“It’s worth remembering that markets were very upbeat in the early summer of 1914,” said former U.S. Treasury Secretary Larry Summers.
Summers was warning the attendees to this year’s upcoming World Economic Forum in Davos, Switzerland, that there are precedents for such bountiful seasons. The trouble is, history shows that such incredibly good times tend to be followed by incredibly bad ones. “Financial history demonstrates that the biggest liquidity problems always follow the moments of greatest confidence,” Summers continued. “Complacency can be a self-denying prophecy,” Summers says.
“A glut of cheap money and the strongest global economic growth in three decades have encouraged banks, private equity firms and hedge funds to bet that the good times will keep rolling,” says a Bloomberg report.
“It’s too good to be true,” adds Vittorio Corbo, head of Chile’s central bank, who will speak at a seminar in Davos about the dangers of derivatives. “Tomorrow the mood could change. We have to be prepared.”
These voices of warning will soon be echoed by Jean-Claude Trichet, head of the European Central Bank. They will all certainly be dismissed. The crowd will remind itself that it heard similar warnings last year. And lo…nothing bad happened. Last year too, the self-same Summers told Davos attendees to watch out…to be more prudent in their financial affairs and more modest in their projections. Of course, they did just the opposite – which is why the Great Credit Boom continued.
Takeovers last year rose to a record $3.6 trillion, according to the Bloomberg report. Morgan Stanley’s Capital International World Index of stock prices rose to a new record high on January third… and the head of Goldman Sachs (NYSE: GS), the alpha male of Wall Street, earned a bonus of $53.4 million.
Prices of London’s priciest digs – where the super-rich are roosting these days – grew even more expensive last year. They rose nearly 30% in a single year. And bonuses for Wall Street’s masters of the universe, its five largest investment firms, rose too – by 30%. Meanwhile, one of those firms – Morgan Stanley (NYSE: MS)- announced another mega-deal in the real estate sector, last week. The company says it bought CNL Hotels & Resorts for $6.6 billion.
What’s a New York investment house doing buying a hotel chain? What does it know about running a hospitality business? Nothing. But gone are the days when the owners of businesses knew the business they were in. Now, the economy has been financialized and the financializers are getting rich. In the old days, a family might run a hotel chain, trade the stock among themselves – at, say, five times earnings – and put an ambitious nephew, cousin or son at the top post. They would, of course, be careful not to pay him too much…and be sure to put other nephews and cousins in the business too…to give the enterprise more management depth and to keep control in family hands.
But along comes a big investment firm with a buyout offer, backed by debt financing. The offer is too good to refuse. So, a ‘liquidity event’ turns the family into billionaires. The company is placed in the hands of professional managers and goes public at 20 times earnings. The investment firm makes millions on the deal.
And now, the new CEO earns $10 million a year and thinks he is underpaid. Meanwhile, the firm sells millions in bonds, which are then repackaged and resold, with swaps and derivatives all over Wall Street. And the stock – which is now held by millions of people who wouldn’t know a hotel from a gas station – soars.
Before…there was just a family with a family asset, a hotel chain from which it earned a living. But now, millions of people own a stock that has gone up in price. Investment bankers can afford to build a bigger, swankier house in Greenwich, CT. Hedge funds, pension funds and wheelers and dealers all have multi-million dollar positions in the company’s debt. And investment industry pros can earn their own fortunes just by trading the company’s stocks, bonds, and derivatives.
Is this a great system, or what?
‘Or what’…is what we wait to find out. In real terms, there is still a hotel chain, with a certain stream of revenue and profits. But this new financialization has created a whole new industry…and a whole new flood of liquidity. People have ‘wealth’ that didn’t exist before. The only trouble is, the ‘wealth’ is a fiction.
But when you get to the top of a liquidity bubble, who cares?
Debt…debt…debt… nobody seems to worry about it going down. The gap between good debt and bad debt – that is, between emerging market bonds and those of the U.S. Treasury – fell to a record low last week. And hedge funds in the United States are the most leveraged since 1998 – the year that Long-Term Capital Management collapsed – according to Bridgewater Associates.
The European Central Bank at least, still keeps track of its money supply. It reports that last fall, M3 was clocked rising at nearly a 10% rate – its fastest in 16 years. This prompted the ECB to raise its key-lending rate.
“Current risks are ludicrously under priced,” says Willen Buiter a professor at the London School of Economics. “At some point, someone is going to get an extremely nasty surprise.”
So far, the surprise has been that no surprise has come. But the longer it delays…the nastier it is likely to be.