If you believe that the best way to handle the current economic crisis is hurling gobsmackingly large amounts of money at it, all to be used at the discretion of the Treasury secretary and the chairman of the Federal Reserve, you may well be an idiot. That’s according to a rule of thumb devised by famed investor Warren Buffett.
Back in July, Brian Carney interviewed Ted Forstmann in the Wall Street Journal
. The reason for the interview was that in 1988 Forstmann wrote an uncannily prescient oped for the Journal
warning that the junk-bond craze was going to end badly. Well, just a few months ago in July, Forstmann once again took to the pages of the Journal
to caution investors that a fiscal conflagration was imminent. “We are in a credit crisis the likes of which I’ve never seen in my lifetime,” Forstmann said. “The credit problems in this country are considerably worse than people have said or know. I didn’t even know subprime mortgages existed and I was worried about the credit crisis.”
Forstmann also helpfully passed on how Buffett broke down the components of the typical boom-to-bust business cycle. “Buffett once told me there are three ‘I’s in every cycle. The ‘innovator,’ that’s the first ‘I.’ After the innovator comes the ‘imitator.’ And after the imitator in the cycle comes the idiot. Which makes way for an innovator again,” he said.
So let’s look at how the current credit crisis has occurred, using Buffett’s rule. Some innovator on Wall Street slices and dices mortgage debt and manages to sell that debt at a handsome profit. Even though that debt consists of a lot of bad paper lumped in with the good, through the magic of derivatives — and other financial products more complicated to understand than programming God’s VCR — they manage to make money off it. Then come the imitators, piling into the market. Only there’s a lot more bad paper to go around than good, so mortgage securities aren’t as valuable as they once were (and they were financially iffy to begin with).
Soon housing prices stagnate – because every idiot knows that’s what happens sooner or later when real-estate prices rise for years on end – which removes the only thing propping up the value of the bad mortgage debt. Credit stops flowing. Mighty investment banks start toppling. (Lehman Brothers had a mere $2.5 billion in bonuses to hand out to their New York staff before they filed Chapter 11.) The coup de grace? Ordinary Americans are being told to cough up somewhere north of $2,300 for every man, woman, and child in the country, or else we’re facing the prospect of $30 trillion in global wealth vanishing overnight. In Buffett’s formulation, if the taxpayer steps in at this crucial point in the cycle — that has to make us the idiots, right?
So what should we do to avert this imminent crisis? Treasury Secretary Henry Paulson estimates bailing out Wall Street will cost some $700 billion, but it might be more – so why don’t we go ahead and hand him a blank check with no strings attached?
To paraphrase Ronald Reagan, the ten scariest words in the English language are “I’m from the Treasury Department and I’m here to help.”
In some respects, calling in a benevolent financial dictator would appear to make things much simpler. Wall Street is a complicated place and math is hard. Paulson and Fed Chairman Ben Bernanke would have you believe that it’s perfectly natural that the solution to a large financial crisis is throwing a large amount of money at the problem. They seem to hope that no one will notice that the problem with the bailout isn’t ironing out some of the fiscal particulars: It’s philosophical.