Our next speaker had a lot to do with making this thing happen today and I'm very, very grateful.
He and I had more than a few conversations about this, both after our Houston event and then via the email.
So he was really instrumental in making all of this happen today.
He's co-founded Behring Asset Management in 2002 with his partner, Bill Lagner, and the Behring Fund has performed in the top 6% of global macro hedge funds.
He's committed Austrian, attended Mises University in 1990, and has been a consistent critic of the credit bubble and all the players that were involved in that.
And he's going to talk today about navigating the financial markets with an Austrian compass.
Please help me welcome Kevin Duffy.
Thank you, Doug. I'm really excited to be here and that we're actually able to pull this off and bring everybody together.
I'm just thrilled. Bill and I started this hedge fund eight years ago
And after navigating several bubbles, the housing bubble, the credit bubble, and now the sovereign debt bubble, and being a short seller through all that, I'm just excited to be able to afford a cup of coffee.
But I didn't grow up wanting to be a short seller, an Austro-libertarian short seller.
You know, I just wanted to make a good living, thought I wanted to be a doctor or a lawyer.
When I think back on my career, I was really very fortunate.
I had some very positive influences.
My dad, who happens to be here today, is very entrepreneurial, always encouraged us to take risks,
and even convinced me at the age of 13 to buy my first stock.
I discovered contrarian investing after college,
after learning a painful mistake in trying to buy technology stocks in the personal computer
bubble of 1983 and I thought at the time I learned a very good lesson at an early age
and maybe I could take that mistake and apply it and make sure others didn't make the same.
I discovered Mark Faubour, who I'm thrilled is going to be here, the luncheon speaker
today.
And I discovered his interviews in Barron's in the late 1980s.
And it was really a fascinating time because of the bubble, not only the bubble in Japan,
but the mirror image of that, which was the idea that America was in decline and that
at the end of the, by the end of the century, we'd all be working for the Japanese.
But with all these influences, and really it was a stroke of luck that I had all these
influences, probably the most important was discovering Austrian economics.
And maybe the luckiest break I had was I didn't have any formal training in economics, and
then so it was easier for me, I wasn't really hardwired towards Keynesianism or interventionism,
I wasn't hardwired and I discovered Austrian economics in 1989.
Lew Rockwell was on CNN's Crossfire with Pat Buchanan on the right and Michael Kinsley
on the left. And this was the time of the Exxon Valdez oil spill. And I saw Lew actually
defending Exxon with the common sense argument that they really didn't intend to dump all
this oil off the coast of Alaska. And I thought, well, this is interesting. I really need to
and you'll learn more about this von Mises Institute and Austrian Economics.
So a friend of mine, Chris Scott, now Professor Scott and I, we attended Mises University in 1980.
We went out to Stanford University and it was a week-long boot camp in Austrian Economics.
And Joe Salerno was there, of course, Lew Rockwell, Murray Rothbard, Walter Block, Roger Garrison.
and it was just an incredible eye-opening experience at the time.
In the, let's see, to give you a sense of what we're going through in the late 1980s,
it was really a fascinating time because of what was going on with Japan and the bubble in Japan.
Austrian economics, I could sense as a contrarian that when you had housewives selling mutual funds door-to-door
and you had million-dollar golf club memberships that there was something quite wrong with Japan.
But the Austrian economics provided another way of viewing Japan,
which was explaining the artificial, the bubble, the credit expansion that took place in the five years leading up to the bubble.
But more importantly, it talked about the intervention,
and the fact that the policies at the time were going to be very interventionist during the 1990s.
As this bubble was bursting, the central bank, the Bank of Japan would intervene with lower interest rates.
There would be Keynesian stimulus attempts.
And so I started reading about America's Great Depression by Murray Rothbard
and how this was essentially the difference between the 1920-1921 recession and the 1929-1930 recession was the first one was non-interventionist, the second one there was massive intervention.
And what I thought it taught me was that Japan would just go through a couple of decades or decade or two of depression and stagnation.
Another aspect of this was the idea of industrial policy, the idea that business and government could cooperate, that there was some kind of a third way between socialism and capitalism.
And the Austrian School really showed that there was a fallacy with that logic.
and I also came across at the time, there's a very interesting article by Jim Grant, it was called Bring Back the Bank Run, it was in 1990 and he talked about this system, the banking system, the fractional reserve banking system which was essentially socializing the risks and capitalizing the gains and that there was a
change in the whole regulatory climate during the 1980s, and this really took place with
the bailout of Continental Illinois in 1984. And so, as early as 1990, this too-big-to-fail
doctrine was already in place, and people like Jim Grant and Murray Rothbard were predicting
that this was an accident waiting to happen. So, when I discovered this, I thought this
This was like discovering the Holy Grail, and I wanted to be able to apply this to investing,
and I think Mises with this quote really sums up how to integrate the two.
Entrepreneurial judgment cannot be bought on the market.
The entrepreneurial idea that carries on and brings profit is precisely that idea, which
did not occur to the majority, it is not correct foresight as such to yield profits, but foresight
better than that of the rest, the prize goes only to the dissenters who did not let themselves
be misled by the errors accepted by the multitude."
And I think what he was saying was a couple of things.
One is sort of like outrunning the bear.
You don't have to outrun the bear, you just have to outrun the next person.
And that it was avoiding the errors of the multitude.
So if everybody else was following this incorrect roadmap, could we follow this Austrian roadmap
and have an advantage in the marketplace?
And I think it also says the prize goes only to the dissenters.
It goes to, ultimately it goes to the nonconformists, it goes to the contrarians.
So I was obviously very excited to discover this at a young age in my career, but there
was a downside in all this. And it wasn't like discovering tomorrow's Wall Street Journal
as Burt Blumer once said, it's okay to forecast the end of the world, but don't ever give
a date. So this was like having the Wall Street, you know, not tomorrow's Wall Street Journal,
A Wall Street Journal that really didn't have any date on it.
So it didn't tell us about timing.
This is a lesson that I learned and my partner Bill learned
during the late 1990s in shorting the technology bubble
is it just went on and on and it was absolutely brutal
to be a short seller through all that.
What are these two roadmaps?
The lens of viewing the world.
The way I see it is it's just an interventionist lens and a non-interventionist lens, okay?
The interventionist, the non-interventionist believes that there is a natural order to
the world, that there are correcting forces, that you have, the economy is a very, it's
a healthy system, it's self-correcting, it's self-cleansing.
The interventionist doesn't believe in that. He believes that the system is inherently
unstable and it's prone to bouts of excess, of greed, of depression, and that it requires
stabilizers. It requires punishing the greed, clamping down on the excesses when people
Swing to the other extreme that we have to provide for aggregate demand. We have to have
the government basically stimulate. So it's this constant trying to smooth out the ups
and downs. The villains, if you are looking at the interventionist view of this, is the
The villains are the short sellers. They're the critics. They're the non-conformists.
If you're looking at the non-interventionist view, the good gut, the short sellers are
actually the price discovery agents. They're actually checking. They provide a check on
the boom because they are, they're selling first into the boom and they're trying to
contain the boom. So it's really the Austrian view of this boom and bust cycle is that the
sins are committed during the boom phase and the bust phase is the healthy cleansing part.
The interventionist view is exactly the opposite. So empirically, there's a lot of anecdotal
I think the first is probably the most obvious, that the system that we have that's been prone to all these accidents is a highly interventionist system, and that intervention was institutionalized back in 1913 with the creation of the Fed.
Each crisis gets, this is not, if you bought into the interventionist view, that you have this unstable system just kind of bouncing around and it's somewhat predictable that we're going to have a downturn and then we come in with some new rules and regulations and we pave the way for the upturn,
Then why is it that it's not happening in such a predictable manner that each crisis
is getting greater, each response, each stimulus response is getting more massive, and even
the frequency we're starting to get, these crises are coming closer and closer together.
If you could look back at the tech bubble and of course at the end of every bubble bursting,
we need to find scapegoats and of course the villains are always in the free market, they're
always the short sellers.
We just round up a few bad apples, blame it all on capitalism, pass a few regulations
and go on down the road.
That was somewhat easy to do during the tech bubble.
It's becoming increasingly difficult as each of these bubbles burst and each crisis
gets us closer and closer to the root of the problem, which is the Fed mispricing credit.
It's the moral hazard of essentially mispricing risk. We keep getting closer. So in this case,
the Fed has come under a lot more attack than it did, let's say, after the tech bubble burst
in 2000. The regulation, the whole idea of regulation, if you were an interventionist,
you predicted this crisis would have been, at the root of this crisis, hedge funds, relatively
unregulated hedge funds. But in fact, at the root of this crisis were the heavily regulated
investment banks and money center banks. In fact, the largest, the most politically connected
Going back to what Grant predicted in Rothbard back in the late 80s and early 90s that this
very unstable system in moving towards too big to fail, that those would be the institutions
that would ultimately fail.
The interventionists continually get it wrong.
If, you know, an example of this was during the early part of 2007, the subprime, as this
credit bubble built, the first cracks in that bubble were in the subprime area.
And you had Ben Bernanke, Hank Paulson, you had all these interventionists coming out
and saying, well, this problem is contained, we've got everything under control.
And they kept on saying that, they kept saying that, don't worry, we've got everything under
control.
And then in the, and they keep coming in with bigger and bigger bailouts, bigger responses,
Paulson coming in and threatening his bazooka, and he didn't think he would have to use it,
but in fact he did have to use it.
And the bailouts were basically sold as, if we don't do this, we're going to have an absolute disaster.
Well, that was in the middle of September of 2008, and the market collapsed.
Once they passed the bailouts, after the fact, the market collapsed in the fourth quarter of 2008.
The interventionists continually lie about, not only, they lie, but they also lie about history.
And here's an example of that. Jim Cramer, this laissez-faire has really killed us.
And Hank Paulson, government intervention is not something I'm here to espouse, but it's better than the alternative.
And then when they passed, when Paulson was asking for a $700 billion blank check from the taxpayer, I'm not looking for extraordinary power.
And there's also the corruption of history, and I think this is one of the things that I learned from the Mises Institute was, you see this, Bernanke was the Time Person of the Year, which is probably a pretty good contrary indicator.
and yet back in 2000 or 1999, Jeff Bezos of amazon.com was the person of the year. So it's a pretty good top indicator. But the language is always that Hoover was basically laissez-faire, that he didn't intervene, that he allowed, he allowed this to happen. It was basically FDR who came in and saved the day with the new deal. The reality is the Austrian
Show is just completely the opposite that Hoover, and Hoover even wrote in his memoirs,
he admitted that he was not laissez-faire, that he was very interventionist, and in fact
his program, he was really the predecessor of the New Deal, and the corruption of history
is taking place right now. I mean here we are and the Austrians I think have been somewhat
vindicated by the events of the last several years and yet the interventionists who didn't
see it coming are saying nobody saw it coming. The slide that I had up about the interventionist
lens and the non-interventionist lens, part of the argument is regulation and I think
I think we haven't really, our side has not articulated this quite as well as I think we should have.
This mess that we had, this credit crisis, was this a failure of the market's ability to regulate?
Well, how does the market regulate?
The market regulates, it's like any healthy economic system.
You have to have a way of removing waste and you have to have a way of correcting error.
The human nature has it through extinction, the human body has it through digestion, and the free market, the economy has it through failure, and also through price discovery agents like short sellers.
Failure was not allowed to happen, so it's hard to blame this whole mess on the free market and its lack of an ability to regulate when you've taken away the very means of regulating.
Short sellers have also been very much under attack, as they always are.
Short sellers are always vilified, they're always blamed.
and Bear Stearns and the recent hearings now are trying to blame, they say that it was
the rumors that created the reality and the spreading of these rumors and stock shortsellers
piling on that created the run on the bank.
The government regulates through essentially the opposite.
It weakens the market's ability to regulate itself. So instead of failure, the government
has bailouts. Instead of the price discovery agents like short sellers, we try to muzzle
short sellers and we play this confidence game. I'll give you an example of this. Bill
Michael Ackman, a short seller and a hedge fund, did a report on MBIA and MBIA was given
its investment grade credit rating by the rating agencies.
The rating agencies, well I'll get into that in a minute, but he published his research
online for the whole world to see.
Eliot Spitzer at the time wanted to go after hedge funds and instead of looking at, instead
of going after MBIA and going after the rating agencies for their investment grade rating
on MBIA, instead they went after Bill Ackman. So this is, I mean not only are the regulators
doing a horrible job, but what they're doing is they're attacking the critics and their
It's kind of a little bit like public education. There's a crowding out that goes on here.
I think the rating agencies are a huge part of this. You've had a huge failure of the
rating agencies, the so-called gatekeepers. Well, is this a failure of the free market?
It's not a failure of the free market because the rating agencies were cartelized and politicized
Back in the early 1970s, they are very much a part of the fabric, the regulatory fabric.
This is not a system that was created by the free market, this was a system that was created
by government intervention.
So the failure of the rating agencies really is a failure of regulation.
These are just a couple of quotes vilifying the short seller and let's see, okay, pretty
close to wrapping it up here.
As Jeff Scott mentioned to me the other day, we go through these recrimination cycles.
So the interventionists who fail to see the crisis coming then need to go in and blame
the very crisis that was caused by intervention.
They have to blame it on capitalism and they have to round up some scapegoats and essentially
make the waters pass a bunch of rules, pass a bunch of regulations, make the waters safe
for the kitties to go out and swim in again.
And this happens over and over again.
Of course, after the Enron, after the collapse of Enron,
the beauty of Enron was that it failed.
That's the difference between that cycle and this cycle.
The Goldman Sachs's and these companies
were not allowed to fail this time.
So they've just lived, gone on to live another day
and who knows what else they've created,
what other mess they've created.
But with this recrimination cycle, back after the trial, so we passed Sarbanes-Oxley, and of course the SEC's budget then doubles in the next three years, I think it took ten years for it to double before that, and we haven't had this financial deregulation that everybody talks about, we haven't had this take place, we've had more rules, we've had the SEC
Their budget, I believe, grew by 76% in real terms from 2000 to 2008.
So we haven't really had deregulation take place.
But in 2006, I remember the kind of closing the book on Enron was the Enron trial
and sentencing, skilling and lay.
And the commentary at the time was, this was some of it that I got down,
This is good. It restores confidence. So it's always a confidence game.
This was the biggest bubble in history. I don't think that's going to happen for a long time.
And Sarbanes-Oxley was a good idea. We needed to prevent the end runs of the future.
Well, the regulators are always fighting the last war and the bubbles are happening closer and closer.
So the housing bubble had already taken place by this time.
It really peaked in the fourth quarter, the first quarter of 2006 and we still had this credit bubble, the credit spigot was wide open and we were setting ourselves up for the subprime disaster in February, March of 2007 and I think Businessweek captured the zeitgeist of the time with this cover, it's a low, low, low rate world and how credit was just going, cheap credit was going to flow
Indefinitely. So the cake had already been baked. We're fighting the last war and we're
telling everybody, we're telling investors, it's safe to go out and swim again when the
waters were infested with sharks. So where are we in the recrimination cycle? Well, I
think we're probably at the top. We're going through the exact same experience today that
This was all, the credit bubble was caused by a little bit too much testosterone and
the three women in charge are now going to clean up the mess.
Again, we're passing financial regulation, we're making the water safe for the kids to
swim in again and we're telling everybody that America is back and that this massive
stimulus is going to work.
So the interventionists have really kind of made their bed and this debate is going to
be resolved I think in fairly short order in the next several years.
And I love this, Obama-nomics is working better than you think.
Who says Wall Street?
So we're a little bit skeptical right now.
And I also love the quote on the right by Mark Zandi. Notice that he now works for Moody's
and the rating agencies have been a part of all of these problems. This was a quote recently
in Barron's, last week's Barron's, about the EU bailouts, a trillion dollars. It was
meant to remove any potential for contagion, problem solved, and that lasted for about
about a week before that drug wore off.
Jason Trennert, who Bill and I saw the other day when we were eating lunch, walked by us.
We're bullish until the bills come due.
Well, we think the bills are coming due at this point, and the timing of this conference
couldn't be any better.
So my dad, when we were growing up, my dad always said, told us to find the parade and
get out in front of it.
Always find the parade and get out in front of it.
And I think the parade is Austrian economics and I think it's time to get out in front
of it.
Thank you very much.