Good Layman's guide to the financial crisis

[Dayuhan]

I think you may be falling a bit for the old naked short hype routine. It's become a bit standard in times of economic stress; there was a veritable Grecian chorus of it during the tech crash in 2000-2001. CEOs of failed companies always want to blame the failure on short sellers, and there are always a bunch of investors and financial journalists (the ones who were supposed to see it coming and didn't) who want to buy in to the story.

At the end of the day, though, it's a scapegoat: short sellers are not lions bringing down big game, they are jackals prowling for the sick and dying. They don't "bring down" healthy companies, and their presence is a sign, not a cause. The "phantom shares" do appear, but only for the duration of the failure to deliver, generally brief, and the quantity is rarely sufficient to have any significant impact on the share price. The buyer has to either borrow the shares or close the position fairly quickly. If the company is fundamentally healthy any depression in the share price is likely to bring in buyers and the result will be no more than a momentary blip.

In this case it does look like an insider trade is a real possibility: it's illegal but it happens. It might look like an absurd bet from the outside, but if you knew the company had been papering over the cracks for a long time, the glue was coming loose, and the weakness was about to become clear it was a very sensible bet. It looks like somebody knew, but that somebody was not the cause of the collapse, they just saw it coming and made money out of it. Bear Stearns and Lehman didn't collapse because of short selling, they collapsed because of a long series of bad decisions and excessively risky investments. Of course the people who made those decisions would rather point the finger at someone else, much like every day trader who ever lost his shirt playing penny stocks claims to be the victim of the evil market makers.

Trying to blame the recent recession on manipulations by some conspiratorial cabal only distracts attention from where it is desperately needed: on the long series of bad decisions - by Government, by the financial industry, and by large numbers of ordinary investors - that drove the pattern that produced the recession. It didn't happen overnight - this recession was firmly rooted in the collective psychosis of the late 90s equity bubble - and conspiracy theories will not aid in understanding it or in preventing similar upheavals in the future.

One thing that gets far too little attention, for example, is Government's consistent refusal to engage in countercyclic intervention during upward cycles and consistent over-intervention during downward cycles.

[tequila]

The mother of all carry trade faces an inevitable bust - Nouriel Roubini, FT.

Since March there has been a massive rally in all sorts of risky assets – equities, oil, energy and commodity prices – a narrowing of high-yield and high-grade credit spreads, and an even bigger rally in emerging market asset classes (their stocks, bonds and currencies). At the same time, the dollar has weakened sharply , while government bond yields have gently increased but stayed low and stable.

...

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.

People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade – you short the dollar to buy any global risky assets.
Yet, at the same time, the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn (£1,000bn, €1,200bn) purchase of Treasuries, mortgage-backed securities (bonds guaranteed by a government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets – the VAR again looks low.

So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles ...

[Dayuhan]

It's quite amazing that with all the "we can't let this happen again" talk, we keep walking down the same road. Government responded to the 2000/2001 recession by dropping interest rates too low and keeping them there for too long, fueling a new wave of speculation. Now we're doing the same thing. The problem is that Government focuses on regulation aimed at the last crisis, which does nothing to avert the next, and ignores the need for incentive management on the macro level. Trying to use regulations to suppress risk-taking in a cheap money environment is a waste of time, you can't regulate against an overwhelming incentive. It's like keeping gas cheap and then trying to force people not to use it. Cheap gas gets burned, cheap (or free) money gets risked.

Again, over-intervention during down cycles, under-intervention during up cycles...

[Ski]

I was listening to the BBC News last evening when I heard quite a remarkable claim.

The newsreader claimed that the recession in America is over with!

U-3 unemployment is up to 10.2%, and it's going to as high as 13% before it levels out. U-6 unemployment, which is a much better indicator of true unemployment, is up to 17.5%.

Just because the stock market is over 10,000 again does not mean the recession is over. The stock market is a global system for one thing, not a national system.

The delusion continues.

[slapout9]

Just because the stock market is over 10,000 again does not mean the recession is over. The stock market is a global system for one thing, not a national system.

The delusion continues.

Agree, the whole Stock market is delusional, it is about making money with paper as opposed to making products and services for an economy.

[davidbfpo]

An article on an emerging European bank giant, Banco Santander of Spain and within the chairman explains their success:

‘If you don’t fully understand an instrument, don’t buy it,’ he told an awards ceremony last year, parodying Rudyard Kipling. ‘If you would not buy a specific product for yourself, don’t try to sell it. If you do not know your customers very well, don’t lend them any money. If you do these three things, you will be a better banker, my son.

See:http://www.spectator.co.uk/business/...t-crunch.thtml

[Dayuhan]

I was listening to the BBC News last evening when I heard quite a remarkable claim.

The newsreader claimed that the recession in America is over with!

U-3 unemployment is up to 10.2%, and it's going to as high as 13% before it levels out. U-6 unemployment, which is a much better indicator of true unemployment, is up to 17.5%.

Just because the stock market is over 10,000 again does not mean the recession is over. The stock market is a global system for one thing, not a national system.

The delusion continues.

They are using a conventional definition of recession: two or more consecutive quarters of declining GDP. By this definition a recession is held to have ended when positive GDP growth resumes. It's not based on the stock market, it's based on GDP growth.

Of course resumption of GDP growthe doesn't necessarily mean all is well with the economy. Unemployment will lag well behind, and really addressing employment issues will require some significant changes. We desperately need to resolve the huge and growing disconnection between the output of American education and the needs of the American economy. It would also be useful to finally accept that Americans, individually and collectively, need to compete to prevail in the global economy.

[Ken White]

...We desperately need to resolve the huge and growing disconnection between the output of American education and the needs of the American economy.

Even politicians with some common sense and basic honesty would help.

It would also be useful to finally accept that Americans, individually and collectively, need to compete to prevail in the global economy.

That too...

[Ski]

Heard some very disturbing things about the economy over the weekend from a reliable source in the upper echelons of the financial world:

Gold to hit $2000 - by summer of 2010
Oil to hit $130 a barrel - by summer of 2010
Unemployment in the US may hit 15% (U3) before stabilizing - end of 2010

My point about the stock market was due to the mouthbreather serving as a newsreader commenting about how the US stock market was over 10,000 and she used it as a reason why the US was out of the recession.

There are going to be some significant change to the defition of recession before it actually ends. GDP doesn't mean #### when 20% of your population isn't working.