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Sunday, December 28, 2008

What's wrong with finance in America

I didn't plan to post today, but three things moved me to do so. The first was the amazing New York Times story about Washington Mutual's mortgage lending policies, which is yet another parallel to the stories of Madoff, Enron, and the Harvard endowment. The huge Washington Mutual operation, it turns out, did not even make a pretense of making sound loans to people who could pay them--they simply made as many loans as they possibly could. The whole story is evidence of the extent of the rot within our entire financial system, which, I am beginning to think, may have to rebuilt from the ground up like the city of New Orleans (not, I know, a reassuring analogy.) We are eventually going to discover, I think, that the whole recovery and boom of the second half of the Bush Administration was built entirely on sand.
The second was an article in the current New York Review of Books about how drug companies have managed to corrupt the process of trying out and approving new drugs. It does a great deal to explain why American health care is the most expensive in the world and why the expense does not translate into better health. It doesn't even mention, by the way, one of the biggest abuses of the system: the American decision (unique, I believe, in the industrialized world) to allow the advertisement of prescription drugs on television. But it will make it very difficult for readers to see their doctors the same way the next time that they visit them.
But my second stimulus was personal--I paid a charge bill that I received from one of our leading banks. It's a card that I don't use very often but I've switched to paying the bill online, and every time I do, I notice the same thing. After a (properly) rather complicated logging in procedure, one can click a link that shows the current balance (several hundred dollars in this case), with further links allowing one to either "view statements" or "pay bill." I naturally clicked "view statements" to see if I recognized the charges that added up to (let's say) $540.25, and I did. So I went back a page and clicked "pay bill." The new page came up with place to type in what I owed--but that space had a default amount in it. What was the default amount? Not $540.25--but $15.00, the monthly minimum. Nowhere on that page did my actual balance appear. To find that I had to go back a page again (since I hadn't committed the figure to memory.)And I did.
Now I hardly think that the software code that produced that result was an accident. Obviously the practice of inviting the customer to pay only the minimum indicates the bank's preference. Even now, with bankruptcies soaring all over the country and major banks (including theirs) drowning in bad debts, they want me and their other customers to go further into debt. That, as much as the stories in the Times and the New York Review, tells me how the United States got into the mess that it is in today.
Yesterday's post on the foreign scene appears below. Meanwhile, yesterday, in response to Hamas's decision a couple of weeks ago to halt the cease-fire with Israel, Israel has undertaken a huge military operation that has killed well over 200 people already. The renewed rocketing that followed the Hamas decision had not killed anyone, although a rocket fired yesterday (when Hamas retaliated in greater numbers) did kill one Israeli. The Israeli government has historically been proud of its tradition of disproportionate retaliation, but it seems to me neither moral nor, to date, effective. (And because I'm a consequentialist rather than an intentionalist, the latter point bothers me more than the former.)

Saturday, December 27, 2008

Legacies of error

It's a banner Christmas season for movies again, and for months I've been looking forward to Valkyrie, the Tom Cruise vehicle about the conspiracy to kill Hitler. While Hollywood's capacity to mangle history must never be underestimated, the subject is so extraordinary compelling that I am going to remain optimistic. (I never read reviews of something I want to see until I've seen it: I don't want to know anything in advance.) I couldn't make the film yesterday, but I decided to bone up on the subject matter again, and I walked to my local library (it's only two blocks away) and got out their copy of William L. Shirer's The Rise and Fall of the Third Reich.

I remember the arrival of that book via the Book-of-the-Month Club in 1961. I don't think my father ever opened it: he was too much a man of action to get into a book of a thousand pages. But I did within a couple of years, and it was one of the first works of serious history that I made my way through. I don't think I had opened it up in more than four decades and I was now amazed at how good it actually was. Shirer had really made an exhaustive study of the Nuremberg records, in particular, and he narrated the anti-Hitler conspiracy in extraordinary detail. Like most GIs, he wrote capably if not musically, and of course his subject provided more than enough drama.

Two things beyond the story itself (and the role of Count von Stauffenberg, whom Cruise is playing) stood out for me. The first was the bizarre nature of the Nazi regime, especially in its later stages when things were going badly. While it was certainly totalitarian in enforcing its views upon the average citizen and stifling dissent, its upper reaches were ruled by anarchy. The Army High Command in particular was never really loyal to Hitler. Dozens of generals were involved in the conspiracy and many more generals and field marshals knew about it and kept their mouths shut even though they refused to participate. The security services, led by Heinrich Himmler, had inevitably gotten some word of what was going on, but Himmler himself by 1943-4 was thinking about eventually making peace with the allies after Hitler's disappearance, and that may have made him less aggressive than he might have been about taking action. (Himmler actually tried to implement that plan in the last days of the war and was shocked to find that the allies were not interested.) Like certain other governments, the Nazi regime ran on the personal favor of the man at the top, and like certain other heads of state, Hitler was too lazy to pay close attention to what was actually happening in many spheres. He had also alienated the military by cashiering literally hundreds of generals (many of which he eventually brought back.)
Although the conspirators were courageous men, their anti-Nazi zeal, it must be said, waxed and waned along with the fortunes of war. They were quite active during the winter of 1939-40, before the attack on France, which they did not expect to succeed, but after France fell they apparently basked in the glow of victory and did not really revive their activities until late 1941, when Soviet Russia had refused to fall and the United States had joined the war. Even then it took more than a year for them to become serious. The conspiracy included quite a few high civil servants and some churchmen (both Protestant and Catholic) and professors, as well as a few former trade union leaders, intelligence officers, and, as noted, Army officers. Many of them were old enough to remember the results of the defeat of 1918--including, eventually, Hitler's rise--and their goal in 1942-3 was a new government that could negotiate peace at least in the West. Some actually hoped to continue fighting the Soviets and many hoped to keep some of Hitler's territorial gains in the East. They decided rather early on that Hitler had to be assassinated but initially discovered that that would be no easy job. Not only was he well guarded, but he never stayed in one place very long and constantly altered his movements. On one occasion a conspirator entered a room with a delayed-action bomb similar to the one Stauffenberg used, only to find that Hitler was only going to be there for a few minutes, not half an hour. He had to abort the plan.
Another aspect of the story caught my eye, however, because of its contemporary relevance. Nearly until the last minute some conspirators feared that the assassination of Hitler, followed by peace on any available terms with the allies (who had made it known through some covert contacts that they were not interested in peace with anyone in Germany), would create another "stab-in-the-back" legend like the one that had grown up after 1918, when a democratic revolutionary government had been forced to make a disastrous peace. As it turned out, various delays prevented the execution of the plot until about seven weeks after the Normandy invasion, when Germany was on the point of being driven out of France and the Soviets were also in the midst of their greatest offensive to date. By then the conspirators realized that their plans for peace were almost certain to fail, but their leaders decided that it didn't matter. The assassination of Hitler had become a matter of German honor.
What struck me about this, not for the first time, was how one single mistake, one terrible, fateful decision, can reverberate through history for many decades. In Germany's case that mistake had occurred in July 1914, when most (not all) of the German leadership had convinced itself that the time was ripe for a trial of strength between Germany and Austria-Hungary on the one hand and Russia, France, and possibly even Britain on the other. The real source of the July crisis was Balkan nationalism--the Serbian desire to destroy Austria-Hungary, which had led to the Archduke Franz Ferdinand's assassination--but Berlin's decision to force a confrontation led to the world war. When no quick victory occurred, the German government had to tell itself and its people that the war had been forced upon it. The imperial government chose not to take advantage of President Wilson's attempts to mediate a peace in 1916-7--attempts which, I have found, were more bitterly resented by the British than by the Germans--and instead decided on unrestricted submarine warfare and brought the United States into the war in 1917. It waited until the German Army was collapsing to take up Wilson's offer, and by then it was far too late to get a genuine peace of understanding that would have preserved the authority of the German government. The Versailles Treaty and the economic chaos of the 1920s--hyperinflation, followed by a brief recovery, followed by a depression--became new excuses to blame the leaders of the Weimar Republic and the allies for Germany's problems. The war guilt clause of the Versailles Treaty, meanwhile, led the new government to sponsor a whole academic industry designed to prove (falsely) that Germany had not started the war and therefore did not deserve to pay reparations.
Now the Bush Administration's policies in the Middle East have also been catastrophic, as a review in the current New York Review of Books points out. Thanks in large part to the Atlantic and Pacific Oceans the United States can still afford such mistakes and survive, but I am afraid that that miscalculation, like the German one in 1914, may poison our politics for a long time. The decisions to invade Iraq, to interrupt the peace process in the Middle East, and to insist on Palestinian elections discredited the US around the world and strengthened our enemies in the region. The decision to remove the government of Afghanistan has contributed to the destablization of nuclear-armed Pakistan. Much of the American people, I think, realizes that these decisions--especially the Iraq war--were mistaken. That has not however prevented the Bush Administration, including Secretary Gates (who will continue in office), from laying a basis for a long-term Amerian presence in Iraq, and President Obama is on record favoring a larger effort in Afghanistan. Bad policy, in short, may have been institutionalized already. But even if the new President does reverse course on some of these fronts--as I hope he will--both the Republican Party and a good deal of the foreign policy establishment will call him an appeaser and blame any further problems on a failure to stick with Bush's policies.
Despite the drop in violence in Iraq, much evidence suggests that the situation there will deteriorate again as American troops withdraw. Nothing has happened to indicate any real interest in national reconciliation among the Sunnis, Shi'ites and Kurds, and the new round of provincial elections, like those in 2005, are almost certain to harden ethnic lines and re-open conflicts in disputed areas. Meanwhile, the situation in Afghanistan is deteriorating, and Pakistan and India are on the brink of war after Mumbai. (In a clever fantasy op-ed a few weeks ago Richard Clarke, the Clinton Administration's terrorism czar, suggested that the perpetrators of the Mumbai attack counted on it to renew tensions with India and force the Pakistani Army to move troops from Pakistan's western border to its eastern one. Today's papers report that those movements are now taking place, making it easier for the Taliban (which the Pakistani government has always wanted in power in Afghanistan anyway) to operate freely in the tribal areas. On another front, a New York Times article last week talked about the popularity of militant Islam among the young people of Jordan--until now our most reliable and pro-western ally in the Middle East.
A couple of weeks ago I heard Robert Baer, the former CIA agent whose first book was the basis for the movie Syriana, argue that the United States had to give up the idea of transforming the Muslim world. I could not agree more, but I do not know whether that idea will have much traction even within the new Administration. But I think much depends upon our ability to face this reality. If we continue to go further down that path in an attempt to justify our initial mistake, the consequences could eventually become much more serious, even if they never do quite approach the consequences for Germany of the error of July 1914.

Saturday, December 20, 2008

Holiday Miscellany

This week I got around to reading Michael Dobbs's book, One Minute to Midnight, on the Cuban Missile Crisis. A Washington Post reporter who had previously written a sensible book on the collapse of the Soviet Union, Dodd did some serious archival research--particularly in military records--and interviewed various surviving Soviet and American participants. His portrait of Nikita Khrushchev seemed to me a little more favorable than was justified by the story he had to tell, while his portrait of John F. Kennedy, while it was rather slow getting started, eventually recognized the President's critical contribution to the resolution of the crisis. Like many journalists who write history, he mixed original sources and anecdotes that have appeared in various more or less responsible books more than I would have liked, but without doing any serious damage to history. But his major contributions came from the realm of military history, and showed that the whole situation was far, far more dangerous than we have ever known before.
The Soviet decision to build up in Cuba was evidently made without careful planning, and inevitably encountered tremendous obstacles. Cuba was mountainous, tropical, and possessed of a most primitive road net, making the movement of Soviet heavy equipment--including missiles--a most hazardous proposition. (Two Soviet soldiers died in an accident while moving a nuclear-armed cruise missile at the height of the crisis.) The Soviets were even less prepared from a naval point of view, and the crews of four submarines suffered from almost unbearable heat, lack of water, and high carbon dioxide levels during a cruise to the Caribbean for which they simply had never been designed. Communications between Cuba and the Soviet Union were also poor, enabling a Soviet air defense unit to shoot down an American U-2 on Saturday, October 27--the blackest day of the crisis--without any authorization from Moscow. But despite all that, the Soviet threat during the crisis was much worse than we had believed. A significant number of Soviet medium-range missiles with one-megaton warheads were in fact ready to fire by the end of the week. More importantly, the Soviets, as one of their generals revealed in a conference in the early 1990s, had tactical nuclear weapons in Cuba. One--a V-1 style cruise missile composed of the fuselage of a Soviet fighter plane with a nuclear bomb inside--was targeted on the Guantanamo naval base and ready to go at the height of the crisis. Others could have struck the US invasion fleet. And at another point late in the crisis, a Soviet submarine captain, ceaselessly harassed by a flotilla of US warships that had located and surrounded him, made ready to fire his nuclear-armed torpedo (shades of that classic Cold War movie, The Bedford Incident at one of his tormentors. At the time he had no idea whether nuclear war might have already broken out.
Khrushchev flirted with disaster by setting this mad enterprise in motion, but he turns out to have been rather more cautious in his handling of the crisis than we ever knew. Dobbs's biggest revelation relates to Wednesday, October 24, the day when, as every American account of the crisis has emphasized, the ExCom (the American leadership) discovered that Soviet ships had turned back rather than face the American "quarantine," or blockade, that we had counted on (wrongly as it turned out) to prevent the Soviet missiles from becoming operational. That was when the ExCom realized the Soviets had "blinked," but Dobbs found conclusive evidence that Khrushchev had in fact made that decision much earlier. The Soviet ships had begun turning back sometime on Tuesday, less than 24 hours after Kennedy announced the quarantine to the world on television on Monday evening. Dobbs couldn't find any Soviet documentation about the actual Soviet decision--Russian archives have never been as open as American ones, and they have been rapidly closing again in the Putin era--and thus he could not date it. But thinking the matter over, it seems to me almost impossible that Khrushchev could have reacted that quickly to Kennedy's speech, which took place early on Tuesday morning in Moscow. The decision to turn back, I suspect, had been made even earlier, in response either to the obvious movement of American ships and troops or to the rumors that were sweeping Washington of an impending strike against Cuba. (My family and I were living in Senegal at that time, and we heard those rumors from another American Ambassador, William Attwood, who was returning to Guinea from Washington on the weekend before the crisis broke.)
The American military, meanwhile, was preparing for war, including general war with the Soviet Union. (Preparation was not confined to the military either. During my research for The Road to Dallas an FBI agent confirmed something Carl Bernstein had discovered writing his biography of his Communist parents: the FBI during the week of the missile crisis was preparing to detain those Americans listed on its "Security Index," a list of subversives thought too dangerous to leave at large in wartime.) General Thomas Power, the commander of hte Stratetic Air Command, did not, as the movie Thirteen Days claimed, go from DEFCON 3 to DEFCON 2--one step short of war--on his own authority, but he did decide to broadcast the decision in an uncoded radio message to make sure the Soviets got it. He also sent B-52s on their way to the Soviet Union late in the week, fully loaded with nuclear weapons. By Saturday, the 27th, the Joint Chiefs had a commitment to begin bombing Cuba on the following Tuesday (they were very angry that the date had not been set for Monday instead), with an invasion to follow a full seven days later. (It would hard to imagine a plan more certain to lead to Soviet retaliation i the world during that week.) It was in the midst of all this that an American U-2 pilot, flying to the North Pole from Alaska to collect data on Soviet nuclear tests in the Arctic, took a wrong turn and found himself over the northeast corner of the Soviet Union with Soviet jets frantically trying to reach and destroy him. He miraculously managed to glide back to Alaska for an emergency landing. Dobbs tells his story for the first time.
After his initial retreat, Khrushchev apparently began thinking about how and when to agree to withdraw Soviet missiles. He was however apparently encouraged on Thursday by a famous Walter Lippmann column suggesting the trade of U.S. Jupiter missiles in Turkey for the ones in Cuba. (Dobbs never mentions that Kennedy had actually predicted such an outcome several weeks before the crisis began in a high-level meeting.) That led him to up his terms on Saturday, demanding such an American withdrawal as well as an American pledge not to invade Cuba. Kennedy, several jumps ahead of Khrushchev on this point (as he frequently was ahead of all the rest of the best and brightest in their deliberations), argued for such a trade in an all-day Excom meeting on Saturday but did not establish anything like a consensus. The Excom drafted, and then publicly released, a letter to Khrushchev that merely promised to discuss "other armaments" once Khrushchev had agreed to withdraw his missiles and end the crisis. Then, as McGeorge Bundy was first to report,he convened an even smaller meeting of Bundy, McNamara, Rusk, RFK, Sorensen, and one or two others, and decided that Robert Kennedy would offer the trade to Ambassador Dobrynin, provided that it remain covert, in a last desperate try to avert war.
RFK's promise, however, seems to have played a marginal, not a critical, role in the resolution of the crisis. Khrushchev, Dobbs discovered, was already declaring his intention to give in to the Presidium on the afternoon of Sunday, October 28, Moscow time (around the time of dawn in Washington), when Dobrynin's cable recounting the conversation arrived. But only minutes later, another frightening report arrived: that Kennedy would go on television at 9:00 AM Washington time, or 4:00 PM Moscow time--quite possibly to announce the beginning of war. It was at that very moment that a Soviet announcer broadcast Khrushchev's letter agreeing to withdraw the missiles in return for a no-invasion pledge. But the report of Kennedy's speech was false. A Soviet operative in the US had misinterpreted one network's announcement that it was going to rebroadcast Kennedy's Monday evening speech at that time. When Kennedy accepted Khrushchev's offer, Air Force Chief of Staff Curtis LeMay pronounced the outcome the greatest defeat in American history and called for an attack the next day.
Although Dobbs seldom misses an opportunity to mention Kennedy's medical and sexual problems or to quote him in the earthiest possible language, in the end he acknowledges his critical role. Alone among the senior leaders of his Administration, he realized that no military outcome of the crisis could be a good one for the United States, given the likelihood that the Soviets would retaliate either against Turkey or against helpless West Berlin. And all Dobbs's new military data confirms Kennedy's greatest fear throughout, that the military of either side could easily trigger a war that the political leaders wanted to avoid, and that the war would never develop according to plan. Dobbs does not seem to realize, however, that the Administration had essentially abandoned the no-invasion pledge within a few months. By April 1963, as I showed in The Road to Dallas, they were busily planning Castro's overthrow again, projecting an American invasion as soon as the CIA had figured out how to bring about a coup or civil disturbance big enough to allow the United States to claim that order in Cuba had broken down. (Even Castro's assassination, which the CIA was still trying to arrange, could have served as an adequate pretext.) Only after Kennedy's own assassination did such plans come to an end. (On p. 341, Dobbs states that Kennedy's assassin "had been acive in a left-wing protest group that called itself 'Fair Play for Cuba." Readers of The Road to Dallas know that that is a very misleading characterization. Oswald never met a single actual member of the FPCC, and its New York chairman stopped writing to Oswald after he quickly emerged as a loose cannon who would not conform to committee procedures. The FPCC chairman, like the Communist party leaders to whom Oswald also wrote, sized him up as an agent provocateur, and I concluded, based on a great deal of evidence, that they were right.) We had only one John F. Kennedy as President, but that turned out to be enough. Only once, in 1983, did the two sides ever come anywhere near as close to war again. That crisis, at the time of NATO's Abel-Archer exercise, is known only to a few specialists, and only in outline. Now the Indians and Pakistanis are challenged by the need to escape from a similar nuclear-armed predicament.

Most of the Obama cabinet has now been chosen. It suggests that the new Administration will be more innovative and ambitious at home than abroad. Hillary Clinton, Robert Gates, and National Security Adviser designate James Jones are establishment choices, and the President himself will have to provide the impetus for any basic shifts in our foreign policy. I still hope that he will. The cabinet marks the breakthrough of Generation X into our national leadership. In addition to the President himself, 7 of the 21 cabinet and high White House officials announced to date were born in 1961 or later, led by Treasury Secretary Tim Geithner. 7 of them are also women. Veterans Affairs choice Eric Shinseki, an exact contemporary of Joe Biden, represents the Silent generation, and most of the Boomers are from the mid- to late 1940s. Curiously, my own 1947 cohort is well represented by Hillary Clinton, Bill Richardson, and Tom Daschle, but there is no one from 1946, the year that gave us Bill Clinton and George W. Bush. We can all agree, perhaps, that they have had their day. . . .

The Harvard Crimson reported yesterday that the five top officials of Harvard Management, the team that manages the endowment, received salary and (mostly) bonuses amounting to $22 million in the fiscal year that ended last June 30. In the following four months the endowment lost $8 billion in value, as I discussed two weeks ago. I have contacted some classmates about registering a protest once again.

Happy winter solstice to all.

Wednesday, December 17, 2008

Publication of "History Unfolding, 2004-2008"

History Unfolding: Crisis and Rebirth in American Life, 2004-2008 has now been published and is available here. It includes most of the posts of the last four years and I hope it will be widely read and widely linked. It would not have appeared without the encouragement of the many regular readers here. Here are some pre-publication comments. Happy Holidays!

"Whether as truth-teller or truth-seeker, David Kaiser is principled, fierce, and relentless. This collection of his reflections is cause for great celebration."
Andrew J. Bacevich, author, The Limits of Power: The End of American Exceptionalism

"These are profound assessments of our immediate past by a brilliant liberal commentator. Kaiser is a famous historian writing here in the great tradition of the engaged public intellectual. Here is a record of our times, written as ‘history unfolds.’ This is Kaiser at his best, blending perspective and occasion with acute insight, broad perspective, and clear thinking. He reminds us of who, and where, the country is today."
George W. Baer, author, One Hundred Years of Sea Power


History Unfolding is a rare treat. It brings to the discussion of foreign affairs, and domestic politics too, all the virtues we have come to expect from David Kaiser’s splendid books: lucidity, clarity of expression, and a capacious knowledge. But History Unfolding provides something even more vital: a passionate engagement with the affairs of the day that is ever tempered by Kaiser’s thoughtful sensibility, taste for nuance, and his old school respect for—dare I say it—the facts.”
Jonathan Rieder, author, The Word of the Lord is Upon Me

As a new president confronts grave challenges at home and abroad,and pundits proclaim a thousand medicines, thank goodness for the calm, reflective pen of a historian like David Kaiser: able and willing to set the present within the context of the known past. Kaiser is like Alistair Cook: engaged, experienced, enlightened - willing to explore today, what other historians won't dare to say until tomorrow."
Nigel Hamilton, author, Bill Clinton: Mastering the Presidency

Saturday, December 13, 2008

How the village went broke

Many years ago I read a reference to a hypothetical economics problem--a Chinese village in which all the inhabitants made their living by taking in one another's washing. I just did a google search to try to find a complete version of it but came up empty, and therefore must try to work it out for myself. The idea always struck me as a reductio ad absurdum, that is, a logical exercise culminating in an absurdity, and thus refuting the original premise--in this case, that such a thing was possible. The problem, it seemed to me, was that washing was a luxury, not a necessity. If everyone was doing nothing but one another's washing, their per capita income would equal the cost of doing their own washing, and thus they would have no money for food, shelter, or even the original clothing to wash. Such a village, on the assumption that it was a self-contained, autarkic economic unit, would in reality have to grow its own food. The laundry owner, like the blacksmith, the carpenter, and everyone else who did not work the land, would have to buy food; that it turn would give the farmers the money they needed for the services of those tradesmen. And if the village were not totally self-contained, surplus food could be sold elsewhere, allowing everyone, eventually, to get a little richer and afford more services, including perhaps an occasional concert by a traveling pianist or a barnstorming sports team. But it seemed to me then, and it still does, that any sound economic structure had to rest at bottom on the production and sale of life's necessities. No village that did not produce some of them could survive on its own.
Yet it has occurred to me over the years that the American economy has been coming closer and closer to that mythical Chinese village. Laundering is a service, and we increasingly have a service economy. But critically, in the last few decades, we have taken yet another big step down the road to perdition. The purchases of goods and services that make the economy grow have increasingly been financed not (in the first instance) from the production and sale of necessities, much less from the sale of necessities to other villages, that is, in the real world, to other countries. Instead, from the top of the economy to the bottom, they have been financed by ever-expanding debt--by the creation, in effect, of new money. In principle that is nothing new. The expansion of the money supply began in the early modern period when the first banks began issuing new credit instruments which, they believed, the acquisition and sale at profit of new goods (such as products from foreign lands) would enable their borrowers to repay with interest. But as everyone gradually came to understand, that kind of expansion of credit and money had to keep pace with the expansion of actual production. If credit expanded much more rapidly than productive capacity, then eventually large numbers of creditors would be unable to pay their debts, banks would fail, and panic would result. The great panics of 1929-33 led to a sustained effort to regulate both the expansion and contraction of credit and the issuance of securities so as to avoid anything similar ever happening again--and that effort succeeded quite well for as long as men and women old enough to remember 1929-32 still exercised power and responsibility and cast large numbers of votes at the ballot box.
It is a cliche, but nonetheless a true one: the United States, at every level, has been living beyond its means. Sometime in the last ten years, I believe, our national savings rate fell below zero, and that despite the conributions that so many wage-earners make into various forms of IRAs. Hundreds of thousands, perphaps millions, of Americans hold maxed out credit cards. Hundreds of thousands of students have taken out tens of thousands of dollars of loans. All that, however, turns out to be chump change compared to the millions--perhaps trillions--of debt incurred by financial institutions as leveraging money to finance enormous transactions and continually inflate the prices of various kinds of securities. The expansion of debt has driven the expansion of income at the highest level of our society--and that, as we all know, as been where the greatest expansion of income has taken place, especially in the last eight years.
Imagine, in short, a Chinese village composed entirely of laundries that also has a bank. Somehow--perhaps through deals with banks in a neighboring village--that bank borrows money with which it buys futures on the profits of all the laundries from the laundries themselves. The sale of the futures allows the villagers to buy the food and services they need from neighboring countries. And because the whole world is flooded with credit, the local bank in turn can turn those futures into long-term securities and sell them to some one else. That, it seems to me, is how the American economy has been running for some time. We haven't been producing very much that the rest of the world needs to buy from us for quite a while, but as long as ever-flowing credit kept our service economy going and our financial giants profitable, we didn't care. But suddenly this bubble--which I think is certain to turn out to dwarf any bubble in human history--has inevitably burst. Huge financial institutions are failing right and left, university endowments (who have used a lot of leverage themselves) are dramatically eroding (see last week), and at some point, I predict, credit card terms are going to have to get much, much tougher.
I cannot be sure of my next point, but it seems to me that all this may make recovery considerably harder than it was--or than it could have been--during the great depression. Fiscal stimulus created a partial recovery from 1933 to 1936, but unfortunately, fiscal retrenchment led to a severe recession in 1937-8, and only war and vastly expanded production really got us out of the depression. (Paul Krugman, citing an older authority, recently argued that the New Deal actually provided only a very limited fiscal stimulus.) But in the 1930s the United States was awash in productive capacity in both agriculture and industry--and still protected by substantial tariffs. The problem was simply to get income into the hands of consumers who would buy farm and industrial produce. The problem now looks harder to me because we have given up much of that productive capacity (and the Republicans in Congress, apparently, would like to give up even more in Detroit). Money to buy goods has largely gone out of the country, and it has come back to buy American financial instruments that have now lost most, or all, of their value. We may need, literally, a new financial industry run on completely new principles, and I don't know where it's going to come from.
Nor is that the only problem. Economists from the 1930s through the 1970s seemed to grasp that a healthy economy depended on higher incomes for the mass of the people to allow them to increase demand for both goods and services. In the 1980s supply-side economics argued that allowing the rich to keep more money would fuel investment and expand production. Instead, we now know, it fueled irresponsible investment in assets that have turned out in the end to be worthless. American firms, which in the 1950s and 1960s focused on hiring more workers, now try to use as few workers as possible. That has created short-term increases in profit but long-term economic catastrophe.
Getting out of this will require sustained concentration, analysis, courage, and patience--exactly the qualities that, I would argue, have gone out of fashion in the last few decades, not least in my own academic profession. The Obama Administration will need to devise plans and they will take years to work. Barack Obama clearly has the rhetorical skills to sustain public confidence for some time, but it will challenge him to keep it going long enough. For younger generations, however, this is both a very difficult time to reach adulthood, and a time of great practical challenges. The Boomers had the opportunity to raise the nation's consciousness, and they did. The Gen Xers and Millennials must now address serious, concrete problems, and that, for them and for the country, will be just as important and just as satisfying, if they can do it. Tomorrow, if time permits, I will say something about our prospects in foreign affairs.

Saturday, December 06, 2008

Financial brilliance?

About five years ago, as I recall, I had an interesting conversation with my friend and Harvard classmate Bill Strauss, who had heard some interesting gossip about our alma mater. It concerned the management of the Harvard endowment. Because the endowment managers--most of them, anyway--were employees of a non-profit, Harvard had to disclose their compensation. Their compensation, like that of most fund managers, was based upon the performance of the part of the multi-billion dollar endowment which they controlled. Putting all that together with the easy money of the first half of this decade had produced striking results. Inidividual managers were receiving bonuses of up to $30 million in a single year. Bill Straus, who sadly died of cancer about a year ago, had an odd mixture of views: he was a social conservative but an economic liberal who believed that the endowment of a university was supposed to benefit the university community, not the men and women who managed it. He was particularly outraged because these bonuses--which, he calculated, would have paid the tuition and fees of an entire Harvard class for one year--were being paid while tuition consistently increased an annual 3-4%. He suggested that we start a protest, and we did. Initially a total of seven classmates joined in: a writer and entertainer (Strauss) two attorneys (both of whom worked thousands of miles from Wall Street), a journalist, a freelance writer who was in the process of becoming a clergyman, and two academics (including myself.) In a series of letters addressed to Harvard President Larry Sumemrs, we made a number of suggestions: that the compensation of any Harvard employee be limited to what the President of the University made (about $750,000); that tuition be frozen and eventually cut back, so that today's students (who were paying more than three times as much for their education, adjusted for inflation, as we did) would not have to begin their careers with a large burden of debt; and that Harvard establish a program of loan forgiveness for students who went into some form of public service. Our campaign immediately attracted significant publicity, and the reaction we received was quite revealing.
President Summers, an economist and former Treasury Secretary, never signed his name to a reply to any of our letters, but he spoke to use directly at our 35th reunion in 2004 and told us that we were "deeply misguided." The performance of the endowment managers had been spectacular, he said, and they deserved every bit of their reward. I heard equally patronizing reactions from every financial professional with whom I discussed the issue over the coming months. "Those guys are oustanding," I remember an investment banker telling me in the gondola at Stowe, "and they should get every penny they want." Michael Lewis, the author of Lia'rs Poker, wrote an extremely patronizing column about us when Summers began to show some signs of taking us seriously, arguing that our dubious moral outrage was having an influence even on those who actually "understand how the money game is played." I heard however that at least one of Summers' associates in the financial world--a veteran of one of New York's leading investment banks--had expressed private agreement with us that the fund managers were being exhorbitantly compensated, and eventually some action was taken. Jack Meyer, the chief endowment manager, and several of his colleagues left the employ of Harvard to start their own hedge funds. They apparently remained the managers of a good deal of the endowment, however, under financial terms which no longer had to be disclosed. Meanwhile, in the last three years (during which Summers also stepped down for a variety of accumulated reasons), some real steps were taken. A new manager was appointed at a much lower salary (but continued to show excellent results through 2007), and Harvard announced a new financial aid policy designed to reduce tuition and fees to a much more reasonable proportion of family income. We were very pleased by that.
All the while, however, I personally had been troubled by another aspect of the situation. While not a financial professional, I had done what I could to study the publicly available financial accounts of Harvard to try to estimate the benefits that the university was reaping from the reported enormous increases in the endowment. Without being able to review the data now, I can report that I could not find commensurate benefits in the figures. The endowment was said to be growing by leaps and bounds, but from what I could tell the proportion of the university budget which income from it was funding was not increasing nearly as much. I tried to get more of an explanation from Harvard financial officers but never succeeded (at one point I received a set of figures that did not seem to be consistent with the official published documents.)
What I was wondering was whether the gains would in the long run turn out to be genuine. As was frequently explained to us, the managers were running the endowment like a hedge fund, leveraging its substantial cash with other people's money to buy some highly speculative assets. The compensation for the managers, moreover, depended on the annual increase in the estimated value of those assets, not, apparently, on the amount of increased income they provided in the short term. That seemed to me to be an invitation to value assets as highly as possible, and to put short-term growth ahead of long-term income--exactly the opposite, one should think, of a strategy more appropriate to a university. I suggested to my co-protesters that we raise these issues as well but I never could persuade them to do so. I did read in the last two years, however, that two of the hedge funds started by former endowment managers had now collapsed.
On Thursday, walking through the Providence airport, I noticed the front page of the Wall Street Journal and saw that the other shoe had dropped. The Harvard endowment had lost at least 22% of its value during the first four months of 2008. That loss amounted to $8 billion, dropping the total to $36.9 bilion. "Harvard," the story continued, "said that the actual loss could be even higher, once it factors in declines in hard-to-value assets such as real estate and private equity--investments that have been increasingly popular colleges. [Harvard's new, aggressive endowment management strategy, the article indicated, had been widely imitated.]" The University anticipated a 30% decline for the fiscal year ending in July 2009. That means that the gains of 2005-7 would be completely wiped out, and I frankly doubt that the hemmorhage will stop there. The story added that Harvard has been trying to sell $1.5 billion in private equity holdings but that it had received bids amounting to only $.50 on the dollar. Eventually even those might look pretty good.
It was in the early 1990s that my contemporary Camille Paglia wrote a brilliant essay, "Junk Bonds and Corporate Raiders: Academia in the Hour of the Wolf." She used those words as a metaphor, to describe the takeover of university humanities departments by postmodernists selling increasingly popular intellectual snake oil. Now, however, the same title could be applied to what has happened to the financial resources of our greatest universities. Like their counterparts in the academic departments, the (mostly Boomer) managers of the endowment showed extraordinary cleverless, but an utter absence of wisdom. They turn out not to be the financial geniuses that so many people assured me that they were, but rather the modern equivalent of what Keynes called "sound bankers"--not bankers who were never ruined, but bankers who were ruined along with all the others. The increasingly popular financial practices of the last 35 years have now brought down the American economy--and have brought down the financial health of most American universities along with it.
I can't help expressing a little pride in my own very modest contribution to the economic health of my alma mater. I am not referring to contributions--I gave token ones in the past but stopped doing so in response to the current controversy. What I have done is to publish three successful books for the Harvard University Press. They were not the literary equivalent of sub-prime derivatives or private equity funds--those would be the celebirty-authored books that fill the best-seller lists, and which are bought far more often than they are actually read. They were, I like to think, carefully crafted products of some general interest for which I was modestly compensated, and which made modest, real sums of money for the press through sales to people who wanted to read them. It is now the task of the younger generation to put real money into investments like that--and to create new economic insitutions, I suspect, that will make more investments like that possible, and make stocks and bonds issued by productive corporations, rather than mysterious financial instruments, the investments of choice once again.

Stereo 411