Financial History Reveals Recurring Risks and Enduring Resilience - Episode Hero Image

Financial History Reveals Recurring Risks and Enduring Resilience

The Long View · · Listen to Original Episode →
Original Title:

TL;DR

  • Understanding U.S. financial history reveals chronic deficits are an anomaly, not the norm, with past surpluses used to pay down debt after emergencies, a pattern now broken.
  • Central bank independence is crucial for economic stability, as political pressure on the Fed in the 1960s-70s contributed to persistent inflation, a lesson currently being tested.
  • The historical pattern of dominant reserve currencies losing status is linked to crises that bankrupt nations, suggesting current U.S. debt levels erode borrowing capacity for future unforeseen events.
  • Shadow banks, operating outside Federal Reserve oversight, pose systemic risk by lacking a lender of last resort, exacerbating runs as seen in the 2008 financial crisis.
  • Private credit markets exhibit herd behavior and a lack of fear, with inflated return expectations and potentially high default rates signaling a late-cycle phase rather than an early opportunity.
  • The widespread use of accounting "practical expedients" in evergreen private market funds allows for artificial markups, masking underlying risks and potentially misrepresenting returns.
  • Despite current challenges like debt and divisiveness, America's 230-year track record of resilience through depressions, wars, and pandemics suggests an enduring capacity to overcome future crises.

Deep Dive

Financial history offers a crucial lens for understanding contemporary economic challenges, revealing that while market conditions evolve, fundamental human behaviors remain constant. Ignoring these historical patterns creates a significant blind spot for investors and policymakers, leading to repeated mistakes and suboptimal decision-making, yet a deep dive into this history can foster a more resilient and optimistic outlook for the future.

The enduring relevance of financial history lies in its ability to illuminate recurring patterns in human behavior and economic cycles. Alexander Hamilton's foresight in establishing a sound credit system and a central bank, principles that have guided the nation for over two centuries, underscores the importance of robust financial architecture. His approach to debt management--using it primarily for emergencies and then retiring it with surpluses--contrasts sharply with the chronic deficits seen over the last 70 years, a deviation from historical norms that poses a significant risk should an unforeseen crisis emerge and necessitate increased borrowing capacity. Similarly, the historical controversy surrounding central banks, rooted in fears of centralized power and regional disparities, mirrors ongoing debates about central bank independence and its susceptibility to political pressure, a factor that contributed to past inflationary spirals.

The tendency for human behavior to remain consistent, despite evolving market conditions, explains why passive investing has gained traction so slowly. Early markets were susceptible to manipulation through "stock pools," a practice outlawed by securities legislation in the 1930s. This shift forced a focus on securities analysis, leading to the rise of the investment analyst profession. Despite this, the difficulty of outperforming the market consistently, a phenomenon noted by figures like Ben Graham and supported by modern studies, means that active management often underperforms passive indexes, especially after accounting for fees. This persistent challenge for active managers, coupled with the inherent incentives within the financial industry, has contributed to the slow adoption of simpler, lower-cost passive strategies.

Furthermore, historical analysis reveals the cyclical nature of asset bubbles and the dangers of herd mentality. The current enthusiasm for private credit and certain private market strategies, for instance, exhibits a lack of fear and an overestimation of returns, reminiscent of past market excesses. The use of accounting "practical expedients" to mark up secondary market assets, particularly in evergreen funds, risks creating an illusion of returns that may not be sustainable or real, especially when these strategies are increasingly pushed into retail investment plans. This historical perspective also highlights the potential for systemic risk in shadow banking systems, which operate outside the direct support of central banks, as demonstrated during the 2008 financial crisis.

Despite the challenges presented by chronic deficits, potential shifts in reserve currency status, and the complexities of modern finance, a long-term historical perspective can foster optimism. By examining periods of profound crisis, such as the Great Depression, World Wars, and pandemics, one observes the resilience of American institutions and its people. The nation has repeatedly navigated immense adversity, driven by innovation, a willingness to learn from failure, and a capacity for reinvention. While significant problems like the national debt and political divisiveness persist, the 230-year track record suggests a fundamental capacity to overcome challenges, indicating that the current difficulties, though serious, may not be an existential threat to the nation's long-term trajectory.

Action Items

  • Audit historical central bank policies: Analyze 3-5 instances of political pressure on central banks and their correlation with inflation spirals.
  • Track US debt accumulation patterns: Compare current debt-to-GDP ratios against historical surpluses during peacetime for the last 200 years.
  • Evaluate private credit risk indicators: Monitor default rates and asset valuations in private credit markets for 5-10 key segments.
  • Analyze shadow banking system vulnerabilities: Identify 3-5 systemic risks within non-bank financial entities that lack direct central bank support.
  • Assess historical asset bubble phases: Document 6 distinct phases of past asset bubbles and identify current market parallels.

Related Episodes

Key Quotes

"You know, they characterized her as a miser; she was very thrifty, which she was. A Quaker, and she learned that in the whaling industry, which was a lot like venture capital. You had to wait a long time for your wealth to come back, if it comes back at all. And she was also very charitable. She just did it very quietly."

Mark Higgins argues that Hettie Green, often maligned as the "Witch of Wall Street," was actually a highly successful investor whose perceived vices were virtues. Higgins highlights her thriftiness and quiet charity, suggesting her misunderstood nature stemmed from not fitting societal expectations of the time, rather than any inherent flaws.

"The more I read, the more I realized that it actually wasn't unprecedented, that the March 2020 panic almost looked identical to the July 1914 panic. World War I, most people don't know, it really came out of nowhere and, you know, similar effects: the entire world just kind of shut down and went to a total war bearing."

Higgins explains that his research into financial history revealed parallels between the 2020 pandemic-induced panic and earlier historical events, such as the 1914 panic preceding World War I. This realization challenged his initial perception of unprecedented economic disruption, demonstrating the recurring nature of such crises.

"And the most lasting thing is repairing the U.S. debt. We were basically bankrupt in 1790, and he basically repaired it by consolidating all the state and federal debts, modestly raising tariffs to ensure there was revenue--there's no income tax back then--and really solidifying the credit of the United States, which we would need over the next 230 years."

Higgins emphasizes Alexander Hamilton's pivotal role in stabilizing the nascent United States by addressing its crippling debt. He details Hamilton's strategy of consolidating debts, implementing tariffs for revenue, and thereby establishing the nation's creditworthiness, which proved essential for its future economic development.

"And the other thing is he established the first central bank. I remember reading it, most people don't know this, but the Federal Reserve is the third central bank. The first one was established by Alexander Hamilton; it was chartered in 1791, only a 20-year charter, disappeared for about five years, and then the second bank came and disappeared in the mid-1830s."

Higgins points out that Alexander Hamilton was instrumental in establishing the first central bank in the U.S., a fact often overlooked. He clarifies that the current Federal Reserve is the nation's third central bank, with two predecessors chartered and subsequently dissolved, highlighting Hamilton's foundational role in U.S. financial architecture.

"And the most memorable thing about it was when my son convinced my father and my father and my mother went on the trip with us, convinced us to eat this ridiculously spicy beef jerky while we were driving through Utah. That was the most memorable. But really, I talked to Jack about this last night and asked him what was most memorable, and it was just, you know, he said, 'Just being with you and being with my grandparents.'"

Higgins shares a personal anecdote from a family trip, illustrating the value of shared experiences and intergenerational connection. He contrasts a humorous, memorable moment with his son's deeper reflection on the significance of family time, underscoring the importance of personal relationships amidst broader historical and professional pursuits.

"And the most important book for people to read right now is a book by Robert J. Samuelson. It's called 'The Great Inflation,' I forget exactly the subtitle, but it's called 'The Great Inflation,' just because I think we are going through a lot of the same issues right now."

Higgins recommends Robert J. Samuelson's "The Great Inflation" as a crucial read for understanding current economic conditions. He believes the book offers valuable historical parallels to today's challenges, suggesting that examining past inflationary periods can provide essential insights for navigating present-day economic issues.

Resources

External Resources

Books

  • "Investing in U.S. Financial History: Understanding the Past to Forecast the Future" by Mark Higgins - The primary subject of the discussion, detailing financial history and its relevance to current economic conditions.
  • "The Great Inflation" by Robert J. Samuelson - Recommended as a timely read due to current economic parallels with the period discussed in the book.
  • "The Big Board" - Mentioned as an interesting book on the history of the New York Stock Exchange, though its recommendation is qualified.

Articles & Papers

  • Paper on Hetty Green (SSRN) - The initial paper written by Mark Higgins that led to his involvement with the Museum of American Finance.
  • Article on Hetty Green (Financial History Magazine) - An adaptation of Higgins' SSRN paper for publication in the magazine.
  • Article on Sylvia Wilkes' Will (Late last year or early this year) - A follow-up article by Mark Higgins and Bethany Binkson detailing the distribution of Hetty Green's fortune.
  • "The Anguish of Central Banking" (September 1979) - A speech by William Greider referenced in relation to the Great Inflation.
  • "The Origins of Inflation" by Allan Meltzer - Referenced as a source documenting the Great Inflation.
  • Article for the Museum of American Finance on Nevada PERs - A case study used as evidence regarding the effectiveness of investment consulting.
  • Article in The Wall Street Journal on Hamilton Lane Private Assets Fund - Referenced for its reporting on accounting markups in private markets.

People

  • Mark Higgins - Author and guest, specializing in institutional advisory services and financial history.
  • Hetty Green - Described as potentially the best investor in U.S. financial history.
  • Bethany Binkson - Author of a follow-up article on Hetty Green.
  • Alexander Hamilton - Described as the most versatile and brilliant financial mind in U.S. history, pivotal in repairing U.S. debt and establishing the first central bank.
  • William Greider - Author of "The Anguish of Central Banking."
  • Allan Meltzer - Author of "The Origins of Inflation."
  • Charles Merrill - Founder of Merrill Lynch, discussed for his experience going against market crowds.
  • Ben Graham - Referenced for his writings on active management's historical failure to beat market indexes.
  • William McKinley - Republican president who championed tariffs.
  • Jason Zweig - Author of a recent article in The Wall Street Journal concerning practices at Hamilton Lane.

Organizations & Institutions

  • Morningstar - The host organization of the podcast "The Long View."
  • Ameritrade - Mentioned as a sponsor powering trading platforms.
  • Schwab - Mentioned in relation to the thinkorswim trading platform.
  • IFA Institutional - Where Mark Higgins serves as Senior Vice President.
  • Museum of American Finance - An organization Mark Higgins is involved with as an editorial board member and guest curator.
  • Federal Reserve - The central banking system of the U.S., discussed in relation to monetary policy and independence.
  • Georgetown University - Mark Higgins' alma mater.
  • Darden School of Business at the University of Virginia - Mark Higgins' alma mater for his MBA.
  • New York Stock Exchange - Mentioned in relation to historical market activity.
  • Securities and Exchange Commission (SEC) - Mentioned for a 1940 study on fund performance.
  • Merrill Lynch - Founded by Charles Merrill.
  • Nevada PERs - A public retirement system used as a case study for investment consulting.

Tools & Software

  • Thinkorswim - An award-winning trading platform mentioned as being loaded with features.

Other Resources

  • Shadow Banking - Discussed as bank-like entities operating outside of the Federal Reserve's purview, contributing to the 2008 financial crisis.
  • Private Credit - Discussed as an investment area with potential warning signs due to a lack of fear and a herd mentality.
  • Asset Bubble Phases - A concept detailed in the book, with six different phases identified.
  • Evergreen Funds - Funds investing in private markets, particularly through secondary positions, with concerns about accounting markups.
  • Practical Expedient - An obscure accounting rule established in 2009 related to reporting NAV for secondary positions.
  • CFA Charter - A professional designation for investment and financial analysts.
  • ChatGPT - Mentioned for its ability to pass the Level 3 CFA exam.
  • MBA (Master of Business Administration) - Discussed as a costly educational pursuit with a lower perceived value compared to independent reading or CFA/CFP.
  • 60/40 Portfolio - A traditional investment portfolio mix.
  • Target Date Funds - Investment funds designed for retirement plans.
  • Alternative Investments - Asset classes outside of traditional stocks and bonds, often associated with higher fees.

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