“Two roads diverged in a wood, and I – I took the one less travelled by, And that has made all the difference.” – Robert Frost
On Sunday 14 September 2008, two roads diverged. Andrew Ross Sorkin, in his gripping account of the financial crash, Too Big To Fail, writes of the breakfast teleconference among the board of JP Morgan held the previous day by Jamie Dimon, the investment bank’s chief executive.
Dimon told his co-executives: “You are about to experience the most unbelievable week in America ever, and we have to prepare for the absolutely worst case… We need to prepare for Lehman Brothers filing [for bankruptcy]. And for Merrill Lynch filing. And for AIG filing. And for Morgan Stanley filing… And potentially for Goldman Sachs filing.” Adds Sorkin: “There was a collective gasp on the phone.”
Policy making on the hoof
The US administration’s response to Lehman Brothers’ bankruptcy was, like its rescue of rival Bear Stearns six months earlier, inconsistent. Historians will doubtless argue until the end of time whether the Federal Reserve was right to let Lehman fail. Regardless of whether you agree, it is quite clear that the American authorities were desperate and making up policy on the hoof.
Having thrown Lehman to the wolves, and watching the resultant turmoil in the financial markets (on the first day of trading after the announcement, the Dow Jones index closed down over 500 points), the Fed quickly moved to bail out AIG and usher ailing Merrill Lynch into the arms of Bank of America.
Nevertheless, the authorities had a choice. Despite the fact that the financial system was rotting away from the inside out, in the weird form of apparently accelerated time that accompanies crises, they stepped in to support it, albeit in a capricious and haphazard manner.
They could simply have walked away and let the markets resolve the situation as only markets can. We will never know how this would have worked out – there is no counterfactual.
An atheist in a foxhole
Politicians tend to avoid hard choices. Discussing the situation with colleagues at the time, I heard on more than one occasion the expression: “There are no atheists in foxholes.” This meant, to my mind at least, that pragmatism would carry the day. The ends would justify the means. I didn’t agree with that approach then, and I don’t agree with it now.
Our own government has faced hard choices. Like the Fed in 2008, it has taken the easier road. When RBS and Lloyds faced their Lehman moment, the collective wallet of the country’s taxpayers was thrown at the problem. It ended with a highly unsatisfactory compromise, with shareholders retaining a thin sliver of ownership, perpetuating the flimsy myth that these banks were still going concerns.
Financial markets are no different from nature. The strong survive and flourish, the weak fade and die. But in challenging times, politicians intervene and distort the system. The result is a zombie economy, such as Japan has endured for something like a quarter of a century.
The eurozone seems determined to follow Japan. The former president of the European Council, Jean-Claude Juncker, has let the mask slip on several occasions – notably when he confessed: “We all know what to do, we just don’t know how to get re-elected after we’ve done it.”
For anybody who believes in robust democracy, Juncker’s opinions are disgusting. But he is the patron saint of the pragmatic. Referring to the Greek meltdown in 2011, he remarked: “When it becomes serious, you have to lie.” And he is all for “secret, dark debates”.
The crash that cured itself
Economist James Grant recently wrote of the deep economic slump of 1920-1921, to which the US government response under Woodrow Wilson and Warren Harding was: nothing. Faced with plunging prices, wages and employment, the authorities simply stepped aside. By late 1921, a recovery was under way. Grant’s book on the subject is sub-titled The Crash That Cured Itself.
I believe we are facing, if not actually experiencing, a second Great Depression – a period in which the economy continually fails to meet its potential. The evidence from the financial markets is misleading, if not outright contradictory. When both stock and bond markets are trading at all-time highs, at least one of these markets must be wrong.
Markets can’t be fully trusted, of course, because as in 2008 and throughout the 1930s, government is doing everything in its power to prevent recession, and central banks are playing along by boosting asset prices.
In an irony that the great Austrian-school economist Murray Rothbard identified (in his book America’s Great Depression), the worst aspects of economic depression were exacerbated by government interference. When the next financial giant comes cap-in-hand for our support, the correct and moral response will be: let them fail.
• Tim Price is director of investment at PFP Wealth Management. He writes The Price Report newsletter with Doug Pritchard.
Category: Market updates