Vern McKinley

Vern McKinley is the author of Financing Failure: A Century of Bailouts (Independent Institute, 2012).

A Bright Shining Failure

Mortgage

Timothy Howard’s The Mortgage Wars focuses on his unique perspective on the lead-up to the financial crisis. He is not a high-profile personality like former Treasury Secretaries Geithner or Paulson or Chairman Bair of the FDIC, as most people probably are unfamiliar with him. From his position as a former chief financial officer of Fannie Mae with decades of experience in senior management there, he certainly has much technical knowledge to share about the buildup of Fannie Mae to its status as a mega financial institution and then its spectacular crash landing in September 2008 when it was placed under government control and into conservatorship by its regulator, the Federal Housing Finance Agency (FHFA) (backstopped by hundreds of billions of dollars of federal funding). It has been nearly six years since that meltdown, but due to pending legal cases against Howard for alleged questionable financial accounting and reporting, which were ultimately dismissed in October 2012, he can only now reveal his perspective on these issues.

The book’s title, The Mortgage Wars, refers to the conflict between Fannie Mae and Freddie Mac and those who tried to reign in the legislative advantages granted to these so-called government sponsored enterprises (GSEs). Howard sets the tone early in the book in Chapter two that his side is fighting the good fight for homeowners:

The mortgage fight was rooted in a fundamental disagreement over the role of government in housing. Supporters of the [GSEs], Fannie Mae and Freddie Mac, argued that housing was sufficiently important to society that the government should sponsor special-purpose institutions to provide low-cost financing to home buyers on an advantaged basis. The GSEs’ opponents argued that their activities distorted capital flows and subjected taxpayers to unnecessary financial risk. The disagreement was ideological, but what fueled it was money. At issue was whether the GSEs or fully private firms—principally commercial banks and bank-owned mortgage companies—should be allowed to control the largest single credit market in the world.

Howard criticizes the opponents of the GSEs by referencing their “unprecedented disinformation campaign carried out through the media…to convince opinion leaders, policy makers, and the general public that the two GSEs were dangerously risky companies that were able to maintain their positions of market prominence only because of bare-knuckled lobbying prowess.” He does this without placing equivalent scrutiny on the hardball tactics and distortions of Fannie Mae over the same period, instead choosing to put it in the best light noting that “Fannie Mae was providing record amounts of low-cost, fixed rate financing to home buyers at minimal risk to taxpayers.”

So what was this war over? Howard traces how, before its nationalization, Fannie Mae was granted a special, quasi-government status that was constructed over the course of decades beginning in the 1930s. The most important aspect of this special status is that it ultimately led to the markets’ perception that the GSEs would be backstopped by the government if they ever approached failure (which they ultimately were in 2008). As a result, Fannie benefited from a capacity to borrow at rates that were lower than what they would pay absent this special status (and thus pass some of this benefit on to borrowers), giving them enormous market power, essentially a duopoly with its sister agency Freddie Mac.

In chronicling the changes at Fannie Mae, Howard reveals how it became famous for its high-profile management team that fought the necessary political battles to maintain this privileged status. He narrates how this really started with the appointment of Jim Johnson in 1991, former executive assistant to and campaign manager for Vice President Mondale. Johnson led the firm as “Fannie Mae catapulted to a position of prominence in the mortgage finance system while building a broad and bipartisan base of support in Congress….” Johnson hired “well-connected and experienced people to work in [Fannie’s] legal, government affairs, regulatory policy and public relations areas…” Similarly Frank Raines, who Howard also profiles in the book, rotated between senior positions in the Carter Administration, then as Vice Chairman of Fannie Mae, then as President Clinton’s Director of the Office of Management and Budget, and then finally as Chairman of Fannie Mae.

In contrast, Howard is not a typical revolving door Washington agent maneuvering between various senior positions at Fannie Mae and senior presidential administrative positions in order to leverage his political acumen for the benefit of this massive institution. As he details the story of Fannie Mae in parallel with his own career, he tells how he spent over 20 years at Fannie Mae, working in the trenches on the key risk management, financial policy and accounting issues for the firm, ultimately becoming its chief financial officer. He is in fact such a financial technician that some people may bore of the details of his descriptions, such as his comprehensive thoughts regarding Financial Accounting Statement 133, which addresses accounting for derivatives.

Howard is obviously biased in his views and cannot be considered an objective observer of the events he describes throughout the book. He also displays an extreme case of resentment against the FHFA’s predecessor agency, Office of Federal Housing Enterprise Oversight (OFHEO), given that they brought a lawsuit against him claiming that he intentionally and fraudulently misstated Fannie Mae’s financial results regarding accounting for derivatives and amortizing of mortgage assets. These charges caused him tremendous personal angst, which is obvious in his description of the ‘politicization’ of decision-making on housing matters and in particular the decisions by Armando Falcon, OFHEO’s director, whose accusations were at the core of this line of cases. Howard notes that prior to the dismissal of the cases and the writing of his book he was advised by his personal counsel not to speak publicly about his experience given the pending lawsuits.

What are to me the most interesting chapters of the book are those focused on the accusations by OFHEO that Howard and others intentionally and fraudulently filed financial reports on behalf of Fannie Mae. No one that I am aware of has publicly told this story before and a great many lessons can be drawn from it. Howard tells of his initial reaction that he was “confident we would acquit ourselves well” of the accusations. He details that Falcon who was caught off-guard when Freddie Mac, prior to Fannie Mae, was found to have accounting, internal control and reporting irregularities for the years 1999 to 2002, which was followed by a dramatic management shake-up. Falcon first ordered a special examination of Freddie Mac and then he turned his focus to a similar examination of Fannie Mae, what Howard calls Falcon’s “path to redemption” after missing the signs of the problems at Freddie Mac.

In his initial statement, Falcon clearly telegraphed that his desired outcome for the probe would be restatement of prior period results, all before the examination even began. Howard also alleges that Falcon regularly leaked internal documents to the Wall Street Journal to raise questions in the minds of politicians predisposed to think the worst of Fannie Mae. He quotes extensively from an inspector general’s report that noted Falcon’s animus against the firm, and which led to a criminal referral of Falcon to the Department of Justice. The examination by OFHEO was in the words of Howard “withering,” detailing the alleged intentional and fraudulent accounting and misreporting. The SEC was left as the final arbiter on the accounting issues and to Howard’s surprise the Commission sided with OFHEO and Falcon in what Howard describes as “extraordinarily vague” language. Fannie Mae’s accountant, KPMG, reportedly sought clarification for the reasoning from the SEC, but was never able to obtain it. Raines and Howard were ultimately forced out of their positions in December 2004, with Falcon pushing for this outcome.

Howard then turns to his ultimate vindication on the “eight actual or threatened legal actions” against him, including possible criminal charges from the Justice Department, possible SEC charges regarding securities law violations, an administrative action by OFHEO, and a class action civil suit. Justice ultimately dropped their charges, the SEC charges slowly went away, and OFHEO chose to settle its case for what Howard describes as “next to nothing.” The civil suit was dismissed in late 2012. After hearing of these outcomes, I am reminded of the classic quote from former Labor Secretary Raymond Donovan to the effect of “Which office do I go to to get my reputation back?”

In comparison to these other issues, Howard spends comparatively little time on the actual ‘meltdown’ of Fannie Mae which receives all of about fifteen pages near the end of the book. At the core of his argument here is that Fannie Mae should not have been placed into conservatorship, presumably because it was in fine shape. One of the most difficult arguments of Howard’s to accept is his contention, stated in chapter two of the book, and argued in more detail in this later chapter, that “Treasury put Fannie Mae and Freddie Mac into conservatorship in spite of the fact that both companies met their statutory capital requirements at the time.” In the chapter near the end of the book on the meltdown of Fannie Mae, he argues that “Fannie Mae had forty-seven billion in regulatory capital and was in full compliance with all of its statutory capital requirements on the day it was put into conservatorship…” You would think that a former CFO of Fannie Mae would be able to get this right, but apparently not. The forty-seven billion figure was not from the date in September when Fannie was placed into conservatorship, but rather June 30th well before that date. Obviously there was analysis by FHFA and Treasury after the June 30 results, which involved adjustments to stated capital which might have taken into account more information on Fannie Mae’s financial position. Howard apparently made no effort to find out how FHFA and Treasury determined that Fannie Mae should be placed into conservatorship.

In later chapters, Howard also descends into speculation and conspiracy theorizing which he presents with no supporting documentation: “On the day of the Bear Stearns rescue, there can be little question that Paulson already was thinking of the GSEs as instrumentalities of the government.” And yet again: “Given the opportunity to eliminate Fannie Mae and Freddie Mac as private entities—which had always been their objective—they eagerly had taken it. “ In general, Howard’s documentation is poor as he does not provide detailed endnotes or footnotes for what he has to say, only a brief three-page section at the end on articles and books he used with no specific supporting citations.

Throughout the book Howard is largely an apologist for the Fannie Mae business model. He never makes a convincing case for his contention that Fannie Mae was not a risky firm, or that it was wrongfully placed into conservatorship. However, he rightfully blames outside political forces for many of the problems at the core of Fannie Mae’s meltdown, but the primary lesson to be learned from Howard’s book is the absolute bastardization and distortion of financial housing policy caused by the GSE structure. This informative book adds to the evidence that Fannie Mae and Freddie Mac are politicized methods of credit allocation that should be entirely privatized.

A Time of Crisis

First Great

An interesting byproduct of the recent financial crisis is the public’s greater awareness of the history of these calamities in the United States. Since 2008, economic historians have come forth with several accounts intended for the general reader. One such is Alasdair Roberts’ new book about a lesser-known instance, the Panic of 1837, and its aftermath.

A few up-front observations should be made regarding Roberts’ chosen topic. Although an agreed-upon definition of recession has been established, and one can say implemented, by the National Bureau of Economic Research (NBER), there is less agreement on what constitutes an economic depression. For example, author Tom Woods has made a name for himself based on the contention that the recession of 1920 to 1921 was actually a Great Depression, but he admits this is not a subject of universal agreement among historical observers. Unofficially, the most common definition of an economic depression is that it is simply a very long and very deep recession.

In point of fact, the NBER has not even designated the economic downturn of the 1830s and 1840s as a recession. This does not mean the downturn was not severe. Select economic data during that period is not up to the standards of more recent data and in many cases it is either non-existent or not reliable. Thus, the NBER does not even start its time series of business cycles until the 1850s. Similarly, the classic A Monetary History of the United States by Milton Friedman and Anna Schwartz does not start its full time series of monetary data until 1867.

However, Friedman and Schwartz do address what Roberts refers to as the first Great Depression in their chapter on the “Great Contraction” of the 1930s:

To find anything in our history remotely comparable to the monetary collapse from 1929 to 1933, one must go back nearly a century to the contraction of 1839 to 1843. That contraction, too, occurred during a period of worldwide crisis, which intensified the domestic monetary uncertainty already unleashed by the political battle over the Second Bank of the United States, the failure to renew its charter, and the speculative activities of the successor bank under state charter.

Thus, Roberts’ title seems justified in employing the term depression, although some might argue that the Panic of 1819 was in fact America’s first Great Depression.

Like many a financial crisis in the 20th and 21st centuries, the run-up to the Panic of 1837 was characterized by inflation and a real-estate bubble leading to malinvestment. Roberts notes the building inflation in the economy beforehand:

Across the country, prices were beginning to skyrocket. According to one index wholesale prices for key commodities in New Orleans increased by over 30 percent between January 1835 and April 1836 . . . The increase in commodity prices, although startling, was nothing when compared to the rise of land values.

However, it certainly appears that Roberts could have provided more detail. Inflation data from this period from Historical Statistics of the United States show that inflation was going down steadily from 1828 to 1833 and was going steadily upward from 1834 to 1837, earlier than the author noted with his example.

Roberts begins his discussion of the contributing factors to the bubble and malinvestment in Chapter 1 by noting that:

[s]ome citizens blamed state governments for granting charters for the establishment of so many banks . . . Other Americans blamed President Andrew Jackson for the bubble [because] Jackson vetoed a bill to renew the charter of the Second Bank of the United States.

Unfortunately, he does not cite any particularly reliable analysis to support these points. He refers to the political battles over the Second Bank of the United States and the withdrawal of federal deposits that were then placed “with about thirty state banks,” but does not make a convincing case for how this could have led to the Panic. The reader is only given the comments of a contemporary 19th century politician and a pair of 20th century historians (including famed big-government advocate Arthur Schlesinger).

Financial crises are often a decade or more in the making. Yet the author neglects to consider the Second Bank of United States as a possible culprit in the building of the bubble. It was, after all, the central bank at the time; not investigating its possible role reveals a lack of curiosity on the author’s part. The Bank was in existence beginning in 1816 and it was fully operational during the period that inflation was building in the economy. This gap may be due to his background not being in finance or economics, but in politics, the law, and public policy. (Like Schlesinger, he is an alumnus of Harvard.)

Later in this chapter, in discussing the Panic itself, he notes that many held Andrew Jackson responsible for the bubble and the crash. Jackson “had been hostile to the Bank of the United States because of the power which it seemed to wield through the manipulation of paper credit.”

The reader then gets a whirlwind tour of events: the Specie Circular of 1836; the distribution of revenues from the sale of government lands to the states according to their populations; the inauguration of President Van Buren; runs on Mechanics’ Bank and Dry Dock Bank of New York, and an apparent resulting contagion that led to the suspension of redemptions of bank notes in New York; interventions by the Bank of England; the flailing around of the Bank of United States after losing its official standing; and the ultimate closure of 200 banks in the United States.

What is not there is convincing evidence as to why Jackson was to blame. Again, the financial and economic aspects of the Panic of 1837 get short shrift, and this disappoints, for this is what any reader expects from a book on this topic.

In total, the run-up to and playing out of the crisis occupy a mere 35 pages in Chapter 1. Nor do the ensuing 125 pages of the book touch directly upon the crisis itself or its causes. Rather, Roberts delves into a more general history of the period by looking at: The States’ Crisis (Chapter 2); the Federal Government’s Crisis (Chapter 3); and Law and Order (Chapter 4). In each, Roberts does try to make some connection, however strained, between the crisis and the topic at hand. The side discussions seem disproportionate, however, to the material devoted to what is purported to be America’s first Great Depression.

To be sure, the troubled financial position of many of the states during this time is well summarized by Roberts. Several states actually defaulted on or repudiated their debts. Much of this borrowing was from British investors to finance canals, railroads, (state-owned) banks, and other projects. One particular passage on policy concerns a British proposal—by Barings Bank—to have the federal government backstop state bonds by providing a guarantee against default. Roberts writes that the proposal was “savaged by Democrats as a scheme to cover the losses of foreign bankers.”

The federal government chapter has at its core a graph that shows the volatile changes in federal revenues and expenditures from the 1820s to the 1840s. It traces the Jackson years and quotes Jackson as having “hated debt.” The federal debt was actually eliminated during this period. This was followed by the “bubble years” of the early and mid 1830s, when revenues and expenditures exploded. Post-Panic revenues and expenditures then plunged to levels not seen since the pre-Jackson years. Roberts goes on some tangents at this point, including a detailed consideration of the Oregon Territory and conflicting British and American claims on it.

Finally, the “Law and Order” chapter details some of the political unrest and violence of this period. Roberts tries to make a connection here leading with the declaration: “Economic troubles led to political turmoil.” He describes in detail the Dorr Rebellion in Rhode Island and the Anti-Rent War in the state of New York.

One could summarize Chapter 5, on the end of the crisis, as: We whipped Mexico in the war and the economy bounced back:

The U.S. victory in the Mexican War marked an end to the depression in two ways. First, it revived the nation’s spirits. In the eyes of many Americans, military success restored national honor, redeemed the democratic way of governing, and gave proof to Europe of the nation’s vitality. Second, the war was an unexpected tonic for the economy, and the mechanism by which the United States was fully reintegrated into international financial markets.

Roberts concludes by revealing a preference for heavy government intervention in an emergency like the Panic of 1837. Comparing it to the crisis we just endured, he writes:

[T]here is an important difference in the willingness of contemporary policymakers to intervene to stop panics, save tottering financial institutions and avoid depressions. Few today would take the view held by many Democrats in the early 1840s that the government should look after its own revenues and let the moneyed interests fend for themselves. Moreover, modern policymakers have tools for intervention that were unavailable in the 1840s. The United States now has a sophisticated central bank, in the form of the Federal Reserve; an equally sophisticated Treasury Department; and mechanisms for taxing and spending that make it easier to provide stimuli in a tailored and timely way.

So, jettisoning the substantive arguments, the author relies on some vague notion that most people believe in interventionist policies and that our sophisticated friends at the central bank and Department of the Treasury will make us financially safe. This, notwithstanding the frenetic and vacillating responses of the authorities during the crisis that hit late in the new millennium’s first decade.

Those looking for a generalized history of the 1830s and 1840s may find Roberts’ book of interest, but for a good economic and financial analysis of the Panic of 1837, one would have to look elsewhere.

Lords of Chaos

The Alchemists

There is often a good story behind the circumstances of how an individual author comes to write a particular book at a particular moment. If you are ever at a social event with an author and want a conversation starter, they are generally more than happy to share their individual story with you. As for books on the financial crisis, one ‘story behind the book’ that I remember was told by Andrew Ross Sorkin, who wrote Too Big to Fail. As he tells it, he came home from work one night at 2:30am as the mega-insurance company AIG was about to collapse, he woke up his wife and described his day to her and he says to her, “It’s like a movie” and in response his wife says “No it’s like a book, Andrew.”

I believe that Neil Irwin, author of The Alchemists: Three Central Bankers and a World on Fire, is in clear denial about his ‘story behind the book.’ As he tells it, his work at the Washington Post in covering the Federal Reserve intertwined with the crisis and he wanted to capture the crisis through the key central bankers of the day. I think the reality is that Irwin at some point read Liaquat Ahamed’s Pulitzer prize-winning book, Lords of Finance, about the key central bankers during the Depression and he decided to update that book for the current crisis. It should be noted that Ahamed wrote a nice endorsement for the jacket cover of Irwin’s book, so even if he is of the same mind as me regarding the genesis of Irwin’s idea he does not seem too annoyed.

The name of the book itself describes someone with a magical power to turn a substance of little worth into something of great value. This is apparently a reference to the capacity of modern day central bankers to turn simple paper money, or even more predominantly today electronic key strokes, into something of worth, essentially a modern day version of Rumpelstiltskin.

Irwin’s book starts out as a history of central banking as he chronicles a litany of central bank failures, which can be summarized as ‘stories about how central bankers completely tanked their nation’s economy.’ He in sequence recounts the story of the first central bank in Sweden, Stockholms Banco, the predecessor to today’s Sveriges Riksbank. It was led by one Johan Palmstruch, who Irwin refers to as “history’s first central banker” whose “actions as a man with the power to print money at will had decimated Swedes’ personal savings, wrecked their national economy, and forced the government to intervene to prevent complete catastrophe.” This is followed by the story of the German Reichsbank, its creation in 1876 and ultimately the hyperinflation it created in the early 1920s that “wiped out the savings of an entire generation.” You would think that Irwin’s recitation of this history would make him skeptical of the idea that we can get a room full of very smart people and plunk them down in Washington, DC, or London or Frankfurt and with minimal effort achieve through alchemy the basis of a stable financial system. Unfortunately, that skepticism does not come through in the later stages of the book, as his comments mostly effuse gushing praise for modern central bankers.

As the story proceeds up to the modern day, the pages committed to each of the key events in this tome of approximately 400 pages seem strangely disproportionate to their importance in the financial crisis. For example the bailout of Bear Stearns, which some have derisively called the “original sin” of the bailouts because it started the authorities down the road of reliance on such interventions, gets all of two pages. What little the book contains on Bear is the same, tired media narrative that if Bear was not saved it would “bring an entire economy down,” and it needed to be bailed out because of how “deeply intertwined” it was with the rest of the financial system. Irwin then notes that “[t]here was not time to do any careful number crunching” which would seem to accurately describe the Fed’s seat of the pants approach to analyzing Bear’s plight. But then a few pages later Irwin reveals an evident blind allegiance to the capabilities of the Fed to reach the proper balance of intervention, as he approvingly quotes a European central banker’s description of the Bear Stearns rescue as “masterful.”

The Lehman failure gets a bit more ink than Bear Stearns, all of about six pages. After tracing through the details of Lehman’s troubled end, almost completely out of left field, Irwin concludes: “In any case, the result was plain: By allowing a financial institution of such great international economic reach to go bankrupt, the Fed failed the global community of central bankers.” He gives no basis to ignore all the reasons he listed against intervening in Lehman: the lack of a buyer for the institution, including the collapse of a consortium that looked into supporting it; Lehman’s deep insolvency; and the lack of sufficient collateral to support any type of standard lender of last resort borrowing. This is one rare moment where he comes down hard on the US central bank and his quoted comment above seems to imply that anyone else in the community of central bankers would have known what to do.

Then Irwin segues immediately into the details of the AIG bailout. After noting that the Fed again performed “some very quick, very scary guesstimation” (more seat-of-the-pants analysis) and then quoting Bernanke hyperbole that “[t]he failure of AIG, in our estimation, would have basically been the end,” Irwin reveals his not-so-surprising conclusion on the efficacy of bailing out AIG. In contrast to the lack of action from Washington on Lehman Brothers, he dramatically and approvingly coos “[t]his time, Washington wouldn’t let down the world.”

Irwin’s analysis of these ‘big three’ intervention decisions by the Fed and Treasury can only be described as weak. He does not drive into the detail of the underlying decisions. He does not engage in good old fashioned ‘shoe leather’ journalism and uncover any new revelations about the decision-making process like so many other books on the financial crisis have done. He merely reveals a bias heavily weighted towards intervention and a ‘Washington to the rescue’ mindset that is not supported in the least by the facts presented.

From this point on in the book (about the last 250 pages), Irwin meanders through a host of topics in his journey through the ensuing four years and into late 2012. An interesting section of the book is rather unique in that it is ground that I have not seen covered in any other book on the crisis. In a chapter called ‘Battle for the Fed’ Irwin traces the Ron Paul-Alan Grayson-Bernie Sanders effort to ‘Audit the Fed.’ He nicely summarizes the ideas of this classic right-left coalition that came together in the aftermath of the bailouts: “In the spring of 2009, people of opposing parties and differing political ideologies could all agree on one thing: The government agency that most clearly deserved to have its wings clipped in response to the economic crisis was the mighty Federal Reserve.”

Irwin gets his ultimate analysis wrong on this topic:

Paul’s name for his legislation was particularly inspired: ‘Audit the Fed.’ After all, every corporation gets audited; any institution of the Fed’s size should be held to such routine accountability. In fact, on financial matters the Fed was already audited, with an independent inspector general in house, oversight by Congress’s investigative arm, and reserve bank audits carried out by the same major accounting companies that audit every major corporation in America.

Unfortunately, he blurs the concept of a financial statement audit and a policy audit on monetary policy as undertaken by a body like the Government Accountability Office and places a great deal of stock in an inspector general that Alan Grayson embarrassed in a classic viral video from 2009. However, in this same chapter, Irwin does a good job of detailing the opposition to Bernanke in his reappointment to the chairmanship in 2010.

The latter chapters of the book are heavily dedicated to the European Union and its troubles during 2011 and 2012. Irwin’s decent summary, as is the case with his earlier reporting of the troubles in the US, provides no great revelations. In a detour of a chapter called “Governor Zhou’s Chinese Medicine” Irwin focuses on China. The most revealing tidbit from this chapter is the following statist comment in describing the Chinese government response to the crisis as compared to the US response:

It all worked. The Chinese economy bottomed out in the fourth quarter of 2008, six months earlier than the U.S. economy did, and it returned to its pre-crisis growth path of nearly 10 percent almost immediately. Democracy and free speech are among the greatest achievements of Western Civilization, but in moments of financial panic, authoritarianism has its advantages . . . . The crisis certainly exposed the weaknesses of free-market capitalism.

With the exception of the unique analysis of the “Battle for the Fed” chapter, in my mind there is little to recommend in Irwin’s book. The lack of depth in Irwin’s analysis of the events of recent history is only outdone by the thinness of the analysis undertaken by the Fed and Treasury in justifying their interventions during 2008 and 2009.

Financing Failure: A Century of Bailouts

Financing Failure
Play

So we were told with the passage of the Dodd-Frank Act that too big to fail was now behind us. Except it isn’t. In fact, the conditions supporting bank bailouts have only gotten worse with the nation’s largest banks actually increasing in size and scope since 2008. TBTF, however, goes back farther than you might think. This podcast with Vern McKinley on his book, Financing Failure, discusses the regulatory history of bank bailouts rather than winding down insolvent institutions. Contrary to the Hank Paulson and Ben Bernanke narrative of the 2008 crisis, although the scope of the problem was new, the subject matter of the problems faced by regulators was anything but unique. McKinley provides this account in interesting detail and considers our future under Dodd-Frank.

David Stockman’s Informed Anger

The Great Deformation

David Stockman is probably most well-known for his service as the first Director of the Office and Management and Budget under President Reagan. For those following politics at the time, the most vivid memory was likely when Reagan reportedly took Stockman “to the woodshed” after he, without clearing it with the President, spilled his guts to a reporter from the Atlantic Monthly about the inner workings of the budget process in the Reagan White House. Shortly after departing from the Reagan Administration, Stockman wrote a top-selling book, The Triumph of Politics, a book which I purchased in the late 1980s and still have on my book shelf, but somehow never got around to reading.

Stockman disappeared from the Washington policy world after the publication of his book, apparently made a great deal of money as an investment banker and investor, and did not have much to say on the public policy front for about 25 years. However, he started appearing on the cable business channels over the last few years as a commentator in the lead up to the release of his book early this year. What his book, The Great Deformation—which in contrast to The Triumph of Politics I can now say I have read—reveals is someone who has repressed his anger at the unfolding of repeated sessions of easing by the Fed on the monetary side and by Congress on the fiscal side. The easing comes as part of a cycle of bubbles inflating, bubbles bursting, and then bailouts of one sort or another. Stockman traces these cycles during the mid-1980s; the late 1990s; the early 2000s; and the most recent financial crisis of 2007 to 2009. One commentator has called his book, the ranting of a “cranky old man.” But, in keeping with the title of the book, Stockman argues that the financial markets are now so ‘deformed’ by the distortions of government intervention that our fiscal and financial fortunes will most assuredly get worse, unless his dramatic prescriptions at the end are adopted.

In case you were not aware of this fact, Stockman was indicted for fraud related to one of his business investments and he weaves this fact into the storyline, engaging in a bit of introspection about how this indictment led him to recognize the market distortions going on about him in the financial industry and this revelation led to chronicling these events in his book: “Indeed, it was only after my own crash landing on the shoals of excessive leverage that I came to recognize the Great Deformation.”

To get straight to the point, if you like a book that summarizes the historical goings on in the financial industry and in fiscal policy since the Nixon administration from a mostly free market perspective, told in a folksy and snarky manner with colorful language and name-calling sprinkled throughout, but lacking much in the way of detailed citations to the specifics, then you will probably like Stockman’s effort. However, even if the prospect of a book with these characteristics appeals to you, you may not want to take the time required to make it through this massive tome of 700+ pages.

To me this verbosity indicates a weak editing job by the publisher, who was apparently unwilling to apply more discipline to author Stockman who tends to spend a great deal of time detailing points that are not necessarily directly linked to his core thesis.   The book could easily disgorge itself of 200 or more pages without reducing the forcefulness of the arguments. In fact, the length of the book apparently taxed the editor’s ability to stay focused, as numerous typographical and grammatical errors are evident throughout the book, as well as misstatements of fact that would have been caught by simple fact-checking (President McKinley was never a senator and Fed Governors Angell and Mishkin were never vice chairs of the Fed’s Board of Governors).

A further point on the editing and style is that Stockman uses the following words and phrases incessantly throughout the text: ‘financial engineer,’ ‘bubble,’ ‘Greenspan/Bernanke Put,’ ‘double down,’ ‘Eccles Building,’ ‘parabolic’ and ‘off the charts.’ If someone asks you to join a college-style drinking game where you have to read Stockman’s book and have a drink every time he utters one of these phrases, don’t do it as you won’t live through the experience.

Another annoyance about Stockman’s style is the absolute lack of direct documentation of his policy arguments. Most recent books on financial crises and their history have endnotes at the back that document in a few dozen pages the direct citations for the book. Examples include Andrew Ross Sorkin’s Too Big to Fail (39 pages); Sheila Bair’s Bull by the Horns (22 pages); Neil Barofsky’s Bailout (21 pages); and David Wessel’s In Fed We Trust (26 pages). I don’t know about you, but when I read a book I usually want to dig deeper into an author’s sources. You are out of luck with Great Deformation as Stockman declares in the book’s final chapter that “…the book is not footnoted because my purpose has been to interpret and pattern the facts, not to discover or explicate them.” In a similar vein, if you like the clarity of a good chart or graph to bring home a point, you are out of luck again, as according to Stockman: “The factual material in the book is presented to illustrate, frame or document my themes, but not to detract from the flow of the argument owing to inordinate detail or spurious precision. For that reason, the book is also free of charts and graphs.”

I must also say there is a lot to like about the book. It is a detailed summary of the last 40 years of economic and financial history, with the vast majority of the book covering events after the evil Nixonian closing of the gold window in the early 1970s. There are a few sidebar references to earlier events, such as the Panic of 1907, the Great Depression, and Eisenhower’s efforts to impose fiscal discipline, but most of the focus is on more recent history. Particularly good sections include those on the ‘warfare state’ as Stockman calls it; his ‘insider’ critique of the Reagan budgets; and the Eisenhower efforts to simultaneously reign in both welfare and warfare spending to balance the budget.

His analysis of the most recent crisis, including a critique of Bernanke’s depression mongering; the juicing of the homeownership rate through government policy that inflated the housing bubble; and a brief history of the buildup of Fannie Mae and Freddie Mac in the years before the crisis are good, although there is not much here that is particularly new or earth-shattering. I do have to say I like his critique of some of the political hacks who were woefully unqualified for their jobs in the Bush 43 Administration, such as Paulson deputy Neel Kashkari, who led the Treasury Office of Financial Stability, as well as the TARP program.

However, it is more than a little disappointing that Stockman did not spend too much time on the most recent crisis. Early on in the book, Stockman traces through bits and pieces of the history of what he calls the “Blackberry Panic of 2008.” But I expected a great deal more discussion at the end of the book also as it traced the events of the past 40 years in roughly chronological order. He never does go into too much detail other than in those early chapters. So if you are looking for a highly detailed analysis of the 2007 to 2009 crisis you are not going to get it in Stockman’s book.

Another curiosity is when Stockman runs through a list of villains and heroes of the Great Deformation. Most of this list makes sense and the villains are those you would expect, the people we all like to dislike: Roosevelt, Nixon, Greenspan, Paulson, Geithner, Rubin, Bernanke, Bush 43 and Obama, among others. What is really strange is the list of ‘heroes.’ These include former FDIC chairman Sheila Bair and President Hoover. Maybe Stockman just isn’t aware of the true facts, but Bair actually led the FDIC Board in multiple bailouts of financial institutions (the bailouts Stockman disparages throughout the book), including for Wachovia, Citi, Bank of America and the broad-based FDIC debt guarantee program. But, what is even more curious is the label of Hoover as a ‘hero,’ as Stockman himself even points out in his book that Hoover initiated the bank bailout program of the 1930s, the Reconstruction Finance Corporation, which he refers to as “a paragon of crony capitalism.” For a study in contrasts between President Coolidge and the interventionist Hoover, see Amity Schlaes’ recent book, Coolidge.

So in conclusion, if you are going to spend a lot of your free time over a month reading Stockman’s book (which I did), I would say the only way it is worth it is if you really are in need of a smart summary of the past 40 years of bubbles inflating, bubbles bursting, and government rescuing over that timeframe from a mostly libertarian, free-market perspective. There are exceptions, including Stockman’s insistence that the federal safety net is absolutely necessary and needs to be shored up and refocused. If you don’t need such a primer, it makes much more sense, if you do want a good flavor of Stockman’s opinions on these matters, to just drop “David Stockman book” in YouTube and spend a few hours watching his various appearances on cable TV and other platforms. The best of these is a Reuters sponsored hour long standoff between Stockman and Peter Orszag, a true Obama statist. Stockman lays out all his standard arguments from the book. If you really love his approach and style upon that viewing and desire more like it, then by all means read this book.