US investors would have best slept through crash after Lehman; Rich Man’s Recovery; Insane financial system lives post-Lehman

September 12, 2013 6:56 pm

US investors would have best slept through crash after Lehman

By James Mackintosh

Recrimination and regret still haunt banks

Five years on from Lehman’s last day, recrimination and regret still haunt banks. But for investors in US equities, it is as though the crash never happened. It would have been best to ignore it all, sleeping through financial battles like a latter-day Rip van Winkle. Like the fictional character, the modern sleeper would be shocked by the changes of the past half-decade; the iPhone is now available in colour, for example. Today’s investor would have to look hard to spot the impact of the crisis on his portfolio, though.US shares have not only risen – the S&P 500 is up from 1,252 on the Friday before Lehman’s fateful final weekend to 1,684 – but the real return, taking account of inflation and dividends, amounts to 7.8 per cent a year since then. Any sensible investor offered such a return at any time should grab it with both hands: it is above the very long run average of 6.5-7 per cent, the supposed “constant” popularised by Prof Jeremy Siegel of Wharton.

It is also identical to the return in the five years up to June 2007, the month before the credit crunch hit.

UK shares have not been far behind the US, delivering an annualised 5.9 per cent after inflation. But not every investor was as lucky as Rip. Hedge funds were whipsawed by swinging markets and failed to keep up with either bonds or equities. Japan’s benchmark Topix index is almost exactly where it was pre-Lehman – although the yen’s rise would have delivered small gains to foreign owners of Japanese shares. And eurozone shares are down, as the ripples from Lehman washed away the sand on which the euro was built.

Explaining to Rip why the biggest postwar recession did not hit markets harder involves the unprecedented scale of money printing by central banks, along with governments happy to transfer cash from taxpayers to investors.

The modern Rip, living off his investments, is happy with both policies – in spite of niggling doubts about why shares are valued more highly today than five years ago.

September 12, 2013

Rich Man’s Recovery

By PAUL KRUGMAN

A few days ago, The Times published a report on a society that is being undermined by extreme inequality. This society claims to reward the best and brightest regardless of family background. In practice, however, the children of the wealthy benefit from opportunities and connections unavailable to children of the middle and working classes. And it was clear from the article that the gap between the society’s meritocratic ideology and its increasingly oligarchic reality is having a deeply demoralizing effect.

The report illustrated in a nutshell why extreme inequality is destructive, why claims ring hollow that inequality of outcomes doesn’t matter as long as there is equality of opportunity. If the rich are so much richer than the rest that they live in a different social and material universe, that fact in itself makes nonsense of any notion of equal opportunity.

By the way, which society are we talking about? The answer is: the Harvard Business School — an elite institution, but one that is now characterized by a sharp internal division between ordinary students and a sub-elite of students from wealthy families.

The point, of course, is that as the business school goes, so goes America, only even more so — a point driven home by the latest data on taxpayer incomes.

The data in question have been compiled for the past decade by the economists Thomas Piketty and Emmanuel Saez, who use I.R.S. numbers to estimate the concentration of income in America’s upper strata. According to their estimates, top income shares took a hit during the Great Recession, as things like capital gains and Wall Street bonuses temporarily dried up. But the rich have come roaring back, to such an extent that 95 percent of the gains from economic recovery since 2009 have gone to the famous 1 percent. In fact, more than 60 percent of the gains went to the top 0.1 percent, people with annual incomes of more than $1.9 million.

Basically, while the great majority of Americans are still living in a depressed economy, the rich have recovered just about all their losses and are powering ahead.

An aside: These numbers should (but probably won’t) finally kill claims that rising inequality is all about the highly educated doing better than those with less training. Only a small fraction of college graduates make it into the charmed circle of the 1 percent. Meanwhile, many, even most, highly educated young people are having a very rough time. They have their degrees, often acquired at the cost of heavy debts, but many remain unemployed or underemployed, while many more find that they are employed in jobs that make no use of their expensive educations. The college graduate serving lattes at Starbucks is a cliché, but he reflects a very real situation.

What’s driving these huge income gains at the top? There’s intense debate on that point, with some economists still claiming that incredibly high incomes reflect comparably incredible contributions to the economy. I guess I’d note that a large proportion of those superhigh incomes come from the financial industry, which is, as you may remember, the industry that taxpayers had to bail out after its looming collapse threatened to take down the whole economy.

In any case, however, whatever is causing the growing concentration of income at the top, the effect of that concentration is to undermine all the values that define America. Year by year, we’re diverging from our ideals. Inherited privilege is crowding out equality of opportunity; the power of money is crowding out effective democracy.

So what can be done? For the moment, the kind of transformation that took place under the New Deal — a transformation that created a middle-class society, not just through government programs, but by greatly increasing workers’ bargaining power — seems politically out of reach. But that doesn’t mean we should give up on smaller steps, initiatives that do at least a bit to level the playing field.

Take, for example, the proposal by Bill de Blasio, who finished in first place in Tuesday’s Democratic primary and is the probable next mayor of New York, to provide universal prekindergarten education, paid for with a small tax surcharge on those with incomes over $500,000. The usual suspects are, of course, screaming and talking about their hurt feelings; they’ve been doing a lot of that these past few years, even while making out like bandits. But surely this is exactly the sort of thing we should be doing: Taxing the ever-richer rich, at least a bit, to expand opportunity for the children of the less fortunate.

Some pundits are already suggesting that Mr. de Blasio’s unexpected rise is the leading edge of a new economic populism that will shake up our whole political system. That seems premature, but I hope they’re right. For extreme inequality is still on the rise — and it’s poisoning our society.

Last updated: September 12, 2013 6:45 pm

Insane financial system lives post-Lehman

By Gillian Tett

There are at least six peculiar features that might make Alice blink

Five years ago, the markets plunged into an Alice-in-Wonderland world. For whenLehman Brothers collapsed, the repercussions were so violent investors were faced with confronting “six impossible things before breakfast” each day, to paraphrase Lewis Carroll.

So, as markets mark the anniversary of that Lehman collapse, is the system any safer or saner? The answer is both Yes and No. The good news is that the chance of another full-blown banking crisis has receded: some of the crazier innovations have been reined in, banks are better capitalised and financiers more cautious.

But the bad news is that the system is just as insane – perhaps more so. There are a host of developments that are at best counterintuitive, and at worst dangerously bizarre. Investors may no longer face six new banking shocks before breakfast, but there are at least six peculiar features of the post-Lehman world that might make Alice blink.

● The big banks are bigger – not smaller. When Lehman collapsed, there was outrage over the fact that many western banks had become so enormous they were “too big to fail”, creating concentrations of risk. Reformers called for banks to be broken up, to make them smaller and create badly needed diversity. Some financial officials, such as Richard Fisher of the Dallas Fed, continue to demand this sensible step. But, as the investor Henry Kaufman points out, the banking world, especially in the US, has become more concentrated than ever. That is unnerving, particularly since no one knows how regulators would ever shut down a really big bank.

● The shadow banking world is taking over more activity, not less. When Lehman failed, regulators suddenly realised they had been ignoring the non-bank sphere, enabling egregious behaviour to flourish. Given that, you might have expected those shadows to shrink. But think again: it has expanded since 2008 from $59tn in size to $67tn, according to the Financial Stability Board. And it is likely to swell further, because tighter bank regulations are pushing more and more activity into the non-bank world. The FSB insists it has become better at monitoring these shadows; we had all better hope it is right.

● The system depends more than ever on investor faith in central banks. One issue that caused the last credit bubble was excessive investor trust in the abilities of central bankers, both to keep inflation low and understand how financial innovation worked. Logic might suggest this blind faith should have wilted after Lehman Brothers failed. Not so; these days all manner of asset prices are now being propped up by a sunny investor belief that central bankers know what they are doing with quantitative easing; even though nobody has tried it on this scale before, or knows how to exit.

● The rich have become richer. The Lehman Brothers crisis triggered a surge of popular anger against wealthy elites; hence the rise of the Tea Party, Occupy Wall Street and other protest groups. But that has not caused elites to lose wealth. On the contrary, one (largely unacknowledged) consequence of QE is that this has raised asset prices and thus benefited the asset-rich wealthy elite, widening inequalities. The Bank of England, for example, calculates that 40 per cent of the QE benefit has gone to the top 5 per cent, including those bankers.

● Financiers have been prosecuted – but not for the credit bubble. After the Lehman collapse, politicians demanded banker prosecutions, and initially this seemed likely to occur. After all, almost 2,000 financial professionals were convicted following the 1990s savings and loans crisis in the US. But while senior financiers have been hauled off in handcuffs since 2008, this has generally not been due to credit bubble issues (think, for example, about Bernie Madoff, Alan Stanford, Raj Rajaratnam, Rajat Gupta and so on).

● Fannie and Freddie are alive and well. Back in 2008, it seemed self-evident that the rotten entities of Fannie Mae and Freddie Mac were overdue for reform; indeed, it was a crisis in those state-backed housing finance agencies in August 2008 that started the chain of events leading to the Lehman shock. But five years later, Fannie and Freddie are more entrenched than ever, accounting for more than 90 per cent of the US mortgage market, up from 60 per cent before.

An optimist might argue these six factors are just temporary distortions; some observers might insist they were inevitable. Housing would have suffered badly without Fannie and Freddie underwriting the mortgage market, for example. But if nothing else, these issues are a potent illustration of the law of unintended consequences, and a powerful reminder of the vast amount of work still to be done before we have a financial world that looks both sane and safe.