Greed is good or maybe not…

     Mr. Gekko (played by Michael Douglas) said, “Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures, the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge, has marked the upward surge of mankind and greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the U.S.A.” However, a quick look at the US unemployment rate would make anyone question the current environment…

     So what brought us to these levels of unemployment? Have we not been greedy enough? Have we, in fact, been far too greedy?  

     Everyone has heard the terms subprime crisis, housing crisis and asset backed securities; but what I haven’t heard discussed much are the numbers behind some of these terms. More specifically, what the growth rates looked like for the securities and loans that lead to the widespread use of these 3 terms. The other day I was reading through a somewhat dated (May 2008) report to the Joint Economic Committee entitled “THE U.S. HOUSING BUBBLE AND THE GLOBAL FINANCIAL CRISIS: HOUSING AND HOUSING-RELATED FINANCE,” the report has some great appendices with US credit growth data, which I have included below.

     John Kenneth Galbraith said it best, "The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version." Every invention is intended to reduce risk and increase reward, but time and again the invention fails. It also appears as if each failure has occurred due to a new form of leverage; the 1920’s and holding companies, the junk-bunks of the 80’s and most recently the asset-backed markets. Leverage is a powerful tool that can beautifully enhance returns, but just as rapidly wipe all equity levels. Have markets forgotten the most important concern with making money? That you need to get your money back to earn more. If you lose it all than what good was that one interest payment, that one dividend; it isn’t good.

     Bill Gross discussed this issue in his September 2010 Investment Outlook. In discussing the aftermath of the Great Depression he says that people recalled the “importance of a return of their money as opposed to a return of their money.” And although I agree with the Gekko idea that we greed causes man to exploit inefficiencies and brings about evolution, there is without question a need for the investment community to recall that a high-return is useless without the return of one’s principal. We forgot this during the past decade, as can be seen from the massive increase in the US credit market. But, greed like leverage can be beautiful or bloody.