The next, worse financial crisis

The last financial crisis isn’t over, but we might as well start getting ready for the next one.
Sorry to be gloomy, but there it is.
Why? Here are 10 reasons.

Wall Street's grim future

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1. We are learning the wrong lessons from the last one. Was the housing bubble really caused by Fannie Mae, Freddie Mac, the Community Reinvestment Act, Barney Frank, Bill Clinton, “liberals” and so on? That’s what a growing army of people now claim. There’s just one problem. If so, then how come there was a gigantic housing bubble in Spain as well? Did Barney Frank cause that, too (and while in the minority in Congress, no less!)? If so, how? And what about the giant housing bubbles in Ireland, the U.K. and Australia? All Barney Frank? And the ones across Eastern Europe, and elsewhere? I’d laugh, but tens of millions are being suckered into this piece of spin, which is being pushed in order to provide cover so the real culprits can get away. And it’s working.

2. No one has been punished. Executives like Dick Fuld at Lehman Brothers and Angelo Mozilo at Countrywide , along with many others, cashed out hundreds of millions of dollars before the ship crashed into the rocks. Predatory lenders and crooked mortgage lenders walked away with millions in ill-gotten gains. But they aren’t in jail. They aren’t even under criminal prosecution. They got away scot-free. As a general rule, the worse you behaved from 2000 to 2008, the better you’ve been treated. And so the next crowd will do it again. Guaranteed.
3. The incentives remain crooked. People outside finance — from respected political pundits like George Will to normal people on Main Street — still don’t fully get this. Wall Street rules aren’t like Main Street rules. The guy running a Wall Street bank isn’t in the same “risk/reward” situation as a guy running, say, a dry-cleaning shop. Take all our mental images of traditional American free-market enterprise and put them to one side. This is totally different. For the people on Wall Street, it’s a case of heads they win, tails they get to flip again. Thanks to restricted stock, options, the bonus game, securitization, 2-and-20 fee structures, insider stock sales, “too big to fail” and limited liability, they are paid to behave recklessly, and they lose little — or nothing — if things go wrong.
4. The referees are corrupt. We’re supposed to have a system of free enterprise under the law. The only problem: The players get to bribe the refs. Imagine if that happened in the NFL. The banks and other industries lavish huge amounts of money on Congress, presidents and the entire Washington establishment of aides, advisers and hangers-on. They do it through campaign contributions. They do it with $500,000 speaker fees and boardroom sinecures upon retirement. And they do it by spending a fortune on lobbyists — so you know that if you play nice when you’re in government, you too can get a $500,000-a-year lobbying job when you retire. How big are the bribes? The finance industry spent $474 million on lobbying last year alone, according to the Center for Responsive Politics.

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5. Stocks are skyrocketing again. The Standard & Poor’s 500 Index /quotes/zigman/3870025 SPX -0.70%  has now doubled from the March 2009 lows. Isn’t that good news? Well, yes, up to a point. Admittedly, a lot of it is just from debasement of the dollar (when the greenback goes down, Wall Street goes up, and vice versa). And we forget there were huge rallies on Wall Street during the bear markets of the 1930s and the 1970s, as there were in Japan in the 1990s. But the market boom, targeted especially toward the riskiest and junkiest stocks, raises risks. It leaves investors less room for positive surprises and much more room for disappointment. And stocks are not cheap. The dividend yield on the S&P is just 2%. According to one long-term measure — “Tobin’s q,” which compares share prices with the replacement cost of company assets — shares are now about 70% above average valuations. Furthermore, we have an aging population of Baby Boomers who still own a lot of stocks, and who are going to be selling as they near retirement.

6. The derivatives time bomb is bigger than ever — and ticking away. Just before Lehman collapsed, at what we now call the height of the last bubble, Wall Street firms were carrying risky financial derivatives on their books with a value of an astonishing $183 trillion. That was 13 times the size of the U.S. economy. If it sounds insane, it was. Since then we’ve had four years of panic, alleged reform and a return to financial sobriety. So what’s the figure now? Try $248 trillion. No kidding. Ah, good times.
7. The ancient regime is in the saddle. I have to laugh whenever I hear Republicans ranting that Barack Obama is a “liberal” or a “socialist” or a communist. Are you kidding me? Obama is Bush 44. He’s a bit more like the old man than the younger one. But look at who’s still running the economy: Bernanke. Geithner. Summers. Goldman Sachs. J.P. Morgan Chase. We’ve had the same establishment in charge since at least 1987, when Paul Volcker stood down as Fed chairman. Change? What “change”? (And even the little we had was too much for Wall Street, which bought itself a new, more compliant Congress in 2010.)
8. Ben Bernanke doesn’t understand his job. The Fed chairman made an absolutely astonishing admission at his first press conference. He cited the boom in the Russell 2000 Index /quotes/zigman/2759624 RUT -0.65%  of risky small-cap stocks as one sign “quantitative easing” had worked. The Fed has a dual mandate by law: low inflation and low unemployment. Now, apparently, it has a third: boosting Wall Street share prices. This is crazy. If it ends well, I will be surprised.
9. We are levering up like crazy. Looking for a “credit bubble”? We’re in it. Everyone knows about the skyrocketing federal debt, and the risk that Congress won’t raise the debt ceiling next month. But that’s just part of the story. U.S. corporations borrowed $513 billion in the first quarter. They’re borrowing at twice the rate that they were last fall, when corporate debt was already soaring. Savers, desperate for income, will buy almost any bonds at all. No wonder the yields on high-yield bonds have collapsed. So much for all that talk about “cash on the balance sheets.” U.S. nonfinancial corporations overall are now deeply in debt, to the tune of $7.3 trillion. That’s a record level, and up 24% in the past five years. And when you throw in household debts, government debt and the debts of the financial sector, the debt level reaches at least as high as $50 trillion. More leverage means more risk. It’s Econ 101.
10. The real economy remains in the tank. The second round of quantitative easing hasn’t done anything noticeable except lower the exchange rate. Unemployment is far, far higher than the official numbers will tell you (for example, even the Labor Department’s fine print admits that one middle-aged man in four lacks a full-time job — astonishing). Our current-account deficit is running at $120 billion a year (and hasn’t been in surplus since 1990). House prices are falling, not recovering. Real wages are stagnant. Yes, productivity is rising. But that, ironically, also helps keep down jobs.
You know what George Santayana said about people who forget the past. But we’re even dumber than that. We are doomed to repeat the past not because we have forgotten it but because we never learned the lessons to begin with.