Bogleheads on Investing- Episode 028 transcript

Roger Lowenstein

Roger Lowenstein reported for The Wall Street Journal for more than a decade and is also an award-winning book author. His work has appeared in Bloomberg, The New York Review of Books, Fortune, The New York Times Magazine, and other publications. His best-selling books include Buffett, When Genius Failed, Origins of the Crash, While America Aged, and The End of Wall Street. In this episode, we discuss Roger’s books and lessons he learned writing them.

Episode 028- guest Roger Lowenstein

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Rick Ferri, November 29, 2020

Rick Ferri: Welcome everyone to the 28th edition of Bogleheads on Investing. Today our special guest is Roger Lowenstein. Roger is a former Wall Street Journal Heard on the Street columnist and the author of six best-selling books about the financial industry.

Hi everyone my name is Rick FerrI and I’m the host of Bogleheads on Investing. This podcast, as with all podcasts, are brought to you by The John C. Bogle Center for Financial Literacy, a 501c3 nonprofit organization. Donations can be made at boglecenter.net. I am pleased to bring you today Roger Lowenstein. Roger was a longtime reporter for the Wall Street Journal. His work also appeared in Bloomberg, Fortune, New York Times magazines and other publications. But most noteworthy are his six award-winning books about Wall Street. We’ll be talking about each one of those books today. So with no further ado let me introduce Roger Lowenstein. Welcome Roger.

Roger Lowenstein: Rick, it’s a pleasure to be on the show.

Rick Ferri: Well thank you so much for being our guest on Bogleheads on Investing. I’ve been a big fan of yours since back in the mid ‘90s, and actually met you one time. I know you’re not going to remember, but we were at a charter financial analyst meeting in Detroit. You were promoting your Buffett book and I got to sit next to you. I got there really early to make sure I got the seat next to you I wanted to meet with you. I thought that was just a fantastic book and we’ll get to all of your books in a minute, but before we get there could you tell us a little bit of how you end up being Roger Lowenstein the author.

Roger Lowenstein: Sure. I was a journalist in college at Cornell. Got very into journalism then. Always was a big reader and had in mind being a writer would be a cool thing. But you know, no idea of financial journalism or financial writing when I should say when I went to college, which was back in the mid ‘70s, there was very little interest on campus or anywhere as far as I could tell in Wall Street. There was so much political focus, due to the civil rights movement and Vietnam war, and then Watergate. And Wall Street was just something that all guys in gray suits did, and we didn’t pay much attention to.

But I got a series of jobs with small papers and just because I wanted to break out into something more interesting, I went down to South America and I was working for a paper, a terrific paper, in Caracas, Venezuela, which unfortunately the current government finally shut down. In Venezuela I supplemented my income, I started stringing for the Wall Street Journal — you may have at least heard of them — because Venezuela had a lot of oil production and was interesting to Wall Street, to its readers, and I discovered there that, you know, I thought we know there’s budget stories and that economic stories could be fun and through the medium of the Journal I realized that there was a real interest and you could get to a lot of facts and also a lot of interesting stories through economic journalism. And after about two years I was ready to come home and they offered me a job. By the time I got there, this was the very end of the ‘70s, late ‘79, and the big story then was mergers and acquisitions. It was just CEOs were waking up in the morning, looking at proxy contests and discovering that they didn’t run their companies anymore. It was exciting stuff. I just got hooked writing about business and investing, in economics, and it sort of took off from there, I guess.

Rick Ferri: And then you went on to write six books so far and I understand you’re working on another one. 

Roger Lowenstein: That’s right. You know I always had this desire to write more long form. I did some magazine work but my family, I don’t mind saying, had an investment, Berkshire Hathaway, and I got interested via that in Warren Buffett and thought he would be a good subject for a book.  He wasn’t so well known back then and that was the first book. That’s how I got into writing books.

Rick Ferri: And I’m going to get to that Buffett book in a minute. Actually the first book that I really want to talk about is your latest book which is America’s Bank: The Epic Struggle to Create the Federal Reserve, and this book was a financial history book. And what made you interested in going back and looking at the struggle to create a central bank?

Roger Lowenstein:  Well two things. And I appreciate you bringing up that one first because it’s really a favorite, a personal favorite. You know I’ve written a lot of contemporary histories of basically bad financial news because when the Fed gets involved, usually the Fed’s like an umpire, you only notice them when something goes wrong. So I was very interested in the role of the Fed and I felt that readers were interested in the role of the Fed.

The history of the Fed was just remarkable to me because we had been so late in ever having what I mean, way after European nations, the Russians, the Japanese, everybody in the entire developed world realized that you had a stronger financial system if you had a lender of last resort, somebody to lend when nobody else was lending. But we didn’t have one and the reasons we didn’t have one go back to George Washington, but they’re really very current. If you look at the American reluctance, say what you will, good or bad about Obamacare, any health care plan. Every other country around the world figures out that it makes sense to have a system. Not the United States, having something centralized, that touches a lot of raw nerves in this country.  It has ever since 1776.  After all, that was our history of rebelling against the central government. And the story of how the Fed was created, really the story of one banker who came here from overseas from Europe and couldn’t believe that an otherwise developed and advanced — financially advanced — country was still living sort of in the 18th century. And so I just thought there was a very good story to tell and a very relevant story today.

Rick Ferri: Yeah, I didn’t realize how late the US was to central banking. I mean of course we in this country think that our central bank is big and powerful and so forth and we probably created the whole concept. But in fact we didn’t.

Roger Lowenstein:  No we didn’t. Our central bank lived on Madison Avenue. It was a guy named J.P. Morgan. I mean, I say that tongue-in-cheek, but not completely because when we would have periodic market crashes and the government goes to him hat in hand to get up a syndicate and rescue the government, and yeah this was fine in an era when the government was small and the economy was small. And finally they did some stirrings before this that we really needed to modernize the system. We were losing. We want the creditor behind all sorts of trade agreements. London had all that business because we didn’t have a lender last resort.

So there were other reasons but in 1907 there was a market crash that came from what we call the shadow banking system, that always seems to come from the edges and creep into the heart.  At that point they went to Morgan and Morgan couldn’t do it this time. It was too big for one man. There were panics in banks across New York city and then across the country and there was increasing realization then that we needed a system, not just, you know we were too big for Big Daddy Warbucks to save us. There was a commission, a congressman, others who went over to Europe and studied central banks.

And by the way it was still such a bogeyman that when the lead senator involved and a few bankers decided to map out how they should happen, they went in secret to an island off the coast of Georgia and wrote the original blueprint for what became the Federal Reserve, telling nobody because if the word got out the people were planning a central bank, it’d be dead in the water. It was hot stuff.

Rick Ferri: That was Jekyll Island.

Roger Lowenstein: Yes it was Jekyll Island.

Rick Ferri: And now let me ask a question. And in your view, and this is your opinion, has the changes that the Federal Reserve bank been going through under first Ben Bernanke, after the financial crisis, and now Jerome Powell with buying assets that are traditionally not treasury bonds in order to help monetary policy. I mean these are big changes.

Roger Lowenstein: Well yeah, the specifics are different. Our financial system is way more complicated. The sorts of instruments that are out there are more numerous and more complicated so that if you want the Federal Reserve, the central bank, to be relevant, it’s going to have to act in different ways and through different instruments. But if you look at the history of the debate around the creation of the Federal Reserve, they had these same debates nut they were just about, there was all this talk then about what sort of debt instruments would the Federal Reserve purchase, which was another way of saying what will be money because anything that the Fed would buy would be money. And farmers from the midwest and bankers midwest said they should buy warehouse receipts. Corn should be money, and you can imagine why the farmers in the midwest would say that. That didn’t make it into the bill. 

So the fight over, or the argument over what financial instruments should be backed by the Fed is age old and the basic purpose, all the instrumentalities of change, is more complicated, obviously far bigger have changed. The idea that the Fed should rush in when there’s a real systemic crisis, that hasn’t changed. And that’s what we saw in 2008 – 2009 , and we’re seeing again of course now in the economic crisis caused by the pandemic. So in that very basic sense  I think the Fed is still doing the job that Paul Warburg, the founder of it, before Nelson Aldridge and Carter Glass, some of the other founders, had in mind.

Rick Ferri: Oh great, thank you for that. Let’s.go back to the beginning, the first book that you wrote, Buffett the Making of an American Capitalist. You did such a fine job with this book. Now I’ve read all the Buffett books before and after, and I’ve always come back to this as the best Buffett book, in my view.

Roger Lowenstein: Thank you.

Rick Ferri:Tell me in investigating this book what did you learn that struck you as being something very different and unique about Warren Buffett?

Roger Lowenstein: Well one thing I learned to appreciate was how tough he is. You know he’s a nice guy, sort of folksy guy, got that chuckling sense of humor and that, all that’s true. That’s not invented or anything. He’s extremely tough. When I say tough, if you ask him for something once, believe me don’t waste time going back and asking three weeks later. He’s enormously efficient, and one of the ways he’s efficient is you don’t waste a lot of time rethinking decisions. He’s sort of cold-blooded about what makes sense. I remember there was a friend of his in Omaha and he was putting together some idea for a new company. He was trying to get investment for it, and actually went to the richest guy in town. This is years before the country knew about Buffett, but everybody in Omaha knew he was the big financial wheel. And he said, “Well, you know, do you think enough of this idea to invest in it?”  And Buffett said, ”No.” And he said, “Well do you think enough of me to invest in it?” And Buffett said, “No.” Just like that, and this gentleman said it was so refreshing, there’s nothing like “no”.

In fact it would be labor, exclamation, explanation, and excuse and maybe I’ll think about it. It freed this gentleman from having to wonder and come back,and freed Buffett to go on to the next thing. He does that all the time with investments. And this is a real lesson. Some people, if they’re presented with an investment idea, maybe their broker says, and they’re sort of wondering about it. They’re not convinced, so they’ll just go in a little bit. Buffett doesn’t go in a little bit, if he doesn’t like something, he moves on. But he’s just very good at saying no. He does that with philanthropies too. If it’s not his thing he doesn’t give a little bit just because he wants to make the person feel good even if the person is a friend. And that’s caused some hard feelings at times over the years. But he’s very tough. He sort of follows his inner compass and he’s also very honest in a fundamental way and I was struck by that.

I was also struck by just how terribly quick he is to just spending time with him. He’s so smart. And I went to all the annual meetings that he held while I was, the three or four years that I was doing the book, and these days it was still held in the Joslyn Museum in Omaha, that moved out of the hotel down on Dodge Street, but that they were up kind of what was then midtown, and a few people there in the Q&A, somebody says, “Mr. Buffett, how good is your health. I can’t afford an event risk”, and Buffett immediately spits back, ”Neither can I.”

He really is quick. I know from firsthand he sees journalists coming around the corner, or people trying to raise money, and you might as well just hit him straight because if you have some ulterior motive you’re going to warm up to your question or your request, he can see it coming around the corner. When I did the book the first thing I did when I got a contract was I wrote him telling him I was going to do it. There were all these situations. I wanted to interview him in his office, at his home, when he was on the road. All that kind of stuff. And he just went back and said, ”No, I’m not interested.” I mean that was pretty hard. And he said something interesting, he said, “It’ll be better for me.” He didn’t want to be crowded by me. He said, ”It’d be better for you as well.” And I at first thought he was just saying that to let me down easy. As I did it, that not having him in the room forced me to come to my own conclusions about Warren Buffett. There’s plenty of material out there. I was not sure you read the book. You know there’s no shortage of information about them and this could be my book.

Rick Ferri: Interesting about Buffett, a lot of people perhaps don’t know this, at first it was a, call it a hedge fund or a private equity fund, and…

Roger Lowenstein: Hedge fund really. It was a private partnership. And since it wasn’t buying mainly private, they had one whole company, but they weren’t buying companies and taking them private, so it was pretty close to the hedge fund model of today.

Rick Ferri: And he made his money by instead of taking a big salary, taking money out of the fund, he took his cut, which if I recall, it was like 20 percent of anything over a certain return. It might have been, it wasn’t the return of the market, but it was over a certain return.

Roger Lowenstein: It was over six percent.

Rick Ferri: There we go, over six percent.

Roger Lowenstein: And I believe, it’s been a while since I wrote the book, I believe, is a quarter of the profits, but over six percent. He had no fee, so it was in a sense a more self-confident framework than most virtually every hedge fund I know set up today. Because today they take a cut of the profits but they also take a fee, a percent of the assets, so if they’re not making it one way they’re making it another way. Buffett took no fee. So if he didn’t beat six percent which was back then an assumed treasury rate, a risk-free rate. So he wasn’t going to earn any money just for getting you the treasury rate, you could do that on your own. You didn’t need him for that, but once he started for the profits he made above six percent, I believe it was a quarter, he took a quarter of it. Yeah and that’s a generous, you know, that’s a big cut. You know, it only paid, I mean his money really was where his mouth was.

He wrote these beautiful partnership letters which were proxies for the annual letters that Buffett shareholders are today. But he just went to the small circle of people who owned his partnership, and he kept saying in these letters, you know someday I’m going to lose money and we’re not going to do this forever. He beat the Dow every year. He’s never lost money, and he just didn’t have a bad game. It was bizarre how good he was.

Rick Ferri: But this is how he made his money. He made his money by taking his fee but leaving it in the partnership, and this is how he became wealthy.

Roger Lowenstein: This was the origin of his wealth. One of the stocks that they bought in the early 60s was a textile maker of broadcloth and things like that in New Bedford Massachusetts, called Berkshire Hathaway. And he sort of got into a ruckus for the guy who ran it. By then he was sort of, he was the biggest outside shareholder. He didn’t like the management. He didn’t want to sell it and so the partnership bought a controlling stake and Buffett became the controlling investor and when he liquidated the partnership at the end of 1968 he just said this is a bad market, I can’t find anything, and he returned all the money to the shareholders completely. Completely called the top of the market, by the way. But there were two stocks that he owned too much of to sell, and so he just said, “I’m going to give you your pro rata share.” One was a retailer named Associated, the other one was Berkshire. And he said, “You can do what you want. By the way I’m holding on to my part of Berkshire.”

And anybody with any brains knew that was good advice for them too. And then he just sort of sat with Berkshire for a few years, and you know it was a textile company. And then he bought a steel mill with it, and a small newspaper. Then he buys an insurance company with it. And now that this textile company owned an insurance company it had float to invest, he starts buying common stocks. And the people were following Buffett, very few said, “I think the guy’s going to do it again.” And in fact now under a corporate framework, I think, from the partnership framework of his early years, he was in fact doing it again and obviously did do it again. The stock back then was 40 dollars, 40 60, 80 dollars or so in those years. So if you’ve gotten into it, then you’d be clipping a lot of coupons.

Rick Ferri: Buffet: The Making of an American Capitalist, I mean you really get into the details of this, how Buffett became what it is today. How Berkshire Hathaway became what it is today. It’s a really great book. Let’s get into the next four books. And the next four books kind of follow a patent and I call them crisis books. You had the financial crisis of 1998 that was caused by a hedge fund called Long-Term Capital Management, and this is a great book. Any finance student needs to read When Genius Failed: The Rise and Fall of Long-Term Capital Management. It was just a real lesson to me on what goes on inside of hedge funds.

Roger Lowenstein: Well I just want to say first that when you mention those four books, and they were all about a financial crisis, at each juncture when I wrote each of them I thought well I’m really lucky because I get to write about the one of the biggest financial crisis of our generation that we’ll ever see. And then like two and a half, three years later the lesson was the lesson doesn’t get learned. John Kenneth Galbraith said, “You know they don’t ask military historians of what do we do to prevent another Waterloo. People sort of figure, well they won’t be dumb enough to invade Russia again. But that’s not true in economics. Everybody in finance, everybody, wants to know how can you avoid the next financial disaster, because they keep happening.”

I still think Long-Term Capital, that’s sort of the way genius failed story, was sort of the model for what happened. Very smart guys because nobody would run money to people who weren’t that much money who weren’t very smart took a whole lot of risk and you’d have to be smart enough to think you were that good to take that much risk. You could say a little arrogant. They thought that they were hedged — guess what, hedges they work great in good times and bad times. I think there’s a line in the book that the correlations go to one which means everything starts to go bad at once nobody wants to take any sort of risk and no matter where you have risk it was going bad against them.

And so it just sort of plays out and you see these people, who were truly the best and brightest, and richest of the financial world, watching them probably day after day as the gods of finance turn against them. The leitmotif of the book is another lesson that happens to learn it won’t be learned, I’m convinced, they were all disciples. In two cases they were Nobel prize winners for having written some of the textbooks of modern financial theory. The idea that you could program all this and feed into a computer with big enough brains a history of price movements and know exactly what you were going to come up against in the future. And you know that works until it stops working. The history books don’t tell us what’s going to happen in the future,  They don’t even tell us what could happen in the future. Lord knows we’ve seen that, now listening to a radio show yesterday about a small business that had all kinds of insurance, insurance against floods, against earthquakes. They didn’t have insurance against a pandemic however, and they’re just things they can’t anticipate. You know markets, they just don’t always act the way they did in the past. Have we tried to model for an event like the Great Depression? In the year 2005, we would have said it happens once a century. After 2008 we would have to up it to twice a century. Now it’s three times.

To think that somehow the computers are any smarter than the data that’s fed into them, and the historical data can guarantee you the future is really a fool’s comfort — that was really the light motif for the book.

Rick Ferri: What was interesting was who were the investors in Long-Term Capital Management, and initially Meriwether went out and they got outside investors. But after a while, and to the benefit of the outside investors, they all got kicked out.

Roger Lowenstein: Yeah not all. The partners in the fund realized they thought they had too much capital. The reason they felt they had too much capital was over the first few years markets had moved in their direction, so the type of trade they did, there wasn’t as much room to go in the future, and they tried to make up for this by adding leverage. In other words if you can’t make as much money, you can still make the same amount of money if you’re more leveraged, which is a really nutty way. You have to take what the market gives you and not be greedy. But they decide to leverage up and the way you leverage up is to have less capital for each style you’re investing. So they returned capital to their outside investors, you know much to the joy of these outside investors.

I want to spend a moment though. You mentioned who their investors were: Merrill Lynch, UBS of Switzerland, all the big names in finance. You know there’s this myth that the inside guy, the pro, knows better. The pro doesn’t know better. The average investor out there, I mean your uncle, your sister-in-law, whoever it is, knows better because what they’re trying to do is they’re looking for stocks they understand. They’re probably buying Apple. They’re following the Peter Lynch dictum. I don’t mean the day traders, but the ones who are buying things for long term. They’re doing things they understand.

Not with the pros who bought LTMC. It was a black box. They didn’t understand it. They weren’t even allowed to see it. They were mesmerized by this image of you know, omnipotence, and they got suckered. Not suckered willfully. There was nothing, nothing untoward about it, but they got duped into taking the same kind of risk that the partners themselves took.

Rick Ferri: And going on to the next crisis book, you talk about the origins of the crash, the great bubble and its undoing, and here we’re talking about the tech boom, the internet boom,  dotcom bubble that occurred in the 1990s, and then it blew up.

Roger Lowenstein: Really a personal favorite, I’m glad you brought it up. This is really a book about the character of Wall Street and the role of executive compensation in how companies will run and misrun companies. Like the late great MCI, the late great Enron and so on. Also the character of speculation, but now speculation on a much more mom and pop level. Can you remember those dot-com stocks? Those are stocks that your uncle and sister-in-law were buying the Web Van, if you remember that name.  And you know pets.com and all those stocks that many, many of them went under, and this was a just a bizarre era in which companies weren’t even showing profits, or the forecasts of profits. And people couldn’t get enough of them.

That was– that era sort of merged into this era. The stock profits were so great that conventional companies felt the need to get their stocks up and they began to play with their numbers.

Rick Ferri: Or change their name to dotcom.

Roger Lowenstein: I mean Enron did that. Enron became, it was an oil ,an energy services company that became a new age company. MCI did that. Lucent, Xerox, Waste Management, all these companies played terrible games with their numbers. Some of them failed, some of them didn’t. But their stocks all plunged, and was all about enriching the executives in the short term by juicing the stock no matter the long term. And really a come to Jesus moment for Wall Street and people don’t remember the stock market fell in half, which is you know quite a serious downturn. President Bush, who was no big regulator, said, “This has got to stop. Business pages shouldn’t look like a scandal sheet.”  I think those are exact words.

Rick Ferri: I recall Wall Street analysts who were highly compensated in many ways by this whole era where you know…

Roger Lowenstein: The whole daisy chain where the analysts of course were touting the stocks that their investment bankers were selling. And you know Mary Meeker was asked Morgan Stanley what was your justification for a very high priced stock and she said “bull market.” Well that’s not analysis that’s cheering. In that she was anything but alone.

Rick Ferri: And then privately there were some emails where these analysts between each other would say I wouldn’t touch this with a 10-foot pole and they put a buy on it because they were looking for investment banking business.

Roger Lowenstein: That’s right. I mean it was you know interest rates once again were very low and people they were willing to take more risk because of that and they thought they discovered, you know, golconda, the expression used in about the 1920s, the new era, this wonderland where companies could sell stock forever without any profits, which you think about was really just a Ponzi scheme because the only source of paying off the first round of investors would be investments from the next round or the next round of investors. Sooner or later, you’ve got to have profits or your company’s not going to survive.

Rick Ferri: It was the new paradigm. The next one is I’m actually going to skip a book here and I’ll get back to it because I want it to be my last book, so I’m skipping one and going to your fourth crisis book and that was The End of Wall Street and here now we’re talking about the mortgage crisis and what created it.

Roger Lowenstein: You know that course broke in 2008. The origins of it were people like you know [Angelo] Mozilo, Countrywide, and Washington Mutual out in Seattle who were feeding the entire country with mortgages. First 95 percent of the equity, 98 percent of the equity, 100 percent of the equity. You know just because it’s not a loan when you give someone 100 percent of the equity, it’s a gift.  Then we’re giving 100 percent loans at steeply increasing prices, so you had millions of homeowners who had zero equity in their homes and who owed an amount of money that couldn’t withstand even a miniscule depreciation in price. This was being blessed by the credit rating agencies. It was being blessed by the Wall Street Banks, who were selling the mortgage securities.

But it really was a larger version, and that was a more serious version, of the first one in this series we talked about, When Genius Failed, of the LTCM. You know it was just giant risk-taking on a much more serious scale because this time the people affected were a sizable percentage of the homeowners of America and homes are something — if Wall Street fat cats want to go out and play with their assets or even their firms, that’s one thing — but when you destabilize American’s homes, which for most Americans are the great bulk of the equity they have, you really get a serious problem. And you remember that we went into this terrible, terrible recession, unprecedented since the Great Depression, when the mortgages collapsed and nobody was prepared for it. Not the treasury, Bernanke. The Fed said that the subprime mortgages won’t be a blip, not only did he say it wouldn’t affect the entire economy, that it wouldn’t even affect the entire mortgage industry. It would just just be a modest rise in subprime default.

All these experts were dead wrong. In fact they were playing a different version of a daisy chain game, because anytime someone needed refinancing, someone’s mortgage was up, they just refinanced. That game of papering over bad loans or more loans can only go on for so long and eventually, in 2006, prices began to peak and once prices peaked the game was over because the whole thing was presaged on ever-rising housing prices. And that was a scary time. It was thrilling to write about, but it was really a frightening time. And I remember that Sunday night when Lehman went down, and nobody really knew whether the sun was going to rise, at least in the financial sense on Monday morning.

Rick Ferri: One of the scariest comments made during that period of time was when Alan Greenspan said, “You know in retrospect we really didn’t understand, you know, how the financial system worked,” or something to that effect.

Roger Lowenstein: What he said was, and this comes up in one of the early books we talked about, Origins of the Crash, when the lack of regulation of financial instruments was a big issue, and Greenspan’s view — of course he’s a big free marketer — look, I’m a free marketer but I believe in the highway you gotta have speed limits, and you have to have speed limits in financial markets — Greenspan had said that basically any deal that private bankers make with each other, since each banker is acting their own self-interest, has got to be rational and basically doesn’t need to be regulated. Which was said in such complete ignorance of what history had shown; if there hadn’t been a banking crisis ad infinitum in the past.

And it was also, it also overlooked a fact of how banks are run. If you’re on the mortgage desk at Lehman and you package a lot of securities, you get paid for it. If they all go bust two years later you don’t have to give the money back. In fact you probably moved on to Bear Stearns or Merrill Lynch by then. It’s somebody else’s problem. So the people making those deals didn’t in many cases even have an incentive not to make bad deals. They had every incentive to make every deal they could, good or bad. And Greenspan, the comment you’re referring to, was he said — I can’t remember the exact words, it’s in the book but — “we who had faith in the markets to operate,” he fessed up.

Rick Ferri: Yeah, it was a little scary to me to hear him say something like that.

Roger Lowenstein: He was naive, maybe willfully, but by the time he fessed up he was out. Yeah he’d been a disciple of Ayn Rand and, you know, ultra freemarketers, and Bernanke at that moment, and this figures in The End of Wall Street, fortunately for us, although we hadn’t seen it coming, he didn’t know what to do because he studied the Great Depression and he knew that you had to be that lender of last resort, America’s bank, the Federal Reserve. And he turned the Fed into the greatest rescue operation in its 100 year history.

Rick Ferri: I find it interesting how Treasury stepped up during this crisis, first with Timothy Geithner, and then Hank Paulson, to work with the Fed, to kind of save the day in many ways.

Roger Lowenstein: Well Hank Paulson, of course, was Bush’s Secretary of Treasury. I interviewed him a couple of times for the book. He and Bernanke made a very interesting team because Bernanke was Republican and Paulson was really a rib rock Republican. Neither he nor Bush came into office with any thought of socializing the banking system and yet when they proposed the TARP, in a partial sense, that’s exactly what they did. You know they had the congress purchase equity shares with federal government in JP Morgan, Bank of America and you know right on down the list of all the biggest banks, and virtually all the banks, you know, some small share to stabilize the banking system. In the case of the banks that were teetering, to save the banks.

So that was, I think, kind of heroic on the part of Bernanke and Paulson, and frankly W [George W. Bush], who you know had no notion of when to do that kind of stuff. But when they came to him and said you gotta do it, he did. The Republican Congress was not so eager. When the TARP was crafted and came to a vote, the House voted down and the market fell 700 points that day. Representative Kyle later said, he said my constituents were divided, half of them said no, and the other half said hell no. But they thought that the Wall Street crisis would just sort of affect Wall Street. The Main Street would just sally on unaffected. And when the market then started to crash day after day, the House was called back and in a hurry to approve the TARP.

Rick Ferri: Yeah very interesting point in history. Let me circle back to the third crisis book which is now in my opinion still on the table and that is While America Aged: How Pension Debts Ruined General Motors, Stopped the New York City Subways, Bankrupt San Diego and Looms as the Next Financial Crisis. To me this is still on the table.

Roger Lowenstein: Yeah thank you. Yeah that was different in this sense from the others. The pension crisis is a slow burning crisis. These other ones all had big crescendo-like moments. LTCM when it took a bailout from the banks on Wall Street. The mortgage crash when Lehman went under, and so on. This one book was published in 2008. I started working on it in 2006 and we’re still talking about as current in the end of the year 2020. And the reason that’s so is because, of course, the pension system isn’t one system, it’s, particularly the public pension system, is thousands of individual systems. Teacher systems, state systems, municipal worker systems, across the country. They’ve each hit against hard times at different times, but since that book has come out Puerto Rico, Stockton, California, Detroit, small and large cities across the country have failed, some of them literally in bankruptcy, and some of them effectively like Puerto Rico. Chicago, now there’s no way to see how they get out of their pension mess. Same thing with New Jersey and that’s as much a political book as a financial book because there’s nothing wrong with the pension system in theory. Collective insurance is a very good idea. If a group of people insure themselves, the odds are it’s going to be a sounder system than if, you know, one person saves for their own retirement.

The problem is that when you get political actors approving benefits — and these are benefits that stretch out 20 and 30 years in the future — that political actor has an interest, of course, in awarding generous benefits because by the time the benefits come due they’ll have retired, certainly moved on to another job, in most cases retired. And so there’s just a natural moral hazard, and they keep voting these benefits in and not approving adequate funding. And the book was not an attack on pension funding or benefits. It was just to cry, please fund whatever level you decide. And that’s a negotiated question between unions and the government. Whatever level you decide you gotta fund it but you can’t approve benefits without funding them. And I’m afraid, as with the others, that’s a lesson that we’re still learning the hard way. And given what the pandemic has done to municipal finance, you know there’s gonna be a lot more that to come.

Rick Ferri: And one of the big problems that I see as a financial advisor is that these areas of the country that you mentioned that have big pension holes. They’re losing business. I mean people are leaving because they keep having to increase their state income tax. And now you see an exodus of wealthy individuals, of retirees, of businesses from those areas of the country that have these huge pension liabilities to other parts of the country where there’s not as high or as onerous of a tax rate on either the corporation or the individuals. And that makes it even harder for the people who stay back.

Roger Lowenstein: Sooner or later taxpayers also will vote with their feet. In a sense — and this may sound circuitous — but we learned a lesson with teachers unions, the sanitation workers unions, and so on and so on in jurisdiction after jurisdiction they represent a narrow interest and those interests aren’t society’s interest. That society has a much greater interest. Our cities and states have to be run and compensation has to be meted out, including pensions. With that larger interest in mind, not just with satisfying the narrow parochial interests of public sector unions.

Rick Ferri: Roger, just want to get your parting views of how do you think America sits today in the world?

Roger Lowenstein: You know I think we’ve been through a very rough time. But I think we’re starting to see silver linings. There were people saying that — and I really didn’t believe this because I think it’s never as dark as it looks at the darkest hour — but you know Wall Street would never come back and the economy would never come back. And we’ve now lived through the pandemic for six, seven months. The economy’s lived through it for six, seven months. The pandemic’s still with us but mortality rates are dropping from it. The economy has been I think you’d have to say remarkably resilient in the face of everything it’s been through. I’m hopeful that the spirit of the country is becoming less rancorous and maybe a little more united. Look 2020 was a tough year but you know if I had to bet, 2021 –  2022 and so on things will start to look better. We’ve been through periods like the Great Depression, and then we’ll get through this one.

Rick Ferri: You’re working on another book and I know that you can’t disclose what it’s about but I just sort of made a list of three big areas where if I was to make a guess as to what it might be about. It might be about trade and trade conflicts. It could be about Medicare and COVID. And the last, it could be about small business and how small business is changing. I know you can’t tell people what the book is about, but…

Roger Lowenstein: Well, I’ll just say  it’s historical but it has great residents of today and it’ll be out in a year and love to talk to you about it in depth when it comes.

Rick Ferri: Okay fair enough. Well thank you so much for being our guest on Bogleheads on Investing. We really appreciate the time today.

Roger Lowenstein: Rick it was really a pleasure to talk with you.

Rick Ferri: This concludes Episode 28 of Bogleheads on Investing. I’m your host Rick Ferri. Join us each month to hear a new special guest. In the meantime visit bogleheads.org and the Bogleheads wiki. Participate in the forum and help others find the forum. Thanks for listening.

Investment adviser, analyst, author and industry consultant

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