Jon Taplin’s Blog

I have written about Jeremy Grantham before. I think he’s one of the few money managers who “get’s it”. His quarterly letter, just out is a bracing bit of neo-realism that I would recommend to anyone, but most especially our new President. A few excerpts.

 The incredibly inaccurate efficient market theory was believed in totality by many of our financial leaders, and believed in part by almost all. It left our economic and governmental establishment sitting by confidently, even as a lethally dangerous combination of asset bubbles, lax controls, pernicious incentives, and wickedly complicated instruments led to our current plight. “Surely none of this could happen in a rational, efficient world,” they seemed to be thinking….

If in real terms we assume write-downs of 50% in U.S. equities, 35% in U.S. housing, and 35% to 40% in commercial real estate, we will have had a total loss of about $20 trillion of perceived wealth from a peak total of about $50 trillion. This relates to a GDP of about $13 trillion, the annual value of all U.S. produced goods and services….

At 40% of $30 trillion, ideal debt levels would be $12 trillion or so,almost exactly half of where they actually are today! It is obvious that the scale of write-downs that we have been reading about in recent months of $1 trillion to $2 trillion will not move our system anywhere near back to a healthy balance. To be successful, we really need to halve the level of private debt as a fraction of the underlying asset values. This implies that by hook or by crook, somewhere between $10 trillion and $15 trillion of debt will have to disappear. Given where we are today, there are only three ways to restore a balance between current private debt levels and our reduced, but much more realistic, asset values: we can bite the bullet and drastically write down debt (which, so far, seems unappealing to the authorities); we can, like Japan did, let the very long passage of time wear down debt levels as we save more and restore our consumer balance sheets; or we can inflate the heck out of our debt and reduce its real value.

Well, let’s put it this way: Larry Summers runs no risk of being on any of the many lists of people who gave clear warnings of potential financial disaster. And dozens did. Summers was emphatically not a whistleblower. He did not rail against falling financial standards. What he did, with his allies Greenspan and Rubin, was beat back a heroic attempt in late 1998 by Brooksley Born, then boss of the CFTC in Chicago, to supervise OTC derivatives. They held her off, presumably in the Greenspanian spirit of “the less regulation, the better.”

Anyway, I urge you to read the whole Grantham Letter. I certainly hope it finds it’s way to the President’s desk. My only confidence in the economic team is that they know how the Treasury Department works. It is up to Barack to call the tune and Summers and Geithner to dance. This is going to be a tremendously tricky year to navigate the horrendous deleveraging Grantham describes. We can only hope that Summers and Geithner are able to abandon the efficient market certainties of their earlier carreers and understand we are in a new world.