Washblog

Or something even deeper?

Here's the story, mine, of a person trying to sort through incomplete information.  The level here is so much more basic than what you're writing about.  

But underneath it all what we're talking about is the fact that so many people in our society send out resources that we own to be managed by other people. We don't know how it's being managed -- we don't know what projects it's funding, how it's shaping society -- or whether it's being managed even with our interests in mind.  That's pretty remarkable.  

I manage a small amount of funds for someone else in a caretaker role. Most of it was in socially responsible stocks managed by Washington Mutual until about 2 weeks ago.  I took it out, then, as I felt uncertain about the market.

I told the agent I wanted the $ in a CD because that was FDIC insured.  I said I wanted the absolute safest investment. But he talked me into some other kind of investment that I don't understand (don't even remember what it was -- that's how unsophisticated I am about this stuff -- and I'm sitting here with the confirmation document from the bank and it doesn't say what the new investment is.)  

I argued with him a bit.  I said -- well I want what's absolutely the safest, most guaranteed.  The agent assured me this was absolutely the safest way to invest this $ - safer than FDIC.  So I said, ok.  I felt pushed, and I caved in.

But then I got the confirmation document and it says: "Not FDIC insured, may lose value, no bank guarantee."  

So I called back and I said -- you talked me into something you said was safer, but the documentation says it's less safe.  I'm an unsophisticated investor.  I just want this in a CD, please put it in a CD.  The agent argued with me and said I should wait, I should do it later (in order to come into the bank and get a better deal).  I felt really stupid  -- but I said no, I'd just like you to switch it right now to a CD.

I hope he did it.

I don't pretend to be a stock market guru. We live in a world of very, very, very rich people who have almost unimaginable amounts of money to throw around. They can move a market at their whim.

What I can tell you for certain is that these people are consistently making assumptions that are not panning out and they are consistently having to be rescued by government cash and government programs.

Think of it this way: people once believed that if they acted virtuously there would be rain when they needed rain, sun when they needed sun, no earthquakes or plagues. Science now tells us that Nature controls these things dispassionately, without reference to our "virtue". But people still need that "virtue = profit" model and so as science waxed and religion waned and democracy - the knowledge that we all are the collective masters of our collective fate -  was created, people came up with this near-religious concept of the "Invisible Hand" to bring back the magical relationship between virtue and profit and to take regular people out of it.

They ultimately created models with names like "Black-Scholes" and "risk-free" and "arbitrage-free". These are a financial religion. They are also provably incorrect and people have lost billions on a regular basis insisting that they are correct. Financial catastrophes, evolutions and revolutions come far more often than these models assume.

For that reason I can tell you one solid piece of financial advice that is also as old as the hills.  Baron Rothschild, the quintessential banking opportunist, is said to have advised that the best time to buy is when there is "blood in the streets." Rothschild was substituting intuition for modern math, but then even modern math can't get more precise than that. What it means is that  - contrary to the self-satisfied, religious believers in financial order and calm - there will always be opportunity and you will know that opportunity when people tell you that there is no opportunity to be had. I write the above knowing full well that my own pessimism is ultimately an optimistic sign. I hope so, anyway.

What I mean is that one can consistently make money by knowing that crisis is inevitable. Therefore you can make money in times of calm by betting that crisis is coming and in times of crisis by betting that the storm will pass. If you wait until after it becomes a foregone conclusion that good times are here to stay and after it becomes a foregone conclusion that  we will never arise from the present catastrophe.

There has been, it must be said, a LOT of talk about the inevitability of catastrophe. That is a good sign, as I said. However, I, for one, see a lot of optimism hiding in these pronouncements of doom. They seem very shallow to me. And there seems a very great faith that the Big Money will quickly ride in and save the day. I would like to see that faith shaken before I bet big.

But that's me. Maybe I'm a little pessimistic.

Nevertheless, the displacement of economy-changing sums of money is not over and that - to me anyway - is enough to make this a crisis.

As for what people should do with their own money, again I'm not a financial advisor, but I do want to warn people about gold. Gold, despite what people say, is not money. You cannot buy anything at Safeway with gold. There is no gold drawer in cash register. Yes, gold can go up and, yes, gold can be a hedge against inflation but the gold market has a strong speculative component and is therefore subject to rapid swings.

What you can rely on is the full faith and credit of stable, modern governments. Their debt or debt guaranteed by them should always, always be your first line of savings. (a government bond or an FDIC-insured deposit, for example. Remember, bank deposits are "debt" in this sense. They pay interest because you are lending people that money.)

The only problem with bonds is that at many times in history they effectively pay very little above the rate of inflation, if anything. Still, that's not a tragedy if safety is your big concern. And if you want to get a little fancy you can buy the bonds of other nations, which tends to protect you from domestic inflation.

Ultimately the big governments will enter these credit markets and use OUR collective credit to back them up. It's what always happens. It's just a question of when, how well these things are managed and how broad is the consensus to make sure that the productive part of the financial system is made stronger and the managers and owners who should by rights lose everything at least have to make some sacrifice.
 

You can't ignore the fact that a banner headline in the New York Times has historically been an indicator of a market change. You can't ignore something called the VIX that says the market is so volatile and frothy it MUST get better. You can't ignore any number of "oversold" indicators.

Stocks are creatures of rich, institutional investors. Those people work by different rules and they have such HUGE amounts of money that they don't just move markets, they make markets. I am not saying that this is artificial, either. This is what stocks are. There is no "real" in the stock market. There is only the consensus of wealthy, institutional traders.

What happened in the financial sector IS a crisis. That can mean that now is the time to buy. It can mean that it is the time to hide under your financial bed. And speaking of "under the mattress" I forgot to mention that the government offers TIPS or Treasury Inflation-Protected Securities which offer a measure of inflation safety in addition to the full faith and credit of the U.S. government.

If you are going for super-safety AND you think the Federal Reserve Bank may cut rates so much that inflation will rear its head, TIPS might be a good option for that part of your savings for which you want maximum safety.

But if you define "safety" as "not missing the boat" then please read again what I said about my own pessimism possibly being a positive indicator for the stock market.

Personally, I am very concerned how blithe is the faith that things are going to be okay now. But, again, the Federal Reserve influences SO much money (and not just any kind of money, U.S. dollars) that they can re-capitalize the entire banking system if they act fast and hard enough and there is enough room to move in rates.

So, you be the judge of what to do with your money, but POLITICALLY we are ABSOLUTELY talking about a classic Progressive intervention in the market. Notice you haven't heard a peep from these "free market" Republicans, objecting to the enormous stimulus and intervention that is being talked about. Everybody is on board the New Deal all of a sudden.

http://link.brightcove.com/services/link/bcpid1155328549/bclid1137812485/bctid1388808219

These remarks, found towards the end of the video, refer to a massive rescue plan led by New York Insurance Superintendent Eric Dinallo: and they put forward the case that we need a classic, New-Deal-style, Progressive, regulatory intervention plan on top of the rate cuts and fiscal stimulus package:

"Treasury is very Darwinist and hands-off.....This plan as interpreted by the press is not going to work. There is no plan. The idea is to explain to the banks the issue, see if the banks will voluntarily do something - they're not going to - and then have to go to the Federal Government. It's a very complex and sophisticated business. Hank Paulson does understand it, but the Treasury Department has been all-voluntary. They've not demanded anything and I don't think they're going to change. The Treasury Department is very much oriented towards a free capitalism and I think that's a very big mistake right now."

For those of you who don't understand how things could have gotten this messed up - yet again - Jim Cramer has another nice little piece here wherein he trashes Alan Greenspan ("an acolyte of libertarian Ayn Rand") who disdained regulation - even that which was in his statutory power and even when it was patently necessary.

As I wrote in previous comments, what we are dealing with is a financial religion, not finance. These are not people who have numbers and formulas that DO work. They are people who have numbers and formulas which, in their minds, MUST work. If not, they would have to face the fact of how little they actually understand or, more properly, how much denial they are in.

Here's a bit from the Financial Times about bond insurer ACA, that was recently and suddenly downgraded to a "junk" credit rating:

"Can we lay out the intricate web of counterparty  risk for swaps and derivatives - who owes what to whom?" asked Richard Bookstaber, an expert on systemic risk and former risk manager at Morgan Stanley and Salomon Brothers. "At this point we cannot. And so we cannot map out how a failure in one segment of the financial market might propagate out to affect other segments." The International Swaps and Derivatives Association, which represents participants in the privately negotiated CDS [Credit Default Swaps] market, says fears are unfounded, and that derivatives help to hedge and redistribute risk.

In May last year, ISDA published a report into counterparty risk prompted by what it termed 'occasional suggestions that, in the low volatility markets of the past few years, big players might be letting their guard down and allowing counterparty exposures to rise, possibly to unsafe levels.' The report concluded that this was not true, largely because banks were using collateral agreements to mitigate their exposure to counterparty risk.

In fact it was these collateral agreements - the very defences banks had put in place to guard against counterparty risk - that brought ACA to its knees.

When the banks bought insurance from ACA, they demanded that the insurer agree to post collateral to them on its mark-to-market losses if its credit rating slipped below a certain level.

This kicked into effect when Standard & Poor's cut ACA's credit-rating to junk, triggering a so-called "cliff effect" - all counterparties called in vast amounts of collateral at the same time. ACA did not have enough money to meet their demands. "The market cannot know how many more potential cliff effects there are - as the terms of each trade are not public," said a counterparty risk officer at a large European bank. But market players agree counterparty risk will have to come back into the spotlight."

If some of this seems opaque, tell me and I'll get somebody to explain it to me, then I'll try and parrot their words to you. ;-)

I also found this article to be incredibly insightful.

Interview with a Hedge Fund Manager (N+1 Magazine)

I barely understand the explanation of the mechanics of finance and hedge funds. But I did (kind of) understand this:

HFM: ...It's kind of an interesting interaction in the sense that a lot of this mortgage project was almost created by the bid for the CDO [collateralized debt obligations] paper rather than the reverse. I mean, the traditional way to think about financing is "OK, I find an investment opportunity, that on its face, I think, is a good opportunity. I want to deploy capital on that opportunity. Now I go look for funding. So I think that making mortgage loans is a good investment, so I will make mortgage loans. Then I will seek to fund those, to fund that activity, by perhaps issuing CDO paper, issuing the triple-A, double-A, A, and down the chain." But what happened is, you had the creation of so many vehicles designed to buy that paper, the triple-A, the double-A, all the CDO paper... that the dynamic flipped around. It was almost as if the demand for that paper created the mortgages.

n+1: Created the loans?

HFM: Called forth the loans, because it became a really profitable business. You saw where you could issue these liabilities. Say, I could issue these liabilities at a weighted average cost of LIBOR [London Interbank Offered Rate] plus one-fifty, and I know all I have to do is just push that money out the door, push that money out the door, LIBOR plus three hundred, and I'll make a huge amount of money from doing that origination activity or just on the equity piece that I keep, which is highly, highly leveraged. The person who really knows the mortgages is not the person who is really taking most of the risk. The person who is taking most of the risk is the kind of undifferentiated mass of buyers out there.

n+1: Right, and when you say the person who knows the mortgage, meaning the person who knows that the person they find on the street...

HFM: May not be a good credit, right? What tends to happen in financial markets, is bad things happen when you really divorce the people who take the risk from the people who understand the risk. What happened is that that distance in the sub-prime market just increased and increased and increased.

Interviewee HFM (hedge fund manager) basically says that the people who used this weird-ass CDO finance tool made A LOT of capital available to the sub-prime mortgate market without understanding the risks of that market.

Whoops.

Well, from the consumer standpoint, many home buyers had no idea what the risks were. So the experts weren't alone in their ignorance.

HFM also explains how their in-house mortgage industry expert couldn't see the forest for the trees, didn't see the bubble, and got caught when it popped.

I've seen this kind of True Believer phenomenon before. The "New Economy" and the .com bust wasn't so long ago.

I really don't know what can be done in the future to prevent future bubbles and pops.

Regulation to outlaw True Believers?

Identify disconnects between risk and risk takers?

I think the best we can do is hope the people in charge aren't idiots. This housing bubble popping and the lunacy of the rampant sub-prime mortgages weren't a surprise. We've all been waiting for it to burst.

But instead of exercising caution, tapping the brakes, the current kleptocrats punched the gas peddle.

What do we do about that?

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