Friday, July 18, 2008

Ted Forstmann-Austrian Economist

"Twenty years ago, Ted Forstmann contributed a scathing--and prescient--op-ed to this newspaper warning that the junk-bond craze was about to end badly: 'Today's financial age has become a period of unbridled excess with accepted risk soaring out of proportion to possible reward,' he wrote in October 1988. ... Within a year, the junk-bond market had collapsed, and within 18 months Drexel Burnham Lambert, the leading firm of the junk-bond world, was bankrupt. Mr. Forstmann sees even worse trouble coiming today. For a curmudgeon, he is a cheerful man. ... 'We are in a credit crisis the likes of which I've never seen in my lifetime,' Mr. Forstmann warns. He adds: 'The credit problems in this country are considerably worse than people have said or know. I didn't even know subprime mortgages existed and I was worried about the credit crisis.' ... Forstmann's argument about the present crisis starts with the money supply. After Sept. 11, 2001, the [Fed] pumped so much money into the financial system that it distorted the incentives and the decision making of everyone in finance. ... But after 9/11, the Fed opened the spigot. Short-term interst rates went to zero in real terms and then into negative territory. ... This led to a series of distortions in the financal system that are only now coming to light. ... Straightforward economics tells us that when you print too much money, it loses value and prices go up. But Mr. Forstmann is most concerned with a different, more subtle effect of the oversupply of money. When it becomes too plentiful, bankers and other financial intermediaries wind up taking on more and more risk for less return. ... By his own description, he's a bit of a figure from another age---'a bit like Wyatt Earp in 1910.' ... 'You've got ... Paulson saying, 'Oh, you see the good news it's over.' The problem, according to Mr. Forstmann, is that it's far from over. 'I think we're in the second inning of this'. ... Take what happened to Bear Stearns. 'What should be the health of one brokerage firm in America mean to the entire global financial system? To any ordinary person, probably not much. But in today's world, with all the interdependence, a great deal'.' ... 'Buffett once told me that there are three "I's" in every cycle. The "innovator," that's the first "I'. After the innovator comes the "imitator." And after the imitator in the cycle comes the idiot. ... So when Mr. Forstmann says we're at the end of an era, it's another way of saying that he's afraid that the idiots have made their entrance. ... 'The creation of much too much money caused all of this excess,' he says. In other words, his is not an argument for draconian regulation, but for sound money", my emphasis, Brian Carney at the WSJ, 5 July 2008.

Forstmann gives a "conventional" Austrian analysis of current conditons, I agree with. When I saw former used car salesmen, literally, selling mortgage products in the San Fernando Valley near Los Angeles, California making $500 thousand to a million dollars a year, in 2005, I saw the end in sight. Forstmann's point about the change in the capital market line's slope is valid too.

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