Referees are supposed to be invisible. Everyone knows they’re on the field–highly trained, deeply knowledgeable about the rules, watching every play to ensure the game is being played the way it should be. When a referee becomes visible, it’s usually a bad thing.
This happened last football season to an NFL referee, Ed Hoculi. In the waning moments of a game the San Diego Chargers were on the verge of winning, Mr. Hoculi made a clearly incorrect call that handed victory to the Denver Broncos instead. Mr. Hoculi immediately acknowledged his error and expressed his regret. Despite a long career as one of football’s best officials, he has been disciplined by his league. He no longer appears in the most important games, apparently waiting for his invisibility to be restored.
I think investors think about their governments in much the way sports fans think about referees–that officials are intelligent, competent, there to save the day when trouble emerges. That’s why I think both the markets and ordinary citizens were so shocked last year when some Republican congressmen blocked the first bank bailout bill, saying the US would (in some way not clear to me) be better off if credit markets collapsed. Then the plans that Congress did enact kept changing, sometimes retroactively. Treasury Secretary Paulson, despite his supposed deep knowledge of Wall Street, intensified the crisis by allowing Lehman to fail.
But what seems to have made the most profound negative impact, particularly among foreigners, on the credibility of the US has been the Democrat-led attempt to retroactively rewrite the tax laws to punish a group of (admittedly pretty slimy) AIG traders. To some, the emotional tone of Congress conjures up memories of the McCarthy hearings of a half-century ago. Others point to the apparent unconstitutionality of a punitive tax directed at a specific minority. Still others worry about the apparent lack of thought given to other consequences of the proposed legislation–that US financial institutions might be drained of talented workers, for example, who could avoid a punitive tax by plying their trade for a non-US bank. Probably the most disturbing is the idea that our legislators don’t appear to know very much at all about how the economy works, or even what the issues are. It’s sort of like going to a game and discovering the refs not only have never played the sport, even on an amateur level, but have not made any effort to read the rule book.
The investment point:
There’s an investment point here. I think there are two big imponderables facing the US stock market in the years ahead. The first is how, and for how long, the immense loss of wealth by US financials will have a negative effect on the US economy. The second is what damage the poor performance of our politicians during the financial crisis will do to the prospects for future investment in the US, whether by companies or individuals, US or foreign.
No one, other than possibly the residents of San Diego, have lost faith in Mr. Hoculi. No one has stopped watching football. On the political front, it’s true that in addition to laws, every country has informal rules that stack the deck to some degree in favor of locals. In the US during the Eighties, for example, Japanese automakers adhered to “voluntary” restrictions on imports to the US for fear of punitive legislation if they didn’t. It’s ok for European allies to own US ports but not Middle Eastern ones. In today’s world, it will be extremely difficult for any Chinese entity to buy US assets. Of course, Coke can’t buy a Chinese juice company, either. France recently barred Pepsi’s bid for Danone, on the idea that the latter’s yogurt technology is a strategic national resource. And in Russia, the rules can change retroactively almost any day.
Yes, the playing field isn’t ever completely level anywhere. But the local ground rules are usually very well understood and factored into any investor’s risk/reward calculations. Until six months ago, the US has been regarded as relatively open and relatively stable. Today, I think Congress has pushed us much farther toward the “unstable” end of the scale than we would care to think. We have to worry about how long this will last–whether, like Mr. Hoculi, Congress will gradually become invisible again or whether it poses an enduring risk to the size of new investment flows.