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Households' balance sheets continue to improve


The Fed recently released flow of funds data for the second quarter, which includes an update to Household's Balance Sheet. The decline in real estate prices has reduced the value of real estate holdings by about $1 trillion in the past year. However, this loss was more than made up for by a $5 trillion surge in the value of total financial assets and a modest decline in liabilities, resulting in an increase in net worth of $4.4 trillion over the past year. Most of the gains in financial assets have come, not surprisingly, from equity holdings and pension reserves. Despite the fact that the equity market at the end of June was still down about 15% from its 2007 highs, financial assets were only down about $2 trillion from their highs, or about 5%—a testimony to household's ability to add significantly to their savings.

It's also interesting to note that over the past year, households have reduced their holdings of Treasury securities from $1.15 trillion to just $0.84 trillion, despite the $1.3 trillion increase in Treasury debt over the same period, reflecting the important role that foreigners have been playing in financing our huge federal deficit (which, if Treasury yields rebound, may prove to have been a wise move on the part of households, and an unwise move on the part of foreigners). Another important story here is that households have been deleveraging—liabilities have declined by almost $1 trillion over the past four years—as they have been forced to adjust to lower home values, and it has been very painful. Nevertheless, it is encouraging to see that households' equity as a % of real estate holdings, which peaked at almost 60% in 2005, was unchanged in the second quarter at 38.6%, suggesting that most of the downward adjustment is complete.

Why we need a more limited government

One of my core beliefs and assumptions is that a good deal of the money that government spends is wasted or spent less efficiently than if the money were left in the private sector. Thus, more government spending only weakens the economy. By the same logic, less government spending would end up strengthening the economy.

The TSA is an excellent example of how government screws things up. Even its creator says it has turned into a monster. Read the whole thing: "TSA Creator Says Dismantle, Privatize the Agency:"

... a decade after the TSA was created following the September 11 attacks, the author of the legislation that established the massive agency grades its performance at “D-.”

“The whole program has been hijacked by bureaucrats,” said Rep. John Mica (R. -Fla.), chairman of the House Transportation Committee. 
Allowing airports to privatize screening was a key element of Mica’s legislation and a report released by the committee in June determined that privatizing those efforts would result in a 40% savings for taxpayers.
“We have thousands of workers trying to do their job. My concern is the bureaucracy we built,” Mica said.
“We are one of the only countries still using this model of security," Mica said, "other than Bulgaria, Romania, Poland, and I think, Libya."
HT: Tom Burger

UPDATE: Reader "Ian" notes an excellent article about how Canada and Sweden have shrunk the size of their governments meaningfully and successfully, and are probably the early leaders in a process that will sweep other countries in the years to come. Here are some choice quotes summarizing the thoughts of economist Vito Tanzi:

The state can’t survive without the market economy – but the market economy cannot survive the excesses of the state. One must yield to save the other. People once advocated government intervention to fix “market failure.” Now people primarily sense “political failure” and look elsewhere for solutions.
Government expanded as long as people perceived it as competent and benevolent. In this period, policy makers – “people who acted on behalf of the State” – were regarded, illusion though it was, as consistently faithful, wise and capable. These policy makers possessed “Solomon’s wisdom, Google’s knowledge and the honesty of saints,” Mr. Tanzi says.
The exit strategy for the state, Mr. Tanzi says, need not be all that difficult. The state, he says, now operates as a monopoly insurance company, insuring almost everyone against almost every risk. It does so inefficiently. Taken as a whole, the welfare state may now be considered delusional. Almost inevitably, it will end in bankruptcy.

Inflation picks up



The August rise in consumer prices exceeded expectations. The headline CPI rose 0.4%, vs. an expected 0.2%, while the 0.2% rise in the core rate was a tad higher than expected. As the first chart above shows, core inflation over the past six months is running at an annualized rate of 2.7%, while overall inflation is 3.6%. As the second chart shows, the rise in core inflation has been quite pronounced, and apparently owes a lot of its strength to the Fed's second round of Quantitative Easing which began almost a year ago.


What is most impressive about the rise in core inflation is that it has happened at a time when the economy has been demonstrably weak and the output gap has been gigantic (10-12% by my estimation). The main reason the Fed was so anxious to engage in QE2 was that it feared the output gap posed a serious risk of deflation. The bond market has been willing to ignore signs of rising inflation because of the pervasive belief that a large output gap provides an insurance policy against rising inflation. Yet these beliefs are being challenged almost daily. Thus, the Treasury market is perched very precariously on the edge of acceptable valuations, as real 10-yr Treasury yields are now clearly in negative territory.


Here's a Big Picture thought: what we see happening over the past year or so is the gradual undermining of widely-held theories about how the economy and inflation work. Keynesian economic theory is taking a beating, because it was used to justify a $1 trillion government spending stimulus package that not only failed to stimulate the economy as predicted, but most likely helped to weaken the economy. The Phillips Curve theory of inflation is also taking a beating, because inflation is much stronger than it has been predicting, given that unemployment is still very high.

The bad news for Keynesians and Phillips Curvers, however, is good news for supply-siders like me. Supply-side theory has been predicting relatively slow growth and a tepid recovery for over two years, since it recognizes that deficit-financed spending has no power to generate growth, and big increases in the deficit inhibit risk-taking because they tell the market to expect big increases in tax burdens in the future. (Two consistent themes of my predictions since early 2009 have been that the economy was likely to grow, but at a sub-par pace, and that inflation was likely to rise.) Rising tax burdens reduce the after-tax rewards to work and investment, so you end up getting less of both.

Monetarists and supply-siders have been predicting rising inflation for over two years, since they recognize that accommodative monetary policy, when fortified by a very weak currency, rising gold and commodity prices, a steep yield curve and low to negative real yields, will inevitably lead to higher inflation regardless of how weak the economy is. Indeed, in the supply-side framework, a weak economy is to be expected when monetary policy is inflationary. That's because easy money weakens a currency, and that increases the rewards to speculative activity while reducing the rewards to investment, and with weakened investment you get weak growth.

Along with the decline of Keynesian theories and the rise of supply-side theories, we are seeing a powerful realignment of political power in Washington. Obama, a dyed-in-the-wool Keynesian, is still insisting that what we need is more spending and more government control over the economy. But he is fighting a losing battle as more and more people begin to realize that Big Government is antithetical to prosperity. Keynesianism is all about giving power to politicians so they can pull the levers that supposedly will create growth, but now we see that politicians are fallible just like anyone and spending other people's money is never a very productive enterprise. Indeed, giving a handful of individuals who happen to inhabit Congress the power to spend a trillion dollars they don't have is so foolish as to be dangerous to our economic health.

What we can expect to see more of, fortunately, is policies that return power to the private sector, while also increasing the after-tax rewards to work and investment. Even if it takes a year or so for policies to make a clear shift in a more pro-growth direction, the prospect of improvement and the fact that in the meantime the economy is likely to continue to grow, should be enough to push equity valuations and Treasury yields higher.

Industrial production picks up



August Industrial Production rose more than expected (0.2% vs. 0%), and the July increase was revised upward by 0.5%, thus ending the slump that had persisted throughout the first half of the year. As the second chart shows, Europe's may still be in a slump, but at this point that is hardly news. Manufacturing production (top chart) also pulled out of its slump, and is up at a 3.8% annualized rate over the past six months. This is most definitely not the sort of thing you would expect to see if the economy were rolling over as so many seem to believe. Growth may not be as strong as it should be, but the economy is still growing. Continued growth, even at a relatively slow pace, puts the economy on a much better footing than the markets are giving it credit for. Pessimism is pervasive, but so far unwarranted.

PPI update


The August headline Producer Price Index came in per expectations (0% change for the month), while the core PPI came in a bit lower than expectations (0.1% vs. 0.2%). On the surface this sounds good, but from a longer term perspective, as the chart above shows, we are likely still in a rising inflation environment.

Over the past three months, the core PPI has risen at a 3.4% annualized rate, which puts it well above the range of 1993-2007. And as I have noted repeatedly over the past year or so, when both core and headline measures of inflation rise at the same time, it is a good indication that monetary policy is accommodative. When money is tight, then increases in food and energy prices force other prices lower. When money is easy, all prices can rise. Plus, it is significant that inflation can be as high as it has been in recent years despite the economy's agonizingly slow recovery and its huge output gap; only easy money can explain that.


This next chart shows the index itself, plotted on a semi-log scale so that the slope of the line equates to the rate of change. I've divided the past 50 years into several different inflation regimes: the early 60s, when inflation was extremely low and stable; the period from '66 through '73, when inflation pressures started to build; the '74-'82 period when a plunging dollar, soaring commodity prices and a Fed that couldn't figure it out pushed prices up 9% per year on average; the '83-'03 period, when the Fed successfully tamed inflation and kept it relatively low; and the past six years, when first Greenspan and then Bernanke started using monetary policy to "stimulate" the economy. Inflation since 2003 has been running at least double what it was during the Fed's golden years (1983-2003).

Note also that even though inflation has been relatively low and stable since 1983, the level of producer prices has risen by a total of 88%—almost double. Moreover, the CPI has increased 131% over the same period. Just a few percentage points a year can really add up over time.

Federal finances update


A quick update on Federal finances, which remain in a shambles with a deficit/GDP ratio of about 8.5% (the deficit in the past 12 months was $1.3 trillion). Nevertheless, it bears noting that the growth of spending has moderated significantly in the past two years. The 6-mo. annualized rate of increase in federal spending was 20% in July '09, and that growth rate has declined impressively to only 3.6% as of August '11. It's also very much worth noting that the growth of federal revenues (thanks to an increase in the number of people working, rising incomes, rising capital gains realizations, and very strong corporate profits) has been in the 7-10% annualized range since the beginning of last year. With revenue growth outpacing spending growth, the 12-mo. deficit has dropped from a high of $1.5 trillion early last year to $1.3 trillion.

Thus, if current trends continue, the deficit will continue to shrink. That won't happen, however, unless we reform entitlement programs. And even if we do, the progress will be glacial unless policies coming out of Washington become more pro-growth. The more we can cut the growth of spending and incentivize the private sector to grow, the better off we will be. Rolling back government means expanding the private sector, and the private sector is the only true source of jobs and prosperity.


This next chart shows how important it is to shrink government spending. There's a natural tendency of spending to follow the business cycle, mainly because when the economy slips into a recession, unemployment rises and automatic stabilizers (e.g., unemployment insurance) kick in at the same time that GDP declines, thus giving a big boost to spending relative to GDP. But the past several years have been a fantastic laboratory experiment in what happens when government spending goes into overdrive (e.g., TARP, ARRA, cash for clunkers). The unprecedented post-war increase in federal spending as a % of GDP has coincided with an unprecedented rise in the unemployment rate.

Caveat: it's tough to prove that the rise in spending has been the cause of the rise in unemployment or whether the two are simply being affected by some other variable. But simple logic and everyday experience say that if government spending ramps up enormously, then government is absorbing a significant amount of the economy's resources and using those resources less efficiently than if they had been left in the hands of the private sector. You can't have massive growth of government without the economy taking a hit. Japan, Italy, and Greece are prime examples of economies that have been burdened by excessive levels of government spending and disappointingly slow growth for many years.

UPDATE: The eminent economist John Taylor yesterday presented to the Senate the outlines of a comprehensive, pro-growth budget strategy that brings spending as a % of GDP back to the levels of 2007 (without reducing nominal spending at all), and reforms the tax code in revenue-neutral fashion by broadening the tax base and reducing marginal tax rates. It sure makes sense to me.

Panic exhaustion?

It should be obvious by now that financial markets have been in a panic for the past two months over the increasing likelihood of a Greek default, and all the death and destruction that could follow in its wake. In my posts I've tried to quantify the panic by looking at a variety of market-based indicators of the panic: the zero rate of interest on T-bills, the record-low level of Treasury yields in general, the very high level of implied equity volatility, the very high level of the ratio of implied volatility to the 10-yr Treasury yield, the very high level of Eurozone swap spreads, the generally low level of market PE ratios (as contrasted to the record-high level of corporate profits), the pronounced underperformance of Eurozone equities relative to US equities, and the huge declines suffered by Eurozone bank stocks. For an even greater variety of charts and figures, I suggest this post from Pater Tanebrarum, in which—among other things—he makes it absolutely clear that European bank stocks are collapsing. (HT: Tom Burger)

The charts that follow are a closeup look at some of the more important panic indicators from the US market. It is too early to draw a firm conclusion, but it looks to me like the panic is slowly fading. A skeptic would say this is just the last gasp of the bulls, but it's hard to square that with the fact that the news out of Europe has only gotten worse, as the first chart below (Greece 2-yr bond yields) shows. Perhaps the market is just getting exhausted from so much panic?




After a swift plunge in early August, US equities have been inching slowly higher.


The implied volatility of equity options, a good proxy for raw panic and fear, shot up to an impressively high level in early August, but since then it has been trending slightly lower.


The 10-yr Treasury yield also plunged in early August, but since then shows tentative signs of having bottomed.


The ratio of the Vix to the 10-yr shot up in early August and has been quite elevated ever since, but it has failed to make a new high.

Or here's another thought: maybe the panic has been overdone?

Most observers agree that the biggest problem these days is too much debt. Debt burdens are smothering economies, and a default by one government could spread like wildfire to others and quickly bring down the entire European banking system. Banks are undercapitalized and over leveraged, with too much exposure to a PIIGS default. If the banks fail then the wheels of commerce grind to a halt. 

But as I argued awhile back, the real damage that too much borrowing causes has already happened. Greece has been borrowing money for years and squandering it on inflated pensions, a bloated bureaucracy, corruption, etc. Greece has taken resources from the productive parts of the world and basically flushed them down the toilet. The money is gone, and its economy failed to grow enough to support the repayment of its debt obligations. The losses have occurred in fact, but it takes awhile for them to be recognized and written off. What we have seen in the past two months is the agonized attempts of market participants to avoid taking some of those losses. It's like a game of financial musical chairs: suddenly everyone realizes that there is one less chair (Greece's inability to repay its loans), and all scramble to avoid being the one left holding the bag.

Once again: it's not the burden of debt repayments that smothers economic growth, it's using debt for unproductive purposes that smothers an economy. That's why US economic growth has slowed even as government spending and debt have exploded; we've been wasting money left and right, and that reduces our capacity to grow because the money otherwise would have been used for more productive purposes.

So instead of fearing the eventual Greek default, we should realize that the damage has already been done and we have been living with the consequences for years. The losses have been incurred, and the market is well on the way to apportioning the losses by slashing the price of Greek bonds and decimating the market cap of the banks that hold Greek debt. These price declines don't mean more bad news for the economy, since they are merely the price tag for the mistakes of the past. 

The good news that will come out of all this is that Greece won't be able to continue to waste the world's resources nearly as much as it has in the past. Like it or not, in one way or another, the Greek economy is going to have to get by on less and lots of people are going to have to tighten their belts. Before Greece joined the eurozone, this would have been solved by a devaluation. (Devaluations are the process by which a government steals wealth by force from its citizens.) If Greece only does one thing right, it should remain in the eurozone and thereby avoid a devaluation, but then of course it would have to make the adjustments obvious (and politically painful) by cutting spending and raising taxes.

What about the likelihood of bank failures when Greece and perhaps another PIIGS country defaults? Well, banks can be recapitalized, or they can be nationalized, or new banks can sprout up out of the ashes of dead banks. It happens all the time. The failure of a bank is simply the last chapter in a book about money being flushed down the toilet. It's not the end of the world.

UPDATE: The excellent economist Alan Meltzer has an op-ed in today's WSJ in which he argues that Greece and the other welfare states (i.e., those who can't figure out how to control their spending) could effectively devalue without leaving the euro. How's that? The fiscally conservative countries could effectively leave the euro and start a new, stronger currency union:

Although the European Central Bank treaty does not permit devaluation, there is a way for Greece, Italy, Portugal and perhaps others (known by the acronym PIGS) to devalue while remaining part of the euro. The northern countries can start a new currency union limited to those who adopt common, binding or enforceable fiscal arrangements like those that German Chancellor Angela Merkel and France's President Nicolas Sarkozy discussed last month. The new currency could float against the euro, allowing the euro to devalue. Once devaluation restored competitive prices in the heavily indebted countries, they could be admitted to the new currency arrangement if, and only if, they made an enforceable commitment to the tighter fiscal arrangement. If all countries rejoined, the old system would restart with a more appropriate, binding fiscal policy rule.

Social Security is essentially a Ponzi scheme

As with my post on Solyndra the other day, I feel obligated to ensure that as many people as possible understand that Social Security is essentially a Ponzi-like scheme and scam that is virtually guaranteed to be a horrendous investment.

It's ironic that Social Security's biggest defenders are also those who most profess concern for the welfare of the average Joe. That's because the average Joe would be far better off if he or she were able to invest his or her FICA contributions in a private investment account. You can see for yourself using the social security calculator here.

To understand why it's a poor investment, think of social security as an annuity (in which you pay some amount every month to purchase a monthly income stream that begins at some time in the future) that is not run by actuaries (who determine how much is needed to support those future obligations based on projected returns on investment) but instead by politicians (who are mainly interested in buying votes from today's generation), and whose underlying investments are not real investments but claims on some future generation's income. In a sense, Social Security is simply a tax masquerading as an annuity. Our politicians have over-promised and under-invested, leaving the social security system with an immense unfunded liability. And of course it should also be noted that your promised social security benefits are not an obligation of the U.S. government, and as such they can (and most likely will) be reduced in the future. Moreover, they are not an asset that you can sell or leave to your heirs, which means that those with shorter lifespans end up subsidizing those who live longer.

Michael Tanner of the Cato Institute has a nice, easy-to-understand explanation of why Social Security is a Ponzi scheme here, and which I reproduce almost completely because it is so good:

The original Ponzi scheme was the brainchild of Charles Ponzi. Starting in 1916, the poor but enterprising Italian immigrant convinced people to allow him to invest their money. However, Ponzi never actually made any investments. He simply took the money he was given by later investors and gave it to his early investors, providing those early investors with a handsome profit. He then used these satisfied early investors as advertisements to get more investors. Unfortunately, in order to keep paying previous investors, Ponzi had to continue finding more and more new investors. Eventually, he couldn't expand the number of new investors fast enough, and the scheme collapsed. Ponzi was convicted of fraud and sent to prison.
Social Security, on the other hand, forces people to invest in it through a mandatory payroll tax. A small portion of that money is used to buy special-issue Treasury bonds that the government will eventually have to repay, but the vast majority of the money you pay in Social Security taxes is not invested in anything. Instead, the money you pay into the system is used to pay benefits to those "early investors" who are retired today. When you retire, you will have to rely on the next generation of workers behind you to pay the taxes that will finance your benefits.
As with Ponzi's scheme, this turns out to be a very good deal for those who got in early. The very first Social Security recipient, Ida Mae Fuller of Vermont, paid just $44 in Social Security taxes, but the long-lived Mrs. Fuller collected $20,993 in benefits. Such high returns were possible because there were many workers paying into the system and only a few retirees taking benefits out of it. In 1950, for instance, there were 16 workers supporting every retiree. Today, there are just over three. By around 2030, we will be down to just two.
As with Ponzi's scheme, when the number of new contributors dries up, it will become impossible to continue to pay the promised benefits. Those early windfall returns are long gone. When today's young workers retire, they will receive returns far below what private investments could provide. Many will be lucky to break even.
Eventually the pyramid crumbles.
Of course, Social Security and Ponzi schemes are not perfectly analogous. Ponzi, after all, had to rely on what people were willing to voluntarily invest with him. Once he couldn't convince enough new investors to join his scheme, it collapsed. Social Security, on the other hand, can rely on the power of the government to tax. As the shrinking number of workers paying into the system makes it harder to continue to sustain benefits, the government can just force young people to pay even more into the system.
In fact, Social Security taxes have been raised some 40 times since the program began. The initial Social Security tax was 2 percent (split between the employer and employee), capped at $3,000 of earnings. That made for a maximum tax of $60. Today, the tax is 12.4 percent, capped at $106,800, for a maximum tax of $13,234. Even adjusting for inflation, that represents more than an 800 percent increase.
In addition, at least until the final collapse of his scheme, Ponzi was more or less obligated to pay his early investors what he promised them. With Social Security, on the other hand, Congress is always able to change or cut those benefits in order to keep the scheme going.
Social Security is facing more than $20 trillion in unfunded future liabilities. Raising taxes and cutting benefits enough to keep the program limping along will obviously mean an ever-worsening deal for younger workers. They will be forced to pay more and get less.

Don Beaudreaux has an excellent collection of thoughts and references on this same topic here, here, and here.

Is Greece another Lehman?


For now, it's all about Greece. 2-yr Greek government yields are now just shy of 70%, and the bonds are trading at just under 40 cents on the dollar. In sharp contrast, 2-yr Irish government yields are only 9.5%, and the bonds are trading at 94.6 cents on the dollar—thanks to a credible austerity plan which involves real spending cuts. If Greece doesn't default or restructure its debt in a major way, Greek bonds would be one of the world's most fabulous investments. But with prices so low, the market is essentially saying a major Greek default is a done deal, and the only piece of the puzzle that is missing is exactly how big the default/restructuring will be.

Watching Greek yields rise this year has been like a watching a slow motion train wreck. A default seemed to me like a slam-dunk last April, so I'm surprised that it hasn't happened yet, and that the world is still trying to adjust to the reality of a looming default. How much worse can things get?

Well, with Treasury yields at historically low levels, with T-bills yielding zero, with gold trading at $1800, with Eurozone bank stocks cratering, with the Italian stock market down 42% since February, and down 70% since its 2007 high, the market is pricing in lots more bad news—something like an end-of-the-world-as-we-know-it scenario. A Greek default leads to a Portuguese default, which drags down Ireland and eventually Italy and perhaps Spain, and along the way the cumulative defaults wipe out the capital of the entire Eurozone banking system, which in turn sparks a global financial and economic collapse.

So the question is: will a Greek default precipitate another meltdown of the world's financial markets and send the global economy into another tailspin? Are we on the cusp of another Great Recession or even a Global Depression? Is Greece the catalyst, as was the Lehman default?

I think there are some huge differences between a Eurozone default today and the bursting of the U.S. housing market bubble, which was the proximate cause of the Lehman default and the financial panic of 2008.

The financial crisis of 2008 was triggered by a decline in U.S. housing prices and a consequent rise in mortgage defaults. Mortgage default rates rose from 1% in 2006 to over 4% in 2008, and peaked at 5.6% in 2009. Cumulative defaults ended up being well over $1 trillion, but at the depths of the crisis I recall that many securities were priced to default rates as high as 50%.  Millions of homeowners were defaulting; millions of mortgages were at risk; thousands of mortgage-backed securities were involved; many hundreds of banks and financial institutions around the world had significant exposure to the collapse of the U.S. housing market. The huge losses and the fears of much more to come triggered panic selling, which resulted in downgrades, which forced more panic selling.

The Eurozone sovereign debt crisis involves only a handful of borrowers: Portugal, Ireland, Italy, Greece, and Spain. Together they owe $3.9 trillion, with Italy accounting for 56% of the total. To judge by prices in the credit default swap market, the real risk of default is concentrated mainly in Greece (1850), Portugal (1220), and Ireland (910), which together owe $820 billion. Italian CDS are priced at 430 bps, which equates to the upper range of high-yield bonds, where default rates are measured in the single digits and recovery values are well over 50%. A couple of dozen of Eurozone banks hold the lion's share of the debt that is subject to default.

The 2008 crisis was acutely aggravated by the fact that it was literally impossible for anyone to fully understand the default risk of mortgage securities that were comprised of millions of mortgages issued under all manner of conditions (e.g., fixed rate, variable rate, interest only, 95% LTV, 100% LTV), based on homes in hundreds of different regions, and securitized into thousands of vehicles, that in turn were split up into dozens of derivatives, which were owned by many hundreds of banks and financial institutions around the world. The risks inherent in the mortgage market were far too complex to understand, much less quantify, and the uncertainty itself was a major factor driving down prices, forcing defaults, and shutting down commerce. By the time the dust had settled a few years later, securities that were priced to death and destruction ended up paying handsome returns. In short, the uncertainty meant that at one point the market was expecting an order of magnitude more losses than ended up occuring.

In contrast, the sovereign debt crisis is very easy to understand and quantify: a handful of borrowers, no securitization, no complex derivatives, and only a few dozen lenders at risk. None of the PIIGS face the risk of deflation, which would be akin to the price declines that undermined the U.S. mortgage market. A PIIGS default, if one occurs, is all about politics: can the country adopt the necessary fiscal discipline to convince markets that its debt will be repaid? Or perhaps as the news today suggests—that China may be willing to buy a big chunk of Italian bonds—other countries may be willing to shoulder a significant portion of the PIIGS debt burden. Just a few decisions here and there could make all the difference in the world.

Consequently, I would argue that the Eurozone sovereign debt crisis is amazingly transparent, whereas the 2008 mortgage market implosion was a blizzard of obscurity. That difference alone should make the outcome much less serious than what the world faced and feared in late 2008, and that's why I think the market is too pessimistic.

My 9/11 remembrance

I was deaf when I flew into JFK from Argentina on the evening of Sept. 10th, 2001. A week before, I had travelled from Los Angeles to Buenos Aires to deliver a speech to a gathering of several hundred bankers. My message to them was going to be that unless Argentina changed its policies quickly—rejecting the IMF's demand for higher taxes and dollarizing its currency to avoid the disaster of devaluation—their country was likely to suffer a major crisis before the end of the year. (My prediction was off by only a matter of days, as it turned out.) As the plane began its descent to Buenos Aires' Ezeiza airport, I woke up and discovered I was deaf.

I had been losing my hearing in stages before then, so this didn't just come out of the blue. But it was the first time I found myself profoundly deaf for a prolonged period of time. My meetings in Buenos Aires had to be conducted with a yellow pad. After the speech and the meetings I went to spend a few days with some good friends in Mendoza, Argentina's wine capital. They insisted on taking me skiing at Las LeƱas, and on the way back (Sunday the 9th) we were almost killed by a truck driver who had fallen asleep and woke up to find himself on the wrong side of the road and headed straight for our car. Our driver, my friend's son, swerved off the road, narrowly missing the truck, and our car slammed into a concrete post. I was sitting in the front passenger seat, and avoided serious injury only because the post hit the car right between the front and rear right-side doors, only inches from me. At the time, we were rushing back to the airport in Mendoza so I could catch a flight to Buenos Aires with enough time to make a connection to JFK, so that I could deliver my presentation on Tuesday in New York.

It was a very bad omen, but I didn't realize it at the time.

I made it to the Mendoza airport just in time, and connected in Buenos Aires just in time, and wound up in my hotel room in mid-town Manhattan late Monday afternoon. My speech was scheduled to start at 8 am Tuesday morning at Lever House, just a few blocks from the hotel. I checked out of my hotel shortly after 7 am, and went to Lever House with my bag, since I had a noon flight out of JFK back to Los Angeles and planned to go directly from Lever House to the airport. At the time I had no idea what was happening just a few miles to the south, and apparently, neither did anyone I saw that morning.

Since I couldn't hear anything, I think my presentation to a gathering of Unilever's international Treasury personnel went OK until 8:45 am or so, when I began to realize there was a lot of commotion and people were pulling out their cell phones. I thanked everyone for their attention, apologized for not being able to hear, and said I would be leaving since I had to catch a plane. That's when Paul McMahon, Unilever's Treasurer, grabbed my arm and started trying to explain what was going on. I was confused and the commotion was intense, but I got the message that going to the airport was not an option. Suddenly someone turned on the TV in the conference room and we saw the Towers burning, and after what seemed like just a few minutes one of them collapsed. Paul scribbled a short summary for me, and, like all the rest, I just sat down without knowing what to do.

What followed was a blur. Phones didn't work, and I couldn't use one anyway. After an hour or two, a secretary managed to communicate with my wife to tell her I was Ok. I didn't have a hotel room to go to, and finding a reservation at any hotel in mid-town proved to be impossible. We looked out the windows down to Park Avenue, and people by the thousands were walking uptown—an endless stream of humbled humanity. With nothing else to do, we all went to a nearby Italian restaurant where they had previously planned to have lunch. I think we were the only ones in the restaurant. We had a long but quiet lunch. The waiters also had nothing else to do, so they carried on as if nothing were amiss.

After lunch I wandered across mid-town with Paul, who had offered to share his hotel room with me. As we passed the Hilton on Sixth Avenue I decided to give it a try, and to my surprise they had a room. I spent the rest of the week in that room, and I'll never forget walking out on Sixth Avenue the following morning, standing in the middle of the street, and seeing not a single car moving anywhere. Manhattan was all but deserted, with only a few people such as myself out on the street, gaping at the empty streets. To the south, of course, was the hideous cloud of smoke that towered over everything, streaming east. I decided to see how close I might get, but by the time I got as far as the Empire State Building, the smoke became too much to bear and I turned back.

Somehow I managed to catch the first flight out of JFK the following Friday. Security was intense. Every one of us on that plane looked at everyone else and wondered if we were looking at a terrorist. The stewardesses apologized for serving our meals with plastic forks and knives. The mood was somber and conversation was almost nonexistent. It was at that moment I realized that the terrorists had succeeded not only in destroying 3,000 lives and the pride of New York, but in making sure we would all pay a huge price for an endless number of years.