Cross-post from Naked Capitalism is a riposte to Stanley Druckenmiller’s advice that the young declare war on baby-boomers.
I pointedly avoid New York Times columnist Thomas Friedman; you can glean everything you need to know about him from the official Thomas Friedman Op/Ed Generator or some of Matt Taibbi’s lambastings (see here, here, and here for examples).
So without attempting to wade too deeply into the goo of Friedman’s latest column, let’s limit ourselves to the the fact that Friedman is running PR for former Soros Fund Management lead investor Stan Druckenmiller. The column also serves to illustrate how Serious People like Friedman were ready to jump on the deficit cutting bandwagon once the shutdown/debt ceiling drama was put to rest for a bit.
Druckemiller’s latest cause is to foment generational warfare. He’s going to college campuses and telling students that things suck (which they know full well) and they need to go after Boomers who are gonna get too much in entitlements if things don’t change. Now from what I can infer, the presentation is sophisticated, since Druckenmiller throws other big Federal spending items into the mix, like defense. But the fact that he depicts tax rates as a problem is a major tell.
Curiously, for someone who says he’s a friend of Druckenmiller, Friedman is remarkably circumspect about Druckemniller’s political history. Druckemniller has not only been one of two or three biggest Republican donors for the better part of two decades, he’s been firmly aligned with the aggressive “shrink government/cut taxes” effort, back to being a strong ally of Newt Gingrich. For Druckemmiller to point at Boomers and act as if he’s part of the solution, as opposed to one of the long-standing proponents of tax cuts, which among other things were one of the big causes in the rise in government debt levels under George Bush, is remarkably disingenuous.
Similarly, Friedman mentions in passing Druckenmiller’s successful bet against subprime as a reason to take him seriously. As we discussed in ECONNED at length, the supbrime shorts, most importantly Magnetar, were what turned what would have been a S&L level housing crisis into a global financial meltdown. The use of credit default swaps on subprime mortgages created exposures that have been estimated at 5-6 times that of the value of mortgages. The synthetic side bets were a multiple of the real economy borrowings. As we explained in 2010:
The current number one non-fiction best seller, Michael Lewis’ The Big Short: Inside the Doomsday Machine…Lewis’ tale is neat, plausible to a mass market audience fed a steady diet of subprime markets stupidity and greed, and incomplete in critical ways that render his account fundamentally misleading….
Lewis repeatedly and incorrectly charges that no one on Wall Street, save his merry band of shorts, understood what was happening, because everyone blindly relied on ratings and failed to make their own assessment. By implication, the entire mortgage industry ignored the housing bubble and the frothiness of the subprime market. This is simply false (although with Bernanke and the persistently cheerleading US business media largely missing this story at the time, the “whocouldanode” defense is treated more seriously than it should be). Many people in the credit markets were aware that the risks were increasing in the subprime and residential real estate markets. Every mortgage industry conference during this period had panels on this topic, every credit committee considered it throughout 2005-07…
Lewis completely ignores the most vital player, the one who was on the other side of the subprime short bets. The notion that “it’s a CDO” is daunting enough to stop the non-financial reader in his tracks. The author is remarkably uncurious about who the end investors were for CDOs.
Listen up. Who really was on the other side of the shorts’ trades is the important question. And the section in which Lewis finally gets around to that (more than halfway thought the book, reader sympathies to his key actors now firmly established) hides the fundamental flaw in his narrative in plain sight:
…whenever Eisman sets out to explain the origins of the subprime crisis, he’d start with his dinner with Wing Chau [a CDO manager]. Only now did he fully appreciate the central importance of the so-called mezzanine CDO – the CDO composed mainly of BBB rated subprime mortgage bonds – and its synthetic component, the CDO composed entirely of credit default swaps on triple-B rated subprime mortgage bonds. “You have to understand this,” he says. “This was the engine of doom.”…
All by himself, Chau generated vast demand for the riskiest slices of subprime mortgage bonds. This demand had led inevitably to the supply of new home loans, as material for the bonds.
Yves here. It wasn’t all by himself, as we will see soon:
….the sorts of investors who handed money to Wing Chau, and thus bought the triple A rated traches of CDOs – German banks, Taiwanese insurance companies, Japanese farmer’s unions, European pension funds, and in general, entities more or less required to invest in AAA rated bonds -did precisely so because they were supposed to be foolproof, impervious to losses, and unnecessary to monitor of think about very much.
Yves again. Note that these are the international equivalent of widows and orphans, but because they are exotic, presumably elicit less sympathy. But as we will discuss soon, by this point in the tale, January 2007, that list of prototypical chumps was out of date, which has further implications for the real significance of this trade.
Starting in mid-2005, when the creation of a standardized credit default swap on mortgages made it feasible to take large subprime short positions, a system quickly developed that overrode the normal checks and balances of the market and allowed the unscrupulous to 1. Profit from making bad loans, and 2. Force the creation of more bad loans, which would both increase their profits and make it more likely that their bet would be successful…
The subprime market would have died a much earlier, much less costly death absent the actions of the men Lewis celebrates. They didn’t simply keep the market going well past its sell-by date, they were the moving force behind otherwise inexplicable, superheated demand for the very worst sort of mortgages. His “heroes” were aggressively trying to find toxic waste to wager against. But unlike short positions in heavily-regulated equity markets, these wagers, the credit default swaps, had real economy effects. The use of CDOs masked the nature of their wagers and brought unwitting BBB protection sellers to the table, which lowered CDS spreads (and as in corporate bond markets, CDS dictate, via arbitrage, interest rates for bond issues) and pushed down the interest rates on the cash bonds backed by those same loans, which in turn made it perversely attractive for lenders to generate mortgages with the worst characteristics. And it isn’t surprising that weak-credit borrowers were enticed by this once in a lifetime “opportunity”.
Back to the current post. So why are the young people Druckeniller trying to incite against their elders in such terrible shape? There’s an immediate factor and a longer-term trend. The immediate one is the aftermath of the global financial crisis, which has produced disastrously high levels of unemployment for the young, particularly college graduates. And Druckemmiller doesn’t bear some vague general guilt as a member of the financial services industry that emerged more powerful as a result of this event; he actually bears considerably more responsibility than most by having taken out huge bets against subprime that drove demand to the worst sort of mortgages and had way too many fragile, levered, critically positioned financial institutions on the wrong side of the trade. For instance, on of the parties on the other side of Druckenmiller-style bets were monolines. When they went seen as being at risk, the auction rate securities market froze because monolines were also guarantors of municipal bonds, and everyone knew this short-term muni paper would fall in value as the monolines were downgraded. The result was that interest rates jumped to the parties that had issued this paper, helping to wreck the budgets of cities and transit authorities. That’s only one example of the many sorts of collateral damage that resulted from the remarkably lucrative subprime short bet.
And if you widen the frame, this country has been through a protracted and successful campaign to revise the social contract to favor capital over labor. You can see its success in the accelerating rise in income inequality, the lack of economic mobility, and the huge corporate profit share. Warren Buffet claimed that a level of over 6% of GDP wasn’t sustainable; depending on how you measure it, it’s currently at over 10%, some peg it as high as 12%. That rise in corporate profit share has come at the expense of employment and wage growth. The policy shift started under Carter, but the old model of having companies share the benefit of productivity gains and basing overall prosperity on wage growth was abandoned in the Reagan/Thatcher era for one that favored asset price growth and used rising levels of consumer leverage to mask stagnant wages. Druckenmiller was a huge backer of the politicians that promoted those programs. Yet he has the temerity to try to turn young people against ordinary folks in their 50s and 60s, most of which who never had any political influence, when he was a major sponsor of the very policies that have helped impoverish American youth. Perhaps Druckenmiller is making such an aggressive and public disinformation tour because he knows that if young people were to turn on the old, he’d be one of the most deserving targets for their vengeance.
