Friday, December 12, 2008

"Downturn to conclude in June" - Not my words...

Late yesterday the Wall Street Journal reported:
“On average, economists expect the downturn to conclude in June 2009, marking an 18-month duration, the longest postwar period of decline. The economists on average said the unemployment rate will peak at 8.4% in response to this recession.”

In a separate set of headlines:
“Bernard L. Madoff, a former chairman of the Nasdaq Stock Market and a force in Wall Street trading for nearly 50 years, was arrested by federal agents Thursday… Mr. Madoff told his sons he believed losses from his fraud exceeded $50 billion.”

I was not going to cover this chapter of Galbraith’s “The Great Crash of 1929” until later, but these two headlines just make me jump back to page 14- “Aftermath II”…

During the book, Galbraith points to a group called the Harvard Economic Society – a group of economists from Harvard. He also points to some other high profile economists from well regarded Universities like Joseph Stagg Lawrence of Princeton and Irving Fisher of Yale who strongly supported the whole run-up of the market. His recounting of the Harvard Economic Society’s predictions are remarkably similar to the quote from the WSJ above:

11/2/29: “The present recession, both in stocks and business is not a precursor of business depression.”
11/10/29: “A serious depression like that of 1920-21 is outside the range of possibility.”
12/21/29: “A depression seems improbable; [we expect] recovery of business next spring, with further improvement in the fall.”
1/18/30: “There are indications that the severest phase of the recession is over.”
3/1/30: “Manufacturing activity is now definitely on the road to recovery.”
4/19/30: “By May or June the spring recovery forecast in earlier newsletters should be clearly apparent.”
5/17/30: ”Business will turn better this month or next, recover vigorously in the 3rd quarter and end the year at levels substantially above normal.”
8/30/30: “The present depression has about spent its force.”
11/15/30: “We are now near the end of the declining phase of the depression.”
10/31/31: “Stabilization at present depression levels is clearly possible.”

Galraith concludes in his understated tone “even these last forecasts were widely optimistic. Somewhat later, its reputation for infallibility rather dimmed, the Society dissolved.”

The Chapter goes on to recount how “among people of prominence worse havoc was worked on reputations. In such circles credit for wisdom, foresight and common honesty underwent a convulsive shrinkage.” In addition to the soiled reputations of the economists, he talks about a couple of bank presidents, but saves the worst story for the end of the chapter – Richard Whitney who was the head of the New York Stock Exchange.

Like the current day story of Mr. Madoff, who is the former Chair of the NASDAQ Stock Market and owner of his own Wall Street firm, Richard Whitney also ran a stock exchange and headed his own Wall Street firm. Whitney and Madoff shared the common practice of keeping their books to themselves, and thus employed very large leverage to make their investments. With major drops in the market, they were eventually unable to cover their leveraged and illegal positions.

The current press is talking about Madoff essentially running a Ponzi scheme. In one other strange twist of similarity between eras, Galbraith covers the fact that the term Ponzi is based on the case of a Charles Ponzi, who in the mid-1920’s made a business of brokering land in Florida. Apparently there was speculation on real estate before the collapse of the stock market in 1929. Ponzi was incredibly misleading about what people were buying - selling lots of 1/23rd of an acre 25 miles away from the Ocean. However, there was the similar practice of enabling buyers with insufficient means to purchase property beyond their ability to payback. The scheme to drive prices up and up collapsed and ended with land owners stuck with their properties and no way of either selling the property or covering the payments. Sounds familiar.

Thursday, December 11, 2008

Mollie is in!!!!

Mollie just found out she got accepted to Cornell! Proud Dad!

John Kenneth Galbraith's "The Great Crash of 1929"

I just finished reading John Kenneth Galbraith’s “The Great Crash of 1929”. He wrote the book in 1955 and recounted what happened and looked at the reasons why. Very interesting, and while there are many things that are different, there are a number of similarities that I will try to highlight in my next couple of blogs.

From Sept. 3, 1929 until Nov. 13, the Times Industrial Index fell from 452 to 224 – almost 50% exactly. Prices stabilized for a while, but continued a long term trend down until they reached their eventual bottom at 58 on July 8, 1932. Meaning $1,000 invested on Sept. 3, 1929 became worth $130. Ouch.

So we all know that the Dow Industrials fell from a high of 14,164 on Oct. 9, 2007 to a low of 7,557 on Nov. 21, 2008 – a little less than 50%. Of course the Dow has rallied back to about 8,600 as I write this on Dec. 11, 2008 – an improvement of about 14% above the bottom. Looking back to 1929-30, the Dow Industrials rallied about 29% from a low in 1929 of 228 to close at 294 on April 14, 1930.

Of course the numbers do not really look at the reasons behind the crash. Galbraith summarizes the reasons:
1. The bad distribution of income.
2. The bad corporate structure. “The most important weakness was the vast new structure of holding companies and investment trusts.”
3. The bad banking structure.
4. The dubious state of the foreign balance.
5. The poor state of economic intelligence.

He morphs the 5th point into the government reaction to the economic events in the 1930’s. For example, I was surprised to learn that FDR’s Democratic Party ran their successful 1932 election bid with this as part of their platform called for an “immediate and drastic reduction of governmental expenditures” to accomplish at least a 25 % decrease in the cost of government.

Anyway, over the next week or two I will do some research on today’s metrics and contrast them to what Galbraith covers in his book about 1929. I think I will find quite a few similarities – especially on the first 4 points. However, it is really quite remarkable the difference in the government’s reaction this time. As Galbraith points out “The avoidance of depression and the prevention of unemployment have become for the politician the most critical of all questions of public policy.