Natively, I tend to be an optimist.  The present environment has given thin gruel for optimism, so I haven’t been as perky as I might otherwise be.  Here are a few reasons for optimism:

  • Credit spreads have been declining, and more corporate bond deals are getting done in the credit markets.
  • Commodity prices have fallen and stabilized.
  • The balance sheet of the Federal Reserve is shrinking.
  • Money market and other short duration funds seem to be safe.
  • Equities might be cheap relative to cash, but are still expensive relative to junk and low investment grade bond yields.

On that last point I want to quote Doug Kass, who I respect as an investor:

On multiple fronts, equities appear to have incorporated the bad news and are undervalued both absolutely and relative to fixed income:

  1. The risk premium, the market’s earnings yield less the risk-free rate of return, is substantially above the long-term average reading.
  2. Using reasonably conservative assumptions (most importantly, a near 50% peak-to-trough earnings decline, which is over 3x the drop in an average recession), the market has discounted 2009 S&P 500 earnings of about $47.
  3. Valuations are low vis-à-vis a decelerating (and near zero) rate of inflation. Indeed, the current market multiple is consistent with a 6% rate of inflation.
  4. Stock prices as a percentage of replacement book value stand at 1x, well below the 1.4x long-term average.
  5. The market capitalization of U.S. stocks vs. stated GDP has dropped dramatically, to about 80%, now at the long-term average. Warren Buffett was recently interviewed in Fortune Magazine and observed that this ratio was evidence that stocks have become attractive.
  6. The 10-year rolling annualized return of the S&P is at its lowest level in nearly 75 years, having recently broken below the levels achieved in the late 1930s and mid 1970s.
  7. A record percentage of companies have dividend yields that are greater than the yield on the 10-year U.S. note. At 46% of the companies, that is over 4x higher than in 2002 and compares against only 5% on average over the last 30 years.

On point 1, I will say that equities are cheap to cash and Treasuries, but not Corporate bonds and bank debt.

For point 2, we have gone through a massive levering up; it would be no surprise to see a leveraging down.

Point 3 — I don’t get it.  Inflation has a small effect on valuations.

Point 4 — This is true but it could go lower because there is no one that wants to buy and hold at present.

Point 5 — In this environment, where there is a lack of buy and hold capacity, why are we satisfied with normal valuations?

Point 6 — True for Treasuries, wrong for corporates.

Point 7 — The 10-year Treasury is artificially low.   It is not a good metric for dividend yields.

Mr. Kass is a bright man, and probably a better investor than me, but there are reasons to be concerned in this economic environment.  Be careful, and don’t make rash moves in this volatile environment.

1) One of the unwritten rules of the corporate bond market is avoid the sector that has been the biggest issuer lately.  Underwriting and credit quality get sloppy in any sector that issues a lot of debt.  It would be a salutary warning for telecom bonds in 2000 and financials in the mid-2000s.  Even though they are not  corporates, the same would apply to mortgage bonds near the end of the real estate boom.  The little bit of extra spread would not be worth it.

Well, what if a sector is expanding rapidly, and there is no incremental spread?  Again, not a corporate sector, but that describes our dear Government today.  We talked about “crowding out” in early 80s, but it never truly materialized.  It is probably not happening now either.  Most corporations that want to borrow can’t, and those that can don’t want to.

All the same, outside of TIPS, I don’t see a lot of value in Treasuries at present.

2) Note to the Fed: if you want to keep mortgage rates low, buy mortgage bonds, not Treasuries.  The cost of that is that the Fed would bear some risk if Fannie of Freddie went down.  But Fannie, Freddie, and the Fed have one unified balance sheet given that the Federal Government is behind all of them.

3) But, is it desirable that banks lend at this point?  It might be better for them to restore their balance sheets, battered from the sloppy underwriting of the boom years.  Then they could once again lend soundly.

It makes little sense to try to force debt onto the US consumer who is largely overleveraged.  So why try to prompt banks to lend?  This applies to my mutual bank idea as well.  Do we really need more aggregate lending when the economy as a whole remains overlevered?

4) We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.”

So said Mr. Luo, a director-general at the China Banking Regulatory Commission.  I’ve been saying for a long time that China is stuck, and that we are their problem, and not vice-versa.  There may come a point where they stop buying US Dollar-denominated debt, and let existing debt mature, but that will come after a shift in their own economy where they are no longer driven bythe promotion of their exports.  There aren’t many large good alternatives to US debt for parking the proceeds from exporting aggressively.

5) In a downdraft, pockets of hidden leverage get revealed.  Consider the states of the US.  With the declining economy, revenues from real estate taxes decline, as do capital gains and wage taxes.  Budgets of 46 of the states are facing significant deficits.  Governments got to used to capital gains taxes, rising wages, rising property assessments, and high turnover of property.  Now those are gone.   Rainy day funds were not established at necessary levels and were drained too early.

6) In a downdraft, pockets of hidden leverage get revealed.  Consider the Ponzi schemes that have come to light: Madoff, Stanford (it seems), and a small number of smaller Ponzis.  Why revealed now?  During a boom period liquidity is superadequate; most investors don’t face a need to call for cash.  Investors are happy to receive highish stable rates of return that come with seeming safety.  During the bust period many need cash, and the frauds are revealed for what they are.  Ponzi schemes are mini-bubbles; they pop when the call on cash is too great, if aren’t discovered as frauds during their growth phase.

7) In a downdraft, pockets of hidden leverage get revealed. Prime brokerage is very profitable to investment banks, but even they have to do risk control in a tough environment.  Hedge funds with better risk control get more leverage, those with worse risk control get less.  As I have said before, hedge funds aren’t the most stable vehicles in a downdraft.  They are reliant on the good graces of their prime brokers and the patience of their limited partners.

8 ) In a downdraft, pockets of hidden leverage get revealed. While housing prices kept rising, aided by increasing buying power facilitated by poorly underwritten loans, the mortgage insurers happily clipped profits; their greatest worry was the banks eating their business through second lien loans.  Most of the banks that did a lot of that financing have gotten whacked.  The mortagage insurers had somewhat more flexibility in their balance sheets, but if present loss rates continue for the next two years, many of their operating insurance subsidiaries will need to file a plan to remedy their impaired balance sheets.

9) In a downdraft, pockets of hidden leverage get revealed. (Sorry, last one.)  Just as Iceland was a harbinger of global weakness, and especially to the UK, might Eastern Europe prove to be that for Western Europe, and particularly Austria?  (Also here and here.)  Many Western European banks are exposed to Eastern European creditworthiness.  Some individual borrowers in Eastern Europe have mortgages denominated in Swiss Francs or Euros.

I’ve seen situations like that before, and sometimes I call it a currency vise.  It works well for a time during the boom phase, but then weaker currencies get trashed during the bust phase.  It simultaneously makes it more difficult to service the debt in the newly expensive hard currency, and the lender isn’t better off either — he now faces credit problems.

10) I’ve done many pieces on hidden credit problems inside ETFs and ETNs.  After my last piece, a reader asked if I would do a survey article on the problems.  Sorry, no survey article, but I can summarize them all for you here.

  • Exchange Traded Notes [ETNs] carry the risk that their sponsor will default.  They are unsecured obligations of a bank, but they have done some sort of hedge to provide the ETN buyer with a certain return so long as their bank is solvent.  For the bank, it is a sweet deal, because to them it is cheap funding.
  • Leveraged funds carry two risks.  The first is that any swap counterparties that the fund deals with goes bust.  The second is the money market instruments / cash equivalents behind the derivatives in these funds don’t prove good.  Granted, it is hard to lose in the money markets, but choose your credits with care.  Lehman went down pretty quickly.
  • Then there is the risk that a counterparty could go bust in a currency fund, as in the last article that I wrote.

ETFs and ETNs are great new  products that increase the scope that an investor can pursue.  Just be aware that in some funds there can be credit risk — with currencies, commodities, leveraged funds, and ETNs.

I’m tossing this out for comment.  This blog post alleges that US money market funds faced a calamitous withdrawal on 9/18/08, and the US Treasury put a stop to it , and then announced the TARP, etc.

I viewed the recommended video, and indeed Paulson says little, but might hint at bigger things.

But we have better information from the Joint Economic Committee of Congress.  Let me quote from this on page 9:

Breaking the Buck Causes Runs on Money Market Mutual Funds. On Monday September 15, 2008, the $62 billion Reserve Primary Fund, a money market mutual fund, “broke the buck” because of its investment in Lehman Brothers’ short-term debt securities. The Reserve Primary Fund suspended redemptions for one week.

On June 30, 2008, money market mutual funds had total assets of $3.3 trillion of assets. Among these assets, money market mutual funds held $701 billion of commercial paper, or about 40 percent of all commercial paper outstanding. “Breaking the buck” at the Reserve Primary Fund caused investors to question unnecessarily the soundness of other money market mutual funds.

Irrational runs on money market mutual funds began. For the week ending on Wednesday September 17, 2008, investors redeemed $145 billion from their money market mutual funds. On Thursday September 18, 2008, institutional money managers sought to redeem another $500 billion, but Secretary Paulson intervened directly with these managers to dissuade them from demanding redemptions. Nevertheless, investors still redeemed another $105 billion. If the federal government were not to act decisively to check this incipient panic, the results for the entire U.S. economy would be disastrous. [Emphasis mine.]

1. To satisfy redemptions, money market mutual funds slashed their holdings of commercial paper. Commercial paper outstanding fell by $52 billion during the week ending on Wednesday September 17, 2008 as money market funds refused to rollover commercial paper. If this trend continued, major non-financial firms would

a. Lose their primary source for short-term borrowing, and

b. Call upon their back-up lines of credit with commercial banks.

2. Given the extreme funding problems commercial banks were encountering during the week, commercial banks would either:

a. Slash credit to small- and medium-size non-financial firms and households to meet the line of credit commitments to large non-financial firms, or

b. Not be able to fulfill the line of credit commitments to large non-financial firms at all.

3. The result would be a disabling credit contraction that would trigger a severe and lengthy recession with large declines in production and employment, further erosion in household wealth, and a significant increase in the federal budget deficit as countercyclical outlays soared and tax receipts dwindled.

Birth of a Comprehensive Plan. This run forced Chairman Bernanke and Secretary Paulson to reassess the federal government’s previous ad hoc approach to the global financial crisis. Together Bernanke and Paulson concluded a comprehensive plan was necessary to (1) restore confidence and (2) kick start credit markets into functioning again.

To stop the runs on money market mutual funds and to revive the market for commercial paper, Chairman Bernanke and Secretary Paulson acted swiftly on Friday September 19, 2008.1. Secretary Paulson announced a temporary program through which the Treasury will use the $50 billion in the Exchange Stabilization Fund to protect investors in money market mutual funds from any losses should their fund “break the buck” during the next year. Money market mutual funds will pay an insurance premium to the Treasury for this guarantee.

2. The Federal Reserve established two loan facilities to help money market mutual funds meet any demand for redemptions.

a. The Federal Reserve will extend non-recourse loans of up to $230 billion to banks and other depository institutions to buy investment-grade asset-backed commercial paper from money market mutual funds.

b. The Federal Reserve will extend non-recourse loans to primary dealers of up to $69 billion to buy short-term debt securities of Fannie Mae, Freddie Mac, or FHLBs from money market mutual funds.

So is that why our government acted so precipitously?  To rescue the money markets?  That seems to be true, but after a shutdown of withdrawals, the government could have simply quietly bailed out a few funds, and the crisis would have passed.  Instead, they panicked, and opted for an unwarranted wider solution, the TARP.

There would have been better ways to deal with runs on money market and other funds, but the government uses old models in their economic reasoning.

I’ve been seeing a bunch of “buy and hold is dead” pieces.  Here’s an example.  Look, my view is that investment methods travel in eras.  I remember the 80s-90s, where buy-and-hold was the rage.  I also remember the 70s where tactical asset allocation returned, as well as gold bugs and other tangential market participants.

The popularity of investment styles is a trailing indicator of investment performance.  Buy and hold will once again be popoular after three years of a rising market, and that should arrive in the next 20 years sometime.

It may take too long, but “buy and hold” will return.

As I stated in my prior piece, Bailouts are Unfair to Those Who are not Bailed Out, the main objective of the management of a large company that is in trouble is to get your foot in the door.  Get something going now, even if it is inadequate, so that you can beg for much more money later.  Once Congress has committed to initial funding, they will be far more disposed to hand over more money, in order to protect their earlier bad decision.

Another way to think about it is to set up a pattern.  Even if it is a small amount, getting a legislature to agree with a concept on a small level is the precursor to getting it to agree for big money.  Once a pattern is set, the legislature will continue to fund, absent some big economic catastrophe, or other political hurdle.

So we have GM coming back to the trough.  Congress protected them last time, they will protect them this time as well.  There is no good reason to give them money, in my opinion.  Better to send them through bankruptcy, and let Toyota and Honda buy what few pieces of GM have value.

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For those that read me, please realize I work along two tracks — first, the government should not intervene in private transactions.  (That means no central bank also.)  That is my core belief, aside from fraud and implied fraud.  There should be freedom of contract.  But the second track is, “Well, if you are going to be rogues and intervene in the markets, well, here is a less evil way to do so.”  I offer those thoughts, because I know my first track will not be bought.  So it goes.

Full Disclosure: long HMC

Animal Spirits: A notion of Keynes that implied that the willingness of businessmen to take risk was unpredictable and somewhat irrational, leading to booms and busts.  I don’t agree, at least not entirely, but first a word about rationality and economics.

Thinking hurts, at least for most people.  It takes effort, which is why people conserve on doing it.  Instead, they substitute “shortcuts” for thinking that may have some plausibility.

  • This has worked in the recent past, so it should work in the near future.
  • My friend Fred has done this, and it has worked for him, so it should work for me.
  • James Cramer (or Warren Buffett, or fill in your favorite expert, even me) thinks this will work wonderfully, so I will do it as well.
  • Everyone is doing this and doing well.  I have missed out on it in the past, so I better get going now.
  • The academics say you can’t succeed at beating the market, so I won’t try to do so.
  • I’ve read some books on investing, and there is a really simple formula for beating the market.  I’ll follow that method.
  • No one hedges that risk, so I won’t either.  The risk can’t be that large.
  • The government has always been capable of dealing with economic troubles; they should be capable of dealing with this one as well.

Though my examples come from investing, they apply to other areas of business, finance, and life generally.  Few people like to go back to first principles to think through a problem.  Many follow the crowd, or so-called experts.

As an aside, because people don’t like to think hard, they don’t optimize, as the neoclassical economists posit.  Instead, they choose solutions that they deem to be “pretty good,” and stop their searching.  Searching is a cost.  But neoclassical economists insist  that consumers maximize utility and producers maximize profit anyway.  Why?  If they don’t assume that the math doesn’t work, and they can’t publish something that looks semi-scientific.

Crowd-following is common to humanity.  It takes a lot to stand apart from highly correlated behavior.  I’ve told this story before, but in late 1999, I was talking with my mother (a very good self-taught investor), she told me about many of my cousins who were speculating in tech stocks.  I said to her, “They don’t know anything about investing!”  My mom replied, “Oh, David.  You’re such a fuddy-duddy.  I just bought some Inktomi!”

Now, to set the record straight, that was just 1% (or less) of my mom’s assets, so an occasional flyer is acceptable.  Call it “Mad Money.”  😉  For my cousins, it was most of their investable assets.  My mom is fine, and the fuddy-duddy did all right also, but the cousins swore off stock investing.

I saw the same thing with people in their 401(k)s and other DC plans in 2002 — no more investing in equities.  Real estate was the place to be. Buy what you know, and residential real estate always goes up.

Before I continue with the residential real estate example, here are two questions I ask in order to decide whether a course of action makes sense:

  • What if everyone did this?
  • What is the current risk-adjusted free cash flow yield?

The first point should make you remember that any smart strategy can be overdone.  Any business can be overlevered, etc.  We can ask questions about market size, profit capacity and other things to try to determine what a speculative stock or industry could potentially be worth in the long run.  The same thing is true on the bear side — almost everything has some value even in bear market phases.

The second point has value as well.  I use an equation like this:

Free Cash Flow Yield + Necessary Capital Gains Yield = Funding Yield

or:

Necessary Capital Gains Yield = Funding Yield – Free Cash Flow Yield

By necessary capital gains yield [NCGY], I mean what is needed to keep an asset whole.  During “normal times” the NCGY is negative by some amount that reflects the normal risk margin for the asset class.  Near the peaks of bull markets, NCGY goes positive.  Think of real estate investors having to feed their properties.  Rents less expenses are less than the mortgage payments.

At the depths of bear markets, both free cash flow yields and funding yields rise considerably, but the FCF yields more so.  Few are investing, because they are looking through the rear view mirror at the past losses.

Eventually, some enterprising sorts that don’t care about convention see the large negative NCGY, and start putting money to work.  The cycle starts to turn, and things begin to normalize, or at least, begin the next cycle.

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By believing in limited rationality for men, and recognizing the boom-bust cycle, do I come to the conclusion that Keynes did about animal spirits?  No, I don’t.  Businessmen may follow trends, but enough of them pay attention to the NCGY of their businesses that they know when future opportunities are good or bad.

In that same sense, if our government is trying to get economic behvavior to “normalize,” perhaps it should look at the constraints that businesses/consumers live under, and ask what could be done to change things.  It is not so much a question of animal spirits, as where people find that they have an advantage.

At this point, where so many find themselves hemmed in by debt, demand falls, and the economy suffers.  Perhaps an approach similar to what Barry Ritholtz has proposed would be useful.  Give each household a voucher that can only be applied against debts.  The indebtedness of the private sector will decline.  Their willingness to spend will rise.  Overleveraged households delever; underleveraged households spend more; the US is that much more indebted.

Though it may seem unduly populist, giving money to each household solves two problems: it reduces household debt problems, and it also reduces credit stress at the banks.  What could be better in this environment?

Amid my recent difficulties (sickness, loss of my main computer, difficulties updating my blog software), I have been musing about the health of our economy going forward.  Before I give my opinion, I want to share a range of views that I think are worth reading:

I admire the efforts that many are making in moving back to first principles.  We see analyses from Classical, Austrian, Post-Keynesian, Minsky (nonlinear dynamics), and other perspectives.

My view remains that depressions result  from a buildup of too much debt, including debt complexity.  With the recent analysis from Credit Suisse, they dissed adding together financial and nonfinancial debts, as there would be double counting.  Let me first say that there is no good measure here, but the double counting in a complex debt economy is useful to see.  When there is a chain of parties relying on debt repayment, like a set of dominoes, the system is fragile; one little jolt could change things for many.

Aside from that, our economy behaves like an  economy in a depression.  The banks lend considerably less.  Corporations as a whole cut back as aggregate demand drops.  People save more.  Prices of asset ratchet down to reflect current buying power, which seems to be shrinking every day.  The government replaces markets in the process of trying to save them.  Protectionist pressures are global, as is the economic weakness.

I don’t find the actions of the Fed or the current stimulus bill to be very relevant to our crisis, because they do little to reduce our indebtedness as a percentage of GDP.  In a credit based economy, once the banks and consumers are stuffed full of badly underwritten debt, it is difficult for the system to clear until those debts are reduced/liquidated.

I once wrote a five-part (labor of love) series for RealMoney called, If You Get to Speak to Management.”  It is offered freely here.  Tonight, I want to offer a simpler bit of advice: “Ask the opposite question that you would want to ask.”

Management teams and investors relations folks are generally pleasers.  They bias what they say toward what  people want to hear.

Are you concerned about them contimuing the buyback?  Then ask them about retaining capital for capital flexibility.  Are you worried about their balance sheet?  Then ask them about how they will grow the dividend and buyback.

In an environment like this, where capital is scarce, it could be productive to ask how management teams are managing M&A and buyback when valuations are so cheap.  “Why aren’t you buying out your cheap competitors?  Why aren’t you buying your own stock?”

I had a boss 1998-2001 who was a pro at this.  He would ask “dumb” questions on conference calls, and I would start to correct him, and he would make a “slash the throat” gesture.  I would shut up, and invariably, the Wall Streeter would tell a variety of lies that we would listen to, and once the call was done, disregard them.

It was an excellent tool for validating who thought we were patsies, which we were not.  Sticks in the mud, well, maybe, but we did well for our clients.

As for now, I still think the tool is useful.  Ask the opposite question to management teams and see how they fare.

When I was an actuary running a GIC desk inside a medium-sized insurer in the 1990s, I quickly learned about creditworthiness.  My company, for the sake of accounting convenience, placed all GICs in a separate account.  Now the state of domicile did not have a law that said that guaranteed products in separate accounts have protection from the assets in the separate account, and the company if the assets in the separate account fail.

So, when no one would buy the GICs, because an A1/A+ insurer was no longer good enough, in 1997, I shut the line down.  I looked into credit enhancement — the cost was too high.  I asked the CEO for a guarantee — he refused (he did not understand much generally, except how to line his venal pockets).  I did what was best for the company, given the limitations of the management team, and closed the line of business.

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My goal as an actuarial businessman was to make profits with modest risk for my ultimate owners, who were the mutual policyholders.  Once I faced a situation where there might be easy profits — writing floating rate GICs.  So, I went to my models and tried to figure out how we could make money safely while our interest rates would shift every three months.  I came to the conclusion that there was no safe way to do so, and so I walked into the office of my boss and told him so.  He surprised me by supporting my thesis, and in his usual back-of-the-envelope way, explained to me in a few minutes why it had to be so.

A few weeks later, he informed me that an actuary from Goldman Sachs (yes), would be dropping by to tell about one of their new derivative contracts that would enable us to write floating rate GICs profitably.  The meeting day came, and I validated the expectations of my boss.  The year was 1993.  I asked the actuary from Goldman what happens if the yield curve inverts.  He answered honestly, “This strategy blows up when the yield curve inverts.”  Score a small victory for me.  I gave myself points for avoiding trendy bad ideas.  Over the next twelve months, two major insurers and one investment bank would announce billion-dollar blowups from following that strategy.

After the blowups, I went back to the buyers of floating-rate GICs, and asked them if they would accept a lower spread over LIBOR.  The response was a firm “no.”  So much for that market.

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Shortly after the visit from the Goldman Sachs actuary, interest rates began to rise.  I had benefited from falling rates for some time, and I had gotten a bit lazy, because the investment department could buy investments, and I could wait to sell my GICs.  After all, with rates going down, time was on my side.

Now, there was one odd thing about the company that I worked for.  They left the hedging decision in the hands of the line actuary and not at the investment department (no joke).  I had control of interest rate policy for my line of business.

1994 started out bad for me.  The rest of the industry went wildly competitive selling GICs, and I was way behind my quota.  What was worse, I had a lump of maturing GICs that left my line of business short of cash.  Our Treasurer gave me a curt phone call that my line of business had forced the company to draw down on its line of credit.  (The Treasurer was the only person in the firm that could have blended in easily at AIG.)

I considered my options.  I could sit on my hands, and the wrath of Senior Management would grow.  Or, I could write business with subpar profitability.  With the yield curve so steep, I wrote a bevy of barbell GICs that the buyers mispriced.  They would compare a GIC with half maturing in one year and half in five to a three year GIC.  With a steep yield curve, that was the wrong decision.

I sold a bunch of those barbells to get out of my cash hole, and then began cutting bargains, and selling like mad, as I concluded that the residential mortgage-backed market was pushing up interest rates.  I sold my quota early that year, and the investment department dawdled (at my request), waiting to put cash to work at higher rates, and improving credit quality as well.  It was the best year we ever had, amid the worst year for the bond market in 60+ years.

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I don’t recommend handing over interest rate policy to those that manage the line of business.  That is too dangerous a thing to do.  I didn’t undersatand that at the time, so I did the best that I could, which was pretty good.  Sadly, the same was not true for the actuaries at the other two lines of business — they assumed rates would stay low.

I tell these three stories to illustrate the ethical choices one faces when working in a financial business.  Will you act in the best interests of your ultimate owners, or will you serve the management, or worse, yourself?

We can lay the blame for mismanagement at the doors of the company managers of financial companies.  But lower level managers have their share of blame as well.  Did they follow the short term economic incentives given by their companies, or did they do what was right for their owners.

When working for investment firms at later dates, I would tell the junior analysts these stories, and I would ask them, “What do you think they gave me as a bonus?” (for my work that protected the company and made very good money?)  They would always guess high.  I never received more than a couple of thousand dollars, and I was happy with it.  I did my job to do what was right in my field, not to make excess money.

And so I would say to my peers in financial services… have you done what is right?  Have you served the best interests of shareholders?  Not you, your boss, your CEO…  You have a choice, as I do.  Life is too short to work for unethical firms.  Find a place where you can ply your trade ethically and competently.  I am grateful to my current firm for having such a place today.

Earlier than many, I have written that our period of economic weakness was a depression, not a recession.  Here are a few examples:

Depressions are ill-defined.  Some say that it is a 10% decline in real GDP.  My view is more qualitative.  When the banks can’t lend, it is a depression.  We didn’t call 1973-4 a depression; the banks were stressed but not dead.  Our banks are in worse shape now, and the level of bailout/stimulus needed to make them willing to lend freely is staggering.  (Aside from that, do we really want to dig ourselves into a deeper liquidity trap?)

We have others willing to declare a depression, for example: IMF Chief Says Nations in ‘Depression’. We have others willing to blame the weakness on flawed monetary policy and flawed credit regulation.  That piece, from the author of the Taylor Rule, is the best I have seen from a reputable mainstream economist.

I still hold to my view that depressions occur not because of trade wars, tight fiscal policy, or tight monetary policy.  Those factors have negative impacts, but depressions occur when overall debt levels get too high, with layers of debt upon debt, allowing for cascades of failure to happen when the private enterprise system can borrow no more, and cannot service the debt.

I have not read the Credit Suisse report cited by Paul Kedrosky, but I am similarly dubious that their analysis of total debt levels makes a difference.  Consider the levels of leverage now versus the 30s, and consider whether the banks could lend or not.  To me, they are peas in a pod, and similar to Japan in the late 80s.  Leverage builds up, and eventually can’t be serviced.

Few want to talk about the event that I call “The Not-So-Great Depression.”  Our present circumstances may end up better or worse than the Great Depression, but it will end up worse than recessions in the latter half of the 20th Century, in my opinion.  Be wary, and play it safe where you can.