history. Its aim is to deny the fact that the only way that you can prevent the kind of economic slowdown that we’re having in America now is to write down the debts. If you don’t write down the debts, you’re internal market will shrink and you’re going to end up looking like Greece, or like France with all the riots that they are having there, or like the other countries that are rioting because they don’t want to be turned into a Neo-feudal society.
[Jim] This seems to be occurring in Puerto Rico as well. So what becomes more profitable for American economy is the military and the armaments that we ship and use in all these adventurers wars that we have in the 800 hundred US military bases around the world.
[Michael] The difference is that in the past when you had militarism, you actually had to fight a war. Soldiers had to go in. You know the old joke about wine that’s being sold in an auction. It’s a hundred-year-old bottle and is very, very expensive. A rich guy buys it and pours it out to impress his friends, but it tastes like vinegar. He complains to the auction house, but is told, “Oh, that’s not wine for drinking! That’s for trading!” That’s what most U.S. arms are for: not really to use. You’re never again going to get Americans to be drafted and go into the army to actually, use them. These arms are not for fighting; they’re for making profits. Seymour Melman explained that in Pentagon Capitalism.
[Jim] The permanent war economy.
[Michael] That’s right. Meaning more profits for the military industrial complex. You don’t actually use the arms. You just pay to produce them and throw them away. It’s like what Keynes talked about, building pyramids in order to create domestic purchasing power.
[Jim] And you can’t, as Melman tried to do, use economic conversion to more civilian uses. That never happened.
[Michael] Seymour Melman explained that the U.S. government decided to make a different kind of a contract with the arms manufacturers. It’s called cost-plus. As he summarized it, the government guarantees them a profit, but to prevent monopoly rents, they determined the prices to be paid at, say, ten percent over the actual cost of production. This led the arms-makers to see that if their profits were going to rise in keeping with the cost of production, they wanted as high of a cost of production as possible.
So, the engineers working on the American military industrial complex aimed at maximizing costs. That’s how we got toilet seats that cost $650.
Countries that don’t have Pentagon capitalism, like Russia or China, are able to produce weaponry that outshines America. Even broke Iran, can make missiles that apparently get right through the U.S. defenses in Syria and Iraq, because they don’t have cost-plus. They’re trying to be efficient, not just to have an excuse for making money via a cost-plus contract.
[Jim] How do we turn this around? You’ve made the connections to show that everyday people and their lives are profoundly impacted by the unreal world that the financial predators are creating.
[Michael] Reality isn’t the aim of their economic models. For instance, just today I saw Paul Krugman on Democracy Now. He said that the reason we’re in a depression is because President Obama did not run a large enough budget deficit! He’s a Keynesian, but goes so far as to insist that debt has no role to play in deflating the economy. That’s largely because Krugman serves in effect as a bank lobbyist – not only here, but in Iceland and other countries. To me, the current economic squeeze is that Obama didn’t let the banks collapse. He kept the bad he debts on the books instead of treating them as bad loans to be absorbed by the banks that wrote the junk mortgages and lost in their speculative gambles.
[Jim] And ate the homeowners!
[Michael] Yes. He kept their bad, outrageously priced loans on the books and evicted 10 million families. He called them “the mob with pitchforks,” and Hillary called them “deplorables.” That shows you where the Democratic Party is at, and why it was so easy for Donald Trump to make a left wing run around the Democratic Party. That is how right wing Obama was. His legacy was Donald Trump, via Hillary Clinton.
[Jim] Krugman is the most well-known so-called Keynesian economist in the country, right?
[Michael] The reason he’s so well-popularized by the pro-financial class is precisely because he doesn’t understand money. So bank lobbyists love him and he’s popularized by the right-wing New York Times. He had a wonderful debate with Steve Keen that anybody can see on Google, where he says that it’s impossible for banks to create money and credit. He thinks that banks are savings banks, and they’re just relending deposits. Steve Keen explained what endogenous money is. That’s what we talk about in Modern Monetary Theory.
[Jim] And the Wall Street Journal.
[Michael] And the Washington Post. They go together. They don’t want economists to be popular who talk about debt and why the debts can’t be paid or the need for a debt write down. Krugman attacks Bernie Sanders as if he is an unbelievable radical for backing public medical care.
[Jim] On February 17, Krugman wrote a column “Have Zombies eaten Bloomberg’s and Buttigieg Brains?” He said “My book is arguing with zombies.” And one of the zombies is his obsession with public debt and the belief that we should be terribly scared of government debt, can’t do anything because of deficits. Eeek! And that’s the way Buttigieg talks. The very moment when mainstream economics, if you like centrist economics, has concluded that these debt worries, were way overblown. The president of American Economic Association gave this presidential address saying that debt is not nearly the problem people think it is. It’s not a constraint, and of course, Republicans have pulled off one of the greatest acts of policy hypocrisy in history – you know, the existential deficit threat. I don’t want to see a democratic centrist bring us into this deficit scaremongering. That would be a really bad thing that would block any kind of initiative.
So, what does the everyday person make of this debate? And what’s the attraction of Trump his message to people who feel that their real-world needs are being addressed?
[Michael] I think the reason people voted for Trump’s was mainly Hillary. She said that voters should vote for the lesser evil. There was no question who the “lesser evil” was. It was Donald Trump. Did you want World War III, or Donald Trump? It’s not a very nice choice, but Hillary’s viciously right-wing, especially where Russia is concerned. The Democratic National Committee and deep state are all about Russia, Russia, Russia! And calling Trump Putin’s puppet.
Then finally the Mueller report came out and found nothing there! So you can view the Democratic Party as the political arm of the military industrial complex and the banking complex.
[Jim] And Obama totally propped them up. But now, Bernie! What about him? The Democratic establishment is against him, and so is the Republican establishment.
[Michael] If the enemy of my enemy is my friend, then Bernie’s enemies are the Democratic Party establishment and the Democratic National Committee. So of course a lot of people are going to love him.
[Jim] Yup. He wants to cancel student debt! He is talking your language!
[Michael] If the student debt is not canceled, you’re going to have a generation of graduates unable to get the mortgage loans to buy homes, because they’re already paying their income to the banks.
[Jim] They’re living at home!
[Michael] That means that you’re going to have a shrinking economy. So of course you have to write down student debt, and also other forms of debt – credit card debt and other debt. The economy cannot recover if you don’t write down the debt overhead.
The good thing about writing down the debts is that you wipe out the savings on the other side of the balance sheet. Some 90 percent of the debts in America are owed to the wealthiest 10 Percent. So the problem is not only the debt; it’s all these savings of the One Percent! The world is awash in their wealth. If you don’t wipe out their financial claims – which are the basis of their wealth – they’re going to take you over and become the new financial Lords, just like the feudal landlords. The banks are the equivalent of the Norman invasion. and the conquering landlords that reduce the economy to a peonage!
[Jim] But the moral argument is made that they’re the best. They’ve survived, right? I’m playing devil’s advocate here. So they serve a purpose, don’’ they? Their wealth is a sign that the system is working.
[Michael] That’s not what Adam Smith and John Stuart Mill said, or Ricardo and the entire 19th century classical economic school. They said that economic rent is unearned income. So the aristocracy (“the best”) doesn’t earn it. It is a result of privilege, which almost always is inherited wealth or monopoly privilege, that is, the right to appropriate something that really should be public. Land ownership and mining should be public wealth, as are mineral resources in much of the world. Education should be public. People shouldn’t have to pay for it. The idea initially in the United States was that education should be free as a human right. Medical care is also, as Bernie says, a human right, as it is in a lot of the world. So America, which people used to think was the most progressive capitalist country, suddenly becoming the most neo-feudal economy.
[Jim] How about Max Weber and the Protestant ethic as the spirit of capitalism? The argument is made that those who are productive are rewarded by heaven, while those who are poor deserve it. Wealth was a sign that God had bestowed his grace on its owner.
[Michael] That sort of the patter talk a century ago hasn’t stood up very well. The wealthy claim to be wealthy because God loves them. If they can convince other people that God loves them and hates the rest of the people, they make God into the devil. They make him hate the working class, and make them dependent on this unnecessary class of parasites. That’s crazy! But that’s what happens if you let the wealthy take over religion. Of course, they’re going to say that religion justifies their wealth.
That’s what makes modern religion the opposite of the religion that I described in the Bronze Age. Upon taking the throne, rulers took a pledge to the gods to restore equity and cancel the debts. That included restoring lands that had been forfeited, giving it back to the defaulting debtors to re-establish order. That was the idea of religion back then. But today’s religion has become a handmaiden of wealth and privilege, and of “personal responsibility” to make people pay for education, health care, access to housing and other basic things that should be a public right.
[Jim] Which is what preoccupies the average American, when seventy percent of their earnings are going to these sorts of things, and for taxes and rent. I have a brief quote here from Martin Luther King, who I think represents the sort of religious tradition you’re advocating. He had been deeply influenced by the theologian, Walter Rauschenbusch and his 1907 book, Christianity and the Social Crisis.
[Michael] Read it, so that so they can hear it.
[Jim] Here’s the main quote: “The gospel at its best deals with the whole man; not only his soul, but his body; not only the spiritual well-being, but his material well-being.” King wrote in an inspired passage, “any religion that professes to be concerned about the souls of men and is not concerned about the slums that damned them, the economic conditions that strangled them and the social conditions that crippled them is a spiritually moribund religion awaiting burial.”
[Michael] That’s right. Religion was about the whole economy. Not just a part of the economy. Today they’ve separated religion, as if only spiritual and has nothing to do with the economic organization of society. Religion used to be all about the economic organization of society. So, you’ve had a decontextualization of religion, taking away from analyzing society to justify the status quo by teaching that if things are the way they are, it’s because God wants it this way. That’s saying that God wants the wealthy and privileged to exploit you, especially by getting you into debt. And that’s just crap!
[Jim] And that gets us away from the classical tradition, which does try to see this as social.
[Michael] And that’s why Christian evangelicals hate Jesus so much.
[Jim] There you go! But we love Bernie! Can he win? We’ve only got about a minute to go …
[Michael] Of course he can.
[Jim] You think he will be able to withstand the onslaught that he’s going to get?
[Michael] A year ago I was pretty sure that the Democratic National Committee was going to put the super delegates in to sabotage any attempt that he was going to make to get the nomination. Now it’s clear that the Democratic Party will be torn apart, and this means the end of it if he’s not the nominee.
[Jim] All right! Well, from your mouth to God’s ears! Thank you, Michael. This has been so enlightening.
[Michael] Thank you.
[Jim] I’m so blessed that we are in the audience here too on the Radical Imagination. So happy to have had you here. I hope you’ll come back again. This is your most recent book, “… and Forgive Them Their Debts.” Thank you very much! This is Jim Vrettos for the Radical Imagination. See you next week. Thank you, Michael!
Thirty-five years ago business publications were writing that major money-center banks would fail, and quoted investors who said, “I’ll never own a stock again!” Meanwhile, some state and local governments as well as utilities seemed on the brink of collapse. Corporate debt often sold for pennies on the dollar while profitable, growing companies were starved for capital.
If that all sounds familiar today, it’s worth remembering that 1974 was also a turning point. With financial institutions weakened by the recession, public and private markets began displacing banks as the source of most corporate financing. Bonds rallied strongly in 1975-76, providing underpinning for the stock market, which rose 75%. Some high-yield funds achieved unleveraged, two-year rates of return approaching 100%.
The accessibility of capital markets has grown continuously since 1974. Businesses are not as dependent on banks, which now own less than a third of the loans they originate. In the first quarter of 2009, many corporations took advantage of low absolute levels of interest rates to raise $840 billion in the global bond market. That’s 100% more than in the first quarter of 2008, and is a typical increase at this stage of a market cycle. Just as in the 1974 recession, investment-grade companies have started to reliquify. Once that happens, the market begins to open for lower-rated bonds. Thus BB- and B-rated corporations are now raising capital through new issues of equity, debt and convertibles.
This cyclical process today appears to be where it was in early 1975, when balance sheets began to improve and corporations with strong capital structures started acquiring others. In a single recent week, Roche raised more than $40 billion in the public markets to help finance its merger with Genentech. Other companies such as Altria, HCA, Staples and Dole Foods, have used bond proceeds to pay off short-term bank debt, strengthening their balance sheets and helping restore bank liquidity. These new corporate bond issues have provided investors with positive returns this year even as other asset groups declined.
The late Nobel laureate Merton Miller and I, although good friends, long debated whether this kind of capital-structure management is an essential job of corporate leaders. Miller believed that capital structure was not important in valuing a company’s securities or the risk of investing in them.
My belief — first stated 40 years ago in a graduate thesis and later confirmed by experience — is that capital structure significantly affects both value and risk. The optimal capital structure evolves constantly, and successful corporate leaders must constantly consider six factors —
- the company and its management,
- industry dynamics, t
- he state of capital markets,
- the economy,
- government regulation and social trends.
When these six factors indicate rising business risk, even a dollar of debt may be too much for some companies.
Over the past four decades, many companies have struggled with the wrong capital structures. During cycles of credit expansion, companies have often failed to build enough liquidity to survive the inevitable contractions. Especially vulnerable are enterprises with unpredictable revenue streams that end up with too much debt during business slowdowns. It happened 40 years ago, it happened 20 years ago, and it’s happening again.
Overleveraging in many industries — especially airlines, aerospace and technology — started in the late 1960s. As the perceived risk of investing in such businesses grew in the 1970s, the price at which their debt securities traded fell sharply. But by using the capital markets to deleverage — by paying off these securities at lower, discounted prices through tax-free exchanges of equity for debt, debt for debt, assets for debt and cash for debt — most companies avoided default and saved jobs. (Congress later imposed a tax on the difference between the tax basis of the debt and the discounted price at which it was retired.)
Issuing new equity can of course depress a stock’s value in two ways:
- It increases the supply, thus lowering the price; and it
- “signals” that management thinks the stock price is high relative to its true value.
Conversely, a company that repurchases some of its own stock signals an undervalued stock. Buying stock back, the theory goes, will reduce the supply and increase the price. Dozens of finance students have earned Ph.D.s by describing such signaling dynamics. But history has shown that both theories about lowering and raising stock prices are wrong with regard to deleveraging by companies that are seen as credit risks.
Two recent examples are Alcoa and Johnson Controls each of which saw its stock price increase sharply after a new equity issue last month. This has happened repeatedly over the past 40 years. When a company uses the proceeds from issuance of stock or an equity-linked security to deleverage by paying off debt, the perception of credit risk declines, and the stock price generally rises.
The decision to increase or decrease leverage depends on market conditions and investors’ receptivity to debt. The period from the late-1970s to the mid-1980s generally favored debt financing. Then, in the late ’80s, equity market values rose above the replacement costs of such balance-sheet assets as plants and equipment for the first time in 15 years. It was a signal to deleverage.
In this decade, many companies, financial institutions and governments again started to overleverage, a concern we noted in several Milken Institute forums. Along with others, including the U.S. Chamber of Commerce, we also pointed out that when companies reduce fixed obligations through asset exchanges, any tax on the discount ultimately costs jobs. Congress responded in the recent stimulus bill by deferring the tax for five years and spreading the liability over an additional five years. As a result, companies have already moved to repurchase or exchange more than $100 billion in debt to strengthen their balance sheets. That has helped save jobs.
The new law is also helpful for companies that made the mistake of buying back their stock with new debt or cash in the years before the market’s recent fall. These purchases peaked at more than $700 billion in 2007 near the market top — and in many cases, the value of the repurchased stock has dropped by more than half and has led to ratings downgrades. Particularly hard hit were some of the world’s largest companies (i.e., General Electric, AIG, Merrill Lynch); financial institutions (Hartford Financial, Lincoln National, Washington Mutual); retailers (Macy’s, Home Depot); media companies (CBS, Gannett); and industrial manufacturers (Eastman Kodak, Motorola, Xerox).
Without stock buybacks, many such companies would have little debt and would have greater flexibility during this period of increased credit constraints. In other words, their current financial problems are self-imposed. Instead of entering the recession with adequate liquidity and less debt with long maturities, they had the wrong capital structure for the time.
The current recession started in real estate, just as in 1974. Back then, many real-estate investment trusts lost as much as 90% of their value in less than a year because they were too highly leveraged and too dependent on commercial paper at a time when interest rates were doubling. This time around it was a combination of excessive leverage in real-estate-related financial instruments, a serious lowering of underwriting standards, and ratings that bore little relationship to reality. The experience of both periods highlights two fallacies that seem to recur in 20-year cycles: that any loan to real estate is a good loan, and that property values always rise. Fact: Over the past 120 years, home prices have declined about 40% of the time.
History isn’t a sine wave of endlessly repeated patterns. It’s more like a helix that brings similar events around in a different orbit. But what we see today does echo the 1970s, as companies use the capital markets to push out debt maturities and pay off loans. That gives them breathing room and provides hope that history will repeat itself in a strong economic recovery.
It doesn’t matter whether a company is big or small. Capital structure matters. It always has and always will.