So says Jeremy Grantham, co-founder of Boston-based investment firm Grantham, Mayo and Van Otterloo, now known as GMO. Some call him the philosopher king of Wall Street because of his highly insightful views on markets and the economy, usually with a longer-term perspective. In a profession of touts, fast-buck and scam artists, Grantham's commentaries are notably refreshing. They're detailed, scholarly, sober, clear and especially important at a time of unparalleled excesses, great economic uncertainty, voices ranging from gloom and doom to blue skies and all clear ahead, so who knows what to believe. Few people sort things out better than he, and whether right or wrong, he makes consummate sense and should be taken seriously.
He calls his latest commentary "Immoral Hazard" and takes straight aim at the perpetrators. It's not the first time, and with good reason. Bad policy yields bad results with former Fed Chairman Greenspan Exhibit A.
Grantham notes: "It's not that the former Fed boss...was incompetent that is remarkable. (It's that even now) so many people (still) don't seem to get it." Do they "just believe high-quality, self-justifying blarney?" Or do they think top jobs ipso facto "attract great talent by divine right?" Often, the most important jobs get "mediocrities" like Greenspan and the current White House occupant. Even worse, Washington is infested with them.
Grantham first learned of Greenspan in the late 1960s when he headed economic consulting firm Townsend-Greenspan & Co. Even then, his assessment was unsparing: "To be brutally honest, he was considered run of the mill by anyone I knew then or have met later who knew" of his work. Consider his "famous" January 1973 call that "it is rare that you can be as unqualifiedly bullish as you now can." It was right at the start of a punishing recession and 60% two-year market decline in real terms, second only at the time to the 1929 crash.
Never one to equivocate, Grantham cuts to the chase and draws blood: Greenspan's call "was one of the first of a long line of terrible prognostications for which he has remarkably 'not' been remembered," except by a few historians and analysts like Grantham. He seemed to pop out of nowhere to become Fed Chairman in 1987, not for his professional skills but for plenty of political ones. The Greenspan years and what's so far followed haven't been "our finest hour in the US."
A smattering of skilled leaders handled things way back compared to the "rudderless" kind under Greenspan and today. Moments (far too few) showed "vision, leadership and backbone." They then gave way to political opportunism and "easy paths taken" for short-term gains - most notably since the Reagan era. Referring to when Greenspan became Fed Chairman, Grantham continued saying we're "get(ting) ready to celebrate the 20th anniversary of the Great Moral Hazard." Asset bubbles are tolerated because of who wins and loses. If managed well, speculators and Wall Street profit hugely, bail out at tops (the old pump and dump scheme), then let the public take the pain. No problem though if they miscalculate. Fed Chairmen like Greenspan and the current maestro step in with bailouts.
It's called "moral hazard," and the term goes way back - to the 1600s. English insurance companies then used it in the late 17th century. In the modern era, it got more study in the 1960s, but at the time didn't imply fraud, immoral behavior or outsized excess. Economists used the term to describe market inefficiencies when risks are displaced. It was before what became known as the "Greenspan put," or the idea that Fed Chairmen provide insurance - to bail out investors who take imprudent risks, so take even greater ones since winning is always guaranteed. But only for high-rollers.
Moral Hazard 101 - A Brief Case Study
Take Long Term Capital Management (LTCM), for example, and its dream team management:
-- a former highly respected Salomon Brothers fixed income chief who became tainted by the firm's auction-rigging scandal; no matter, he remained highly regarded by Wall Street;
-- a former Fed Vice-Chairman; and
-- two economics Nobel laureates.
They played high-stakes poker with little regulatory oversight and used their good names to do very risky things - like putting on interest rate swaps at market rates for no initial margin; borrowing 100% of value of top-grade collateral held; using that cash to buy more securities, then using them as collateral for more borrowing. In other words, it was a scheme to theoretically leverage to infinity, LTCM practically did it, and for a while it worked.
Things began unravelling in 1998. It started in July when Salomon Smith Barney announced it was liquidating its dollar interest arbitrage positions. LTCM took a hit, then things got worse when in August Russia declared a moratorium on its rouble and domestic dollar debt. Panic ensued, it spread to other markets, risky investments fled to high quality ones, then they were sold to raise cash.
LTCM was one of many large investors affected. By September, it dropped 52% in value and needed new capital to avoid a dilemma that could impact all of Wall Street if not addressed. LTCM's balance sheet assets were leverage thirtyfold to $125 billion, then tenfold more by off-balance sheet transactions for a total valuation of around $1 trillion - or too big to fail. If they folded, a financial panic could ensue, so the situation was critical. Enter the Fed after some initial high-stakes maneuvering failed. It engineered a multi-billion dollar bailout to avoid a greater financial market collapse.
I am a 72 year old, retired, progressive small businessman concerned about all the major national and world issues, committed to speak out and write about them.
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