Liar’s Poker – A Popular Book Predicts Our Demise

When asked, the average, eager, Wall Street bound undergraduate would tell recruiters their favorite book is Liar’s Poker and their favorite movie is Wall Street. Michael Lewis’s semi-autobiographical book, Liar’s Poker, is a first hand account of the rise of Salomon Bond traders, junk bonds, and mortgaged backed securities in the 1980’s. The 1980’s was an era of deregulation; the deregulation that in part lead to S&L Crisis of the late 1980’s and early 1990’s. Lewis’ 1985 Salomon Brothers analyst class is in large part running Wall Street in 2008 and those eager undergrads that so idolized the trader lifestyle, big money and even bigger egos, are left holding the bag – a largely empty bag containing pink slips and severance checks.

The flood of new mortgage instruments and consumer debt did not come without its skeptics. It appears however that this skepticism skipped a generation. With little regard to the continued escalation of debt in the US, structured products ruled the day for the past decade. Lewis highlights on page 60 of the book,

But a few of the old hands within Salomon Brothers suffered a more complicated response to their money…they were uneasy with the explosion of debt in America. (In general, the better they recalled the Great Depression, the more suspicious they were of the leveraging of America)

“That is where we are: wild, reckless, and deeply in hock, ” Lewis comments as he further points to an article in the Institutional Investor of July 1987 by Salomon Brothers’ Head of Bond Research, Henry Kaufman,

One of the most remarkable things that happened in the 1980’s was [the] sharp explosion of debt, way beyond any benchmark. It was way beyond anything you would have expected relative to GNP, relative to monetary expansion that was taking place. But it came about, I think, as a result of freeing the financial system.

Unfortunately the explosion did not stop. According to The Federal Reserve Board, the household debt ratio (ratio of debt payments to disposable personal income) increased from 10.6% in 4Q80 to 12.3% in 2Q87 (the time of Kaufman’s article). This ratio continued to balloon to a maximum 14.42% in 4Q06, settling at 13.85% for the most recent quarter ended 2Q08. Mortgage debt has lead the way growing from 8% in 1980 to nearly 14% in recent quarters.

Household debt to gross disposable income paints an even uglier picture. … UK consumers narrowly defeat the US as the most levered consumers. US household debt as a percent of household disposable income as exploded from less than 80% in 1985 to nearly 140% in 2007. The rest of the G7 has followed suit with Japan, Italy, and Germany showing substantial declines in consumer savings rates coinciding with large increases in consumer debt.

Kaufman highlighted the growth of debt as a percent of GNP. Household debt to GNP rose from 47% in 1976 to 65% in 1989. Household debt as a percent of GDP has continued to skyrocket from 49% in 1980 to nearly 99% in 2008. The substantial debt burden left little room for error for the US consumer. Slight increases in interest rates (adjustable ARMs), decreases in income (rising unemployment), and deterioration of disposable income (rising commodity prices) has rendered the US insolvent.

Deregulation brought a lot of LUV to air travel; unfortunately, similar love has not been shared with Wall Street, Main Street, or Joe the Plumber. Remember, “objects in mirror are closer than they appear” – here’s to 2028.