I have been asked to give a talk to a Rotary Club today. This is what I am going to try to tell them:
CDO’s and CDS’s
Our first mortgage was a face-to-face affair with a local company. That got replaced by financial intermediaries who converted our mortgage into CDO’s. And then to protect themselves against this financial skullduggery, everyone bought CDS’s. The market is huge and completely opaque – witness the billions being poured into AIG. We need to either make a market or to shut the CDS market down completely. Lehmann Brothers CDS’s closed at 90 cents on the dollar so things might be OK.
REFORM ACCOUNTING – DEMAND TRANSPARENCY
US reporting emanated from Stock Exchange Crash of 1929 and is required of public companies only. Enron brought SPE’s the light; this crunch brought SIV’s to light. Time for churches to lead the way! The problem at present is that no-one knows who is holding what.
CREDIT CRISIS – REBUILD TRUST
We are facing a credit crisis in the true meaning of the word credit meaning to believe. We no longer trust each other. Markets are built on trust. We can throw billions of dollars at the problem, but until we re-establish trust, the markets are not going to come to life again.
ADAM SMITH WAS RIGHT
Smith said years ago that competition drives out profit — excessive profit. We all thought that we could beat the market. We all built our expectations too high. As Chinese dollars flooded the economy and returns fell to normal levels, we all sought to escape Adam Smith’s truth and make a quick buck by leveraging. The result was inevitable.
ILLUSIONS OF A RISK-FREE WORLD
We have taught portfolio theory to a generation of students who came to believe that diversification drove out risk. First, it merely drives out non-systematic risk; market risk remains. Second, it ignores uncertainty. The unpredictable tiger caused more damage in Las Vegas than all the tables put together.
THINK LONG TERM
I am increasingly coming to the belief that we are coming to the end of an industrial age that began several centuries ago in Britain. It has been fueled by cheap energy, abundant water, access to minerals, and relatively cheap labor. All of that is coming to an end. We may not run out of oil, but we will run out of money to pay for it. We need to start thinking about a drastically different world. The current crisis is simply a small ripple on a longer wave.
PREPARE FOR THE PAYOFF
We have promised ourselves trillions of dollars in benefits. We have fought a war on borrowed money. All of this will have to be paid for. Expect your taxes to rise dramatically and after-tax company profits to fall.