Newsweek 2009
http://www.thedailybeast.com/newsweek/2009/03/28/bonuses-don-t-create-bubbles.html
It’s the end of a quarter of a century of Reaganomics. It’s the end of equities, of globalization, of capitalism itself. We need a new system, a new economics, a whole new set of values. The bull market in overheated rhetoric is in full swing, and as is so often the case when a bubble bursts, there is a strong reaction against the intellectual foundations of the era that spawned it, spiced with rage against the people who benefited so handsomely.
Human beings have a deep need for this kind of simple but powerful narrative to help us impose structure on confusing events. The assumptions and values that gave rise to the U.S. credit bubble were seriously flawed. As for the cast of villains—the greedy financiers, the CEOs pocketing enormous bonuses while their institutions hemorrhaged red ink, the smug central bankers, inept deregulators, compromised politicians and manically bullish TV pundits—all played a role in the American meltdown. But they did not cause it. We know this for sure because in recent memory a much larger bubble inflated, popped and brought down a banking system without any of these characters being present.
In the 10 years before the peak in 1989, Japanese stock and real-estate prices rose 500 percent. This compares with a 200 percent gain for U.S. house prices in the 10 years leading up to 2007 and a 70 percent rise in the S&P over the same period.
The Japanese collapse unfolded with no alphabet soup of structured products, no Ayn Rand acolytes sitting at the central bank, no Japanese version of Jim Cramer, no Glass-Steagall reform. The separation between stockbrokers and commercial banks was policed by the all-powerful mandarins of the Ministry of Finance, who were about as distant from “market fundamentalists” as it is possible to get this side of Marxism.
The men who ran Japan’s major banks were dignified figures in dark suits and they took great pride in Japan’s industrial prowess. There were no egregiously rich bankers. Like all Japanese executives, they received modest annual compensation, about $500,000. At that rate, it would take a Japanese banker 1,000 years to match the $500 million reputedly earned by Lehman Brothers’ Dick Fuld since the mid-1990s. They rarely owned any stock themselves, let alone options, which didn’t even exist in Japan. Shareholder value—the very American idea that management’s first priority is boosting the stock price—was a concept they would have greeted with incomprehension.
Yet these are the men who fueled one of the biggest asset bubbles in history. Why? They bought the prevailing storyline, built on real but selected and incomplete facts. The narrative of the recent U.S. bubble years—though grounded in strong noninflationary growth, the spread of the Internet and the booming emerging-market economies—ignored the imbalances, mispricing and risks metastasizing in the shadowy recesses of the financial system. Likewise, in the 1980s the Japanese came to believe that they could extrapolate Japanese industrial dominance and rising asset prices out into the far future, willfully blind to the risks.
Yet the consensus that formed after Japan’s crisis was almost the opposite of the mood in America and Europe today. Rather than working to rein in the markets, Japan had to give markets a chance to work, the thinking went. Bureaucrats had become too powerful. In 1997 the Hashimoto administration introduced a Japanese “Big Bang,” named after the Thatcher reforms of the 1980s. Banks were allowed into the stockbroking business. As today, the response then—politically and psychologically necessary, but only partially valid at best—was to reject the values of the bubble era.
The real lesson is that very different systems, and very different casts of characters, can produce bubbles. Not because the people involved are ideologues, though they may be. Not because they are greedy, though they may be that too. The deeper reason, confirmed by the insights of behavioral finance, is that human beings are social creatures with limited ability to see beyond the prevailing narrative.
By definition, the larger the bubble, the more people will buy into it. In the case of a truly spectacular, world-changing bubble like the one we’ve just seen, almost everyone is complicit: not just investors and self-interested intermediaries but politicians, regulators, journalists, academics, not least all the ordinary folk who jump on the bandwagon. This is true whether the style and pay packages of the characters are Japanese or American.
The bad news is, this will never change. Bubbles are the price paid by any system that allows people to exercise their own judgment. The good news is that people learn from mistakes. It will be a long time before the words “dotcom stock” arouse anything other than ridicule. This time around, the excesses spread far and wide, covering nearly every sort of asset class, including credit, stock markets, housing and commercial real estate, commodities, contemporary art, racehorses, fine wine, etc. As in Japan, investors who experienced the trauma of the bust will likely remain skeptical of many such asset classes for the rest of their lives.