Guest Post: Review of Barry Ritholtz’s "Bailout Nation"

Submitted by Richard Smith, a somewhat jaded capital markets IT professional, aviator and amateur mathematician who lives in London. He has been watching the capital markets from the sidelines for over twenty years. He frets over his ducklings, and should probably get out more.

The indefatigable Barry Ritholtz is a fund manager and TV talking head: one of the few CNBC regulars who made sense during the 06/07/08/09 financial crisis. As if that wasn’t enough day jobs, he also is also the author of the blog “The Big Picture”, one of the top finance/economics blogs. Perhaps he wasn’t quite in the vanguard of prophets of doom, but he caught on pretty fast and blogged about it from ’06 onwards.

The blog’s hallmarks are a pungent style (sometimes ribald), irascible disdain for unevidenced assertions of all kinds (especially, partisan ones and trolling), a hapless love for enormous graphical charts, and a knack for apposite quotation and concise summary. Ritholtz is, if you like, a serial producer of soundbites that have content. With some training in law and mathematics, he has good background for making sense of the crisis in the markets. Oh, he talks about his fund on the blog from time to time, but that’s only to be expected, and you really couldn’t call it hard selling.

Evidently that’s still not enough hats for him, since in ’08, with the financial crisis just getting into its stride, he embarks on a high level economic history of the US from 1791 to the present, covering the early incarnations of the Federal Reserve, the Depression, the manufacturer and railway bailouts of the 70s and 80s. Its (sadly) rare perspective is that it is all written from a moderate Republican viewpoint (be suspicious of the Federal Reserve, see bankruptcy as a natural and desirable aspect of capitalism, concede that well-functioning free markets do need some kind of regulation, admit that there were some good things about the institutions established as part of the New Deal). It is a plausible and detailed story to a non expert like me. Dealing with the slow demise of the automakers, he gives a perhaps excessively concise summary of American car design and manufacturing quality post war (“…shit…”).

Then in August ’08 he realises that he is fundmanaging, talking-heading and blogging his way through a crisis that will give him a once-in-a-lifetime seam of subject matter, so he switches to a more-or-less real time chronicle of events, and manages to conclude at just the right time, in March ’09, with the first phase of the crisis at an end.

So how does finance blogging’s master of the soundbite shape up on a bigger canvas? Not too badly, in the circumstances. The change of focus leaves the first few chapters of economic history dangling somewhat. Is the moral hazard idea strong enough to link the bailout of Lockheed with the bailout of AIG? Well, it could do with more elaboration than it gets here. Still, the structural sacrifice is well judged: he is pretty much first to market with a colourful narrative of ’08, some shots at identifying a set of causes and culprits, a takedown of some common red herrings, and a somewhat hazy initial verdict on the outcome of the massive state interventions that will keep American financial markets ‘free’. Ritholtz is blessedly unencumbered by the quintessential American Protestant hypocrisy that what you call a thing matters more than what it is. With so much self-serving obfuscation around, this really matters.

The narrative is pretty good. Somewhere the piece on the Fannie and Freddie collapse got lost or remodelled but the rest of the highlights are there – the fantastic outbreak of greed, fraud and delusion in the housing market and in the financial markets; the monolines, Countrywide, Bear, Lehman, AIG, Citi, BoA/Merrill, the rating agencies, the TARP and its predecessors and successors. The global perspective is largely ignored, but it’s a minor omission; perhaps, though, rolling in more instances of bank folly from overseas would have provided ready counters for some of the more parochially American ideas about the root causes of the crisis.

Looking for deep analysis of causes (psychological, moral, political, economic) in a book constructed on the fly like this is a fool’s errand. Nor does Ritholtz have much to say about the details of key crisis mechanisms: the shadow banking system, the modern versions of banks runs via prime brokerages; he skips the technicalities of the various financial innovations that contributed to the crisis (off balance sheet vehicles, CDOs, CDS); nor does modern financial theory put in an appearance. Instead he sticks to an ordinary, except very very enormous, story of folly and greed. He gives us a list of people and institutions that are to blame. Of course a screw-up on this heroic scale takes many hands to bring it off, so the environment is target-rich; Ritholtz’s list is so long that his bounteous ire is expended on many targets and the impact is diffused. There just isn’t enough indignation to go round – a fact which, in the wider world, and aided and abetted by many who are quite content with the status quo ante, is already taking any momentum there might have been out of moves towards large scale reform of the financial system.

Consistent with Ritholtz’s line in the early chapters, Alan Greenspan is his chief villain, for his 20-year history of large scale market interventions via interest rate manipulation (all the while insisting that state intervention in markets was deplorable), his aggrandizement of the Fed’s role, his increasingly evidently witless insistence that enlightened self-interest makes regulation unnecessary. Next up is the Fed itself, then the arch-deregulator Phil Gramm; then it’s the ratings agencies, and the SEC. The list goes on and on and on though, so you will have to buy the book to get the picture. One point Ritholtz highlights, that I haven’t seen beaten to death anywhere else, is the remarkable fecklessness of institutional bond and equity holders, these days far more preoccupied with hitting their benchmarks than with corporate governance. Maybe overt and closet indexing really has had the dire effect on management scrutiny by shareholders that was predicted for it twenty years ago. Bank equity is treated as option money by holders, who shrug. Bank bondholders buy CDS, and shrug. Bank capital is treated as option money by bank employees, who shrug. Management have their cumulative bonuses and severance terms – you can guess what their shoulders are doing. This set-up didn’t end well in 09 and won’t next time, either.

Two comments on the deregulation piece of Barry’s rant.

First, the demise of Glass-Steagall. Ritholtz sees this as kicking off Citi’s foray into universal banking; in fact it is more of a belated recognition of the status quo. American banks have been trying to end-run Glass-Steagall for a long long time. London’s Big Bang was an early straw in the wind: in 1986 Bank of America, Chase and Citi were buying up not very good UK securities trading firms at silly prices, because they could establish roughly Anglophone subsidiaries in an overlapping time zone doing something completely forbidden in the US. There is regulatory arbitrage, by God. Incidentally, London is still trading off its ability to be 5% sleazier than the States: witness the location of AIGFP and ofthe world HQ of the hedge fund industry. Anyhow, with a precedent established, courtesy of Big Bang, Citi could buy SSB confident that its legal path would be smoothed. As it was – and be damned, inter alia, to the proper functioning of FDIC, whose charter becomes unworkable when you have universal international banks trading in securities. Now we have ‘too big to fail banks’ – Barry for once has little to say about the self-serving contradictoriness of this construct, wherein a bank can attain a sort of critical mass and is henceforth exempted from any kind of market discipline, and can always depend on a bailout. This is not free-market capitalism: it is a one way bet that must end up lethal for nationalfinances at some point. It is therefore alarming to see any restructuring of these not-so-dormant financial supervolcanoes (proliferating after the BoA/Merrill and JPM/Bear/Wamu mergers) moved so quickly and firmly off the reform agenda.

Secondly, elsewhere in the book, Ritholtz highlights a little mentioned clause in the Securities Litigation Reform Act of 1995 that effectively eliminates liability for fraud from the accountants who audit companies. Presumably that wouldn’t have made it into the books if there wasn’t a pre-existing concern among the well connected and legally liable. But it is a green light for much worse: within two years Jim Wadia is at the controls in Andersen, and they are willing to sign off any old books and dream up any old accounting wheezes. Within 6 years you have WorldCom and Enron. 10 years later you have the full blown financial-economic nirvana of off balance sheet entities of banks, whereby the bank derives the economic benefits of risky loans without (apparently) actually owning the risks. In the meantime company accounts mean little, the audit means nothing, and the auditors are actually conniving at frauds (see Satyam). The spectacular repudiation of commercial good practice, integrity, honesty and responsibility embodied in this legsislation means that it definitely belongs in Ritholtz’ list. As if the dominance of the Big Four accounting firms wasn’t bad enough in itself, this legislation’s implications for the level of integrity we can look for in corporate conduct in future years are discouraging. AA won the race to the bottom; how far behind were the others? I can’t help wondering whether Phil Gramm has something to do with this piece of law. Its relevance to the situation at Enron, where Gramm was deeply connected, is striking.

Ritholtz and red herrings: one of the eye-catching features of this crisis has been the underperformance of the traditional print and TV media: miles behind the game by and large, and mostly a source for a proliferation of self-serving red herring explanations served up by gormless media hacks. One-year Naked Capitalism vets will remember that in the run-in to the Lehman bankruptcy, Yves, whose idea of an exotic portfolio seems to involve adding a few Ginnie Maesto the predominant T-Notes and T-Bills, was suddenly portrayed as a ruthless short seller propagating negative rumours about Lehman for profit. Lehman, meantime, was supposedly in great shape and terribly hard done by. Well, none of that was exactly right, it turned out, quite quickly. In a good chapter, Barry deals briskly with some of these useless memes: Mortgage Interest Deduction, Naked Shorting, Fannie and Freddie, and (a particular hot button issue for Barry), the CRA, now incomprehensibly resuscitated by the usually more astute John Carney.

Ritholtz had his own run-in with red herrings, and won: his pretty uncontroversial attack on the practices of the rating agencies appears to have led his first publisher, McGraw-Hill, a subsidiary of ratings agency Standard and Poors, to start making difficulties with publication. No Chinese walls there, eh? McGraw Hill underestimated their author, and made the fatal error of suggesting to Ritholtz that the reason for cold feet was that the claims in the book were poorly documented, leaving them with nowhere to hide when, as readers of his blog might have expected, he came up with 30 closely written pages of references. They are still in the book and are a nice set of primary sources, at least if the web links last for a bit – Barry, take local copies! Anyhow, Wiley stepped up and that particular exercise in truth suppression failed. What an indictment of American publication practices that episode is. But what an advantage to be able to blog about it…

Ritholtz includes a table of the bailout monies committed to the rescue – it is particularly salutary to be reminded of theabsurdly easy terms of the recapitalization of Citi. What a rip-off – one more giant subsidy conducted, with brazenimpudence, in the name of free markets.

Some vague talk of ‘unintended consequences’ is as much as he’s prepared to vouchsafe about the expected outcome of these and other fantastic and largely involuntary acts of largesse from the American taxpayer. He’s no macroeconomist (is that a drawback?). Lastly there are suggestions, variously non-surprising or wacky, from his blog readers about what to do about the mess. Despite the rapid drafting, the index is actually useful – nice touch – some behind the scenes work there.

So – does Ritholtz give us a convincing synthesis of the root causes, and a clear view of what may happen next? Not really; but that’s asking a bit much in the timescales available to him. Any really first rate trainwreck just needs a run of uncorrected errors, that needn’t have anything to do with each other. We can certainly see a run of mistakes in the historical record of the last 25 years. Greed and illusion, unleashed by deregulatory dogma and regulatory somnolence? It will be interesting to see what diagnosis and prognosis Yves comes up with.

In the mean time, you can refresh your memory of events, source your references, have a go at rebutting fatuous partisan claims, and enjoy scathing commentary, choice phrases, and juicy quotes, with ‘Bailout Nation’.