Thursday, October 16, 2008

Financial Reckoning Day

Financial Reckoning Day: Surviving the Soft Depression of the 21st Century. William Bonner and Addison Wiggin. Recommended.

I will preface this book review with a disclaimer. The authors have an extensive website ( where you can read many articles with much of the same information as in the book. The authors could also be described as 'goldbugs', and many of the articles have a certain late-night-infomercial feel to them. That being said, I found the book to be very interesting and would like to share my thoughts and impressions with you. I highlight the book not for any investment advice - which is surprisingly almost non-existent - but as a history of the Crash of 2008, and other booms and busts throughout the ages.

In my view, Financial Reckoning Day is a history book. Written in 2003, it is a call of warning that our financial system is unsustainable. The authors set out to tell us why.

The first chapter accounts the boom years between Fukuyamas' "The End of History" and the dot-com collapse of 2001. The second chapter draws parallels between military exploits and financial cycles; both Napoleon and Hitler's ill-advised offensive maneuvers are shown related to bull and bear markets. Chapter Three is devoted to John Law, widely recognized as the father of fiat currency in the early 1700s. The fourth chapter gives us a case study 10 years prior to our own boom and bust - the Japanese. And the next chapter is purely devoted to the author's most culpable player - Alan Greenspan. Greenspan received years of accolades as the master of the world's financial markets, and now must share in the blame.

I found the remaining chapters to be the most interesting, as I feel they capture the true reasons for our current crisis. From these chapters I gleaned three main underlying factors: the wide ranging blame can be distilled into Failed Policies, Demographics and Human Nature.

Human Nature

Which of mankind's greatest achievements and failures cannot be attributed to factors of human nature? The fallibility of man allows us to do both unimaginable good but can lead us to unspeakable despair.

Greed is highlighted in nearly every financial article these days. While it is mostly used to describe evil CEOs and corporations, we must not forget the individual. Was not greed a factor in the unqualified homebuyer's decision to purchase a home he could not afford? How about the "flippers" and other investors that wanted to make a quick buck in the real estate market? If not only greed, perhaps it is vanity that has led the average American to spend every dollar they earn - and more.

Vanity is a nagging voice imploring us to "keep up with the Joneses". Certainly if they can afford new cars and European vacations, we can too. Heck, don't we deserve it? Vanity has also invaded our psyche - we are the smartest, most technologically advanced beings to ever walk the earth. We have solved so many of the world's problems...why should we think the economy cannot be tamed.

Another dangerous human characteristic is a crowd or mob mentality, also known as "groupthink". It can reduce a normally level-headed person to do amazingly illogical acts. As these groups begin to think the same thoughts, "irrational exuberance" can take hold. Investors throughout history have fallen prey to this phenomenon. The difference today? Global communication allows for the entire earth to have access to the same information. Every man can now be a part of every boom..and bust.


Perhaps one of the most frightening factors is the cold hard fact of demographics. As noted in this post, finance can be distilled down to one concept - old people lending money to young people. When there is an imbalance in demographics, there tends to be an imbalance in financial markets. As you may know, there was a global spike in births after the conclusion of World War II. The "boomers" get a whole chapter just to themselves. Four interesting statistics:

1. Average age of American baby boomers on January 1, 2001: 46
2. Average amount in retirement account: $50,000
3. Number of years at 6% growth to reach comfortable retirement income: 63 years
4. Amount in U.S. Social Security Trust Fund: $0
Besides the large effect that the aging population will have on Social Security and health care benefits, they will continue to exert an inherent downward pressure on both the housing and stock market. As people age, they stop working and earning - and begin selling. When there are more sellers than buyers, prices fall. The alternative is to continue working until later in life...which is an undesirable thought to most of us. However, as life expectancy has increased, does it not stand to reason that we would have to work longer as well?

Failed Policies

The frightening aspect of our situation is that 2 of the 3 factors I have listed have little to no solution. And while governments around the globe scramble for new policies, there is certainly the distinct possibility to actually do more harm than good.

The authors place most of the blame on Greenspan's policies; and fiat currency in general. As for fiat versus a commodity-based system, I do not have the background to have an informed opinion. From my limited research, there are positives and negatives to both systems - as with most things in life. While there are booms and busts in fiat currency systems, there have been similar 'panics' in gold, silver, and other commodity-based economies. The world seems to have adopted central bank guided fiat currencies, and I don't really see a shift away from that.

Much of the blame is then laid at the feet of Alan Greenspan. After the tech stock boom of the late 1990s, interest rates were slashed and kept low. This allowed for massive amounts of cheap money to flood into the real estate market. With easy and inexpensive money available to nearly anyone with a pen, home prices soared to unrealistic levels.

Other policies that fueled the fire were mandates to make home loans available to subprime borrowers. This was accomplished by a plethora of innovative new mortgages and the implicit backing of Fannie Mae and Freddie Mac by the federal government through the U.S. department of Housing and Urban Development. Fannie and Freddie were subsidized to take on more and more subprime debt, and the American public was more than willing to oblige.

Lack of government oversight is also blamed in the Crash of '08. There were, no doubt, cases of predatory lending. The process of purchasing a home is a daunting one and can easily be manipulated by the unscrupulous. Perhaps the most unregulated entity...the exotic derivatives market that has been likened to the world's largest casino. Credit Default Swaps, packaged as a way to hedge against risk, seem now more like insurance fraud. There will most likely be sweeping reform in this and other areas of the financial sector in the coming months.

As one can see, there is plenty of blame to share. I, too, have benefited and become somewhat entangled in the credit boom and subsequent bust. Now with the stock market plunging and other areas of the economy showing signs of deep recession, we can only hope we all can find a way to recover in an expedient fashion. As for "Surviving the Soft Depression" as the book claims, I found no hard advice. Basically, the authors suggest you sell stocks and buy gold, but it would seem too late for that. Anyone have a time machine?

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