Endgame

INTRODUCTION

Endgame

People only accept change in necessity and see necessity only in crisis.

—Jean Monnet

Every child learns about the Great Depression in school, but economists, historians, and commentators have not agreed on what we will call the turbulent economic period we are currently living in. Some do call it a depression. Others call it the Great Recession. And some refer to it as the Great Financial Crisis. The Great Financial Crisis is particularly apt, because crises force us to make difficult choices. And one thing that everyone can agree on is that this new era of turbulence will impose difficult choices on governments and voters around the world.

I (John)1 am somewhat of an expert on bad choices—not only my own, but I have had the joys of seven teenage children. As our family grew, we limited the choices our kids could make, but as they grew into teenagers, they were given more leeway. Not all of their choices were good. How many times did Dad say, “What were you thinking?” and get a mute reply or a mumbled “I don’t know.”

Yet how else do you teach them that bad choices have bad consequences? You can lecture, you can be a role model, but in the end you have to let them make their own choices. And a lot of them make a lot of bad choices. After having raised six, with one more teenage son at home, I have come to the conclusion that you just breathe a sigh of relief if they grow up and have avoided fatal, life-altering choices. I am lucky. So far. Knock on a lot of wood.

I have watched good kids from good families make bad choices, and kids with no seeming chance make good choices. But one thing I have observed: Very few teenagers make the hard choice without some outside encouragement or help in understanding the known consequences, from some source. They nearly always opt for the choice that involves the most fun and/or the least immediate pain and then learn later that they now have to make yet another choice as a consequence of the original one. And thus they grow up. So quickly.

But it’s not just teenagers. I am completely capable of making very bad choices as I approach the beginning of my seventh decade of human experiences and observations. In fact, I have made some rather distressing choices over time. Even in areas where I think I have some expertise, I can make appallingly bad choices. Or maybe particularly in those areas, because I have delusions of actually knowing something. In my experience, it takes an expert with a powerful computer to truly foul things up.

Of course, sometimes I get it right. Even I learn, with enough pain. And sometimes I just get lucky. (Although, as my less-than-sainted Dad repeatedly intoned, “The harder I work, the luckier I get.”)

Each morning is a new day, but it is a new day affected by all the choices of the previous days and years. My daughter Tiffani and I have literally interviewed in depth more than a hundred millionaires and talked anecdotally with hundreds more over the years. I am struck by how their lives, and those of their families, come down to a few choices: sometimes good choices and sometimes lucky choices; often, difficult ones. But very few were the easy choice.

What Were We Thinking?

As a culture, the current mix of generations, all over much of the developed world, have made some choices—choices that, in hindsight, leave the adult in us asking, “What were we thinking?”

In a way, we acted like teenagers. We made the easy choice, not thinking of the consequences. We never absorbed the lessons of the depression from our grandparents. We quickly forgot the sobering malaise of the 1970s as the bull market of the 1980s and 1990s gave us the illusion of wealth and an easy future. Even the crash of Black Monday seemed a mere bump on the path to success, passing so quickly. And as interest rates came down and money became easier, our propensity to acquire things took over. In Europe, the advent of the euro gave southern Europe the interest rates of the German Bundesbank, and the Germans got a southern European currency in return.

And then something really bad happened. Homes and other assets all over the world started to rise in value, and we learned through new methods of financial engineering that we could borrow against what seemed like their ever-rising value to finance consumption today. Everybody was responding to incentives—the problem was that the incentives were misguided, and the regulators were not doing their job.

We became Wimpie from the Popeye cartoons of our youth: “I will gladly repay you Tuesday for a hamburger today.”

Not for us the lay-away programs of our parents, patiently paying something each week or month until the desired object could be taken home.

As a banking system, we made choices. In the United States, we created all sorts of readily available credit and packaged it in convenient, irresistible AAA-rated securities and sold them to a gullible world. We created liar loans, no-money-down loans, and no-documentation loans and expected them to act the same way that mortgages had in the past. What were the rating agencies thinking? Where were the adults supervising the sandbox? (Oh, wait a minute. That’s the same group of regulators who now want more power and money.)

It is not as if all this was done in some back alley by seedy-looking characters. This was done on TV and in books and advertisements. I (John) remember the first time I saw an ad telling me to call this number to borrow up to 125 percent of the value of my home and wondering how this could be a good idea.

It turns out it can be a great idea for the salesmen, if they can package those loans into securities and sell them to foreigners, with everyone making large commissions on the way. The choice was to make a lot of money with no downside consequences to you. What teenager could say no?

In the United States, Greenspan kept interest rates low, which aided and abetted the process. The Bush administration started two wars and pushed through a massive health care package, along with no spending control from the Republican Party, thereby running up the fiscal deficits.

The financial industry’s regulators allowed credit default swaps to trade without an exchange or supervision. A culture viscerally believed that the McMansions they were buying were an investment and not really debt. Yes, we were adolescents at the party to end all parties. And as our friend Paul McCulley said, the ratings agencies were handing out fake IDs to this underage drinking party.

Not to mention an investment industry that tells its clients that stocks earn 8 percent a year in real return. Even as stocks have gone nowhere for 10 years, we largely believe (or at least hope) that whatever the latest uptrend is will be the beginning of the next bull market.

It was not that there were no warnings. There were many who wrote about the coming train wreck that we are now trying to clean up. But those warnings were ignored.

Derision, scorn, laughter, and dismissal as a nonserious perpetual perma-bear were heaped on these commentators. The good times had lasted so long, how could the trend not be correct? It is human nature to believe the current trend, especially a favorable one that helps us, will continue forever.

And just like a teenager who doesn’t think about the consequences of the current fun, we paid no attention. We hadn’t experienced the hard lessons of our elders, who learned them in the depths of the depression. This time it was different. We were smarter and wouldn’t make those mistakes. Didn’t we have the research of Bernanke, the ECB, the BIS, and others, telling us what to avoid?

In millions of different ways, we all partied on. It wasn’t exclusively a liberal or a conservative, a rich or a poor, a male or a female addiction. We all (or most of us) borrowed and spent. We did it as individuals, and we did it as cities and states and countries.

In the United States, we ran up unfunded pension deficits at many local and state funds, to the tune of $3 to $4 trillion and rising. We have a massive (multiple tens of trillions of dollars) bill coming due for Social Security and Medicare, starting in the next 5 to 7 years, that makes the current fiscal crisis pale in comparison. We now seemingly want to add to this by passing even more spending programs that will only make the hole deeper.

Europe has even larger underfunded social programs and banking systems that are quite suspect and heavily overleveraged with massive loans made to countries that will not be able to pay them back in full. Japan has taken the savings of two generations to amass the largest debt to GDP of any country in history, with little hope of avoiding serious pain as their population ages, needs to stop saving, and will begin selling their bonds to be able to live comfortably in retirement.

Now, we are faced with a continuing crisis and the aftermath of multiple bubbles bursting. We are left with massive government deficits and growing public debts, record unemployment, and consumers who are desperately trying to repair their balance sheets.

We are left with no good choices. For some countries, it is more a case of difficult choices such as reforming the tax system and entitlement programs. These are good things to do, not bad things, but are not easy because of entrenched special interests and political disunity. Some countries (like Greece and its compatriots) must choose between very, very bad and disastrous choices. No matter what they choose, they will have significant economic pain....