The Way the Future Blogs

The Atlantic is a magazine that I’ve never been comfortable with. Some years I’ve subscribed to it — and, as each trivia-filled issue turned up in my mailbox, wondered why — until, every now and then, they would publish a piece I was really glad to have read, and I would grit my teeth and sign up for another. Their December 2008 issue (as you see I don’t read them as fast as they arrive), is one of those, only this time it isn’t just one piece that I keep urging people to have a look at. There are two of them.

The first is by a former fund runner, Henry Blodget, and it is called “Why Wall Street Always Blows It.” Blodget should know because (as he says in the article) “I was a famous tech-stock analyst at Merrill Lynch. I was famous because I was on the right side of the boom through the late 1990s…. By late 1998, I was cautioning clients that ‘what looks like a bubble probably is,’ but this didn’t save me. Fifteen months later I missed the top and drove my clients right over the cliff.”

And so, Blodget says, will people in his position always do because that sort of bubble — in which the price of securities gets bid up way beyond their real value is bound to happen … and bound to burst.

What’s the solution? Why, you want to buy and hold as long as the bubble is bloating, but get out before it pops. That’s good advice, and it could make you really, really rich if followed … but you can’t follow it. Blodget tried to. He cut back, and advised his clients to cut back, on the high-performance tech stocks that fueled the boom.

The damn things kept going up — way up — anyway.

You can see the stocks you’ve dumped going way past the point you sold them at for just so long before you begin to think they’ll keep on doing it and you’ve missed the boat. For Blodget that point came when, “in early 2000, weeks before the bubble burst, I put a lot of money where my mouth was. Two years later, I had lost the equivalent of six high-end college educations.” Because, as he also says, getting out of a bubble too early causes almost as much trouble as getting out of it too late.

The other piece in the same issue is called “Be Nice to the Countries That Lend You Money,” and it is the text of an on-the-record conversation between financial writer James Fallows and Gao Xiqing, who is the manager of a significant chunk of the money China has loaned to the United States. Gao is a pretty Americanish Chinese with a law degree from Duke and an American employment record that includes working for Richard Nixon’s Wall Street law firm.

I’m not going to try to synopsize what he said to Fallows, only to tell you that if you read it, you’ll be glad you did — even if he makes your blood run cold when Fallows hints at the “too big to fail” principle as applied to the American debt, implying that it would cost China too much to call it, and Gao agrees, “Yes, in the short run, not in the long,”

The House of Cards, Jean-Baptiste-Siméon Chardin, 1736–7

You remember what has gone before. I posted some text called, “My Worst Prediction Ever: Corporate Leisure Time,” and before you knew it, I was claiming that the recent fad for paying top corporate personnel mostly by huge bonuses rather than by straight, if large, salaries is what caused the world financial melt-down of 2008.

“Oh,” you say, “what nonsense! How could so simple a bookkeeping device have such catastrophic effects?”

Well, like this. Let’s say that the board of directors of the XYZ corporation calls you in and says, “Mr. Phan, we like the cut of your jib, so we’re going to offer you the job as our CEO. Since you don’t have an impressive work history, the salary we can offer you is only $37.50 a week. Now, we know that’s not much. But we’re willing to pay for results.

“So here’s what we’ll do. XYZ’s stock hasn’t been doing well in the market lately. It’s been running at about $18 a share on the Big Board. We’d like to see it at around $30. We will give you a year to get it done, and we don’t care how you do it, but if 365 days from today, XYZ is at that higher figure, we’ll give you a $2 million bonus.”

So what would you say to that? I think I know what you would say. I think you would say, “Yes, sir!” And I think you would say it with great speed, so the nice XYZ man wouldn’t have time to change his mind. After all (you might calculate) there was a chance that you could just stumble into some new business opportunities that would actually make the company gain that much in a year.

And — this, you promise yourself you might try but only as a very last resort — you might go to dealing in those “derivatives” that nobody seemed to understand but some people seemed to be making an awful lot of money on.

 
What are these “derivatives”? There are two that caused most of the trouble, and they are called “sub-prime mortgages” and “credit-default swaps.” The sub-prime mortgage is easy enough to understand. “Sub” means below and “prime” in this case means “a good investment.”

So what happened is that some banker (call him the “predatory lender” or just “thief”) had gone to nice old Mrs. Whitehead, who had lived in the shotgun flat behind the AME church since Lyndon Johnson was in the White House, and made her an offer she couldn’t refuse. “Sign this mortgage paper,” he said, “and I’ll give you forty thousand dollars. Here’s a pen.”

Now Mrs. Whitehead is not a fool. The first question she asks him is how in the world she can make the payments called for on a monthly income that is derived mostly from Social Security, plus what few bucks remain of what Mr. Whitehead left when he passed. But she’s not a CPA, either. Thief shows her in black-and-white that her house cost $10,000 when she and the Mr. bought it, has been gaining value ever since.

Were the payments on a $40,000 mortgage too onerous? No problem. Before you know it the house will become worth $60,000 or more. So you refinance at the new value, pay off the old mortgage, and walk away with a few thousand more of spending money, and ain’t America grand?

That system worked well as long as house prices kept going up … but not one day longer.

Then the system came cascading down. Real estate prices stopped rising, maybe dipped a little. Mrs. Whitehead couldn’t pay her mortgage any more. Thief’s bank foreclosed and poor Mrs. Whitehead was out on the street.

 

Did Thief know that was going to happen when he sold her that first mortgage?

Of course he did. He just didn’t care. His pay wasn’t based on how reliably the customers paid off their mortgages, it was based only on how many mortgages he sold.

That’s when I might lose you. “Hey,” you say, “hold on a minute. If that’s the way these people run their bank, aren’t they going to wind up with a vault full of worthless paper?”

I pat you on the head. “Exactly, my son. They do.” Of course, they could foreclose the mortgage — say the one on poor Mrs. Whitehead’s shotgun flat. But what would they do with the house once they had taken it over? If they want to get actual money, they have to sell it. But in today’s market, all they could get for it is say, $35,0000, while the amount due on the mortgage — the amount they’ve been carrying on their books as an asset — is now at, say, $50,000. So every mortgage foreclosure that they handle in that traditional way shows up on the books as a thumping great cash loss for the bank, and there are millions and millions of them.

You think that over for a moment, then you sigh. “Beats me,” you say. “I don’t see any way out for the bank. They should have seen this coming and avoided it, maybe by being a little less unethical in the way the loans took place. But they didn’t, and now only a miracle can save them.”

I have been patting your head again, this time quite hard. “Clever child!” I cry. “That’s what did it for them, at least for the moment. A miracle! Have you ever heard of transubstantiation?”

In the days when I was making much of my living from lecturing, I was generally careful not to make specific technological predictions about the future, particularly the easy ones — faster computers, cures (or ameliorations) for most diseases. I did let myself talk about social trends, though, and one trend I thought I had spotted was what I called the growth of corporate leisure time.

See, I had observed that as people became more prosperous they, or at least some of them, began to be willing to devote some of their recently acquired leisure time to doing things for people who needed help. They might help hand out Christmas baskets for the poor in the holiday season, or volunteer to drive the destitute to their doctors’ appointments, when they could get any. Whatever. It did happen. I saw it. And if this were true for individual humans, why shouldn’t corporations do the same?

I even thought I saw signs that some such process was beginning to happen with corporations, opening art galleries, or underwriting schools or classes. And especially I thought that it was happening with institutions like AT&T’s Bell Labs, the brightest jewel in America’s research diadem, where the executives in charge of the program were letting the scientists themselves decide some of the research programs they wanted to pursue.

Well, it sounds flimsier now than it did half a century ago, but I did get some powerful seconds to the those motions., one from Sylvia Porter, whose newspaper column on the financial world was the most widely syndicated in America.

And now in these opening years of the twenty-first century, how fecklessly naïve we all seemed! That isn’t how things are going at all.

 
Time was, back around 1960 or before, people bought stock in corporations because they wanted a share in their earnings. The plan was not to watch the price of the stock go up on the New York Stock Exchange and then sell it for profit when the price looked right. It was simply to tuck those gorgeously engraved stock certificates away in a safe place — under the matresss, maybe — and collect those quarterly dividend checks for the rest of your life.

(Oh, there were stock speculators, sure, wild men like Bet-a-Million Gates and his ilk, but reasonable investors stayed away from that kind of thing.)

So then what happened?

I’ll tell you what happened. Bonuses happened. Executives stopped working for those handsome salaries and expected large lump-sum payments. And the whole financial structure that held the markets together went mad.

 
Next: “The Bonus Babies.” Coming soon to a computer near you.