Why this market crash was different from the others
It’s easy to see why the market fell in 1929, says this Wall Street veteran, but how many really understand today’s financial woes?
John D. Rockefeller used to hand out shiny dimes to adults — and nickels to children — to demonstrate his generosity.
That didn’t prevent his company, Standard Oil, from being broken up as a monopoly.
Goldman Sachs is in the habit of making large donations to various foundations. So far, of course, it has not been broken up. Far from it — the U.S. government has gone out of its way to keep it humming along.
But here’s one big difference between then and now, says Mr. Raymond DeVoe, Jr.
Everyone knew what Standard Oil did — it was the world’s first giant oil company. But does anyone really know what Goldman does?
Mr. DeVoe borrows this observation from an article by Mr. Frank Rich in the New York Times. Then he expands on it in the latest version of The DeVoe Report.
A veteran of Wall Street, Mr. DeVoe surmises that the mystery of Goldman Sachs is closely allied with the mysteries that led to the market crash of 2008.
He compares this crash to the Great Crash of 1929. It’s fairly easy to see why the market fell eighty years ago.
But how many people really understand the complex financial dealings that have led us down the garden path today? And if we don’t understand them, how are we going to prevent it happening again?
A secret society
Mr. DeVoe knows a number of people who were at Goldman Sachs when it was a partnership, not the public traded company it is today.
It was, he says, “almost a secret society. I got the impression that the firm did not encourage fraternization with outsiders, since they might learn what Goldman was doing and profit from the knowledge.”
The big event of the year was the naming of partners. This in itself was a mysterious process that few of the competitors understood. “I have been with friends who were almost suicidal when they failed to make partner.”
The cult of secrecy and the fierce competition among divisions in the firm appears to have persisted to this day, Mr. DeVoe. “The firm was criticized for packaging collateralized debt obligations and selling them to institutions, while at the same time a trading operation was using complex instruments and strategies to be effectively short some CDOs.”
In other words, the right hand and the left hand are not just moving in different directions — they are fighting each other.
It’s almost as though the “Chinese walls” that are supposed to keep the investment banking and research divisions of a firm apart were working all too well. But there’s a bigger question, says this analyst.
Complexity escalates risk
Some of these investment strategies “are so complex that few outside that sector would understand it,” states Mr. DeVoe. He quotes a warning from Mr. Richard Bookstaber. Back in 2007, this hedge fund manager pinpointed the weaknesses that led to the current crisis in his book, A Demon of Our Own Design.
“Complexity escalates risk,” wrote Mr. Bookstaber. “Regulations to limit risk will encourage creators of instruments to make them more complex in order to circumvent regulations — which further escalates risk.”
Adds Mr. DeVoe: “All this is my answer to Mr. Rich’s question — that only CEO Lloyd Bankfein and perhaps a few others know or understand what Goldman is doing.”
He turns to one more article, also from the New York Times, written by Mr. Ron Chernow (author of the definitive biography of John D. Rockefeller, by the way).
Five years to unwind
Mr. Chernow’s article was entitled “Everyman’s Financial Meltdown,” and its subtitle hit the nail on the head, says Mr. DeVoe. “The 1929 Crash was different from 2009’s: people understood it.”
The Crash of 1929 is relatively simple to explain, adds this analyst — “wild overspeculation with low margins.”
He cites a personal experience in the brokerage business. Colour TV was taking off in the late 1960s. One evening in 1968, an investor came in to cash in his stock in Radio Corporation of America. He had bought 100 shares in 1928 and now at last, after four decades, the stock had quadrupled to reach its 1929 high. He had broken even.
The Great Crash became the Great Depression due to blunders by the governments of the day, explains the analyst. Protective tariffs brought world trade to a halt, for instance, and the raising of taxes to balance the budget choked the economy. This is easily understood, Mr. DeVoe states.
“But how many people today understand collateralized debt obligations or credit default swaps?” He cites one more example.
When Mr. Warren Buffett’s Berkshire Hathaway Corporation acquired General Reinsurance in the early 2000’s, the firm was ordered to eliminate its derivatives (which Mr. Buffett famously called “financial weapons of mass destruction”).
There were over 20,000 contracts with numerous counterparties — and it took traders five years to unwind them!
And General Reinsurance has generally been conservative in its actions, says Mr. DeVoe, who knew the company well in his days as a security analyst. The same can’t be said for all financial firms.
“My questions — who knows how complex and convoluted these derivative instruments have become with another decade to add all kinds of features to them?”
In short, we are not out of the woods yet. The financial system of eighty years ago seems simple and almost quaint nowadays. But there is nothing simple about today’s financial doings.
Concludes this long-time analyst: “What bothers me is that the institutions that survive are still playing similar games, and making them even more complex, mysterious and probably dangerous.”
This time it is different, he suggests, in all the wrong ways.
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