In a couple of weeks I'll be celebrating the two year anniversary of this blog. The space has been more silent than usual, as I really have so little to say--largely because I said so much earlier. This blog effort has been singularly helpful in my process to becoming a little less perplexed about the market. Without this space, I would not have found and tackled Hedge Funds and Systemic Risk. Without this space, I would not have had a venue for writing my thoughts to which I can return for reference or refer others.
Stumbling upon that paper directed my efforts to investigating CDO's and the mechanics of this debt: how structured, risk tranches, loan composition, guarantors, size of the market, size of the guaranty market. That paper also made me want to step back and look at the root cause. It was never the subprime issue--and that was the initial snow shoveled on the pile of shit. Rather the inflated price of houses to the earnings of buyers COUPLED with the extraordinary yearning for yield that compelled lenders to come up with innovated ways to put buyers in homes as well as earn handsome fees.
Those things are merely market forces. But unfettered market forces produce some pretty noxious behavior. Child labor laws came about not because of overzealous government regulation, but rather through overzealous capital putting children in harm's way. If history has proved anything it is this: we will have periods of expansion, funded with leverage; and we will have periods of contraction that will result in de-levering. This current period of over-levering though is historic given the use of synthetic liquidity/leverage in the form of derivatives.
While I don't think that what we are witnessing in terms of an event should be surprising, but the MAGNITUDE of it should be frightening. And I believe that the market response reflects that fear with gold having it's single best day yesterday since WW2.
None of this would have been terribly problematic had (1) risk been priced effectively and (2) we had effective regulatory oversight. Cheap money and the search for yield certainly does engender creative ways to satisfy that yearning--but had risk been priced in appropriately we would have reduced the magnitude of the crisis, but not avoided it. Effective regulatory oversight--to include the rating agencies-- would have sent up some red flags sooner.
In effect investors have been flying blind. Investors depend on executives to price risk effectively. Reports yesterday say that AIG had no idea of the magnitude of their own issues. If those close to the situtation do not understand it, how is the hapless investor to know?
These crises are the free markets' way of purging the system. Accordingly, they should not be eliminated. However, these crises should not be laid at the foot of the taxpayer. If the organization is so endemic to the health of the financial system AND the central bank will ultimately have to step into the morass, then there are two simple things that can be done:
- Simple Thing 1: Tax these organizations accordingly--allow the taxpayer to enjoy some of the heyday if they are expected to participate in the mayday. (Hey, I like that!)
- Simple Thing 2: Provide effective regulatory oversight with rules that are designed to optimize the protection of the public's interest with successful operations of the organization.
Of course, I'm just a layperson, but that is my rather over-simplified suggestion!
~~~~~~~~On August 10, I mentioned Farmer Mac, ticker AGM. They were trading at $30. Yesterday, they traded below $10. Farmer Mac is the last man standing in the GSE family. I didn't see any reporting on it. Did you? I took no position on that musing. There are no options; otherwise I would have bought puts. The chart (click to make larger) says it all.
And if you really want to see some nonsense on a stock, you can look no further than CEG This is a 2 day (not 2 year!) 1 minute chart.
And look at Sempra Energy--at the same fated time, 2 p.m
Both of these stocks (and there may have been more) were funded by LEH for their commodity trading. Now I know I will never be a trader because for some reason I was watching CEG and when it hit $13, I hesitated and passed. Sigh. Perhaps I'll get a testosterone shot!