Monday, August 9, 2010

Day 276 – Hood Ornaments

Lehman earnings before the collapse. Takes brass balls to make a hood ornament like this.
          There is nothing like a history of success as a basis upon which to build further success. By the same token, relying solely on past success to provide a clear path into a prosperous future is folly itself. Nothing persuades us quite so well as success that our instincts and abilities are sound, and nothing else is so quick to pull the rug out from under our feet.
          I have said repeatedly here that success is largely a matter of luck. There is no doubt that we can do things to capitalize on luck when it presents itself, but if luck does not present itself there is very little we can do to overcome the adversity that swallows our hopes in its absence. You can be ready for good fortune, but you cannot make it. You can even mitigate bad fortune, but you cannot unmake it.
          Still, we look to past success as an indicator of the probability of future success. We do this as investors. We do this as employers. We do this as humans. We are naturally drawn to what worked before. We are drawn to it, foremost I think, because it is familiar. We know that conditions change, and that, because of the mercurial nature of circumstances, the familiar may not serve us so well in unfamiliar territory. Yet the familiar attracts us because we do not have to think about it so much. This is a danger, but a natural inclination. We want to take the path of least resistance.
Successful executives, being for the most part human, are not much different from the rest of us in this regard. They just have a better recorded history of past successes on which to rely. This history may give them an occasional pass when they err, but it will not make them any more likely to perform up to their reputation when circumstances change. When their bubble bursts they will act and protest in the same ways and with the same results as the fools and charlatans in my past like Henry and Ivan. We have only to look at the events surrounding the collapse of our financial system to see that this is true.
          Dick Fuld, head of the ill fated Lehman Brothers, spent his time before the fall trying to get everyone to believe that Lehman’s problems had to do with irresponsible and predatory short sellers trying to profit off of lies and innuendo. He didn’t do anything to shore up Lehman’s cancerous balance sheet. He couldn’t. He’d been resting on his laurels until it was too late.
Lehman’s earnings were illusory. They were window dressing. They were like the hood ornament on a fancy car with bad valves and clogged injectors. They didn’t mean anything, and they didn’t have any substance. Still, Fuld kept touting earnings as if that should be enough to get the wolves off his back. The wolves did not desist. The scavengers among them were busy shorting his stock. The alpha dogs were demanding more and more collateral. Lehman was getting squeezed in the middle, and all the public hand wringing was just making it worse.
          The reason the wolves did not desist is that the wolves were mostly in the same boat as Fuld. They were all, and indeed they all remain almost two years later, deeply leveraged on overstated assets. An accurate valuation of their worth, individually and collectively, was problematic at best, impossible at worst. Certainly no one wanted to do it. A collective valuation that even approached accuracy would collapse the system. Everyone knew this...the bankers, the auditors, the regulators, Treasury. They just neglected to tell the rest of us. To forestall the collapse, Treasury and the Fed kept proposing ever more ridiculous mergers and absorptions to hide the mess. The NY Fed under Tim Geithner was determined to offload Lehman before it sank. Everyone Geithner approached, and indeed everyone who approached Lehman, wanted the same kind of sweetheart deal that JP Morgan got to absorb Morgan Stanley. Everyone wanted a dirt cheap price and a guarantee from the US taxpayers that they wouldn’t have to swallow any losses. All the potential buyers had enough losses of their own to worry about without buying billions more in a government sponsored fire sale.
          Eventually Lehman was hung out to dry. Treasury wouldn’t back anybody’s play. People are still arguing today about why this happened. Treasury was happy to sweeten the Morgan Stanley deal, and happy to bail everyone else out after the Lehman collapse. Why let Lehman go down the sewer?
I think it was to send a message to the rest of us, especially Congress, just how high the stakes were. In the ugly aftermath of a Lehman collapse no one was likely to question Treasury and the Fed colluding to prop up their buds and compadres at Morgan, Goldman and the rest. Certainly Paulson at Treasury used the prospect of financial chaos to shove TARP down everyone’s throat with little oversight and no accountability. There was even enough residual fear going into the first six months of the new Obama administration to have them looking like Republicans when it came to their treatment of the banks and markets. Of course when you think about it Democrats and Republicans alike use the same currency to get themselves elected.
          What we’re left with today is the same financial system that cleaned us all out two years ago, the same broken down heap with a spectacularly buffed and polished hood ornament. Admire it all you want, but don’t expect it to get you very far down the road.

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