Bill Laggner interview: Greece, GS, derivatives, etc.

Eric King always does a good interview, and Bill Laggner is a hedge fund manager (Bearing Fund, LP) who has been on top of the credit bubble and bust. He comes at things from an Austrian perspective.

Listen here.

Some take-aways:

- People of wealth around the world have lost faith in their respective governments.

- There is a limit to government borrowing, but establishment economists and politicians are very complacent right up to the end.

- Goldman’s swap transactions on Greek debt.

- Good luck getting Greece to go from 14% deficit to 3%. ¬†Mathematically impossible — Greece must default like Argentina did in 2001. They’ll probably leave Eurozone, and this may be best for each of them.

- Portugal, Ireland and Spain face the same issue. Spreads blowing out. Puts heavy pressure on European banks.

- Politicians and talking heads are saying sovereign debt issue is contained, just like they said sub-prime was contained.

- European banks are at least as levered as US banks were two years ago.

- We’re at a juncture where we can print and delay or default and get it over with.

- Some countries may realize they are better off defaulting than taking IMF money and being slaves.

- GS people have been hired by Greek government to advise on bailout.

- Monetary elites like GS face a risk of the structured finance business, their bread and butter, disappearing.

- GS and others don’t produce capital. They speculate and then siphon money from taxpayers when they lose.

- Goldman’s proprietary trading book is highly lucrative, much more so than most other investment banks’. They make money over 90% of the time – how is that possible if it’s all honest?

- Goldman was a credit facility for New Century, one of the worst loan originators in sub-prime. We’ll find out more about their roll in helping build a market for junk mortgages. Possible exposure of fraudulent practices.

- Goldman sold a lot of this mortgage paper on leverage — they provided loans to funds to let them go levered long CDOs.

- Civil litigation will open up Pandora’s Box. Where there illegal activities within Goldman? Possible reputational risk. If they survive, they’ll be a shell of their former self.

- US has the same problems as Europe. US cities and states are just as bankrupt as Greece.

- Local politicians are corrupt and clueless and bankers took advantage of them, as in Jefferson County Alabama.

- Criminal proceedings in Italy against Deutsche Bank should provide insight into possible bribery and fraud related to derivative transactions.

- Expect litigation related to US city and state derivative transactions, as in Jefferson County Alabama.

- Expect increased outrage towards bankers.

- No transparency in US financial system.

- As states and cities go bankrupt, expect them to default on derivative transactions and enter litigation.

- (My own note: what about government employee unions? If you’re looking for an explanation for municipal and state bankruptcies, look there first.)

- US financial reform bill doesn’t solve anything. Still have the moral hazard of too-big-to-fail.

- Geithner is walking moral hazard.

- Amazing rally in risk assets over the last 14 months. Complete about-face in sentiment. New low in bearishness.

- Bill and partner Kevin Duffy are two of the few remaining bears left on the planet.

- VIX is ticking back up, Fed has ended a key lending program, sentiment is too extreme, leading economic indicators are rolling over. Stimulus will wear off like any drug, and there has been nothing done to sustain economy.

- If central banks hit the accelerators on their printing presses to bail out bankrupt governments we could enter a hyperinflationary mode. If we go the route of default, that could be avoided (deflation).

Capitalism needs failure, say winning fund managers

Kevin Duffy and Bill Laggner are acquaintances of mine who run the Bearing Fund, which returned high double digits for its investors in 2008. Their moral and economic philosophy is grounded in the Austrian understanding of the credit cycle and the parasitic role that government plays in today’s economy. I highly recommend an interview with them in this week’s Barrons (subscription only). Here are some excerpts:

Duffy: Any healthy system needs a way to correct error and remove waste. Nature has extinction, the economy has loss, bankruptcy, liquidation. Interfering in this process lengthens feedback loops. Error and waste are allowed to accumulate, and you ultimately get a massive collapse.

Capitalism is primarily attacked by two groups: utopians who wish to impose a more “compassionate” system, and political capitalists who want to enjoy the fruits of success without bearing the pain of failure. They use the coercion of the state to gain privileges, at the expense of everyone else.

As a country we’ve become less tolerant of economic failure. The result has been a series of interventions, such as meddling in the credit markets, promoting homeownership and creating a variety of safety nets for investors. Each crisis leads to an even greater crisis. The solution is always greater doses of intervention. So the system becomes increasingly unstable. The interventionists never see the bust coming, then blame it on “capitalism.” …

Laggner:¬†AIG made sure its creditors received 100 cents on the dollar. Essentially you have the socialization of risk, but the survivors are still highly leveraged. There is still a multi-trillion dollar shadow banking system that FASB [the Financial Accounting Standards Board] wants to address next year. The central planners have already spent $3.15 trillion on various bailouts, credit backstops, guarantees, etc., and given approximately $17.5 trillion of government commitments, etc., while allowing many of these institutions to remain in place, with the same people running them…

Barron’s: What kind of financial reform would you like to see?

Laggner: We don’t believe in a central bank. The idea that banks can speculate with essentially free money from the [Federal Reserve], which ultimately is the taxpayer, and that when they lose money the Fed bails them out and then passes that invoice to the taxpayer — that whole model is broken and needs to go away.

Duffy: To get to the heart of the problem, we need to address fractional-reserve banking, which is causing the instability. We have essentially socialized deposit insurance and prevented the bank run, which used to impose discipline on this unstable system. At least it had some check on those who were acting most recklessly. Until we address the root of the problem, we are going to have a series of crises, greater responses and intervention, and more bubbles — and the system will keep perpetuating itself.

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The whole system is broken and needs to go away. We can only hope that this depression fosters that end, though the actors that control the guns (i.e. government) will use all of their wiles to hold onto their racket.

Yes, the 1700s and 1800s had their booms and busts, but the 200 years leading up to the first world war saw the greatest improvement in living standards that the world has ever seen. The industrial revolution and development of modern communications, medicine and transportation happened on the gold standard, with non-existent or non-interventionist central banks and governments that allowed busts to clear away mal-investments and bad debts so that the market could guide capital and labor into productive hands.

Nobody back then believed that consumption and “stimulous” could generate anything but debt and waste. Since the ruinous economic policies of the 20th century took hold, we have been squandering our wealth and merely coasting on technological improvements, which government only impedes in a thousand ways.