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"Dear Todd Could it be that 9/11 was one of the causes of the recklessness that pervaded the behavior of professionals in the financial markets; recklessness that brought the financial system to the brink of ruin? I admire your stance. You worked hard to reach an understanding of the emotional impact 9-11 had on you. You’ve written about it in such a way that others both inside and outside the financial industry were enabled to ask themselves the same question: has 9/11 changed my emotional dispositions toward life, toward humanity, toward the future? Has it changed the way I feel about my profession? Do I feel differently about the responsibilities that my profession entails? You chose to change tact from the hedge fund to Minyanville. Am I right in saying (among other things) that change was a way to take on “more” responsibility? I can imagine that for others -- especially if they didn’t reflect on the emotional impact -- the effect of 9/11 was not to take on more responsibility but to do exactly the opposite. I can imagine (unrecognized or subconscious) feelings of revenge, of despair, of scorn. I can imagine not so much a death wish as the strong impulse to defy death. I can imagine deep-rooted doubts about the moral worth of one’s actions. I can imagine all of that fueling recklessness. Can you? Recklessness was not the only cause of the crisis; not even the main cause. An overproduction of capital was the main cause. An overproduction that lead to a rise in the price of investments (asset inflation) and therefore a lowering of yield. Lower yields lead to a search for higher-yielding instruments and strategies that inevitably lead to speculation on a grand scale and ultimately, that lead to capital destruction. A secondary cause was the combination of deregulation and innovation in the financial markets. They were driven by a rational reaction on earlier over-regulation, an earlier need to stimulate capital formation, theoretical progress in economics, a form of free market ideology, and of course by the main cause, the search for higher yield. A tertiary cause was a fundamental flaw in the underlying theories of risk inherent in many of the innovations. In a nutshell: the spreading of risk does not lower risk, it simply spreads it. And because of the growing interdependencies in combination with increasing moral hazard(s) in practice, that spreading lead to higher risk. Add to that a Fed policy of low interest rates and monetary expansion that made leverage cheap and easy to see how fragile we were. Taking my cue from your theme of responsibility, I wanted to bring three related sets of questions to your attention. Should the investment-industry take responsibility for the disastrous investment results of the last 15 years? Should they not acknowledge a collective failure? If their main task is the efficient allocation of capital -- on the one hand, guaranteeing profit for investors and on the other, economic growth -- is it then not clear that they as an industry performed miserably? Should the investment industry take (partial) responsibility for the crisis of the financial system and the subsequent economic crisis; perhaps a two-part responsibility? First, because their financial innovations raised systemic risk to levels never before seen and secondly because they failed to prevent the two big waves of speculation (dot.com and credit) and therefore the inevitable crashes that followed? If, as Warren Buffet so beautifully phrased, many of the innovations turned out to be weapons of financial mass destruction, should the industry now work toward financial disarmament and work with the government to use the force of law to get rid of innovations that have proven to be toxic? A simple matrix gives some structure here: innovation should lead to a more efficient allocation of capital without raising the overall level of risk. Therefore innovations that raise the level of risk without bringing more efficiency should to be removed. Those that raise efficiency at the price of a higher level of risk should be handled with care and innovations that lessen efficiency but also lessen risk should be used sparingly. The sad truth is that many of the innovations over the last twenty years fall in the second category: less efficiency, more risk, and there was a lack of care, or perhaps interest, regarding those that brought more efficiency at the price of risk and, ergo, reward. If the industry undertook such a financial disarmament alongside the government, it would create the conditions for a marketplace where self-interest, profits, the public interest, and justice would once again be more inline, and the cost of acting morally right within the financial industry would be substantially lower. It would also take away the underlying reason for direct government intervention and market distortion that inevitably is a consequence thereof. As always with the highest regards for you, Minyan Frans Geraedts"
Minyan Frans, I wanted to share this email as it provoked thought on a number of levels. To be honest, I hadn’t looked through the lens you touched on at the beginning of your note, that September 11th may have instilled a sense of subconscious recklessness in the marketplace that manifested over the last decade. As a context for this discussion, I believe the spectrum of culpability extended from the consumers who over-extended on their credit to institutions that financially engineered the marketplace to policymakers that were complicit by acceptance to the CEO of the United States of America. Insofar as we assume a shared responsibility at some level, we can address the causes, understand the effects, and work towards a solution. I’m tired of the finger pointing and blame placing; it’s what was -- “down and back” -- and it’s high time we shift our focus to what will be as we look “up and out” and get serious about identifying solutions. I’m not being pithy or underestimating the pain out there -- I see it, feel it and hear it on a daily basis. The “other side” will take time (measured in years, not months) and price (on an absolute and relative basis, depending on the dollar) to work through the cumulative imbalances. There aren’t any magic pills. That fantasy was in many ways responsible for ushering in the age of austerity to begin with.
I’ve written that 9/11 changed us all. Some got married and others divorced, some turned to drugs and others cleansed themselves. It was a very dark time that forever altered our generation and I would argue, the course of history. As with most things in life, however, it’s not what happened that matters, it will be how we react to it. Is it conceivable that a subset of decision makers adopted a more reckless mentality after that fateful day? I suppose that may have accelerated a process already in place but I don’t believe it was the genesis of the crisis. Those seeds were planted when the technology bubble took root, Main Street chased the bigger, better thing, and Wall Street happily reinvented risk to facilitate the feeding frenzy. Let’s not forget the financial malaise manifested for a decade like a stealth cancer, masked by the lower dollar (-40%) and skewed by the spending habits of a slimming margin of society (the have’s). The government didn’t capture this dynamic through the economic reports or their steady vernacular, but we steadily monitored the erosion of the middle class on Minyanville. I remember our efforts to note the disparity between what we were being told and what actually happened. John Succo captured it perfectly in 2006 when he wrote, “Yes, the economy is growing, but why? Because real estate speculation is driving growth. Why? Because long-term interest rates remain low. Why? Because investors are still buying financial assets. With what? Liquidity that is being created by more and more debt.” We were persistent and consistent in offering that it won’t matter until it does but when it does, it’ll matter a lot. When it finally mattered, we noted that in order to get through it we needed to go through it and going through it was on the margin constructive. The natural question is therefore begged: how long will it take as we cast our eyes ahead. There are a few variables that will determine that outcome. Much like the spectrum of culpability extended across the societal, industrial and political spectrum, so too will the solution set; and when history reflects on this juncture, there will be great losses, profound opportunities and eye-popping successes. Stepping through this thought process, society is a sum of the parts -- if folks are depressed, it’s intuitive that social mood will manifest in a collective depression. Just as an immediate gratification mindset led to bubbles, the shift from “getting ahead” towards “giving back” will pay profound dividends, both tangibly and intangibly, as we each do our part. Within the financial industry, I’m hard-pressed to see a collective mea culpa although I agree that the quickest path to resolution and recovery is a hand in hand approach. The trick will be to execute the policy in a way that doesn’t stir the populist hornet’s nest or trigger a frightening unwind of the (still) highly interdependent and massively leveraged global financial machination. With regard to oversight, there needs to be respect for the risk, understanding of the products and realization that a monster that took years to build will take years to tame. Enough with the grandstanding and political posturing -- there’s more at stake here than party lines. If we don’t learn to play nice, across the isle and across the sea, the financial markets may well be the least of our worries. I’ve written that I view the Great Depression as a framework for optimism; 75% of America worked, kids went to school, and franchises were formed. While I continue to foresee another side to the financial crisis -- one that will truly test our collective mettle -- we will endure and find our way to better trades and easier days. The trick, quite hopefully, is to enjoy our journey as we find our way. I hope this helped address some of your questions; thanks kindly for taking the time to write. Toddo R.P.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at todd@minyanville.com.The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
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