I’ve got a friend of mine who I always seem to be on the other side of the debate with. His position is that the current financial meltdown is the result of a loss of transparency in the market. There are those that point to SIVs and other off-balance sheet items as the protagonists in this current financial crises. There are also those among us speculating that there’s some vast conspiracy at work to manipulate the market. While I believe that these theories are in part to blame, they are not sufficient to explain the magnitude and depth to the current financial crisis. True, free market economies shouldn’t need much public policy to make them work efficiently but that’s exactly what we’re going to get. Mark my words. What we’ll see is a mass public outcry, a huge tax bill to cover the bailout tab and legislation that burdens business more than it helps. Case it point: Sarbanes-Oxely .
I believe that we’re all complacent in this mess. I remember talking to a neighbor a few years ago that was boasting about the equity he’s been earning in his house. “20% year-over-year appreciation, ain’t that just fantastic” – um, no, not really. We’ve seen the same thing with old school companies over the past few years. How can stodgy old companies that have been around for, in some cases, 100+ years, be seeing 20-30% compounded revenue increases? If you’re a stakeholder or an investor, why should you bother asking a lot of questions with an earning environment like that? Just cash the check, don’t ask too many questions and buy yourself a yacht! After all, why bother worrying about pesky little details like 30-40 times leveraging? It’s cool, right?
We’ve done this too on the home front. It was just too tempting! How could I POSSIBLY resist grabbing some money out of my asset, my house in this case, as the asset price sky-rocketed and the cost of borrowing plummeted? Heck, I don’t even need to be bothered with pesky little details like a job or verifiable income! “Just fudge the numbers a little” says the mortgage broker, “nobody checks those things!”. And so the deception went, on and on, creating an ever more rickety house of cards until it all fell down. I have seen the enemy and it is us – the home buyers, the mortgage brokers, the banks and the speculators. The government kept interest rates too low for too long and here we sit. There’s a great Op-Ed piece in the WSJ by former Fed Chairman Paul Volcker that talks about this. The gist is this: The Fed has subsidized debt which has created a heady payday for Wall street whizzes. Economic Karma says that it all comes around in a circle and that the highs will define the lows and here you have it.
So how about this: It starts at home, why not de-leverage yourself?
I’m not suggesting that you calculate your own personal WACC or optimal capital structure, although that would be fun for all the MBA geeks. No, I’m suggesting something a lot simpler. This is actually something that my wife Jana and I are practicing:
Action Item #1
Once a month, de-leverage your life. Commit to putting together 1 box of unneeded/unwanted/unused junk and taking it to Goodwill. This is not a benevolent act. It is an deliberate exercise to convince yourself that all of the stuff around you is largely unnecessary. Of the 30 tee-shirts you own, how many do you actually wear? My bet: probably less than 10. Get rid of them! Learn to live with less. Learn to appreciate the art of having/owning/cleaning/moving/dealing with LESS! How does this help the personal de-leveraging process? To answer that, we’ll need Action Item #2…
Action Item #2
This should be used liberally in conjunction with Action Item #1: When you’re in Target, Kmart or Walmart ask yourself this: “Is this going to be in my Goodwill box six months from now?”. We’re a consumer world – there’s no escaping that but we do need to look at the means by which we acquire all of this stuff. My thought is this: think long and hard before you “cash out” just so you can head down to Walmart to buy a second X-Box for the upstairs rec-room, not that we can really do that any more, but you get my point…
Take this opportunity to downsize and de-leverage your life!
{ 2 comments… read them below or add one }
Good advice, Pete.
I think you’re fundamentally correct that the past, oh, 30 years of growth in finance was the result of a big fantasy that all of us participated in. Some of us had more to do with engineering it than others, but at any time people could have rejected those ARM loans and taken a closer look at those mortgage-backed securities. Also, remember that the markets got in trouble for doing what they were supposed to do: loan money to people whom they otherwise would not loan money. That was the whole point of Fannie and Freddie – to distort the economy in favor of political ends. It’s sad that this crisis will cause more gov’t intervention when it was government and its privileged corporations that arguably played the most important role in fostering it.
It’s always instructive to take stock of your own life when outside sources of stability break down. I’m really getting into the frugalista philosophy espoused by Wendy McElroy, which is similar to what you suggest: pare your consumption down to things that actually yield value (ideally so you can exchange less of your irreplaceable time for mere money). It’s really about mindfulness – an intentional approach to personal economy just like other aspects of one’s life. The most important transparency is always with oneself.
Good personal deleveraging advice Pete, something I should do more. But gotta differ on the why of Sarbox. It’s ungainly, yes, but think about the parallels between the balance sheet and 10k gymnastics that wrought Sarbox and the situation we’re in now with a suddenly revealed (to many) shadow economy in boutique paper. Sarbox is a speedbump where before there was none – “Think about what you’re saying, Board. Are you sniffing your own fumes on these numbers and assertions?” Sarbox replaced a lost skepticism and traditionalism that checked sketchy quant-birthed assertions and pie in the sky of persuasive boardroom cowboys.
I’m no economist, I just orbit in and out of finance as a marketing strategist/MBA working across the FIRE sectors. This crisis has been obvious in coming since LTCM back in the 90s. But derivatives and the like are only one aspect of the go-go nature of things. Credit cards and others are in the same unreality boat, enabled by better transaction monitoring they’ve come to believe that merely cutting off LOC on iffy risks was “managing risk.” They pushed 2005′s Bankruptcy Bill as phase one of the current meltdown – box consumers in with their debt, no exits. Paulson’s POS was Phase Two. On the revolving credit front, Capital One is a good example. Watch them tank shortly