Slate's "Moneybox" columnist, Daniel Gross, was online Friday, Feb. 27, to discuss his new book, Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation. An unedited transcript of the chat follows.
Daniel Gross: Greetings—and thanks for coming. I'm Dan Gross, "Money Culture" columnist at Newsweek and "Moneybox" columnist for Slate. I've just come out with a new electronic book: Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation (Free Press). For now, it's available only on the Kindle, Sony Readers, on the iPhone, or as an audio book. Readers interested in seeing a PDF of the first chapter and/or learning more about a paper version can send an e-mail to: firstname.lastname@example.org.
I'm eager to answer your questions.
Los Angeles: If Washington is afraid to nationalize Citibank (and other banks), why don't they act as a clearing house and send us shares of Citibank stock when we submit our taxes to the IRS?
Daniel Gross: Hi LA—that's an interesting thought, and not entirely without precedent. In Russia and in former Soviet bloc countries, when they privatized government-owned companies, they sent vouchers, basically books of coupons that were shares in the companies, which people could then trade. Before we get around to privatizing Citi, we'd have first to nationalize. And so far, we're basically getting half measures. The news today, in which the gov't is converting shares of preferred stock into common stock, will bring the government's holding (i.e. yours and mine) up to 36 percent.
Laurel, Md.: Mr. Gross, you were here a couple of years ago promoting your last book about bubbles being good for the economy, pointing out that past bubbles left us lots of fiber-optic cable and railroad mileage, despite offering their investors overall poor return.
So, can we make the housing bubble into a positive?
In my opinion we can and should—lack of affordable housing was major problem in many metro areas a few years ago; so if we sub-divide those McMansions we can provide housing for lots of people ... if local residents will accept that.
Since local voters and homeowners are the same people, are they going to see the economic morality of moving several families into what had been built as a large home for one?
washingtonpost.com: Slate: "Why Economic Bubbles Are Good"(washingtonpost.com, May 10, 2007)
Daniel Gross: Hi Laurel—there's no question that lots of the housing built can find new uses. But I think the situation today is going to be more analogous to the 1920s stock and credit bubble than to the internet and telegraph—in terms of what gets left behind. The utility of bubbles is when they leave behind a new commercial or consumer infrastructure that other people can use to create new businesses.
Housing and mortgage debt won't leave much of that sort of stuff behind (although the refinancing mechanisms and websites like Zillow and Domania are useful and will remain). But here's the thing. The 1920s didn't produce any useful infrastructure. But the response to the bubble did. We got an entirely new financial architecture in the early 1930s: the SEC, deposit insurance, fannie mae, the investment company act. And this proved to be the basis on which the post-war credit-enabled economy boomed.
In the last few years, that infrastructure (like physical infrastructure from the 1930s) has been crumbling. We clearly need—and will get—a different global financial architecture in response to this bubble.
Newark, N.J.: Will bank nationalization allow other governmental agencies to have access to my financial records?
Daniel Gross: I would guess not, thought it's not my area of expertise. But it's my understanding that if, say, the FBI wants your financial records from a private bank, there are avenues through which they can do that.
Fair Lawn, N.J.: In one of his many articles on the subject of bank nationalization, Nouriel Roubini (who strongly supports nationalization) suggests that nationalization is inevitable. He theorizes that the one reason the government has not done it yet is because the effect on the remaining un-nationalized banks would be extremely harmful and that they are waiting for more banks to require nationalization before actually doing so. What is your take on his point of view? Do you feel that the banking industry has somehow stood in the way of nationalization through Lobbying
Daniel Gross: Nouriel Roubini has been one of the smartest and most prescient observers of the financial scene, and I generally agree with his take. In some instances, I do think that nationalization, or some form of it, is inevitable.
I'm not sure that nationalization would be harmful to those that aren't nationalized. There's a real stimga to nationalization. Executives wants to avoid it. Government involvement forces you to shrink operations, to change business practices, etc. I think if banks are nationalized they'll be focused more on cleaning up their mess rather than expanding and taking market share. For banks, the best situation to be in today is not needing any government help at all. Those are the ones whose stocks have performed well, who are gaining market share.
As for the banking industry and lobbying, I think they're sort of divided and confused. To a degree, they haven't come to grips with how the situation has changed. They seem to want unlimited taxpayer help with no strings attached, which is simply a non-starter.
Buenos Aires, Argentina: Dear Mr. Gross,
What we are witnessing in the U.S. seems familiar in countries such as Argentina in terms of the severity of the economic an financial crisis leaving aside that the U.S. dollar is the reserve currency of the world. In countries like Argentina, default and debt restructuring were the tools to try to restore growth. How the U.S. will be able to resume sustained growth with a $5.3 trillion debt pressing the economy down? Is it possible to monetize that kind of debt gradually?
Daniel Gross: Good questions. Resuming sustained growth is going to be a challenge. Given the fiscal situation, and the state of balance sheets, it can't be propelled by credit and debt as it was in 2001-2003. We have to rely on the continuing story of globalization—trade, exports. And we also have to rely on innovation. A third thing that could contribute to growth would be an economy-wide effort to become more efficient, to do more with less. That would have the effect of improving our profitability even if growth isn't that high, and would free up more cash for debt repayment.
The good news is that the U.S. does have the ability to borrow big chunks of money for the long term—10 to 30 years.
Boston: Hi Dan: I enjoy your column regularly and I am looking forward to reading your new book. My question relates to the Stimulus Bill. President Obama and all his supporters cited Japan's lost decade in explaining why we needed to hurry up and spend a trillion dollars. This past weekend I read in the NYT about Japanese citizens who lived through this "lost decade." They didn't describe mass chaos or long breadlines. They mentioned that they had to eat cabbage once or twice a week and fewer 22-year-olds were buying cars. In other words, they lowered their standard of living a small amount to adjust to a slightly shrinking economy. To avoid this fate, we in the United States are going to spend ourselves into oblivion. Do you think the cure could be worse than the illness? Thanks and keep up the great work.
washingtonpost.com: " Lessons From Japan in Stemming a Crisis" (New York Times, Feb. 13)
Daniel Gross: Hi Boston—good point. You're right there wasn't mass chaos in Japan during its lost decade. But Japan probably has greater tolerance for low growth than the U.S. for a couple of reasons. The population growth there is very low, and they have very little immigration. All of which means that if the economy kind of bumps along, if the pie doesn't get that much bigger, everybody still has roughly the same to eat.
That's not the case in the U.S. We have a higher birth rate than Japan, and we have lots of immigration. Check out the Census Bureau for the rate at which our population grows. The # of jobs needs to grow something like 1.5 percent per year just to keep up with growth in our labor force. This dynamism explains why we have a comparative mania for growth. We need the pie to get bigger, since there are more mouths to feed each year. And it explains why even a shallow recession feels really bad.
Lyme, Conn.: I look forward to reading your book. I do not know if you cover these areas, yet I will offer a few opinions and would appreciate your comments on them. I find two large mistakes a number of business leaders and economists made were 1. They realized that econometric and similar economic models are helpful in forecasting along movements as recorded in the past, there are few if any economic models that are able to correctly predict when major turnarounds in past performances occur and 2. while it indeed is appropriate to look more at the most recent data than old data, the attention to more recent data failed to include historic data that observes that our economy tends to move in cycles. Very few economists and business leaders foresaw and were prepared for an economic downturn.
Daniel Gross: Hi Lyme—Yes, I do hit on both those points in my book. One of the real failures in recent years has been in the forecasting industry. Everybody seems to suffer from what I call "pro forma disease." They take the results of the last few years and project them endlessly into the future—i.e. if housing prices rose at 10% per year for the past four years, they'll do so for the next four. That's part of how we got into so much trouble. And many of the models constructed on Wall Street only dealt with information from recent years. In addition, models don't seem to account for the fact that the shape of the economy - of the U.S. and the world at large—have changed a great deal.
Glendora, Calif.: Traditional IOUs represent the value of some real item—a cow or a chicken or a new roof—and are thus implicitly "marked-to-market" at all times. This means that the value of money is a function of the perceived value of real items rather than the inverse, which is a quality of fiat money. Is there a monetary system which would allow the close simulation of the IOUs while allowing easy circulation of the money? If electronic asset transfer was common worldwide, would it change your answer?
Daniel Gross: As long as we're going to stay off the gold standard, and as long as the money in circulation is a function of the demand for it, we'll always be in the situation where currencies fluctuate against real objects. IOUs, as you describe, aren't that much different from currency today. Yes, they represent the value of a real item. But the value of those items fluctuates all the time—a cow can be worth $10 one day and $8 the next.
New York: These guys are many things, but they're not dumb. It seems to me that we should be able to fill up a number of max prisons with some of these guys, if there's the political will to do what's right. Looks like the Wall Street chiselers are counting on prosecutor incompetence and short attention spans. That didn't work out well for Ken "Kenny Boy" Lay or Abramoff, to site two examples, though, did it? What are the prospects here for criminal prosecutions? And what are the prospects that government officials may be implicated in covering up for their buddies?
Daniel Gross: Hi New York—there undoubtedly will be criminal prosecutions, especially of the ponzi schemes and in the mortgage industry. But I'm not that optimistic about widespread prosecution. Because much of the crime was simply incompetence or blindness. Take the SEC. Chris Cox and his team did a simply horrible job overseeing the industry. But nobody is arguing that they broke any laws, or that they were bribed to do so. They just did so because they weren't very good at what they did, and may have been blinded by ideology. The same holds for Alan Greenspan.
At the investment banks, there was probably a lot of fudging of numbers—telling the public one thing while knowing another thing in private. But some of the biggest debacles, say, Citigroup, happened because the people running the company didn't have a clue about the entirely legal (but ultimately destructive) things going on at the bank.
Washington D.C.: In terms of assigning blame for the current economic crisis, some would seek to lay the greater part of it at the hands of Democrats in Congress, saying that they "distorted" the mortgage market by encouraging non-market based standards for lending to help their political base. Despite the obvious and simplistic ideological prism applied in this critique (market vs. government), is there any validity to this claim? Of the bad debt out there, how much of it is the direct result of any "non-market" based lending? How much of it is the result of competition for credit business? Is bad debt the sole cause of the crisis? Were banks forced to make the loans?
Daniel Gross: In a word, no. First, Democrats didn't control Congress in this period. Republicans controlled the House since 1994. From 2001-2006 there was basically one-party rule in Washington.
Second, the worst offenses in lending didn't take place in the regulated mortgage industry, the types of people who were subject to government rules and regulations about lending. They took place in the shadow banking industry—subprime firms that sprung up and the Wall Street investment banks that first funded them and later came to own them. In addition, the problems with subprime and other lending were amplified because investment banks decided to make CDOs out of them, and to trade them with huge amounts of leverage—something Congress had no impact on.
Finally, as I argue in my book, mortgages were only part of the story. Banks are going to lose billions of billions of dollars on loans they extended to private equity firms for mega buyouts, which has nothing to do with mortgage lending.
Rhode Island: Hi Dan,
Love your columns in Slate.
Could you please decipher the real truth about Obama's proposed change in the way upper income folks would deduct charitable expenses?
To hear the talking heads go on about it, you'd think he was eliminating the deduction entirely, which would be devastating to charities.
Yesterday on NPR, I heard Peter Orszag make a comparison between the amount Bill Gates would get to deduct for a $1000 charitable contribution vs. what a middle income person would get to deduct for the same amount. I didn't quite get it.
Can you clarify? Bottom line, do you think Obama's proposed change would lead to upper income donors giving less?
Daniel Gross: Sigh. If there's anything that's been worse than the talking heads on Iraq, it's the talking heads on the economy. They simply, by and large, don't know what they're talking about.
As I read it, the proposal is to reduce the portion of charitable deductions a wealthy person could write off against taxable income, from, say, 36 percent to 28 percent. So if you give $100, it reduces your taxes by $28 instead of $36.
As for whether that leads rich people to give more or less money, I'm not sure. Look, charity is complicated. There are 1,000 reasons people give money. Lots of people who don't take tax deductions give money away (i.e. in Salvation army kettles, or to the homeless, or to their church). The ability to get a tax deduction is only one motivating factor. They make donations in memory of a loved one, or to enhance their social standing, or because they have too much money to spend. Do you think Warren Buffett and Bill Gates are giving away their fortunes because of the tax break associated with it? Some of the greatest acts of charity—Andrew Carnegie giving away his fortune—came before there was even an income tax.
Single mom in Fla.: I am not a Zen master but I lack rage/envy/bluster at the 'masters of the universe' whose hubris takes some of the blame. I need my energy to focus on these issues:
1. When will credit begin to flow again?
2. When will employment numbers improve?
3. When will the Dow top 12,000 again?
I am down six figures in investments losses and $150K in house value (built in 2006.) I sleep at night but I worry like crazy. Please frame up the timetable and do not use the phrase "I don't have a crystal ball." Thanks.
Daniel Gross: Zen master—I'm sorry but I don't have hard and faster answers to your questions. And those who say they do suffer from an excess of confidence.
Credit is flowing—it's just on tougher terms and might cost a little more.
Employment numbers? I think the thing to look for is not so much an improvement (i.e. new jobs) but a decline in the pace of job destruction. My best guess is that'll happen in May or June.
Dow topping 12,000? Beyond human capabilities to divine such things.
Laurel, Md.: If our holding of Citi grows to 51%, can we vote to move its credit card operations out of Delaware, so it would be subject to the usury and fee limits in the other states?
Daniel Gross: Interesting question. But probably not. The holdings would be managed by some government body that would probably not solicit the views of individual taxpayers.
Chicago, Ill.: I've heard Ben Bernanke say that Lehman Bros couldn't be saved, because there simply wasn't a buyer. And TARP hadn't been set up, so the USG couldn't step in and bail it out. There were no options except to allow it to fail. Is this true?
Daniel Gross: Well there certainly wasn't a buyer for Lehman Brothers before it went bankrupt. And TARP had not been set up. Could the government have taken more extreme examples in the absence of TARP to shore up Lehman and stop it from going down. I suppose that between the Fed and Treasury they could have cooked something up. But there wasn't much of an appetite for that at the time.
Olney, Md.: Could you explain the controversy over "mark-to-market accounting" and how it factors in to the banks' problems? The former head of the FDIC is saying that this method of accounting is poorly-thought-out, does not work during a down-turn, and it is a major cause of the situation the banks find themselves in. The analogy seems to be something like this: what if the average citizen were legally obligated to contribute enough cash to your 401(k) to top it out at its 2007 highest-point?
Daniel Gross: yes. Mark to market says you have to value assets at their market price every quarter. That's easy when the asset is a stock, because it's traded every day and we know the price. When assets aren't very liquid—a house, an office building, some funky mortgage investments—that's more of a challenge. Especially when the market for those assets has broken down. Basically, the banks are saying that if they're forced to assign a market place to a lot of these toxic assets, the price will be irrationally low. And it will be so low that it'll force them to take a big charge, and their creditors and investors will suddenly realize that the banks don't have the proper amount of assets underlying all their debt. And that could lead to a death spiral. In addition, if banks mark their assets to a non-functioning market, it would then force everybody else who holds similiar assets—insurance companies, pension funds—to do the same, and to register losses. Another thing: mark to market requires you to register a loss, or a decline in value, even if you don't have any intention of selling the asset. Say you have a house that you bought for $500,000 last year. Now the market says it's only worth $400,000. But you don't plan on moving any time soon, and in fact, plan to hold it for ten years, at which point, it's likely to be worth a lot more than $400,000. So what's the point of marking it to market. .
The flipside is this: these banks had no problem marking things to market when prices were irrationally good. Also, if you were an investor, how much confidence would you have in a bank that doesn't mark assets to the market.
Laurel again: I disagree that the 20s left no infrastructure. That stock bubble was based on new consumer products like cars, radios and refrigerators that basically created modern suburban life once the distractions of the Depression and World War were over.
But the gist of my question is whether we can right-size our "gilded" housing market; which is under political control of the very voter/homeowners whose economic interest are to NOT allow those over-sized houses to be occupied by as many people as could reasonably fit there.
Daniel Gross: the housing market is in the process of being right-sized. the typical size of a new home built in 2008 was about 15% smaller than the ones built in 2007. The market is doing a lot of this work for us. It just takes a lot of time.
Anonymous: Hey Dan, why does Obama and co seem so hostile to the word nationalization? The FDIC does it all the time. The financial system needs triage. The insolvent ones should be shut down and the salvageable ones need to be restructured and recapitalized. This needn't take more than a couple years. Unless we abolish mark to market this is our probable fate anyway, so why delay and create even more uncertainty?
Daniel Gross: Interesting you should ask. I wrote my Slate column yesterday about that topic: http://www.slate.com/id/2212319/
Ottawa, Canada: What are your thoughts about Canadian banks and the regulations that control them? They are still very profitable and none have failed.
Daniel Gross: don't know that much about Canadian banks.
Evanston, Ill.: Hey Dan, Should the Congress pass a law requiring that any bank that secures assets hold a substantial portion of that security on their own books? Without such a realignment of incentives I don't think any amount rating agency regulation or central bank purchases/guarantees will revive the market in a healthy way.
Daniel Gross: That would go a long way to preventing a recurrence of what we just went through. And you're right about the incentives.
New York, N.Y.: Hi Daniel, thanks for your insight and taking our questions. I'm curious about the worst-case downside. To a certain extent the excesses of private institutions and individuals (i.e. risky loans) are being transferred wholesale to the government. Is this a process that can continue without end? Where are the limits to what the government can take on as losses, and what will happen when we get there? I am investing for the long term (30+ years to retirement) so if Bernanke is right and the recession lasts just another year I'm not worried—what worries me is the long-term prospect for national viability.
Daniel Gross: Hi—yes, obviously there isn't an open-ended checkbook for the government. (although we certainly seem to be testing the limits). It kind of helps that the rest of the world is in the same situation, since the dollar and U.S. government debt has become a comparative safe haven. So long as this continues, we can probably borrow as much as we want or need. The deleveraging process, however, has to start sooner rather than later.
Mount Airy, Md.: Dear Daniel,
I recently learned about credit default swaps and CDOs and how these investments have contributed to the current global economic meltdown. The immensity of the impact of these debts is downright scary. It would seem that we could never inject enough capital into the banking system to offset the effects. Is this truly the case? Also, of the billions of bailout money, how much goes to paying off these obligations?
Daniel Gross: a very complicated topic, and in some ways bigger thanthe banks. AIG, an insurance company, is among the biggest players in credit default swaps. And it's true that a certain amount of the bailout money given to AIG has been used to maintain trades and make counterparties to credit default swaps whole. I think going forward, the companies that are on the receiving end of AIG's CDS payments should be forced to take a haircut.
Rhode Island: Hi Dan, regarding the SEC and its role in this debacle, please refresh my memory. I seem to recall that Bush basically fired a previous SEC head because he actually, you know, enforced regulations. That guy was replaced by Cox (is that right?) which leads me to think he was appointed to NOT regulate.
Daniel Gross: Cox's predecessor was James Donaldson, who was much more independent-minded, cut from the cloth of the old Rockefeller Republicans. I'm not sure as the reasons Donaldson left.
forecaster/modeler...: So not true what you are saying. The problem is that the correct people were not hired for the correct jobs. There are plenty of people out there running plenty of software programs—and they have NO IDEA how to interpret the results from the software/models/whatever. And then when the 'correct' (i.e., math people/stat people, whatever) DID put the numbers together, well, most of the time, management DID NOT want to look at it properly.
I.e., no one worth their salt wouldn't put in a distribution in there and say: Hey, ya know, the chances of XXX occurring next year is YYY—so the chances of whatever might be 5%, even though it happened last year—and management would typically just ignore it. (Have you met any phDs in math? Not the most outgoing people. I can say that, I have a master's in applied math.)
So what's a quant to do? This 'revolution' was NOT led by quants; the quants were typically standing by looking and saying: but things aren't going to be next year what they were. They may have been off a year or so, but they KNEW the crash was going to happen. Just that no one wanted to listen...
Daniel Gross: I see what you're saying. Many of the people who made the decisions based on the model weren't the people who were maintaining it.
But with economic forecasters, my original point stands. Economists, as a group, always miss calling recessions. In December 2007, as the economy was about to slip into a recession, they collective forecast growth of about 2% for 2008.
Boulder, Colo.: As a small business owner, I don't understand how the government can justify spending 40 billion dollars to purchase a 40 percent share in a company whose total value is only 9 billion dollars. Why can't the government act like a private equity firm and buy enough shares in the bank to get a controlling interest and than auction off the bad assets and sell the good assets to private interests? What they are trying to do is the equivalent of giving mouth to mouth resuscitation to a beached whale. It's better to just let the scavengers devour the flesh and move on.
These guys at the Treasury remind me of the venture capitalist, all with Ivy league resumes but no business sense who would keep funding failed businesses they had initially funded with 3rd and 4th round financing simply because they did not want to admit failure. These banks were run by con artists who made very stupid business decisions and these people should be purged from the financial system and their Ponzi culture destroyed.
The government should act like a good private equity firm with the motivation to make as much money for the share holders (we, the taxpayers) as they can while reducing risk. They should be less concerned about preserving individual institutions and more concerned about getting money in the hands of groups who know how to allocate capital. You gain nothing by betting on horses who have proven they can't run. I would be much happier if Warren Buffet, the world's most successful investor, was in charge of this recovery than Larry Summers, who is reputed to be a brilliant economist (an oxymoron) but who was against regulating derivatives and was for the repeal of the Glass Steagal Act.
Academic talent and theory is necessary but not sufficient to prevent another great Depression. The Obama administration also needs to employ practical businessmen to implement the strategy with cold precision.
Daniel Gross: I agree w/ you 100%.
Evanston, Ill.: Lehman could have been saved but at that point Paulson was refusing to put up any consideration to get the deal done. He did it for Bears Stearns and Freddie and Fannie. Lehman was a sacrificial lamb and the aftermath was failed game of financial Russian roulette. The Fed has an exigent circumstance clause that allows them to lend unlimited amounts to anyone for collateral IT deems sufficient. Bernanke claims they didn't have good enough collateral but that is a total canard given that the Fed has total unfettered discretion.
Daniel Gross: yes, I think there was definitely a conscious decision to let Lehman fail. There was a sense inside Treasury that Lehman had been put on notice, that they had been given six months since the failure of Bear, Stearns to deleverage, to get their house in orders, and that they just didn't execute.
Daniel Gross: Well, that does it for my hour. Thanks so much for all the good questions. And please keep reading. A reminder, anyone interested in seeing the first chapter of my new e-book: Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation, should send an e-mail to: email@example.com.