Posted on 04/07/2008 3:32:18 AM PDT by ovrtaxt
this is the unspoken implication.
On the other hand, there was a sort of chastisement in the Bear episode. Bear was "bailed out" with regard to its counterparty obligations. But the firm's equity nearly disappeared. It's not as if they got off scot-free and there were no untoward consequences. In reality, Bear was not bailed out. The market was. Bear is being picked clean.
If Jamie Dimon didn't get some kind of immunity from the ocean of shareholder suits that are probably ramping up, he may rue the day he did it.
OK, if you want to make the anti-fed argument, that’s fine with me... I don’t think it’s a point I misse but a point I’m ignoring. We both know that a change like that isn’t going to happen today if ever. And even if it were implemented tomorrow, it still won’t stop the boom bust cycle.
I strongly suspect that you’re trying to use this sword to slay the same dragon you always fight, but that strikes me as futile. you’re mistaking “identification of the problem” with trying to provide an ongoing solution.
My solution on the other hand will do a great deal to address the boom-bust cycle that comes from asset bubbles, and will do so with a policy change that is small and achievable.
What financial wizards don't realize is that boom/bust is easily fixed if it stays in the nonfinancial world. My friends can start new business that are not housing related provided there is no credit contraction. But we are doomed to a credit contraction because of the previous loose credit policies. All Bernanke is doing now by lowering rates now is creating the next credit contraction later (if he is successful now) or creating needless inflation now (if he is not).
Asset bubbles come from credit bubbles, until you understand that, you aren't going to solve anything.
You say rates should be set by market forces but you complain about the effect of the “carry trade” which is a market force. I describe a simple solution for a purely market phenomenon and you respond by saying that a better solution is to find some way (a way you don't specify) to solve an economic policy problem by keeping it in a “nonfinancial world”. You ignore the fact that I'm not talking about that part of the problem at all.
I think it's pretty clear that you know who it is you think is the villain in this circumstance, and I think it's hard for you to get past the idea that I'm culpable in some way because of my choice of careers. But the truth is, I don't think you've actually read my piece at all, or if you did, then I guess you didn't understand it. I'm talking about solving one kind of problem, and you're talking about addressing a completely different one. Your insistence that they are really the same and that your claim that I don't understand the connection are unfounded.
You're clearly a smart guy (please excuse the gender assumption) but you're talking only about the causes of the last problem, while I'm talking about preventing the next one.
What's worse is that you don't seem to understand enough about financial markets as they are now to know that without a change like the one I'm proposing, your solution can't be had without catastrophic effects to overall economy. When a crisis like this occurs, the Fed see’s itself as having it's hands tied. They see themselves as doing what must be done to avoid economic catastrophe. The thinking is that you can't do anything about inflation by putting some high percentage of Americans out of work.
But if a solution like mine was implemented, we take the crisis out of the equation which would free up the fed to take a longer term view and do more of what you would like them to do. And eventually (not quickly as you seem to well know... but eventually) address the very issues you complain about.
Either way though, I think it's pretty clear that we're not speaking the same language.
The problem of growing the credit bubble to solve a credit contraction does not solve anything. Your solution for the asset bubble which is created from the credit bubble does not solve any problem, it will merely result in shifting the bubble into a wide range of assets. Asset bubbles as we would both agree are very psychological and there is no doubt that the housing bubble had that element in Phoenix, Miami, Las Vegas. People in those places argued that their location was different, everyone wanted to move there, or ocean front was limited, or there was a huge population growth for some other reason.
The problem with pinning all the blame on the psychology is that it largely doesn't happen without credit. It's basically an easy come easy go situation. It is too easy to get leverage and flip. Your solution would presumably dampen the bubble in particular places, but would not slow it overall. The same availability or glut of credit will have the same effect, just more spread out.
On two other points, the carry trade is the market response to artificially low short term rates. It borrows short and lends long which means there is a problem somewhere (either short rates are too low or long rates anticipating inflation are too high). On the nonfinancial world, my friends in the housing business would like to start new businesses but cannot get a loan of any sort to do so. It doesn't matter what the Fed sets rates to, it won't help them at all. The problem is essentially that I am unwilling to loan them my money for the long run while they get going because I know the Fed is inflating right now, so I speculate in short assets instead. I don't like to do that, but the Fed has given me no choice.
Who stole the money???
Are to put it another way, the financial institutes cannot go around shaking their bailout tin cups and at the same time not expect to pay the piper.
You’re still talking about a monetary policy issue, while I’m talking about a markets issue. It’s apples and oranges. We cannot address the long term problem that you have identified while the short term problem that I’ve identified continues to make the long term problem worse. But if we were to implement my solution we would prevent the next “emergency” where the Fed would be forced to forget it’s long term goals... again. It would then free them up to address the long term monetary policty issue.
Fed uses inflation to rob Main Street to pay off Wall Street-This is the reason why Wall-Street is generally hated (along with the Federal Govt in WaD.C.)because the bankers are only interested in the bankers. The FED is a Monster- and the leadership should be tried as TRAITORS to this nation!!
Sadly many times people think of solutions they just turn to more government/regulation rather than freedom and de-regulation: Know the problem-People don’t like to take Personal Responsibility anymore..
Here's a simple example: I am offered zero downpayment, zero interest, deferred principle financing on whatever I want. As long as I am early to the party I am fine. With your proposal I would be notified in advance when the party is going to end. That means I am also informed that the party has started so I can jump on it even earlier. I am also more likely to make the decision to go for it because I have less uncertainty about when to cash in. In short, the bubbles would be steeper and the crashes would be much faster and thus take down more unrelated markets.
A. No mention of homebuyers who did not read the fine print or were so dumb as to believe their “variable” interest rates would not be jacked up at the first opportunity (and higher than they were probably led to believe). Anyone who did not see that coming was a fool.
B. The real solution is to make variable interest rate loans illegal. They’re nothing but a “bait & switch” scam.
Actually your just wrong about that and the example I mention in the essay demonstrates it. I’ve spent 20 years studying these market phenomenon, and I know as much about it as anyone alive.
Asset bubbles don’t occur just because of low rates or cheap money. It’s a behavioral phenomenon specific to publicly traded markets. If my suggestion were implemented we would never see a situation where credit spreads got so tight because it would impossible to build a large enough consensus about future expectations to drive them there.
But I confess that one would really need to know an awful lot about how markets actually work to understand that at a glance.
If you’d like to learn something about it try reading “Knowledge and Decision” by Thomas Sowell, and the book I mentioned in the essay is also very good.
I agree. Bernanke has done well considering his options are limited. Now the Fed should stop any other bailouts, and printing of trillions to cover legalized gambling in the derivitives. The American people minus the top 3% will wake up on day to hear news about Central Bank collapse and make runs on the banks, only to find the dollars are worth about 1/10 of their value. Heads are going to roll. I say, let the truth be shouted from the rooftops so the pain and responsible steps are taken in energy independence and fiscal responsibility begin so we can someday get back to what America was all about. Right now, this isn’t my nation anymore. It’s owned by the EU, Arabs, lobbyists and our politicians whom are VERY un-American.
If I’m as smart as you say I am, how come I don’t see your example? I think the essay demonstrates that going long in natural gas while JP Morgan is going short will put a company out of business. I agree that the asset bubble is behavioral, but it is a result of the low spreads, not the cause. The spreads were lowered as people chased yield to the point of insanity, buying traunches of junk with a fake “AAA” rating insured with fake insurance. That kind of excess can only occur from the credit excesses, and it drives the asset bubble. Your notion of future expectations depends on the reality (or nonreality) of the asset pricing. That is good and will help dampen the bubble in the extreme situations. But my expectations are based on the Fed lowering short term rates, and eventually the Fed jiggering longer yields lower. That’s what ultimately drives the tight yields.
In other words...making cheap money available only turns into an asset bubble if everyone does the same thing with it. And the reason everyone has done the same thing (favored the short volatility trade which then tightened spreads) was because it was impossible given public information, to form an opinion about the long volatility trade. But the suggestion I point to would change that. It would make it possible for sophisticated professionals to form an opinion (build a probability distribution) about the likelihood of a spike in volatility. And so long as there is enough people out there saying “today is the day it all falls down”, the crisis will never occur because they will be there to provide a bid when it does. Instead the money goes from one participant to the other rather than just driving bids to zero.
The Amaranth collapse was larger than LTCM but there was no need for a bailout. They didn't just go long NatGas like you say, it was a complex spread position identical in risk terms to the circumstance we're discussing. It was the same thing... the only difference was that there was no collapse of asset values because other market participants were there with long volatility exposure and were willing to provide a bid. That could be our model going forward if we made this one simple change. I don't think this can be explained any more plainly than that. At this point, it's really on you... if you still don't understand what I'm talking about I'll be happy to reccomend other reading material, but this is how markets actually work whether it matches your understanding or not.
Your best explanation yet. But I still disagree with your conclusion. The opinion of the "long volatility" trade was utterly obvious. Most of us saying there is a credit bubble now, were saying it in 2005. My personal posts here pointed out the absurd lending practices and subsequent asset bubble. I didn't get into the cause and effect then because I didn't know enough about it. Now I know that the demand for overrated traunches came from several factors, the main one being carry trade from low short term rates. It was trivial to borrow at 2 or 3 percent and buy longer duration securities with whatever yield was available at "AAA" (which were based on ludicrous assumptions). That is what drives down spreads, not the asset bubble, or lack of knowledge of the bubble or anything else to do with the asset bubble.
The implication that "volatility" or risk is somehow involved in all of this is about as ludicrous as the fake "AAA" ratings and fake insurance on the "AAA" ratings. The market has discovered that fraud and has now priced accordingly, but your plan will not prevent such malarky in the future.
Actually it will... you just don’t understand how those investment decisions are made. You don’t get what professional money managers actually do for a living. That’s OK of course, it’s no reflection on you that you don’t. You have some other job that I probably don’t know all that much about (certainly not as much as you), but it’s pretty clear that it’s a mistake to assume that you know enough to understand the consequences of what I’m talking about.
If the long vol trade was so obvious to you, then you’d be a billionaire right now, and you’re not. The fact that it would blow up eventually was obvious to everyone, but no one could forecast when it would blow up. My proposal would make that forecast possible for those who do this for a living. And that would prevent the market crisis by “creating” liquidity at the most crucial time. Assets will still fall and rise, market volatility will still be present, just like it was during the Amaranth collapse, but it won’t be a broader market crisis.
I’m sorry to put it so bluntly, but the fact that you don’t understand it doesn’t mean it won’t work... it only that you don’t understand it.
My career has been productive enough to satisfy me, no need for the “billionaire” argument. The fact that nobody could decide when a 47T credit to 14T income would blow up is completely irrelevant. The “crucial” liquidity from the other side of the asset bubble will not pay those debts. No money from the other side of the trade (e.g JPM in the Amaranth case) is going to go into the stream of income need to sustain the securities and keep them solvent, never mind worthy of a “AAA” rating. Creating liquidity at the “crucial” time last summer would have been as effective as the Fed liquidity was back then. There’s no way out of a credit bubble other than credit contraction. Your attempt to sustain it and kick the can only makes it crash from a high point later.
Actually none of those conclusions is correct either. The solution I’ve described won’t do any of that nor is it designed to.
But you’ve made it clear that you don’t understand that... Fair enough.
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