FYI | Jan 30 2009
By Greg Peel
Since 1971, representatives from government, business and academia have gathered in Davos, Switzerland, for the World Economic Forum (except for 2002 when it was in New York) – a think tank intended to discuss the world’s economic, political and social problems. Like most think tanks and world forums of such nature, nothing much ever eventuates. There’s a lot of talk, a lot of wailing and gnashing of teeth, a lot of handshakes, but as the last attendee departs, the village always disappears back into the snow like a mirage, after everyone has agreed to consider that something should be done about the state of things.
Celebrated “Liar’s Poker” author Michael Lewis put it this way two years ago:
“It’s become almost obligatory for the world’s most important economic people, at the beginning of each year, to travel joylessly to the base of a Swiss ski slope and worry. And to worry not privately, with dignity, but publicly, to anyone who will listen.”
Nevertheless, Davos is always good for a few headlines at the time. This year’s Forum concludes on Sunday. In the last decade, from the economic perspective, the hot topic has always been financial derivatives, or the evils thereof. In 2007, when Lewis cast his aspersions, little did we know what was about to happen. Indeed, this time last year we were pretty much in the dark as well, despite having already endured about six months of what was first called a “sub-prime crisis” and then a “credit crunch”.
Prior to the Forum’s commencement in 2008, one George Soros shocked the world by boldly predicting we were about to endure the worst economic crisis in sixty years. Soros had written an article for the London Financial Times before donning his parka. He had again been invited to impart his views in Davos, having first been asked to do so back in 1998. In 1998, inviting George Soros to address the WEF was akin to asking Satan to pop in for tea at the Vatican. “Perhaps, your dark lordship,” the Pontiff may have asked, “you could fill us in on how things work at your end so we can better defeat you.”
In 1997 George Soros was the hedge fund guru who almost single-handedly set in train the Asian Currency Crisis. Perhaps beset by guilt, Soros quickly wrote a book in which he outlined his belief that financial derivatives trading, if left unfettered, could cause the worst economic crisis in fifty years. Hence the invitation. When this didn’t actually happen, he later apologised (in 2001). But he was back in 2008 to make the same claim again, just with an extra decade tacked on.
It now appears that this time Soros may well be right. I direct your attention to “I Got It Wrong, Says Soros” (Sell&Buyology; 25/01/08).
Derivatives have been held responsible for all financial calamities ever since the Crash of ’87. At that point the powers that be cried foul and called for greater regulation, and indeed have done so following every crisis ever since – Savings & Loan for example, Asian Currency, LTCM, tech-wreck, Enron, WorldCom. Mostly such cries are ultimately tabled and then ignored, or forgotten about as things pick up again. Occasionally regulations are hastily put in place which either remain to this day or have since been relaxed or rescinded. (Just look at rules surrounding short selling or limits on leverage). When times are good, however, the powers that be rarely bat an eyelid. If US investment banks are making obscene amounts of money then it is simply capitalism working as it should, as far as the regulators are concerned. Pass the brandy.
Not so at the WEF, where for the past few years the warnings have been growing about an imminent crisis fuelled by the mispricing of financial risk. In 2007 the uber-bears were out in force. “The system is becoming very complex. The risk of some crisis happening is rising. The world isn’t pricing risk appropriately,” said Nouriel Roubini. “What’s occurring right now in markets and in policy circles is a dangerous degree of complacency,” said Stephen Roach.
Roubini and Roach, along with others, are now heroes. Retrospective heroes of course. Few gave them the time of day prior to 2008 having been forced to put up with their endless doomsaying for several years. The uber-bears missed the whole twenty-first century boom, so if you’d gone short on their advice you would have blown up well before Bear Stearns did. The fact that they were right all along – just ill-timed – is of little comfort.
One hedge fund that has been on the bear side for all of the boom but timed its transactions to perfection is one FrontPoint Partners. I insist that all read the story of this firm republished in today’s Australian Financial Review (30/01/09) for it is a brilliantly, amusingly, if not coarsely delivered expose of just why your superannuation fund has lost half its value in the last eighteen months. It is the story of the Global Financial Crisis. It is an attack on Wall Street. And it is written by Michael Lewis.
In his lengthy essay, Lewis relives the circumstances of how he came to write his 1990 bestseller, “Liar’s Poker” – itself an expose of investment banking excesses of the eighties, and why he walked away from an industry paying a young man an obscene salary to trade in things he didn’t even understand. At the time, notes Lewis, he thought the whole game must end in tears. As it turns out, he was only wrong by quarter of a century. Lewis goes on to explain how he deliberately tracked down the various FrontPoint partners as he assumed them to be like-minded market colleagues and wanted to make their acquaintance. The essay explains what he learnt.
The only problem arises when one returns to the quote from Lewis earlier in this piece in reference to Davos 2007. The quote came from a commentary published by Bloomberg* in which Lewis basically stuck it up the whole Davos concept and groaned at suggestions that the derivatives industry should be regulated.
“Examine the public statements extruded by the World Economic Forum any year,” said Lewis in 2007, ” and you’ll find the same warmed-over prudence, the same dreary feeling that someone is about to punctuate the nebulous tedium with a proposal to create a commission.”. And:
“Davos is where people with no talent for risk-taking gather to imagine what actual risk-takers might do. Davos Man needs to sit in judgment; Davos Man needs to brood. So great is this need that he will brood about virtually anything, no matter how little he knows about it.” And:
“Derivatives seem to be this year’s case in point. Davos had hardly been up and groaning about the dangers of being alive before Bloomberg News reported what appears to be the general Davosian view: ‘The surging demand for derivatives is making financial markets more vulnerable to any slowdown in the global economy'”. And:
“None of them seemed to understand that when you create a derivative you don’t add to the sum total of risk in the financial world; you merely create a means for redistributing that risk. They have no evidence that financial risk is being redistributed in ways we should all worry about. They’re just – worried.
“But the most striking thing about the growing derivatives markets is the stability that has come with them. More than eight years ago, after Long-Term Capital Management blew up and lost a few billion dollars, the Federal Reserve had to be wheeled in to save capitalism as we know it.
“Last year Amaranth Advisors blew up, lost more than LTCM, and the financial markets hardly batted an eyelash. ‘The financial markets in 2007,’ some member of the global economic elite might have said but didn’t, ‘are astonishingly robust. They seem to be working out how to absorb and distribute risk more intelligently than any member of the global economic elite could on his own.'”
The article was entitled “Davos is for wimps, ninnies, pointless skeptics”.
Unless I have naively missed some artfully hidden sense of tongue in cheek or satire in this 2007 article, I can only conclude that somewhere between 1990’s “Liar’s Poker” and the essay republished in today’s AFR, incidentally entitled “Hitting The Wall”, Lewis had fallen into the same trance of complacency he previously criticised Stephen Roach for criticising, or at least had allowed the flame of anger to flicker and die. Indeed, in “Hitting The Wall” Lewis does concede, in regard to the market meltdown he had expected to happen but hadn’t:
“At some point, I gave up waiting for the end. There was no scandal or reversal, I assumed, that could sink the system.”
Lewis now knows differently.
This year’s Davos won’t really end any differently to its predecessors. There will be a lot of “I told you so” being bandied about and a lot of railing against greed and screaming out for stiff regulation. Just like there was after previous crises. As Obama and counterparts sit down to address their own backyards, and perhaps collaborate on some globally coordinated financial market regulation, it will be political agenda leading opinions and nothing that might specifically arise out of Davos. Nevertheless, the WEF can be entertaining for few days.
