I am not an economist. I do not know the techniques, standards, and theories of behavioral economics. That said, I know that actions speak louder than words.
There has been a lot written about the ‘collapse’ of the U.S. financial system due to the current credit crisis – with pundits, economists, politicians, and others pointing fingers and claiming their ideologies and policy explain why the U.S. is ‘bankrupt’ and doomed. There has been a lot of ink and electricity spent pushing these theories.
Regardless of all the talk and prose, Warren Buffet, the greatest capitalist of all time, put down $5 billion today on the U.S. financial system when he invested in Goldman Sachs. He also has the right to put down another $5 billion over the next five years at today’s prices.
Yes, his deal is a sweetheart deal, but investors like Buffet build wealth and strengthen the economy in times like these. GS, the best brand in the financial world, is paying a big price for Buffet’s brand and knowledge, but it sends a clear signal: the smartest institutions and people are moving forward as hot air blows from Capitol Hill, newsrooms, blogs, and press conferences.
Yes, these times are difficult and there is pain to be doled out, but panics and bailouts are part and parcel of the great engine of economic and social change known as capitalism and have been a regular occurrence in the U.S. since Hamilton’s time. There will be regulatory and institutional tweaks in the coming months and years, but that is how the system functions.
The warrant portion of the Buffet-GS deal shows that the Oracle of Omaha views five years as long-term. How long do you think it will take for this mess to sort itself out? Or are you part of the ‘end of the world’ chorus?
September 24th, 2008 at 10:23 am
I wish they would let the free market prevail. Rich investors looking to make a buck are going to buy low. Why can’t we let some of these banks stay on the market longer and find a suitable “private” investor? I still don’t understand that. I guess the invisible hand doesn’t exist? Besides, the IMF told Asian bankers to let their banks fail years ago…they did. Look at where their markets are today! Plus, our markets would end up more profitable with the might of the American worker. Wait, does that sound naive?
September 24th, 2008 at 11:45 am
Fareed Zakaria’s “The Post-American World” makes the case for the end of American dominance as “the rest” (China, India, Brazil, Mexico, etc.) move towards first or second world status (funny, Richard makes the same case, as does Friedman). He also says that America will remain the largest and strongest country for the foreseeable future, that our economy is strong enough to absorb the Iraq war(and so I’d extrapolate,the financial mess.) Zaharia’s chapters on the US power are stunning about how strong we still are.
He closes by saying that what’s missing is American Purpose, which has been abandoned by the current administration. That’s the weakness more than the economy that the next President will have to work on. Lincoln and FDR faced worse, but came through by promoting a greater purpose.
September 24th, 2008 at 11:47 am
Excellent piece. I’ve long hailed Hamilton as being remembered more notoriously for his dealings with Burr and Jefferson instead of as the most brilliant financial wizard in American history!
The Great Depression piece is particularly useful. There, the government loaned money to homeowners who had defaulted on their mortgages, ultimately saving the economy and earning an effectively passive profit. Imagine how much money the government would make if it made loans during good times and not just bad ones! On A credit paper, not just garbage paper. Perhaps then it would have more money for infrastructure, health care, national defense and other spending; grow the economy in the process (increasing tax revenues); and, eventually, build-up an endowment that might allow for increased tax breaks to future generations. What if it invested in socially necessary causes along the way like new energy technologies and drug research, etc. This isn’t rocket science!!!!
September 24th, 2008 at 5:01 pm
All – Watch the currency. The way the dollar performs over the next 12 months will tell us just about everything we need to know. What we do know is: This is a very, very serious financial crisis. The housing market has a long way to fall. Equities will surely be hit. And it is likely that the real economy event will range from a significant recession to … well … something worse. That said, the underlying real economy is fairly strong, comparatively speaking. Excellent universities, great entrepreneurial areas, cutting edge creativity and innovation. The era of financial market shenigans is over for a while. I’d also keep my eyes peeled closely on the geography of this all. NYC is clearly going to lose real clout in global terms as Tokyo, London, Asian centers, Middle Eastern centers, and also several US cities take a piece of what used to be the NYC financial market. Seems like Silicon Valley remains the US best-bet. But over time the real economy will prevail, however long that time is.
September 24th, 2008 at 7:43 pm
Perhaps we should define “economic death” before we proclaim its arrival exaggerated. Can we really say that we know for certain how recent events will affect economic growth? If last year was difficult with moderate growth, what would a prolonged retraction feel like? Death, in this conversation, is a relative term.
Warren Buffet’s investment in GS is intended to make money for Warren Buffet. Period. He rejected similar offers from numerous other institutions. His faith is in this particular deal over the long term, not in the immediate future of our economy.
September 24th, 2008 at 11:10 pm
Here’s my take…
In the short term, the markets will correct and conditions will appear to normalize.
However, investing is based on return balanced by risk, and the events unfolding now on Wall Street are eroding the confidence of the world’s major investors. The returns will be less, and the risk and uncertainty will be perceived as greater. There will be less reason to invest in the United States. This lack of faith can be deadly due to the huge amount of U.S. debt held by foreign investors.
Trust in the U.S. economy can be rebuilt, but it will be a long, and at times, painful process. It will require cooperation, courage, and wisdom. In other words, a new direction from that of the last eight years.
September 25th, 2008 at 8:40 am
Richard zeros in on the dollar for good reason. Paulson’s plan should eliminate the immediate dangers but will unquestionably devalue the dollar during the next 12- 18 months. That probably translates into another run on commodities. Is that good or bad? In the short term, a weakened dollar makes our products cheaper abroad and that could be good. But it also makes jobs in other countries more lucrative and could lead to a talent drain. If all of those creative and well-educated finance professionals cannot find jobs in New York or the US anymore, will they migrate to other financial centers? How long will they stay there? Will those jobs ever return to the US? What happens to the US economy if it loses a significant portion of that economic sector? On the other hand, manufacturing jobs could return (or stay) in the US but is that the direction the US should go?
Certainly, the US will emerge from this crisis with a different role in the world and with an economic model that’s been permanently changed. That could be a good thing. I’ve often thought that these investment banks and Wall Street folks are mere leeches sucking blood out of the real economy. But the real economy needs a reliable source of capital and that will need to come from somewhere.
If the US truly devotes itself to the task of developing renewable sources of energy and the goal of energy independence, countless entrepreneurial opportunities await and new fortunes will be amassed here. Energy is the true new economic frontier and American could lead it just as it has in the technology arena. But what happens to the rest of the world if America becomes isolationist in its energy policy? Will that prompt the oil barons to strike at the US while the iron is hot?
It sounds cliche to pronounce that America will work itself through this and come out ahead. But we always have and there’s no reason to think that we will not. But things will be different and new challenges (and pain) lie ahead.
September 25th, 2008 at 1:03 pm
With all due respect, paying attention to the value of the dollar will tell much but even more attention should be paid to the bond market and specifically to the market for U.S. treasuries.
An addition of 700 billion plus bailout dollars to a projected 410 billion dollar budget deficit (see pg 28 GAO historical tables http://www.gpoaccess.gov/usbudget/fy09/pdf/hist.pdf) implies financing over 1 trillion dollars of U.S. federal debt this fiscal year! As you noted, the declining value of the dollar is important because it has lead to a declining trade deficit. The declining trade deficit has reduced the amount of U.S. dollars held in foreign central banks, which in turn has lessened the amount of U.S. currency available for buying up the increased federal debt.
So… the interesting question becomes who is going to buy up this debt? The U.S. citizenry? That would be nice (aside from its crowding out problem) but is unlikely because Americans simply don’t save (ala the recent rise in the amount of U.S. debt held by foreign countries). So if the supply of treasuries is going to increase by a trillion dollars at a time when the trade deficit is in decline (due to the declining value of the dollar) then the trading price of treasuries seems likely to tank. As a result, to entice buyers, interest on those bonds will have to rise (i.e. the well documented inverse relationship between the price of bonds and the interest rate). Yet rising interest rates will have a depressive affect on the U.S. economy and as we are entering a probable downturn, this seems unlikely to go unchecked by the Fed. If the Fed chooses, on the other hand, to monetize the debt, then one would expect significant upward pressure on prices. But enhancing upward pressure on prices is not wise either, as there is already significant upward pressure on prices due to stagnating oil production (This latter option reeks of stagflation).
So… the issue to watch in my view is not to value of the dollar, but rather is the behavior of the bond market as it responds to sudden increases in the supply of U.S treasuries (the most probable method of financing this debt) along with decreasing demand for them.