Dear Puritans:

As I listened to President Obama’s latest proposals for dealing with the Credit Crunch, I was overwhelmed with the thought that he is treating the world as a vast Laboratory, in which he is attempting an extraordinary global Experiment.  His object is more than legitimate: it is to avert a financial and social catastrophe, which could have serious political consequences. Never forget that the Great Depression of the 1930s led to the rise of Adolf Hitler and World War-II. The name of  the Obama game is fiscal stimulus.

However, today’s great Experiment is not backed by an adequate theory. The name of Maynard Keynes is frequently invoked but he never advocated fiscal stimulus as such. Rather he favoured the rebuilding of the social infrastructure. This would certainly have resulted in a kind of fiscal stimulus but only in very slow motion – and Keynes envisaged it as happening only when the nation was in surplus. The savings from the Fat Years (the 1920s) were to be spent in the Lean Years (the 1930s). Regrettably,  America is in possession of no savings today from its recent Fat Years, quite the opposite. Three years ago the nation’s Comptroller-General,  David Walker, even declared that the federal government was bankrupt — and that was before fiscal stimulus had begun!

Critics of the Obama approach draw attention to the collapse of the Creditanstalt in 1931 as a fearful precedent. Faced with this event, the Austrian government of the day resorted to nationalisation. However,  the Austrian state was too small to bear the burden of the bank’s liabilities and  itself went bankrupt. Will something similar happen to the United States, faced with the extraordinary sums of money that Obama proposes to borrow on top of its pre-existing debts?  We frequently hear of some banks being ‘too big to fail’; is it possible that some American banks are ‘too big to save’. In the circumstances, it is not difficult to envisage the collapse of the US dollar vis-a-vis the euro and other international currencies, with serious inflationary consequences.

In tomorrow’s blog, I will explain why I think the pessimists may be wrong.

Best wishes –

Will Hopper

Dear Fellow Puritans,

Why good times breed bad guys

“It’s easy to look good in a boom. But also, every boom—and I have lived and worked through four or five—puts crooks in at the top.”

— Peter F. Drucker, The Daily Drucker

There is everything to be said for a daily dose of Drucker

Will Hopper.

Dear Fellow Puritans

Last week the FT interviewed Harvey McGrath, the new chairman of the UK’s Prudential Insurance Company. This is a strange appointment.  What a company like the Pru needs today in a chairman is ‘domain knowledge’ of insurance (to borrow a phrase from Jeff Immelt, CEO of GE).  What does McGrath offer to the party? As the former chairman of the Man Group, he brings  his experience of hedge funds. On his watch, Man lost billions in these overleveraged beasts; it also  invested $350 million with Bernie Madoff.

In his interview, McGrath argued that selling short was as natural an activity as buying. This is a false analogy. Selling in the usual way is as natural as buying; indeed, they are one and the same thing seen from opposite angles, every sale being a buy and vice versa. Short selling, on the other hand, involves borrowing the securities in question, often without making a deposit against them; the ‘leverage’ (or ratio of debt to assets pledged) can therefore be infinite.  In an ordinary buy/sell transaction, one can lose only what one has invested; in a short sale, the potential loss is infinite. Selling shares in the ordinary way can reasonably be characterised as  investment; short selling is undoubtedly speculation. McGrath argues that, on a small scale, it is harmless; that can also be said of swallowing arsenic.

A second objection is that the fees paid by short sellers to borrow shares have usually been grabbed en passant by fund managers  and not been passed on to the  lenders of the shares  — the very people  who  go at risk. This is an abuse of power arising from an acute conflict of interest. One would like to know what the practice was at Man.

The most powerful argument against short selling, however, is on another level altogether.  Companies will flourish only if  shareholders, managers and employees all work togther in a collegial fashion to achieve a common object. A short seller is someone who has declared war on both management and the staff. In most civilised communities, short selling is a criminal activity, an exception being made in very limited circumstances for listed securities . In other words, it is the very opposite of a natural activity. When I was a young man on Wall Stree some decades ago, short selling was tolerated  only: (a) against a substantial deposit; and (b) on an ‘uptick’ (i.e. on a rising market). Why have these limitations been abolished?  

Will Hopper

Dear Fellow Puritans

All financial bubbles from the Great Dutch Tulip Scandal of the 1630s to the Panic of 2008 have much in common with each other — for example, an excess of speculation accompanied by the abuse of credit — but each also has its own particular characteristics. The defining feature of the current crisis is the deterioration in the quality of corporate culture which occurred after 1970; this was most obvious in the United States but affected other countries to a greater or lesser extent. What did Chuck Prince at Citigroup and Fred Goodwin at RBS have in common? Both were non-bankers who ran one of the world’s leading banks into the ground. Both lacked what Jeff Immelt of General Electric has called ‘domain knowledge’. Welch is a superb manager who inherited almost insoluble problems from his predecessor, Jack Welch.

 

It follows that the basic problem reaches far beyond banking and indeed beyond the finance sector. The essential crisis at General Motors (which is effectively bankrupt) and General Electric (which has just cut its dividend and lost its AAA rating) is no different from that at Citigroup or RBS. The public is acutely aware of the crisis affecting the banks and near banks because of its impact on other sectors. However,  the decline in the managerial culture affects the whole of business and society. Among  other things, our book The Puritan Gift addresses this general problem.