Booms and Busts

0:00You know, I heard somebody laughing out there already. So I guess somebody out there knows why I've been selected. To talk about Boehm's and Bush, you might be wondering. And the first part of the story is that I had the very, very good fortune of pursuing a master's in economics at University of Nevada, Las Vegas. Imagine my surprise a couple years into the process, when I meet a guy named Murray Rothbard, and I ended up writing a thesis under Murray, and that thesis was on the very subjects of booms and busts, talked about tulip mania, I wrote about the Mississippi bubble and the The South Sea Bubble I really thought that academic experience would probably be the end of my boom and bust work.

1:03Well, it didn't work out that way. I was actually a banker in Las Vegas, and more specifically, I was a real estate lender in Las Vegas. So, you're looking at someone who may not have the academic credentials of some of the previous speakers, but I was on ground zero of creating, help creating, the biggest boom, and unfortunately, for my net worth, biggest bust probably in history. Now, we should clarify, first of all, that when I was doing my work on booms and busts, that there are schools of economic thought that don't think there is such a thing.

1:55Now, that seems incredible. I think everybody in this room knows there's booms and busts. In fact, I would say there's a fair number of you that are sitting around wondering when we're going to get this boom in the price of gold, for crying out loud. out loud. I know I am. Just give me one more boom. It was kind of that bumper sticker that was going around Texas in the 1990s. Lord, just give me one more boom. We've learned our lesson. I'm not sure we ever have. But if you look at, there's a couple of rational Expectations, economists named Flood and Hodrick, and they actually came to the conclusion that the current imperial test for bubbles do not successfully establish the case that bubbles exist in asset prices.

2:51So these guys actually ground the numbers and they determine that there is no such thing as a boom and bust. Well, I'm here to tell you that there is. Of course, we've talked about the Keynesians a little bit earlier today. Of course, we don't like to, you know, quote Keynes, but he's darn handy every once in a while. And he actually said that there's an instability due to the characteristic of human nature that a large proportion of our positive activities depend on the spontaneous optimism rather than on mathematical expectation. Whether moral or hedonistic or economic, more probably of our decisions to do something positive can only be taken as the results of animal spirits.

3:46So we've got two schools of thought, the rational expectation guys that say there can't be anything, you know, resembling an asset bubble because we all have the available information to tell us that we would never bid the price of an asset up to where it was, say, illogical. And then we have Keynes who said we've got these animal spirits running through us constantly. And of course, you know, we know that Keynes, because of these animal spirits, thought that we needed, of course, more government to control our animal spirits. Of course, I think the Austrians have proven through the work of von Mises and Hayek that it is really Keynesian economics and not the animal spirits that Create the Boom and the Bust Cycle.

4:47The key point of the Austrian trade theory is that an increase in the supply of money engenders an economic boom, and, of course, that's followed by a correction of the malinvestment or the bust. And this has all been pretty well documented. And we've seen this play out over and over again, and by the way, if there's anyone in here that wants to buy Lehman Brothers, you know, I've got the number for you to call, but, you know, Mises was incredibly prophetic about all of this. He wrote in a book that David Gordon didn't mention, but it was one of my favorite books when I was working on my thesis.

5:34This is called On the Manipulation of Money and Credit, and he said the moderated interest rate is intended to stimulate production and not to cause a stock market boom. However, stock prices increase first of all. At the outside, commodity prices are not caught up in the boom. They are stock exchange booms and stock exchange profits. But then the producer becomes dissatisfied. He envies the speculator and he envies the speculator's easy profit. Those in power are not willing to accept this situation. They believe that the production is being deprived of money, which is flowing into the stock market.

6:22and that's precisely the market boom that has created the serious threat for the crisis that lies within. So what we have when we have an increase in the supply of money that is engendered by the central banking system that so many of our morning speakers have talked about, What happens is a series of things that Murray Rothbard has outlined in a great little book that I think we're probably already sold out of. What has government done to our money? But I wanted to kind of use some points that Murray makes about inflation and the increase of supply of money to kind of illustrate what happens in a boom and put it on kind of a personal level.

7:20The first thing that Murray said was inflation, you know, inflation being the increase in the money supply, confers no general social benefit. It just redistributes wealth in favor of the first comers at the expense of the last. When we look at M2 money supply, and of course I just want to use M2 because they quit tracking M3 because it was just so darn expensive. It cost them a hundred grand a year to actually tabulate M3, and the austerity program at the federal government just had to get rid of this idea of tracking M3. In 2001, the M2 totaled $5 trillion, and that's a lot of money. By today, the M2 is now $7.8 trillion, an increase of $2.8 trillion just since 2001.

8:31Now maybe that doesn't sound like a lot, except that that $2.8 trillion increase is the amount of the total M2 money supply in 1987. So since 2001, seven years ago, we've increased the M2 money supply, Federal Reserve has increased the M2 money supply, by the amount that the entire M2M money supply had been created up to 1987, which was only 20 years ago. Of course, this increase in money was what Bill Fleckenstein called Operation Enduring Bubble.

9:23If we had one bubble pop, you know, Greenspan was making more bubbles than Lawrence Welk, I think. Thank you. It's the benefits of having an older audience, I suppose. But, you know, this money doesn't, the point Murray makes and all the Austrians with von Mises and certainly our speakers today Money doesn't produce prosperity. Otherwise, Zimbabwe would be the most prosperous country on earth. It used to be one of the most prosperous, but now they're actually printing themselves into complete disaster. But money doesn't produce poverty. In fact, Mises said in Human Action, the boom produces impoverishment.

10:10But still, more disastrous are the moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusionary prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application and probity. But reverses a fortune he always charges to other people and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse.

11:03A very prophetic statement from Mises. And, of course, where did all this money go after, you know, when it started being created in 2001? Well, we know all the stories. All went into housing. I heard Dennis Gartman this week at a conference in Las Vegas, and he talked about, you know, these dumb waiters who would buy, they took Alan Greenspan's advice. They bought a house on an adjustable rate loan, probably a pay option arm, and then they were able to buy another house because real estate always goes up, and so then they bought two homes, and then they bought four homes, and then they bought eight homes, and we know of situations where there was a gentleman who had been a firefighter in Chicago, and of course if you're A fireman in Chicago, your useful years evidently run out at about 50 years old.

12:10So he retired on a pension, and he came to Las Vegas. He got a little bored. After all, he's only 50 years old, so he decided he ought to get into the real estate business. So a realtor got ahold of him. He bought a home. And he says, well, how much do I have to put down? The realtor said, you don't have to put anything down. So he says, that's great. You can get an option arm, you make the minimum payment, get a renter in there and that will cover and of course real estate goes up every year so you'll be a rich man in a few years. So he didn't buy one home, he didn't buy two homes, he ended up at 16. He hadn't put any money down and he was collecting plenty of rent to pay the initial teaser rates on these arm loans.

12:55When they began to set a year ago last December, he couldn't make any of the payments, and at that point he was seeking out the Council of Bankruptcy Attorneys. So there are stories all over town. We know people who were banquet captains at major hotels in Las Vegas who had money down on five high-rise condos. The biggest cottage business in Las Vegas for a while was getting yourself on the list to buy a new home in Las Vegas. They didn't try to sell you homes. They would have lotteries. And if you were lucky enough to get on the list before the homes were built, then before the home was delivered, you could actually sell your home.

13:45And if you were lucky enough to get on the list before the homes were built, then before the home was delivered, you could actually sell your position to someone else. And so that became an actual business. And the second point that Murray makes about this inflation, of course, is that inflation distorts business calculation. When you have these kind of booms going on, it's not just centered in one thing. It's centered in, there's offshoots. I mean, if there's a lot of homes being built, then that means home builders need to hire more people. And that means title companies need to hire more people. And of course, that's what drove Las Vegas to expand, in my view.

14:36And in my view, if everyone around the country had all this new wealth that had been created by not by their doing, just the mere fact that they were smart enough to buy a home, they could take that money out and go to Vegas and party every weekend with Britney Spears and Justin Timberlake and fund people like that. So Vegas, in another classic malinvestment, went ahead and expanded 38,000 new hotel rooms, almost 5 million square feet of new convention space. And why not? The gaming win in Clark County, which is Las Vegas, 7.6 billion in 2001.

15:25But by last year, it was 10.9 billion. And during that time, 200,000 new jobs had been created, and 4 million more visitors had come. We had 39 million visitors. Certainly, this beat would go on. But it was all on the back of this illusionary wealth that was created by this increase in the money supply. Unfortunately, as you read the papers, things have changed in Las Vegas. Gaming win in the visitor count is down for the last nine months in a row. And in fact, gaming win was down 13% in July. The Echelon project, which was a Boyd gaming project, is stopped.

16:15Of course, people said that would never stop. They've got the steel in the air. There's no way. They've got to complete it. Well, no, they don't. They're going to put that on hold. The steel will be left to rust out there in the elements. A project called the Plaza has been stopped. The Plaza that was being developed by the allied group out of Israel, They paid over $30 million an acre for their land, and now that project has stopped. City Center, possibly a project you've heard about. Largest private project in the country built by MGM Grand in combination with Dubai World.

17:03And, of course, Dubai World has all the money in the world. There's no way they're not going to finish that, right? Well, what we hear on the street is now that budget may be $13 billion rather than the $6 billion it started at and the guys in Dubai are saying no more. You need to find the money somewhere else. So it's possible that Cine Center may not get completed or get completed as it was contemplated. So these are the kind of distortions that come from this kind of inflation and these kind of booms. The other, the other illusions that are created is that the free market typically penalizes inefficient producers.

17:54They, you know, they reward people that are efficient. They reward people that are that are prudent. But of course, that doesn't happen when when you have booms. In fact, I had a number of borrowers and at least one banker that I can think of that, you know, they decided they could get into any business they wanted to. They were so smart and making so much money either at banking or real estate that they could get into any sort of project. In fact, you know, there's one banker who thought that he should get in the G-string business. What he knew about G-strings probably amounted to having put a few dollar bills in them, but thought that since he'd made little money in banking, he was obviously smart enough to get into retail.

18:52So that's another effect of these booms. Of course, the quality of work goes down. Quality houses in Vegas during this boom were terrible and tremendous problems with houses and defects. But what happens is people become enamored with these get-rich schemes, and that's certainly happened in Vegas like no other. Where all of a sudden bartenders and waitresses got their real estate license. At one time we had one realtor for every hundred people in Las Vegas.

19:38Now that is surely an oversupply and believe me that supply has been reduced, but everyone was going to get in the business. They were either going to sell real estate, they were going to make mortgage loans or Before they're going to get in the business of flipping houses. I have a number of borrowers that, of course, they were home builders. They had started from really pretty humble beginnings. And in one case, I remember one of my borrowers, he used to live in one of his model homes. I mean, what could be more prudent than that? He would go there and sleep at night, and then when he'd wake up in the morning, he'd He'd make the bed and everything and then they'd show that house to customers all day long and so he started from very humble beginnings and of course I remember he met a girlfriend that way because there was a woman who was a school teacher and she couldn't get to the model homes during the day so at night she was traipsing around you know looking in the windows and so he caught her and she was an attractive young

20:48And, of course, by the time we met her, she was no longer a school teacher. She was the girlfriend of a developer and, of course, a real estate salesman for the developer. But I can remember the conversation over dinner where we proposed the proposition that maybe houses don't always go up in value. and she was quite indignant about it. I mean based on her six months in the business she had determined that there was no way that real estate could ever go down in value. Unfortunately I don't think she's no longer the girlfriend, no longer a real estate salesman, so I'm hoping that she was able to get her for a school teaching job back, but you know theividher thing that happens is during these booms, during these inflations, that thrift is penalized actually, you know the people that save their money are, are, are, they don't benefit as the central bank pushes down rates, banks offer very low, very low rates, it's the rates that are

22:09very much below that natural rate of interest that the Austrians referred to. And so people are left to take on more risk than they normally would. In fact, a lot of retirees and people who had saved the money in Las Vegas and in Phoenix were forced to, they weren't forced to, but they made the decision to take their money out of banks and invest it with what was quote, hard money lenders. Now one hard money like this crowd might think hard money with gold or silver. Hard money lenders are private money lenders who would, people would pool their money with these lenders and these lenders would fund real estate projects. Similar to banks, but again these are people that had actually saved their money so they demanded a higher interest rate than what So there were all kinds of people in Vegas and all kinds of people in Phoenix that put their money with these hard money lenders, getting 10% and 12%, in some cases 18%.

23:19And of course those were great returns when they were being paid. Unfortunately, these hard money loans in the last year or two are hard money for a reason. Reason. That's somebody from WaMU wondering if we have a buyer here. No, people were, you know, they were collecting all this great interest, but hard money loans are now, they're called hard money because they're hard to collect. But, you know, people live the high life, and there's a gentleman by the name of Scott Coles, perhaps you read about him, He was a hard money lender in Phoenix and a relatively young guy, but with 3,000 investors, he was able to raise nearly a billion dollars to fund Phoenix real estate projects.

24:18And he gave money to charity, he had seven houses, he had many of the members of the Phoenix Suns investing with him. I mean, this guy was a pillar of the community, all of a sudden, that market downturn turned very nasty, and he was unable to collect on those loans. It became increasingly difficult to raise the money to finish the projects that he had started funding. And it was interesting, one of his investors, a woman named Barbara Porter, was quoted as saying, she was a 62-year-old retiree. She had all her money with Scott Coles. The company was called Mortgage is Limited.

25:06And she said, I think the problem is greed. We're all greedy. That's why we put our money there. That's why I put my money there, because he paid 10% instead of 4%. Everybody in town got caught up with the stupid appraising and spending. Now everyone is upside down. Well, not only is she upside down financially, Scott Coles is six feet under because he committed suicide. He got so much pressure from his investors. Inflation lowers the general standard of living, even though people have this illusion that you're living well.

25:51But during these booms, people have to work harder, to work longer. Everybody has, you know, two in-gum households to keep up. and, of course, you're trying to keep up with the Joneses and anybody else out there. So it's really just the illusion of prosperity that's created by all this money and not true prosperity. Of course, this money always ends up with a cluster of errors. It's been mentioned earlier. This is a phrase the Austrians use, certainly Murray used to talk about a cluster of errors that you really don't have in any other business.

26:38Joseph Salerno makes this point very well that there's no other type of business where everybody kind of goes broke at once, the way the banks do. And they're so intermingled because of this fractionalized banking system that we have. Of course, if you talk to the former chairman of the Fed, Alan Greenspan, he's making a pretty dandy living on the lecture circuit, denying that there ever was a bubble, and if there was a bubble, he didn't have anything to do with it. Maybe other people don't quite have that luxury, but Alan is not taking any responsibility. He's handed the reins to Ben Bernanke and, of course, another gentleman by the name of Tim Gaytner.

27:29He's the chairman of the New York Fed. And when you start looking at many of these bailouts and these shotgun weddings that you're seeing on Wall Street around the country, Tim Gaytner is a guy that's front and center with this. Many friends on Wall Street and is the guy that I think is engineering a lot of these bailouts. But of course, what we have now, we've got these malinvestments being liquidated, and there's probably no place like that than, say, Las Vegas, and there's probably no industry that exemplifies that, like banking.

28:19We were talking earlier at the table about a conference that we had back in 2006, and actually spoke at that conference, and I pulled up those notes, and I had these notes about how well the Las Vegas community banks were doing. Nevada, there was a bank, I'll leave the names out of this, But one bank, they had sold out, they made, the investors had made eight times their money in less than a decade. One bank made seven times their money in a decade. One bank made 30 times their money in a decade. And then I made reference to a bank I was very familiar with at the time. The original investors had made 20 times their money in less than a decade.

29:10Unfortunately, that particular bank was seized by the FDIC last Friday afternoon. So it was just two short years ago that these banks were making hay, making real estate loans to developers and doing quite well with it. but when asset values plunge, the party is eventually over and we're seeing that kind of liquidation. At the time, there were 17 banks in Nevada under organization. Everybody wanted to get in on this business. There were 50 banks in California in organization. Everybody wanted to do their own start-up bank. And in fact, there was a website that I saw advertised in the business journal in Phoenix.

30:05Own the local bank, it said. Just go to www.startabank.com. May not be working out for people quite that well. I'm going to leave you with a quote from, again, Ludwig von Mises from a book on the manipulation of money and credit, and it really kind of says it all. If the crisis were ruthlessly permitted to run its course, bringing about the destruction of enterprises which were unable to meet their obligations, Then all entrepreneurs, not only banks, but also other businessmen, would exhibit more caution in granting and using credit in the future.

30:52Instead, public opinion approves of giving assistance in the crisis. Then, no sooner is the worst over than the banks are spurred on to new expansion of circulation credit. So, unfortunately, as Mises wrote, this credit crisis we have now will probably not involve the complete liquidation of the financial system that we have today. But I think it's rooms filled like this with people like you. It's the Mises outreach to not only homeschoolers but educating a new generation of instructors on sound money, sound economics that eventually these businesses and these banks will fail and then that will be our day.

31:52And I'm glad to see that you have joined us in that fight.