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What hockey players don’t know about economics

Economists keep trying to compare this recession with others, says this Wall Street analyst, but it just doesn’t fit into the old patterns.

As hockey games flash across many TV screens this week, one might think, What do the players need to know about economics, as long as they hire good people to look after all that money?

But this isn’t really about the wealth of hockey players. It’s about the failure of economics.

The story comes to us from Mr. Raymond DeVoe, Jr., a market strategist and Wall Street veteran.

Mr. DeVoe has little patience with the clichés and jargon of the market. In this edition of The DeVoe Report, he turns his acerbic wit on the conspicuous inability of economists to make sense of the current crisis.

But he begins with hockey players. And he ends with the unhappy conclusion that “This time it IS different!”

Two jokes about economics

In Mr. DeVoe’s college fraternity, there was a file room where the final exams of many courses were kept. “Since some of the fraternity members were hockey players, this was intended to give them ‘guidance’ on what areas to concentrate on to pass the exam and graduate with the class.

“Not cheating, but certain professors had patterns and would return to the same questions after a period of time.” And this was an Ivy League college, where all are assumed to study diligently.

Mr. DeVoe didn’t use the files. He majored in math and economics. In the first, if you didn’t know the math, you flunked. As for economics, “if you couldn’t fill two or three exam booklets of circuitous reasoning and resounding generalities, you didn’t deserve to be a major in the subject.”

A rumour at this college (Dartmouth, actually) had it that economics papers were not graded “on the curve” but “on the stairs” — the professor would heave the papers down the stairs so those with the highest pencil lead content went the farthest and got the ‘A’s.

A second joke about economics was that the professors asked the same questions every year — but the answers were different.

‘Biggest Gain in 76 Years’

Mr. DeVoe has since come to realize that this joke has elements of truth to it.

This is his definition: “Economics is the study of the reaction to dozens, perhaps hundreds of variables that are interacting with each other in mysterious, unpredictable and changing ways that will be only partially understood afterwards — and quite frequently misdiagnosed in hindsight.”

And here’s what got this train of thought going — recent headlines that screamed “The Biggest Four Week Gain in 76 Years.” The media were pointing eagerly to signs of recovery.

“I could almost hear the soundtrack of ‘Happy Days are Here Again’ of 76 years ago when the Dow Industrials had a four week burst that was comparable to the recovery from the March 9, 2009 low of 6547.05.”

The 1933 gain was almost 62 per cent in four weeks. But in those days small numbers gains could produce big percentage changes. And despite the four soaring weeks of 1933, the 1929 the Dow did not match its 1929 high again until 1954.

And here an economic argument begins.

Square peg, round hole

When Mr. DeVoe underlined the long, hard slog of the Dow to get back to its 1929 high in an article in Barron’s, he received many replies from people who wanted to put a happier face on it.

This full recovery would have happened five to ten years earlier if dividend reinvestments had been calculated, they claimed.

But dividend reinvestment plans were not available then, Mr. DeVoe replied patiently. It was also true “that the minimum commission of $8 made the costs prohibitive for those who wanted to, that people still owning stocks had no interest in buying more, and that many companies severely cut or eliminated dividends for self preservation.”

You cannot impose present practices on an era when they did not exist, he insists. But analysts and economists keep trying to fit the current recession into past patterns, the old “square peg in round hole” problem.

Unrepentant bulls claim that each new bull market will go on indefinitely because “this time it’s different.” But Mr. DeVoe has a gloomier take on that saying. This time, he believes, it is different, but on the downside. This recession is not like its predecessors.

Right between the eyes

Wall Street did not simply shoot itself in the foot, Mr. DeVoe observes, “but more accurately, right between the eyes.” It is effectively dead as we know it, and the whole financial system is in upheaval.

Look carefully, he says, at the bloated role of the financial sector. A quarter of a century ago, it accounted for 16 per cent of U.S. domestic corporate profits. By the 1990s it ranged from 21 to 30 per cent, and in the past decade it was a full 41 per cent of the whole pie.

And as it grew, it fattened on collateralized debt obligations (CDOs). “An old adage of Wall Street is ‘whenever it is easy to make a lot of money quickly — look out’,” says Mr. DeVoe. He cites more than one headline that read “The Profits Were Phony, But The Bonuses Were Real.”

It all began with flimsy mortgages packaged into CDOs, as we all know. “A friend’s son bought a $12 million summer home in Southampton with his bonus from marketing CDOs — and lost his job six months later when the CDO market collapsed.”

The horror stories are many, but the bottom line is this. That 41 per cent of domestic profit represented by the financial sector may have been much higher, Mr. DeVoe points out. So-called “financial engineering” found its way into many manufacturing companies as well — and into merger and acquisition activity. Many profits were declared on very shaky grounds.

“Now most of this is gone with the wine,” concludes this observer, “as financial sector earnings, economic activity, and consumer spending patterns reset to lower levels.”

So this recession leads us into new and uncharted territory. We leave the last word to Mr. DeVoe. “Like the economics final exams at Dartmouth, the questions are always the same. But they have changed the answers.”