On the policy front, I believed in 2008 that it was appropriate for the Treasury to provide capital to banks through the use of preferred stock (though I would have advised the use of Bagehot’s Rule – which would have provided that capital at much higher yields than the Treasury accepted). However, I did not believe that outright purchases of distressed assets were appropriate or ethical, and I railed against the notion of a Troubled Assets Relief Program (TARP), as well as Fed purchases of Fannie Mae and Freddie Mac’s liabilities, FASB accounting changes to reduce the transparency of financial reporting, and other interventions to defend bondholders and put bad private assets on the public balance sheet.
As the government pursued those more outrageous policies, it became clear what I had expected to be a fairly orderly “writeoff recession” (involving the appropriate restructuring of bad debts) was not going to happen, and without that restructuring, that the U.S. economy would be chained to the burden of those debts for a very long time. The inability of the economy to materially accelerate in recent years, and its constant hovering at the edge between expansion and recession, is a symptom of that failure to restructure debt in 2008 and early 2009. One cannot account for the full cost of defending bondholders during the crisis without adding in the trillions of dollars in additional government debt that has been expended in the effort to counteract that economic drag.
I am glad that the economy has created jobs recently. But payroll employment is not a forward-looking indicator, and is unlikely to prevent the U.S. from joining a global downturn that is already in progress among developed countries (chart below from Dwaine Van Vurren). Note that U.S. recessions occurred in 1960, 1970, 1973-74, 1980, 1981-82, 1990-91, 2000-2001 and 2007-2009.
The refusal to restructure debt in 2008 and 2009 (and the associated fear-mongering by financial institutions seeking government bailouts) did something else. It produced economic contraction and job losses unlike anything observed in the post-war period. The appropriate response, at least for any responsible fiduciary, was to stress-test every investment approach against data that included similarly deep economic and market contraction. In the Depression, the market decline from 1929 to 1931 erased the previous overvaluation, and took valuations to levels normally associated with prospective 10-year total returns of about 10% annually. But from there, stocks dropped by another two-thirds.
Read the complete commentary