Gary North

March 3, 2009

David Bahnsen
Senior Vice President
Morgan Stanley
Newport Beach, CA

Dear Mr. Bahnsen:

I am writing this in response to your article, published on December 12, 2005, "Greenspan on the Free Market," which was critical of Austrian School economics. You said at the time, correctly, that Austrian School economists were highly skeptical of the American stock market, given Alan Greenspan's policies as Chairman of the Federal Reserve System. You then quoted several paragraphs by Mr. Greenspan proving that Greenspan was an advocate of free markets.

This article was a follow-up to your article of October 24, "The Streak Goes On," in which you had kind words for President Bush's appointees, most notably Ben Bernanke. You wrote:

His choice of Christopher Cox to director of the Securities & Exchange Commissions, Paul Wolfowitz to head the World Bank, and John Bolton to serve as Ambassador to the United Nations all represent the selection of deeply principled men, committed to reform where it is needed, and progress where it is possible. . . .

Now, this morning, President Bush has pushed his streak yet another notch further with the apparent appointment of Ben Bernanke to serve as the next Federal Reserve Chairman ... The Wall Street Journal and NBC News have confirmed that President Bush will be make this announcement this morning, and supply-siders like myself can barely contain their excitement ... Dr. Bernanke will have big shoes to fill (Alan Greenspan has served as chairman since 1987, covering all or part of six presidential terms along the way), though he surely is up for the task. A much more reliable deficit hawk than our own President, and his predecessor, Dr. Bernanke is a Chicago-school economist through and through, carrying on the tradition of the great Reagan team of the 1980's (think Laffer, Kudlow, Bartley, etc.). A graduate of Harvard College, and MIT (Ph.D), he has served a professor at Princeton University, a federal reserve governor, and recently the chairman of President Bush's Council of Economic Advisors.

First, Dr. Bernanke is, was, and always has been a Keynesian. He made a positive reference to Friedman with respect to Friedman's almost universally accepted thesis that the cause of the Great Depression was the Federal Reserve System's refusal to inflate the money supply, 1930-33. Keynesians have long applauded this thesis.

Dr. Bernanke's recent decisions as Chairman prove his commitment to Keynesianism. There is no Friedmanian 3% per annum constant growth in the money supply. There was a 100% increase in the monetary base in the last three months of 2008 -- the highest and fastest in history.

Second, the performance of the American stock market since October 2007 offers evidence that the Austrian School economists, myself included, who predicted this recession in 2006, had the story right. No other school of economics did.

I advised my GaryNorth.com subscribers to sell all stocks and short the S&P 500 on November 5, 2007. It closed at 1502. Those who took my advice have done quite well. You and your firm did not offer similar advice to your clients.

I suggest that the problem you had in understanding what was about to overwhelm your clients was your hostility to Austrian School economics, which blames booms and busts on central bank policy. Let me explain by referring to your article, "Greenspan on the Free Market."

The invisible hand rears its beautiful head again ... Sorry to mix bodily metaphors, but Adam Smith, Alan Greenspan, and other true believers in the wonders of flexible markets serving as a beautiful economic stabilizer are right on, and all the naysayers, doomsdayers, and other various [fill in the blanks] are dead wrong ... I find this delightful excerpt from departing Fed chairman, Alan Greenspan, to [ironically] pinpoint the exact reason why [supposed] free market advocates in Reconstructionism and Austrianism have been so deadly wrong in all their predictions for over an entire generation now ...

I sense that you had a particular target in mind: someone who promotes Austrian School economics and Christian Reconstructionism. But since you mentioned no names, I will do the same.

I have known many people in my past life (professing Christians) that fell into the hysterical pit of "crisis du jour". Nowadays, I even see more mainstream pundits from the media guilty of it. Whether it be Y2K, 9/11, SARS, oil prices, or Katrina (modern examples), OR, monetary inflation, the nuclear threat, the cold war, a banking collapse, etc. (yesteryear's "crisis du jours"), my hope and encouragement to you is that you will:

(a) Ignore, and run like the plague from, all the false prophets who have ruined their reputations and made fools of you in times past ...

(b) Study the masters of free market thinking (Smith, Friedman) that have so persusasively decimated the "sky is falling" folks for generations ... A true understanding of flexible market forces fully backs up exactly what the maestro says below ...

The term, "false prophets," refers to an Old Covenant office that ended with the fall of Jerusalem in A.D. 70. It was a capital crime to be a false prophet under the Mosaic law. To say that it is a pejorative phrase is not an exaggeration. The phrase "poor forecasters" would have been more accurate.

You then quoted Mr. Greenspan, "the maestro" as you called him, as a supporter of the free market. As you re-read this, bear in mind that on February 18, 2009, he told reporters at London's Financial Times that the Obama administration may have to nationalize some U.S. banks. The report is here.

"It may be necessary to temporarily nationalise some banks in order to facilitate a swift and orderly restructuring," he said. "I understand that once in a hundred years this is what you do." . . .

Speaking to the FT ahead of a speech to the Economic Club of New York on Tuesday, Mr Greenspan said that "in some cases, the least bad solution is for the government to take temporary control" of troubled banks either through the Federal Deposit Insurance Corporation or some other mechanism.

The former Fed chairman said temporary government ownership would "allow the government to transfer toxic assets to a bad bank without the problem of how to price them."

This statement was quoted in the financial press all over the world.

Let me refresh your memory of the passages you cited from Mr. Greenspan in 2005.

"Whether by intention or happenstance, many, if not most, governments in recent decades have been relying more and more on the forces of the marketplace and reducing their intervention in market outcomes. We appear to be revisiting Adam Smith's notion that the more flexible an economy, the greater its ability to self-correct after inevitable, often unanticipated distrubances. That greater tendency towards self-correction has made the cyclical stability of an economy less dependent on the actions of macroeconomic policymakers, whose responses have often come too late or have been misguided.

Being able to rely on markets to do the heavy lifting of adjustment is an exceptionally valuable policy asset. The impressive performance of the U.S. economy over the past couple of decades, despite shocks that in the past would surely have produced market economic disruption, offers the clearest evidence of the benefits of increased market flexbility.

Now Mr. Greenspan wants the U.S. government to do the heavy lifting. That means you and I will do it.

Greenspan continued, praising his career as Chairman. He came into office in the month of the 1987 stock market crash.

We weathered a decline on October 19, 1987, of a fifth of the market value of U.S. equities with little evidence of subsequent macroeconomic stress -- an episode that hinted at a change in adjustment dynamics. The credit crunch of the early 1990's and the bursting of the stock market bubble in 2000 were absorbed with the shallowest recessions in the post-World War II period. And the economic fallout from the tragic events of September 11, 2001, was moderated by market forces, with severe economic weakness evident for only a few weeks. More recently, the flexibility of our market-driven economy has allowed us, thus far, to weather reasonably well the steep rise in spot and futures prices for oil and natural gas that we have experienced over the past two years. The consequence of this flexibility has been a far more stable economy."

I do not perceive that we are living in a stable economy. I think it is safe to say that Mr. Greenspan was a poor forecaster, though not a false prophet.

Your 2005 article was really an extension of one you wrote in August 2002 for the Chalcedon Report. You were adamant that Christians you had met had missed out on the great stock market boom of the 1980's and 1990's.

This was courageous timing, indeed. The stock market was down 50% from its high point in March 2000. As you may recall, it was in the week of the NASDAQ's peak close at 5048 that I warned my Remnant Review subscribers that its 200 to 1 price/earnings ratio was insane and would not survive long. I warned that the end of the stock market mania was at hand. It was. The NASDAQ fell by 80% by the time you wrote your first attack: 1100. Yesterday, it closed at 1322.

The S&P 500 peaked at 1527 (close) in March 2000. Yesterday it closed at 700. Meanwhile, price inflation has raised prices by 22% since 2000. Factoring this in, the stock market has never reached its peak of 2000. Its recovery under Greenspan was a bear market rebound fueled by Federal Reserve monetary inflation. It was a trap for stock market investors. That was when you became a stock salesman. Bad timing.

Your article is not on the web, but you can read the highlights here. You began with a lesson in financial history.

Most adults who were alive during the 1980s and 1990s saw a period of economic expansion and financial prosperity that may possibly be the largest of its kind in human history. Sadly, most Christian investors took no part in the gains and growth that the period produced. This is not just sad, however: it is intriguing. In this article, I want to explore why that is the case, and what attitude a Christian individual or investor ought to have towards his financial planning.

The readers of your article were told that you were a "Financial Advisor" (capitalized). A "financial advisor" is a phrase for "stock salesman." You were a brand-new stock salesman. In the 1990's, you were a manager of a local Christian rock band.

You offered this assessment of Christians' skills at investing.

Several brilliant individuals have written about economics, investing, proper planning, etc. from a Christian perspective. -- The large majority of Christians I have met throughout my life have not been successful in this endeavor especially in the Reformed circles I have grown up in. I firmly believe that this is largely due to a "head in the ground" mentality that has ignored the equity markets, prioritized survivalist nonsense over intelligent investing, and replaced rational concerns about certain economic fears with irrational concerns about the future of our nation and economy.

"Economic fears with irrational concerns about the future of our nation and economy." This has a quaint ring to it, don't you think? Today, the entire industry known as investment banking is gone. It committed suicide in October 2008. Lehman Brothers Holdings went bust after 160 years. Goldman Sachs and Morgan Stanley became commercial banks over one weekend and then got bailed out by the government for $10 billion each. Equity losses worldwide have been huge: from about $63 trillion on October 31, 2007 to $28 trillion today.

Let me preface my next comments with this statement: We worship an awesome God, and He is certainly free in His own covenantal love and wisdom to do with our nation as He wills. However, if God wanted to destroy the American culture for its disobedience by causing a collapse of our banking system, or through any type of "sky is falling" scenario, I do not believe that our biggest concern should be whether or not we have gold coins in our sock drawers, as opposed to stock holdings in our portfolios.

By most economic standards, the sky is now falling, all over the world.

You were writing an anti-gold polemic in the magazine started in 1965 by R. J. Rushdoony, my father-in-law. He had died the year before. He was a gold standard advocate, and from 1965 on encouraged his followers to buy legal gold coins. He wrote a booklet on this, Preparation for the Future. Yet you were saying, loud and clear, that such advice was ill-founded.

God is an awesome God, and He will deal with His people as He sees fit. Our responsibility, in the meantime, is to be "wise as serpents, and gentle as doves," as the Messiah taught. It is not to tout the "nightmare of the month" every time we feel that an economic collapse is coming, render irrational panic in the hearts and minds of Christian investors, and keep our churches' and Christian families' capital forever on the sidelines. The pastors and authors who are guilty of this have done so to the detriment of many people and many churches. I do not want to depress those of you who have held savings bonds or gold/silver positions for the last twenty years, instead of participating actively in the American stock market, by showing a comparison of investment performance. The results would be unbelievable to you, and would probably only force you to commit various violations of the 10th commandment. I do, however, hope and pray that our next generation will not make the same mistakes.

When you wrote, "The pastors and authors who are guilty of this have done so to the detriment of many people and many churches," you knew that the most prominent pastor who did this was Rushdoony. You knew because he had employed your father and had published his writings during the time he recommended gold. You were calling his followers deceived.

It might be helpful at this point to see what the price of gold was in August 2002, just for curiosity's sake.

You continued.

It is my opinion that active participation in the equity markets through dollar-cost averaging is the greatest means of obtaining wealth available to an investor. Running one's own business with success can be a greater means (as can finding success as a professional actor or athlete). But for those in a bit more realistic place in life, an intelligent, safe, diversified, proper participation in the equity markets can be the greatest wealth-building habit in the history of America, especially in the twenty-first century.

What is "dollar-cost averaging"? It is calling your stock salesman, who put you into losing stocks, and telling him to buy more. With what? Whatever money you have left. Not much.

Compared to the market from 1945 to 2007, the losses sustained since October 2007 indicate that the sky is falling. Tens of millions of Americans have lost half of their retirement portfolios. They must now gain 100% after inflation just to get even. At 7% per annum, that will take ten years. They will have no retirement. The dream of a lifetime is smashed. One out of nine homes in America is empty, open to squatters and vandals. Government spending around the world is truly out of control. Monetary inflation (the monetary base) is out of control.

You left UBS in June 2007. That was good timing. By 2004, UBS no longer referred to Paine Webber. UBS buried the name. In 2008, UBS lost $17 billion -- the largest corporate loss in Swiss history. The Swiss government had to bail it out in 2008: $59 billion

You joined Morgan Stanley in June 2007. I hope for your sake you did not accept a stock option plan instead of commissions-only. I say this because of the stock price chart for Morgan Stanley. In June 2007, the share price was $75. That was the month you joined the firm. In October 2008, it was around $7.50. As I calculate it, the shares lost 90% of their value. Frankly, I would not call this evidence of wise investing on the part of Morgan Stanley. It seems that the firm's planners did not know what they were doing. In one weekend, the company's 75-year business model was scrapped by the company, when it became an investment bank. Only then did its share price recover, to 25% of what it was when you signed on. It closed yesterday at $18.

Especially interesting to what happened in October 2008. That was the month when, over a weekend, the company had its lawyers restructure the firm from an investment bank to a commercial bank. That let the company have access to the $700 billion September bailout money. It then took the government's $10 billion. Then there was a share price turnaround. Isn't it great what a government handout can do for the bottom line? (The New York Times has run a story on which companies got how much. Access it here.)

Here was a company that had operated as an investment bank since its founding in 1935. Yet it was standing at the edge of bankruptcy in October 2008. Only the combined efforts of Henry "Goldman Sachs" Paulson, Nancy Pelosi, and Barney Frank saved the firm. They saved Goldman Sachs the same weekend, which also had its lawyers turn it into a commercial bank, thereby making it legally eligible for the $10 billion.

This was not the free market in action. It was raw political power. It was salvation by coercion.

You can tell your clients to take any money they still have left and buy stocks: "dollar cost averaging." You can tell them the market will recover. But if they had shorted the S&P 500 in November 2007, they would have four times as much money as they had then. They could buy four times as much stock today. And that doesn't count the losses they suffered through dollar cost averaging.

These were real losses. It will take years to get even . . . with March, 2000.

On your corporate Web page, we read:

In today's market, it's essential to have a Financial Advisor who can provide insight and guidance based on an understanding of your unique situation. As your Financial Advisor, my goal is to provide a high level of personal service to help you meet your financial goals, along with the breadth of services and expertise that Morgan Stanley offers.

I will leverage the strength and resources of the firm to help address your investment goals, time horizon, risk profile and personal preferences.

A suggestion: in today's market, don't use the word "leverage."

Leverage is a two-way street. Consider housing, especially in Newport Beach, where the Web says you live. In 2007, when you moved to Morgan Stanley, the median price for a house in Newport Beach, where you now live, was $1.6 million. Today, it is $800,000. I hope you were not one of those people who kept their homes, let alone someone who actually bought that year.

Losing $800,000 is painful. Losing it if you bought in 2007 means that you are $800,000 in debt, a lifetime condition of servitude for all but the highest-income owners. I hope you have been renting, or else you bought in 2002. If you bought in 2002, you missed out on $800,000 of easy money in 2007, but at least you could sell today without bringing money to closing.

You may not be able to sell at break-even next month. One specialist in California real estate expects a further decline of $150,000 to $200,000 for the median price in the Los Angeles area. But, given the high prices in Newport Beach, the decline there is likely to be worse.

For comparison's sake, here is what I wrote in November 2005 about California real estate.

If you remember the S&L crisis of the mid-1980s, you have some indication of what is coming. The S&L crisis in Texas put a squeeze on the economy in Texas. Banks got nasty. They stopped making new loans. Yet the S&Ls were legally not banks. They were a second capital market. Today, the banks have become S&Ls. They have tied their loan portfolios to the housing market.

I think a squeeze is coming that will affect the entire banking system. The madness of bankers has become unprecedented. They have forgotten about loan diversification. They have been caught up in Greenspan's counter-cyclical policy of lowering the federal funds rate. Now this policy is being reversed. Rates are climbing. This will contract the loan market. Banks will wind up sitting on top of bad loans of all kinds because the American economy is now housing-sale driven.

How did I know? Because I had read and understood Austrian School monetary theory. I had read and did not believe Milton Friedman's monetary theory. I also recognized that Greenspan was a destroyer.

I realize that you are the resident financial expert for World Magazine, the widely read evangelical Protestant journal of opinion. On January 31, 2009, you recommended a reading list of economics books to World readers. It is a good list. It included Mises' Human Action.

If you had only read and believed Chapters 19 and 20 in 2001, you would not have been sucked in by Greenspan, and your clients would own no stocks and a lot of gold.

You got into the stock sales business at the bottom of the first phase of a bear market rally: 2002. It rose until October 2007, but not in terms of purchasing power. Then it crashed. That was the bear market I called in March 2000. It sucked you in. It sucked in your bosses. You in turn sucked in your clients. Dollar cost averaging, if they did it after October 2007, has ruined them.

You have been a very naive young man. You trusted Greenspan. He has betrayed you: "Nationalize the banks that my policies wiped out!" You trusted his stock market bubble. It has popped. You trusted his real estate bubble. It has popped. You trusted the investment banking industry. Its business model blew up last October. It's gone. You trusted Wall Street. It's busted.

You have spent your entire stock selling career in a bear market, but you thought it was a bull market. So did your clients. It is not going to change back into a bull anytime soon. You have wasted a decade. Don't waste another.

Can stocks go up? Yes; there are bear market rallies. We had one: 2002-2007. Can they go up because the value of the dollar falls? Yes. But a bull market, where investors are going to achieve comfortable retirements? That world died in mid-March 2000.

Now you are older. I hope you are less naive now. I'll know you have reached a new level of maturity when you leave Morgan Stanley and find a good Christian rock band to manage. Just don't manage the members' money for them.