Point – Counterpoint

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Last week the New York Times published a thank-you letter from Warren Buffett to Uncle Sam. The letter expressed Buffet’s gratitude for the monetary and fiscal steps initiated and sustained to rescue the country from the economic and market collapses extending from 2007 to 2009. Although I have tremendous respect for Mr. Buffett, I disagree with his assessment that the government’s actions will ultimately prove beneficial. While they have rescued the economy and the markets from further imminent decline, they have done so at great cost, the consequences of which we can only dimly perceive today. Click here to review Warren Buffett’s letter. My opposing view follows.

Misguided, Even For Government
November 22, 2010

Dear Uncle Sam,

I know you’ve been busy rescuing many of the more prominent branches of the family from their own folly. And Cousin Ben and his friends apparently see an urgent need to continue to help. With so many matters still weighing heavily on your mind, I’m sure you appreciated Cousin Warren’s gracious thank you the other day. Although, to my regret, he and I have never met at family gatherings, I have enormous respect for Warren’s accomplishments and insights, and for his generosity in pledging his fortune to the betterment of mankind. He and I, however, value your rescue efforts quite differently.

No doubt, what you did in late-2008 kept our economy–floundering under an unmanageable debt burden–from collapsing into a full-fledged depression. You kept companies alive, kept millions of people employed and preserved trillions of dollars of securities value.

Unfortunately, we can’t know that these salutary results will last. Many of the underlying causes of the crisis remain, largely revolving around excessive leverage. And the rescue efforts to date and so far proposed have come at a massive cost. If consumer and investor confidence should once more wane, we could find the economy again at great risk of collapse. In any case, we will have firmly attached an anchor of debt around the ankles of future generations.

This introduces the question of morality into our deliberations. We tend to make our financial decisions without regard for moral consequences. The goal of policy-makers and financial professionals is typically to maximize return. It’s a numerical pursuit – far more quantitative than qualitative. The lack of a moral compass in the recent crisis, however, is becoming increasingly evident and burdensome.

Cousin Warren referred to having a pretty good seat as the crisis and rescue events unfolded. Sitting back in the Bob Uecker seats in the southwest corner of the arena, I had a far less precise view of the proceedings, but I could see the action. What became quickly apparent was that your financial commanders determined that the rescue could best be accomplished by throwing Grandma under the bus and bailing out the current working populace with money from future generations. It was easy to see that the primary beneficiaries were the majority of voters. Future generations obviously have no votes, and the elderly retired muster negligible lobbying pressure. The decision-makers clearly determined that rescuing us from problems of our generation’s creation was more important than the penalties we would apply to both earlier and subsequent generations.

Working with a great many retirees, I have an up close and personal appreciation for the damage done to this vulnerable segment of our family. Many of these seniors believed they had retired with a nestegg capable of supporting a reasonably comfortable lifestyle. The Fed’s zero-interest rate policy has eliminated their opportunity to earn any appreciable risk-free return. As recently as this week, NY Fed President Bill Dudley reaffirmed the Fed’s intention to “force” fixed income investors to deploy their assets in higher risk securities. There would be nothing wrong with that if the Fed could assure that such higher risks would never be realized. Unfortunately, that’s not possible. They are forcing these retirees, many of whom have no stomach for risk assumption, to do something uncomfortable and dangerous to earn a return. Should the Fed’s great gamble fail, who will make these people whole? Will you at least apologize? The prime beneficiaries of this great financial experiment might have the opportunity to rebuild their assets. Our elderly cousins will not.

You’re betting the ranch on a rescue effort with no guaranty of success, but with a certainty of future deleterious consequences. Many argue that you had no choice, that you had to do what you did. Letting the dominoes fall would very likely have introduced a depression with monumental pain felt around the world. Hundreds of millions of people with no responsibility for the problems would have suffered along with those who played an integral part in creating the crisis. Great pain would have been shared by huge numbers of otherwise innocent people who simply underestimated the consequences of excessive leverage and mean-reverting real estate prices.

Cousin Warren seems to condone the rescue effort, at least in large part, because a “mass delusion” confounded almost everyone. For example, “rapidly rising (real estate) prices…discredited the few skeptics who warned of trouble.” Should overt government action punish the skeptics who were right and who were waiting for lower prices that would logically result from forced selling by the overleveraged? If the overwhelming majority is deluded and wrong, is that justification for their rescue? Your rescue efforts, particularly the purchase of otherwise unmarketable mortgage-backed securities, compensated many miscreants and bad decision-makers rather than those who properly evaluated the growing risks.

That unfortunate rescue precedent had been set many times over many years. For decades you have felt compelled to bail out overleveraged bankers who failed to appreciate the dangers in their oil patch loans, their LDC (lesser developed countries) loans, their exposures in Mexico and Russia, their exposure to Long Term Capital Management, and most recently and most famously to virtually anyone who wanted to own real estate.

Although we had no dog in the fight back in 1998 when you rescued Long Term Capital Management, I marveled at the abrogation of free market principles, ostensibly because the financial system was in danger of collapse. I recoiled in horror at the thought that we could have been on the opposite side of the trade from LTCM, been right, and could have been handed huge losses when you coordinated an effort to rescue LTCM from its grievous market misjudgments.

While our clients did not lose because of your recent rescue efforts, neither were they compensated for what they sacrificed by not following lemming-like into higher yielding investments that ultimately failed but for your bailout. Correctly foreseeing upcoming problems simply consigned us to the lower returns available in safer securities. Perhaps we were naive not to recognize from your longstanding pattern that we should have ignored the risk and simply relied on your willingness to bail us out as well.

Your recent rescue effort sadly reinforces the lesson of the last few decades that investors should abandon intensive efforts to identify financial imprudence. It is more profitable simply to buy into the concept of momentum investing, especially if a trend is universally believed, because you will ultimately not let truly humongous errors damage the gullible multitude. The overriding lesson apparently is that it is acceptable to sacrifice true free market principles and penalize the foresighted minority for the common good. Isn’t that the essence of moral hazard?

Our family has proven that we lack the will to wean ourselves from the narcotic of financial rescue when our current well-being is significantly threatened. Pious words notwithstanding at the time of the rescue, we never quite find sufficiently effective solutions. Consequently, when the furor subsides, growing greed sows the seeds of the next financial debacle. Each new generation, sufficiently emboldened with the recollection of your willingness to bail, then forgive and forget, develops bigger and better methods of multiplying money before the next bubble bursts.

I’m afraid, kind uncle, that you are regularly conned into panicked belief by the self-interested financial industry that a failure to bail us out of whatever is the current horror of horrors will inevitably lead to a collapse too horrible to be imagined and endured. As a result, you bail and explain to the man and woman on the street that they couldn’t possibly understand the profoundly disastrous ramifications of inaction. Wall Street wins again and again. Moral hazard grows and grows. Even if we ultimately survive this crisis, tomorrow’s bubble promises to be even more extreme, imposing even greater damage on future generations, who had no responsibility for the problems you are trying to solve.

Uncomfortable as the immediate consequences could be, I strongly urge you to abandon the artificial–arguably immoral–support you are currently providing. The free market might penalize asset prices severely as excess leverage is unwound, but we will find a base and have a far sounder foundation for growth in the decades ahead. Our entire family will ultimately be far better served by the verdict of the free market than by your cadre of central planners.

Your discouraged nephew,

Tom

Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.