Tuesday, December 16, 2008

Book of the Year

False Security: The Betrayal of the American Investor by By Bernard J. Reis New York, Equinox Cooperative Press Inc., 1937

People have a general sense of our current economic situation as parallel to that of the 1930's, in the sense that we are suffering from the unwinding of a credit cycle, speculative excesses of the recent past, etc.  The interesting part isn't so much the unwinding of excess.  We all know how that story goes.  The more fascinating part are the details regarding buildup of those excesses.  

Reis lays out an easy to read, systematic indictment of investment excesses during the 1920's, and more distressingly, the details of their failure.  The general sense is fat bankers tossing widows and orphans out of the Titanic's lifeboats.  

It is also surprising to see the popularity of mortgage backed securities in the 1920's, and their inevitable failure.  The current monoline insurers are direct descendants and have proven surprisingly robust in part based on reform to prevent the excesses of the 1920's.  Even though they are ruined, MBIA, for example, is still around and still has cash and is still paying claims.  I won't bother to argue that they will survive or that their claimants will be made whole -- just that they have proven remarkably robust.

The general themes:

1.  Corporate managers self dealing.
2.  Insured Mortgage backed bonds.
3.  Foreign Bonds (ala today's emerging markets)
4.  Investment Trusts
5.  Failure of Directors, Trustees, etc.
6.  Failure of Bankruptcy and Reorganization to protect investors.

These are all illustrated with detailed examples of the failure to protect individual investors.

I found the popularity of real estate speculation and securitization of mortgages to be the most surprising parallel to today.  The financial engineers of the 1920's weren't using arcane financial theory to create instruments of Byzantine complexity.  However, they were relying on the basic techniques of slicing up cash flows to appeal to new customers and to relying on the prestige of traditionally sound firms to obtain the confidence needed to sell these new products.

There is no one alive with direct experience as an adult in dealing with the excess/reform cycle of the 1920's - 1930's.   However, the artifacts remaining from the reform phase -- primarily financial regulation, is surprisingly intact.  It has suffered over the last decade plus, but is surprisingly resistant to change.  Most of today's excesses were enabled by simply going around or "disintermediating" the regulated institutions. 

This book provides a vivid and concrete view of the events that motivated New Deal financial regulatory reform.  In that sense, it fills the void formed by the inevitable loss of institutional experience over time.  

The overall sense is an eerie sense of familiarity with the practices of that time period.  And a strong belief that no one that had lived through this earlier era would have gone within a mile of a multi sector CDO.      

Even better, an extended preview is available on Google Book.  It is also available at libraries -- so it fits in perfectly with the new frugality.  You can find it here using Worldcat.
From the introduction:

This is in the neighborhood of 15% of GDP in 1930, which would be equivalent to $2 trillion today.  In those days a millionaire was rich and a billion was a lot of money.    

An interesting aside is that Bernard Reis was an Accountant and and art collector and the executor of Mark Rothko's estate.  

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