Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


The economic outlook for 2009

How we got to where we are today, who's to blame, and where we're going in 2009. (5-Jan-2009)
Summary Most people are hoping that 2009 will be a much better year than 2008. What they overlook is that the same Generation-Xers and Boomers who created the world wide financial crisis are still in charge. Unfortunately, this means that 2009 will be much worse than 2008.

Contents - This page
Boomers and Generation-Xers
The role of regulators and politicians
Example #1: Fannie Mae and Freddie Mac
Example #2: Bear Stearns
Example #3: The $50 billion Bernard Madoff swindle
Example #4: Thomson Reuters and earnings estimates
A flood of corruption
The expectations for 2009
The outlook for 2009

It's widely believed that Barack Obama will "heal the world" when he becomes President of the United States on January 20.

In particular, it's widely believed that he'll solve the country's economic problems by means of "stimulus package" of $600-700 billion dollars. In fact, the public expects Obama to spend any amount of money necessary to heal the economic crisis. Obama and his advisers have done everything possible to encourage that view. All I ever hear from Obama and his advisers is that high unemployment "is unacceptable," and that "as much money as necessary will be spent" to reverse the situation.

The plan is a "stimulus package" of hundreds of billions of dollars. As I wrote in "One, Two, Three ... Infinity," these dollar amounts are constantly increasing, sometimes on a daily basis, so the amount may very well reach $1 trillion. (As I'm finishing up this article, I hear that the Obama has doubled the planned amount from $600-700 billion to $1.3 trillion.)

From the point of view of Generational Dynamics, none of this makes sense. The same people who have destroyed the world's financial system are now supposedly going to heal it by spending a trillion dollars, with little or no fiscal discipline. This is a recipe for total disaster.

In order to know where you're going, it helps to understand how you got here. For that reason, we're going to go into a lot of detail to answer this question: Who's to blame for the current financial crisis?

Once we've established the generational answer, it will be easy to see exactly why we're headed for an even worse crisis in 2009.

Who's at fault?

What we're seeing today is a lot of finger pointing. Nobody blames himself, but everyone has a favorite other person to blame.

I've been writing about this crisis for years, and one thing that's clear is that there's no simple answer to the question, "Who's at fault?" Deception and fraud have been the norm for several years now, across entire industries, and at every level.

Even Alan Greenspan, in testimony before Congress, said that he was shocked that almost everyone in the financial industry appears to have been committing fraud. In his testimony (PDF) to the Government Oversight and Reform committee, he said:

"As I wrote last March: those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief. Such counterparty surveillance is a central pillar of our financial markets’ state of balance. If it fails, as occurred this year, market stability is undermined. ...

In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment."

Greenspan's statement makes it clear that something has changed in the last ten years. Things are happening that never happened before -- at least in Greenspan's memory.

Let's make a list of the groups of people who committed widespread deception and fraud, leading to the current financial crisis:

Contents - This page
Boomers and Generation-Xers
The role of regulators and politicians
Example #1: Fannie Mae and Freddie Mac
Example #2: Bear Stearns
Example #3: The $50 billion Bernard Madoff swindle
Example #4: Thomson Reuters and earnings estimates
A flood of corruption
The expectations for 2009
The outlook for 2009

What's astonishing about all this is the ubiquity of fraud and deception. It seems that there is no place where honesty, decency and ethics still prevail. Instead, every person has been out for himself or herself, no matter how many other people get screwed.

I've been writing about and analyzing this situation for six years now, and you wouldn't believe how furious I am at this situation and these people. I've been criticized for frequently calling these people "total morons" on my web site, but the only reason I've been doing that is because I didn't want to call them "total crooks."

Boomers and Generation-Xers

I've written many times about how the lethal combination of Boomers and Generation-Xers led to the current financial situation. I'll give a brief summary here:

In the end, the current financial crisis was caused by a lethal combination of nihilistic, destructive, greedy Gen-Xers, working for stupid, arrogant, greedy Boomers.

I've had people complain to me about this characterization of Boomers and Gen-Xers, but nobody who's complained has ever provided any other explanation for the ubiquity of fraud and deception in the last few years.

(For an explanation of generational archetypes, see "Basics of Generational Dynamics." For a more detailed explanation of how Boomers and Gen-Xers colluded to create the current financial crisis, please see "Markets fall as investors are increasingly unsettled by bad economic news.")

The role of regulators and politicians

There's a widely held view that the financial crisis was caused by lack of oversight by regulatory agencies and politicians. Here's a succinct statement of this view by Chrystia Freeland of The Financial Times, appearing on "The NewsHour With Jim Lehrer" on January 1, 2009:

Chrystia Freeland of The Financial Times <font size=-2>(Source: PBS)</font>
Chrystia Freeland of The Financial Times (Source: PBS)

"There was a belief that markets could self-regulate absolutely perfectly. One of the lessons of this crisis is that that's not true. Mortgage markets clearly CAN'T self-regulate themselves perfectly. You can't trust, it turns out, the lenders to always lend prudently. You can't trust the borrowers always to borrow prudently. And that turned out to not just the case with uneducated people taking out subprime mortgages, but it turned out to be the case with some of the smartest guys, people who were earning huge salaries, people who developed complex mathematical models that turned out to be very, very bad at valuing risk."

Statements like this only repeat the problem -- that no one was acting "prudently." This statement offers no solution, but implies that the crisis could have been avoided with more regulation.

What this overlooks is that the regulators and politicians are exactly the same Boomers and Gen-Xers that caused the crisis.

There were plenty of regulations passed in the 1930s, to prevent a repeat of the 1920s bubble that led to the Great Depression. When I was growing up in the 1950s, my teachers all knew what had caused the Great Depression, and they talked about it all the time. It was caused by the greed of bankers and investors, who broke all the rules and harmed millions of people. It was caused by the lack of ethics and morals by the people in charge. It was caused by a complete lack of discipline.

I particularly recall my mother was always furious at bankers and politicians, whom she considered to be greedy and vicious. I never understood why she felt that way, but I do now, when I see what's been happening on Wall Street and in Washington in the last few years. Things have come full circle.

The SEC (Securities and Exchange Commission) was explicitly formed in the 1930s to prevent another bubble; the SEC had totally failed in its mission by the time of the dot-com bubble in the late 1990s.

But nobody even cared. By the late 1990s, all the survivors of the Great Depression were gone (retired or died). Macroeconomists, led by current Fed Chairman Ben Bernanke, had "proven" that there was no need for discipline, after all. Bernanke had "proven" that the Great Depression was caused by a simple accounting error by the Fed. (See "Ben Bernanke's Great Historic Experiment" and "Bernanke's historic experiment takes center stage.")

All forms of regulation and discipline were repealed, starting mainly in the 1980s in the Reagan administration, and continuing through through the father Bush, Clinton, and son Bush administrations.

Thus, for example, we had the repeal in 1999 of the Glass-Steagall Act, originally passed in 1933. Its purpose was to keep commercial banks and investment banks as separate institutions. It can be debated how effective the Glass-Steagall act was, but the way to think of it is that it was just one of a million different laws and regulations that introduced discipline into the financial markets, in order to prevent and expose fraud and abuse.

By the 1990s, it was the common wisdom that there was no longer any need for discipline. The lessons that the survivors of the Great Depression has learned were simply wrong. Everything they said was crap anyway -- they were just doddering old fools who were so out of date that the didn't even use iPods.

Contents - This page
Boomers and Generation-Xers
The role of regulators and politicians
Example #1: Fannie Mae and Freddie Mac
Example #2: Bear Stearns
Example #3: The $50 billion Bernard Madoff swindle
Example #4: Thomson Reuters and earnings estimates
A flood of corruption
The expectations for 2009
The outlook for 2009

The Boomers became doddering old fools too, in their own eyes, but also in the eyes of the rising Generation-Xers. The Glass-Steagall Act was swept away in 1999, along with hundreds of other tiny regulations and rules that were no longer necessary because they were put into place by doddering old fools.

Example #1: Fannie Mae and Freddie Mac

The Federal National Mortgage Association, nicknamed Fannie Mae, was created in 1938 in reaction to the massive homelessness of the Great Depression, after so many people lost their homes through foreclosure. Its purpose was to make sure that every American family could live the American dream with his own home. In 1968, Fannie Mae was made into a private, shareholder-owned agency, since it was felt that it could make money on its own. However, it still had special privileges as a GSE (government sponsored entity) that made it a virtual monopoly. As a result, Congress created a competitor in 1970 -- the Federal Home Mortgage Corporation, nicknamed Freddie Mac.

In the 1970s, housing began to be extremely politicized, with complaints that poor people and blacks were being discriminated against in the housing market. Thus, Democratic party "pro-Black" and "pro-poor" constituencies were demanding easier regulations and easier loans, while Republican party "pro-business" constituencies were slowing things down.

The political paralysis essentially gave Fannie and Freddie the freedom to do anything they wanted. And so they turned to structured financing and hedge fund techniques to fund mortgages. Fannie and Freddie management, with links to the Democratic party, reduced requirements so that they could process a high volume of mortgages, so that they could give themselves fat bonuses.

In 1999, the same year that the Glass-Steagall Act was repealed, many regulatory restraints were removed from Fannie and Freddie. Here's how it was described in a 1999 article in the NY Times:

"Fannie Mae Eases Credit To Aid Mortgage Lending By STEVEN A. HOLMES

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action ... will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.'' ...

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn....

Fannie Mae officials stress that the new mortgages will be extended to all potential borrowers who can qualify for a mortgage. But they add that the move is intended in part to increase the number of minority and low income home owners who tend to have worse credit ratings than non-Hispanic whites. ...

[H]ome ownership rates for minorities continue to lag behind non-Hispanic whites, in part because blacks and Hispanics in particular tend to have on average worse credit ratings.

In July, the Department of Housing and Urban Development proposed that by the year 2001, 50 percent of Fannie Mae's and Freddie Mac's portfolio be made up of loans to low and moderate-income borrowers. Last year, 44 percent of the loans Fannie Mae purchased were from these groups."

As we look back over the past 60 years, we can see that financial regulations have been gradually removed over the entire period, through Republican and Democratic administrations. But if I had to pick a particular year when things really began to run off the rails, 1999 would appear to be it.

When the Enron scandal broke in 2001, the public largely blamed Republicans, because oil and energy are Republican "things." However, the root of the Enron problem was the same kind of structured finance that Fannie and Freddie were using.

Furthermore, after the Enron scandal, Congress passed the Sarbanes-Oxley Act, which provided the most far-reaching reforms of business practices since the 1930s. This act was supposed to make it harder for companies to lie to investors, but as it turned out, it had no effect whatsoever on the breadth and depth of mortgage fraud being pursued by Fannie and Freddie.

Contents - This page
Boomers and Generation-Xers
The role of regulators and politicians
Example #1: Fannie Mae and Freddie Mac
Example #2: Bear Stearns
Example #3: The $50 billion Bernard Madoff swindle
Example #4: Thomson Reuters and earnings estimates
A flood of corruption
The expectations for 2009
The outlook for 2009

Many economists were getting alarmed by Fannie and Freddie, and a March, 2003, speech by William Poole, President of the Federal Reserve Bank of St. Louis, raised an alarm. (This speech gives a detailed history of US housing and mortgage policy since 1918, and is well worth reading in its entirety.)

In his speech, Poole pointed out the following issues:

This last point is quite prescient, as the Fannie/Freddie crisis came very quickly, in September, 2008. (See "Another stunning and historic bailout: Fannie Mae and Freddie Mac" and "Two days after Fannie/Freddie crisis, another crisis looms at Lehman.")

Poole's speech contains a very interesting couple of paragraphs discussing "nonquantifiable risks." As an aside, this entire subject area is very important to generational theory.

"Given the extensive discussion of quantifiable risks, I want to concentrate on the nonquantifiable risks. It helps to make this issue concrete by listing some examples. The failure or near failure of Penn-Central, Continental-Illinois, Long-Term Capital Management, Enron and WorldCom may not have been complete surprises to knowledgeable insiders, but the shocks were certainly "news" to market participants, regulators and the general public. No one predicted the timing of the stock market crash of 1987, or the peak of the equity markets in the spring of 2000. It is well known that even the great Yale economist Irving Fisher was caught completely off guard by the crash of 1929. Surprise legal decisions brought bankruptcy to 52 firms involved with asbestos, to Dow-Corning and to Texaco. Finally, while experts in terrorism may have understood the risks of attacks on U.S. soil, their information was not sufficient to prevent the September 11 attacks; certainly no one else had any basis for predicting the attacks. All of these cases, with the possible exception of Continental-Illinois, reflected nonquantifiable risks.

The point here is not to fault the forecasting record of any person or any agency. Rather, it is to illustrate that major unforeseen events that can bring about a collapse in confidence or disruption to the normal function of financial markets without any warning can and do occur with some frequency. The history of the United States, as well as other countries, is replete with such examples."

On this web site, when I write about "chaotic, unpredictable events," I'm talking about the same thing that Poole is describing. In generational theory, it's exactly these events that can trigger not only a financial crisis, but also a major war. However, they do not CAUSE the crisis; they simply TRIGGER a crisis that was going to happen sooner or later anyway.

Things began to heat up in mid-2003 when Freddie Mac disclosed that it had understated past income by as much as $4.5 billion. This was quite alarming, since it proved that Freddie's operations were indeed so complex that Freddie's management didn't even know how much they were earnings. And $4.5 billion is a HUGE error.

All of that laid the groundwork for the political battle.

By September, 2003, the Bush administration proposed additional regulations and oversight for Fannie and Freddie. As reported by a NY Times article, "The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago."

However, attempts at reforms were blocked by Democratic politicians, led by Barney Frank. The Times article quotes Frank as saying: "These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis. The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing."

If you drill down into this 2003 quote, you can sense the attitude that Boomers (in this case represented by President Bush) are "full of crap." You can also sense the contempt for and rejection of Silent generation values for fiscal discipline. Ironically, Frank himself is from the Silent generation (born in 1940), but he's politically aligned himself with the Gen-Xers who are contemptuous of Silent values.

The political paralysis continued as the situation got worse. As the financial system really started falling apart in 2007, Fed Chairman Ben Bernanke delivered a speech calling for regulatory reform of Fannie and Freddie, but once again, the attempts were blocked by groups led by Barney Frank.

The regulatory situation remained unchanged as the international credit crisis began in August, 2007, through the Bear Stearns collapse and other collapses in 2008, until the September collapse of Fannie and Freddie.

I've gone into the above details because I want to make a point: There was no time when effective regulation of Fannie and Freddie was even possible.

Today it's widely viewed that Fannie and Freddie were the major villains in the subprime mortgage crisis, and it's claimed that if regulators hadn't fallen down on the job, then the subprime mortgage crisis wouldn't have occurred. (From the point of view of Generational Dynamics, this is completely untrue; if Fannie and Freddie had never existed, then the financial crisis would have been just as bad, though in a different form.)

So if you believe that more regulation would have made a difference, then please tell me exactly who would have provided that regulation, and at what time?

The toothless SEC couldn't have done it. The SEC failed to do anything at all about the dot-com bubble, and they were even more pathetic with the Bear Stearns collapse and the Bernard Madoff swindle (see below), so how could they have done anything about the credit crisis? In fact, once the 1999 deregulations occurred, Democratic opposition would have prevented any regulation from succeeding.

I would stop here, but there's more to tell.

On December 21, 2008, the NY Times published a major article blaming the entire subprime crisis and the Fannie/Freddie debacle on the Bush administration, barely mentioning the participation of Barney Frank and the Democrats.

The article was a total lie, and the NY Times reporters and editors knew it.

The Bush administration was so taken aback that they issued a statement describing the "most egregious claims," and listing the large campaign contributions from Fannie and Freddie to leading Democrats, including Senator Chris Dodd, Senate Majority Leader Harry Reid, and House Speaker Nancy Pelosi.

As I've written many times on this web log, I've been sickened and disgusted over and over again by the widespread fraud, sleaze and deception on the part of high level financiers, politicians, analysts and journalists.

The NY Times article is just one more example of this sickening sleaze. And let's not forget that the Times published government secrets at the height of the Iraq war and did everything in its power to bring about the defeat and humiliation of the United States. The NY Times was once considered to be the most respected newspaper, but today the newspaper so sickens me that it makes me gag to look at it.

The sleaze extends to Barney Frank himself, who is denying any part in the debacle.

A bit of drama occurred in early October, as Barney Frank appeared on the Fox News show hosted by Bill O'Reilly. I personally can barely stand to watch this, but if you'd like to hear O'Reilly and Frank screaming at each other, then watch this video:

As disgusting as Barney Frank is, it's worth pointing out that O'Reilly himself has exhibited some of the lapses that he accuses Frank of, in particular not taking responsibility for his own failings. As I described in another posting, O'Reilly has been advising his listeners not to panic and sell because "the bottom will soon be reached." Then he claimed that he doesn't give investment advice, and that everyone is at fault but him for not seeing the coming crisis. Well, why didn't he see it? He's always running various exposés of all kinds of political and financial scams. Why didn't he ever run an exposé of this one? Like all the other "experts," he never blames himself. It's the fault of everyone BUT himself.

And that's the sleaziest lesson from this sleazy disaster. Not only did each person -- journalist, politician, analyst, financier, "liar loan" mortgage applicant -- play his part in creating this disaster, but each person was out for himself during the bubble, and is still just out for himself in the current fallout, blaming everyone but himself.

Example #2: Bear Stearns

There is no better example of how openly illegal activity on Wall Street was not only was not prosecuted, but was actually condoned and excused by the SEC. There's no better example of how additional regulations would have been useless.

Contents - This page
Boomers and Generation-Xers
The role of regulators and politicians
Example #1: Fannie Mae and Freddie Mac
Example #2: Bear Stearns
Example #3: The $50 billion Bernard Madoff swindle
Example #4: Thomson Reuters and earnings estimates
A flood of corruption
The expectations for 2009
The outlook for 2009

The first time that Bear Stearns came onto my personal radar screen in the financial crisis was when when I wrote about a court decision in February, 2007, that forced Bear to pay investors $160 million for failing to detect a fraud in one of the hedge funds that it manages.

By June, an incredible and historic event occurred. Bear Stearns was once again forced to use its own money to bail out hedge funds that it was managing. But now it was for a different reason. It was because the hedge funds had invested in mortgage-backed CDO securities that were turning out to be worthless! This was the first major investment debacle from the subprime mortgage crisis.

(Update: I've been reminded that I wrote about some earlier subprime mortgage debacles in February 2007 in "Rapid collapse of ABX index indicates that investors may be starting to panic.") (Paragraph added 7-Jan)

But why did Bear feel obligated to bail out the hedge funds with its own money? This is the most incredible thing of all: It was because of fear, among Wall Street and regulatory insiders, that if the hedge fund defaulted, then the CDO securities of other hedge funds would have to be "marked to market," and also shown to be worthless. This would push other hedge funds to fail.

This was the first step is what can only be described as a massive criminal coverup that's still going on today.

The only reason that Wall Street works as well as it does is because of trust. People trust their money with managers at an investment bank like Bear Stearns because they trust that the managers have done their job in evaluating the investment, and that the managers are telling the truth. And they trust that regulators will catch crooks in time to prevent investors from losing much money.

The cover-up didn't do Bear much good. Two weeks later, Bear was forced to announce that its hedge funds were almost worthless.

And it certainly didn't do the world much good either. Just one month later, in August, 2007, the international credit crisis began, beginning a period when it became almost impossible at times to get any credit whatsoever.

When politicians, analysts, journalists and pundits try to explain what's going on, they usually say that "people are acting on emotion" or that "people are panicking." If people acted on the facts instead of emotions, then they would still be willing to invest in these hedge funds and the stock market.

I don't know why these politicians and journalists can't figure this out for themselves, but the reason is because the Bear Stearns debacle showed that:

And so OF COURSE lenders are going to be afraid to offer credit, and investors are going to be afraid to invest.

During the subprime bubble, the major crooks were never investing their own money anyway. Lenders wrote subprime mortgages, and sold them immediately to investment banks. Fannie and Freddie were the worst offenders. Banks packaged them as securities, and sold those to poor schmucks. Ratings agencies took fat fees and commissions to give AAA ratings to these near-worthless securities. These people were always investing other people's money, taking fat fees and commissions off the top.

But the Bear debacle made it clear to investors that it was THEIR money that was now at stake, not other people's money. That's when the credit crunch began, and that's when the stock market started crashing, after reaching a high on October 9.

All the lying, fraud and coverups didn't do Bear any good. On March 14, 2008, Bear Stearns collapsed, though it was saved from bankruptcy by a Fed bailout.

Just two days before Bear's collapse, CEO Alan Schwarz went on CNBC and other media and declared that Bear was having no problems whatsoever. It was an out and out lie that did Bear absolutely no good, and probably made things worse because it was soon recognized as a lie.

The story doesn't end there, however.

In June, 2008, the FBI charged two Bear Stearns hedge funds managers, Ralph Cioffi and Mathew Tannin, with conspiracy, securities fraud and wire fraud. Cioffi was also charged with insider trading.

According to the FBI, the managers believed in March 2007 that the funds were in risk of collapse, but lied to investors to keep them from withdrawing cash. The evidence also indicated that that they lied about the level of their own personal investments in the hedge funds. Their cases have not yet gone to trial.

But now get this -- and this is so incredible that I still can barely get over it. The SEC simply ignored the securities fraud, and blamed Bear's troubles on "false rumors." Here's an excerpt of the July 15 Emergency order 34-58166 (PDF):

"False rumors can lead to a loss of confidence in our markets. Such loss of confidence can lead to panic selling, which may be further exacerbated by “naked” short selling. As a result, the prices of securities may artificially and unnecessarily decline well below the price level that would have resulted from the normal price discovery process. If significant financial institutions are involved, this chain of events can threaten disruption of our markets.

The events preceding the sale of The Bear Stearns Companies Inc. are illustrative of the market impact of rumors. During the week of March 10, 2008, rumors spread about liquidity problems at Bear Stearns, which eroded investor confidence in the firm. As Bear Stearns’ stock price fell, its counterparties became concerned, and a crisis of confidence occurred late in the week. In particular, counterparties to Bear Stearns were unwilling to make secured funding available to Bear Stearns on customary terms. In light of the potentially systemic consequences of a failure of Bear Stearns, the Federal Reserve took emergency action. ...

We intend these and similar actions to provide powerful disincentives to those who might otherwise engage in illegal market manipulation through the dissemination of false rumors and thereby over time to diminish the effect of these activities on our markets. In recent days, however, false rumors have continued to threaten significant market disruption. For example, press reports have described rumors regarding the unwillingness of key counterparties to deal with certain financial institutions. There also have been rumors that financial institutions are facing liquidity problems.

Contents - This page
Boomers and Generation-Xers
The role of regulators and politicians
Example #1: Fannie Mae and Freddie Mac
Example #2: Bear Stearns
Example #3: The $50 billion Bernard Madoff swindle
Example #4: Thomson Reuters and earnings estimates
A flood of corruption
The expectations for 2009
The outlook for 2009

As a result of these recent developments, the Commission has concluded that there now exists a substantial threat of sudden and excessive fluctuations of securities prices generally and disruption in the functioning of the securities markets that could threaten fair and orderly markets."

What a pathetic agency the SEC has become, publishing garbage like this. The SEC was created in the 1930s. Its purpose was to prevent any new stock market bubble like the 1920s stock market bubble, with the intention of preventing anything like the 1929 stock market crash from ever happening again.

The SEC totally failed to prevent the huge 1990s dot-com stock market, and subsequently failed to prevent the even huger 2000s stock market bubble based on the housing bubble and the credit bubble. Having failed in its principal mission, the SEC is a total failure as an agency, and is now reduced to issuing regulations that border on gibberish.

Example #3: The $50 billion Bernard Madoff swindle

This is being called the biggest Ponzi scheme (or pyramid scheme) in history. Madoff was able to convince thousands of investors to let him invest as much as $50 billion of their money.

And why not? 70 year old Madoff has been a financial manager since 1960. For a while, he was chairman of the Nasdaq Stock Exchange. He had an unblemished record, and he always provided good returns to his investors.

At some point, he began using one investor's money to pay off the dividends of other investors. This worked fine, as long as he could use his charm to convince more and more investors to invest more and more money. Ponzi schemes always start falling apart when economic conditions deteriorate, and people start asking for their money back, and that's what happened to Madoff. In December, he was arrested for fraud.

Analysts are uniform in pointing out that there were numerous red flags that investors should have noticed. Here's how one blogger, Rick Bookstaber, described the situation:

"Did his investors really believe Madoff was doing split-strike conversions? Given that there were not enough options in the world for Madoff to do such a strategy? And given that no one in the industry heard of him as a player in that market?

An alternative view is that the split-strike conversion story is the equivalent of the “it fell off the truck” story for people buying stolen goods; that investors suspected he was involved in illegal front running, and would just as soon not have had that spelled out for them while the money kept flowing in."

The fact that the signs were so obvious (in retrospect, of course) forms the basis of lawsuits that will go on for years of investors suing their banks and investment firms.

Even worse, several whistleblowers complained to the SEC about Madoff, and the SEC conducted three investigations of Madoff, the latest one in 2007, and always gave him a clean bill of health.

According to one news report I heard, one of the whistleblowers pointed out that Madoff's results were mathematically impossible for the reason given in the above quote -- that there were not enough options in the world for Madoff to have succeeded. (I can just imagine what must have happened. The whistleblower was probably a Boomer or Silent, and the Gen-Xers at the SEC decided that he was full of crap, and so they ignored his warnings.)

One truly remarkable outcome of the Madoff scandal was that it was so huge that the SEC was unable to avoid being blamed for it. That fact alone makes this a historic moment.

Christopher Cox, chairman of the Securities and Exchange Commission, said that he was "gravely concerned by the apparent multiple failures over at least a decade" and that he had ordered "full and immediate review of the past allegations regarding Mr Madoff and his firm and the reasons they were not found credible".

I have little doubt that this "full and immediate review" will find that the SEC was completely guilt-free. It'll be interesting to see who else gets blamed instead.

In terms of public policy, this example shows the folly of current efforts to change regulations. Almost every aspect of Madoff's business already violated numerous regulations and laws. The problem is that there was no will to enforce these regulations in an "anything goes" bubble atmosphere where everyone was making money. The existing regulators were considered to be extinct fossils put in place by the doddering old fools from the Depression era.

That's why you can never use laws or regulations to defeat generational cycles:

That's not to say that regulations shouldn't be tried. But no one should believe that regulations can defeat the generational cycle. There were plenty of regulations implemented in the 1930s, but by the time they became important, they were ignored or repealed.

Example #4: Thomson Reuters and earnings estimates

As regular readers of this web site know, for the last few quarters I've been posting the table of S&P 500 average corporate earnings growth estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters. These tables have shown sharp falls in corporate earnings estimates growth from week to week.

Here is the latest table of these earnings estimates for the fourth quarter of 2008:

  Date    4Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Feb  6:               50.0%
  Jul  1:               59.3%   Start of previous (3rd) quarter
  Oct  1:               46.7%   Start of quarter
  Dec  5:               10.0%
  Dec 12:                5.9%
  Dec 19:                0.5%
  Dec 26:               -0.9%   End of quarter

As you can see, earnings growth estimates were extremely high at the start of the quarter, and investors depended on those earnings estimates to make their investment decisions.

As the quarter went on, earnings estimates continued to fall, and investors who had trusted CNBC and Thomson Reuters' earnings estimates lost a great deal of money.

The point I want to make is that this is the fifth quarter in which this has happened. Here's the similar table for the third quarter:

  Date    3Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Mar  3:              25.0%
  Apr  1:              17.3%   Start of previous (2nd) quarter
  Jul  1:              12.6%   Start of quarter
  Sep  5:               0.8%
  Sep 12:              -1.6%
  Sep 19:              -0.3%
  Sep 26:              -1.7%   End of quarter
  Oct  3:              -4.8%
  Oct 10:              -7.8%
  Oct 17:              -9.1%
  Oct 24:             -11.0%
  Oct 30:             -23.8%
  Nov  7:             -13.9%
  Nov 14:             -18.4%
  Nov 21:             -18.5%
  Nov 28:             -18.7%

What we're seeing is a familiar pattern: The earnings growth estimates are 20% to 50% at the beginning of the quarter, but fall to -20% to -25% by the time actual earnings come in. Exactly the same kind of pattern that has happened five quarters in a row.

My question is this: When can we start to assume that CNBC and Thomson Reuters are committing securities fraud, misleading investors by repeatedly publishing unrealistically high earnings growth estimates?

After all the sleaze, fraud and deception that's already occurred as a matter of standard practice for the last few years, as I've documented in detail in this article, why on earth should we ever assume that CNBC and Thomson Reuters aren't committing fraud as well.

I know for a fact that CNBC has a policy of not reporting "bad news," for fear of losing sponsors. I've commented and given examples many times, and I've heard anchors on the air make offhand comments to that effect. And if Moody's could give phony AAA for near-worthless securities, in exchange for fat fees and commissions from the banks issuing the securities, then it's natural to assume that Thomson Reuters is knowingly issuing phony realistic earnings estimates in return for fat fees and commissions from their clients.

This is something that at the very least deserves an investigation by the press or by the regulators.

The same earnings estimates have turned out to be wrong for five quarters in a row. Thomson Reuters would have to be total morons not to have noticed this. "Fool me once, shame on you; fool me twice, shame on me!" Well, CNBC and Thomson Reuters were "fooled" five times in a row. If it turns out that they didn't do enough due diligence -- or that they looked the other way -- because they didn't want to lose their fat commission and fee checks from the companies they were reporting on, then it's securities fraud, and they should go to jail.

This should be investigated, but of course it won't be. Why? Because the sleaze, the dishonesty, the fraud extends from the financial firms to the press and the regulators. The same Boomers and Gen-Xers who destroyed the world's financial system are still in place, and still committing fraud on the public and investors.

A flood of corruption

What you're seeing, Dear Reader, is part of a flood of swindles and fraud that will be exposed in the next couple of years.

There was a great deal of embezzlement and fraud leading to the Great Depression of the 1930s. I've quoted this passage a few times before, but it's worth posting again. John Kenneth Galbraith described what happened -- and what will happen again -- in his 1954 book, The Great Crash - 1929, as follows:

"In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in -- or more precisely not in -- the country's businesses and banks. This inventory -- it should perhaps be called the bezzle -- amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who ned more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

The stock market boom and the ensuing crash caused a traumatic exaggeration of these normal relationships. To the normal needs for money, for home, family and dissipation, was added, during the boom, the new and overwhelming requirement for funds to play the market or to meet margin calls. Money was exceptionally plentiful. People were also exceptionally trusting. A bank president who was himself trusting Kreuger, Hopson, and Insull was obviously unlikely to suspect his lifelong friend the cashier. In the late twenties the bezzle grew apace.

Just as the boom accelerated the rate of growth, so the crash enormously advanced the rate of discovery. Within a few days, something close to universal trust turned into something akin to universal suspicion. Audits were ordered. Strained or preoccupied behavior was noticed. Most important, the collapse in stock values made irredeemable the position of the employee who had embezzled to play the market. He now confessed.

After the first week or so of the crash, reports of defaulting employees were a daily occurrence. They were far more common than the suicides. On some days comparatively brief accounts occupied a column or more in the Times. The amounts were large and small, and they were reported from far and wide. ...

Each week during the autumn more such unfortunates were reveled in their misery. Most of them were small men who had taken a flier in the market and then become more deeply involved. Later they had more impressive companions. It was the crash, and the subsequent ruthless contraction of values which, in the end, exposed the speculation by Kreuger, Hopson, and Insull with the moey of other people. Should the American economy ever achieve permanent full employment and prosperity, firms should look well to their auditors. One of the uses of depression is the exposure of what auditors fail to find. Bagehot once observed: "Every great crisis reveals the excessive speculations of many houses which no one before suspected." [pp. 132-35]

Galbraith's point was that there were many criminal activities going on before the 1929 crash, but nobody cared, as long as everyone was making money. But once the crash occurred, any irregularity was viewed with suspicion and led to an investigation. These investigations turned up many cases of embezzlement -- people who had "temporarily borrowed" money that wasn't theirs to invest in the stock market, and then got caught in the crash.

That's happening again. If you're one of the people who have committed embezzlement or fraud, then it's time to put your affairs in order, because you're going to get caught. A lot of others will be caught as well.

One of the most vivid historical examples of what's going on today is the bankruptcy of the French Monarchy in 1789 that led to the French Revolution. In the Reign of Terror that followed, any person who was an aristocrat, a relative of an aristocrat, a friend of an aristocrat, a servant of an aristocrat, or even had a resemblance to an aristocrat, would be tried and quickly convicted and sentenced to the guillotine, where his head would quickly and efficiently be severed from the rest of his body.

As I've said before, if you're an economics expert, journalist, investment broker, mortgage lender, analyst, regulator, pundit or politician whom the public decides is blameworthy for the major coming crisis, then I suggest that you'd better have your underground bunker picked out, because people are going to be coming after you, and the guillotine is going to seem mild compared to the punishment that they're going to want to inflict on you.

The expectations for 2009

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Fiscal stimulus programs in 1930s and today: Did Hitler really do everything right?... (1-Apr-2009)
The effects of massive fiscal stimulus - Part II: President-elect Barack Obama is turning apocalyptic in his speeches.... (12-Jan-2009)
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The stories that I've told in this article are so incredible that they're too unbelievable for a novel. I guess that's what the phrase "stranger than fiction" means.

The following has become one of my favorite quotes:

"Insanity in individuals is something rare - but in groups, parties, nations and epochs, it is the rule." -- Friedrich Nietzsche

I used to think this was a joke, but after the last few years, I realize that it's the horrible truth.

The expectations for the Obama administration are almost beyond belief. I made a list of some of the things I heard and read on CNBC and on the web over a period of a couple of days:

The last one is the funniest, but all of them illustrate the insane expectations that people have after the January 20 inauguration.

The outlook for 2009

As I've said many, many times, starting in 2002, from the point of view of Generational Dynamics, if you go back through history, there are many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash.

Contents - This page
Boomers and Generation-Xers
The role of regulators and politicians
Example #1: Fannie Mae and Freddie Mac
Example #2: Bear Stearns
Example #3: The $50 billion Bernard Madoff swindle
Example #4: Thomson Reuters and earnings estimates
A flood of corruption
The expectations for 2009
The outlook for 2009

These are called "generational crashes" because they occur every 70-80 years, just as the generation of people who lived through the last one have all disappeared, and the younger generations have resumed the same dangerous credit securitization practices that led to the previous generational crash. After each of these generational crashes, the survivors impose new rules or laws to make sure that it never happens again. As soon as those survivors are dead, the new generations ignore the rules, thinking that they're just for "old people," and a new generational crash occurs.

It's now been 80 years since the last generational panic and crash, so we're overdue for the next one. A generational panic and crash is an elemental force of nature, where millions or even tens of millions of Boomers and Generation-Xers in countries around the world, never having seen anything like this before, and not having believed it was even possible, suddenly try to sell everything in a mass panic. This will bring down computer systems for hours, perhaps even for a day or two, as people watch tv in glazed horror as their life savings disappear.

What we've seen in this article and in other articles describing the historical generational crashes is that they're all characterized by massive generational fraud and deception, and an almost total lack of morals and ethics.

We've seen how the lethal combination of Boomers and Gen-Xers caused this fraud and deception. But these people haven't changed. It now makes sense to ask the question of what these same people will be doing in the next year, as they continue the pattern of massive generational fraud and deception.

In a little over two weeks, America will be inaugurating Barack Obama as President. Obama is a Gen-Xer who believes that Boomers and Silents are full of crap. He will be leading a cabinet and an administration of Gen-Xers and Boomers -- exactly the lethal combination that's already destroyed the world's financial system.

Obama himself spent years as a "community organizer," a job that views the government's biggest sin as refusing to spend as much money as possible on poor people, and that any kind of fiscal discipline is "ideological."

The public expects Obama to spend any amount of money necessary to heal the economic crisis. Obama and his advisers have done everything possible to encourage that view. All I ever hear from Obama and his advisers is that high unemployment "is unacceptable," and that "as much money as necessary will be spent" to reverse the situation.

Sooooo, we're going to be giving almost a trillion dollars to a group of Gen-Xers and Boomers with contempt for Silent and Boomer values. This is a disaster of almost unimaginable proportions in the making.

The election of Obama has not repealed the Law of Mean Reversion. Nor will Obama's Democratic party Congress be able to repeal the Law of Mean Reversion, even if it were to try.

Therefore, since the stock market has been far overpriced since 1995, as I described in "How to compute the 'real value' of the stock market," and since the Law of Mean Reversion still applies, there must still a stock market crash in store. And with a trillion dollar "stimulus package" at hand, the crash is bound to be worse than anyone ever imagined.

Blogger Matt Stiles, who writes for his Futronics blog, and also contributes to the Generational Dynamics forum, wrote his own outlook for 2009, including the following predictions:

This is a great summary of many of the detailed changes that will accompany the generational panic and crash, although unfortunately he's too optimistic.

Most people are hoping that 2009 will be a better year than 2008. Generational Dynamics predicts that that hope is in vain.

P.S.: Shortly before I finished up this article, I heard on Bloomberg TV that President-elect Obama's "fiscal stimulus" program will cost $1.3 trillion, up from $600-700 billion. Apparently the amount is doubling every 2-3 weeks. Dear Reader, we are headed for a disaster of unimaginable proportions.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.)

Copyright © 2002-2016 by John J. Xenakis.