No such thing as too much or too little. The risk is always there. The only variable is the window of risk we humans chose to act on. Key decision makers and people in positions of power have paid little or no attention to our long term future.
We are now entering the fringes of that long ignored "previously ignored future window of time" and sure enough we all completely unprepared.
Those same people that saw fit to steal prosperity from ALL of OUR futures will see their ill gotten gains eroded much more so than the rest who have much less to lose.
And those with less to lose are sure to behave like it.
We live in a closed system, regardless of what our policies assume.
Apparently a group of wall streeters were supposed to issue a report on the subject of QSPEs... and get this, they recommended that all off-balance sheet assets be forced back on. This includes GS execs and the like. Quite a change in philosophy for the Street.
I would also guess that the recent bubble was the triumph of historical statistical modeling over common sense. FICO scores were valued over verifiable income and cash downpayments.
Seems to me, the players weren't trying to reduce risk, but hide it. No honest person with a brain could really believe that investors were entitled to the returns they were getting on such supposedly low-risk positions. That's why there's still such desperation to avoid writedowns as long as possible--it's just a continuation from a half-decade-long binge of risk denial.
There's no way to move forward until a lot more capital is destroyed. One of the promises of the free market is to allocate capital efficiently. Those who prove they can handle money intelligently, automatically get more of it. Those who can't are quickly relieved of their burden. Isn't that the way it's supposed to work?
If so, the basic rule of thumb is, if you made a ton of money in this game over the past few years, you're gong to have to lose it. There's no alternative.
Now Wall Street Wants Your Pension, Too
JPMorganChase, Citi, Cerberus, and Morgan Stanley are among the firms lobbying Washington to let them take over and run corporate pension fund
The Treasury Dept. on Aug. 6 offered a blueprint for lawmakers on Capitol Hill to allow "financially strong entities in well-regulated sectors" to acquire pension plans , after the IRS ruled that the concept needed legislative approval. "The Administration's proposal says these deals should only be permitted when the acquiring entity has a higher credit-rating than the seller," says Charles Millard, director of the Pension Benefit Guaranty Corp. (PBGC), the federal insurer of last resort of corporate pension plans. "Such a transaction creates greater security for retirees and the pension system." The issue will now, no doubt, move to Congress after the election.
WMT lowering Q3 revs estimates & wall st is clammoring for more stimulus from Treasury so consumers can buy more crap from China.
Seems to me that it would be far more efficient that we ask China supply the stimulus checks directly and we cut out the wasteful overhead of the 3rd party intermediary (US Treasury) that is likely to default anyhow.
I think the case is well made as a criticism of US manufacturing and production. They should have been innovating instead of whining.
However, I think a different criticism is appropriate for financial businesses: they were greedy, seeking ever more returns while becoming blind to the fact that risk must have a cost attached to it. They expected to do nothing but be 'clever' and then to become rich thereby.
I really can't beg enough (on my knees here) Please help spread that link and comment on this pension topic; IMHO, we do not want hedge funds playing casino with pension funds any more than they already are!!!
Please do me a favor and spread that link, talk about it, watch it, call your corrupt Congress or Senate connection, but PLEASE don't let this slip!
DOL already grants underwriters exemptions from prohibited actions related to hedge fund derivatives, but this is an amazing attempt to allow the Bush Coup to privatize social security and to steal pension cash! PROTECT yourselves and do your DD!!!!!
I disagree with Waldman's main point here. People took all kinds of ungodly risks during the boom. Buying 10 houses in Vegas? Insanely risky for both the buyer and lender. But it happened.
The difference between these risks, and - say - the risks of alternative energy investment, is that for the former the payoff for a correct bet is much more immediate. People are willing to risk much more for a relatively quick payout versus an investment that takes years to develop.
Wally,
Some of the US' manufacturers were innovating. Many were private companies that are now making piles of money on exchange rates' effects.
Few businesses are mismanaged like Detroit's. There are some bright spots out there...not enough.
They took tons of risks, just that they didnt bear the negative reward if the risk turned out to be a bad decision. They grabbed the easy pickings while they were within reach, and when the rickety stool they were standing on collapsed, we were the catch them. The question is, what do we do now? Seems like instead of extracting some fruit from their pockets, we are gathering up what they didnt steal and nicely putting it into baskets for them.
There is always risk, but the important thing is that the person who takes the risk has some reasonable belief that they arent just going to get the upside reward. That is partly where we failed.
Investors have come to believe that high yields are available with no risk. Their first impulse will be to sue the bankers, brokers, portfolio managers, etc. when they lose their expected gains and perhaps then some.
Time to get a clue, the rich are going down with the rest of us and while everyone is partly to blame for this mess, the Wall Street gang that worked so hard to buy the Congress and deregulate their industry did commit actual criminal acts for which they should be prosecuted. SIV's only exist because of the "tax advantages" of incorporating them in the Cayman Islands far from the IRS's normal reach. These companies and their CEO's have been living large because they evaded our tax laws, and regulations that were designed to protect the public and the system. They should pay the price.
Same crap that went on after the dot.boom rip off. Upper management and anyone who was in it for the last 5 years needs to be in a cell with Bubba the booty bandit for a night hot fudge packing. Fines don't mean squat to the guys.
deuces...there was a big auction today and a ton of presumably foreign central bank demand, probably because they were so nicely appeased recently with US taxpayers money.
Aug. 7 (Bloomberg) -- The Oakland, California, agency that runs toll bridges across the San Francisco Bay is proving that the era of cheap money for municipal borrowers is over.
This week the Bay Area Toll Authority sold more than $700 million of bonds at rates as high as 5.34 percent to refinance debt that cost 4 percent last year. That leaves less money to finance projects, such as bridge improvements.
The cost of money just went way up,'' said Brian Mayhew, the agency's chief financial officer.You may have projects on the cusp that are going to be difficult to do.''
Almost a year after the Federal Reserve began to cut its target rate for overnight loans between banks to 2 percent from 5.25 percent, borrowing costs for states, cities, hospitals and municipal authorities are going in the opposite direction.
The question is one of risk perception. I think sensible people should be able to see the risk of investing in a bubble. They should have seen it in the dotcom bubble and the biotech bubble, etc. The "risk" of investing in something that doesn't at the time make economic sense is quite different. Should we now take the "risk" for example of preparing for an alien invasion? I doubt sensible people would see that as a sensible "risk" to take and in the past investing in "alternate energy" was also not a very sensible "risk" albeit not quite as foolish as investing to confront aliens. I might add that the lesson not to invest in alternate energy came from the lesson of 1979/80 when people bought little cars and other things were done that quickly seemed silly when the price of oil declined.
Once burned, they weren't about to repeat the mistake.
I'd add that this would all be a good market lesson, but for the government interference. If the big failures are allowed to happen, people would learn, be cautious, and reward those that took productive risks.
Instead we have entitlement on all sides, with bailouts, lawsuits, and criminalizing losses. All the spoils go to the successful conmen - everyone else is left poorer.
As with yesterday's $17 billion auction of 10-year notes, results of the Treasury's $10 billion auction of 30-year bonds were stronger than expected, as evidenced by the very high amount of bids submitted, the aggressive bidding seen in the auction yield and solid amounts of indirect bids, which gauge end-user demand.
The results are good news for those who are worried about the possibility of interest rates rising, but bad news if one thinks of why it is that investors showed such a strong preference for Treasuries over everything else.
The auction yield was 4.609%, 5 basis points lower than expected -- an unusual amount, indicating aggressive bidding. The bid/cover ratio was 2.40, beating normal levels (dating back to 2006 when the Treasury reintroduced 30-year bond auctions following a five year hiatus) of about 2.16. The cover ratio is all the more impressive when considering that the auction size was above normal and the most in two years.
Viewed by dollar amount, it is notable that the total amount of bids submitted was about $24 billion, about 50% more than the average of 30-year refunding auctions dating back to 2000.
The percentage of bids awarded to indirect bidders was 42.89%, much more than the 27% average of the past two years, indicating that the Street's distribution burden will be light.
mp writes:
"Very few brave capitalists took the risk of mothballing rather than dismantling factories and maintaining critical human capital..."
I did, but forget the "human capital" shit. To me, they're "human beings" with knowledge and expertise.
Amen, mp. I'm getting quite disgusted with use of the phrases "human capital" or "human resources" as if flesh and blood human beings with dreams and desires are nothing but commodities to be used to further someones wealth creation scheme.
Buying 10 houses in Vegas? Insanely risky for both the buyer and lender.
No, see, what the point of the post is, is that this was possible because there is no risk in RE, and the risk in the loans was always going to be small because of securitization. So it is the exact opposite from what you are thinking. So someone buying 10 houses on they buy side was thinking little risk because, historically, RE doesn't lose value. The people on the securitization side was thinking, who cares because we're slicing and dicing and spreading out the risk, so that even if something happened the loss would be quite mitigated.
So, you see, everyone was buying these thinking there was low risk. On all side of the sales. And that desire to hear "low risk" is actually what drove the behavior. If you had said "high risk" none of this would have happened.
The story about too little risk, i.e, the financial system took on too little risk. I guess it doesn't take an Einstein to see that more risk might compound the problem of speculation!
Same crap that went on after the dot.boom rip off.
Not at all! In the dot com situation, everyone was trying to place bets on a new technology and who was going to be the next IBM, Microsoft, etc. So more and more money was tossed at companies because no one knew which horse would win, and if it did win it would be BIG. Turns out that bad business models don't work no matter what the technology and if you made the bet you lost. But to lose you had to make the bet, so there's the risk. If you didn't understand that, don't cry to me, although I did enjoy the fabulous catered lunches, outrageous pay, and my Herman Miller desk chair a lot.
This is completely different because, to lose money, you didn't have to place a bet. You are collateral damage because if you bought a house in most areas in the last few years, you're going to be screwed too. Furthermore, you're now being punished by the lack of credit, even though you may be completely credit worthy. Also your job is at risk because, you know, they just cut off all lending for other items too, not just houses. Oh and your kids can't go to that nice school anymore because, even if you can afford the loans comfortably, they won't make them. So this is WAY different than the dot com issue.
No, Ipod, they bought those houses because they thought they could make insane profits for very little effort, in a very short span of time. Time is the issue. Productive investment in say, alt energy, takes time. This is a get rich quick society.
I don't buy that most of these people didn't know there was risk, they were just overconfident on their ability to pass the hot potato to the next sucker.
'The banks and SIVs that bought up "super-senior AAA" tranches of CDOs were looking for safe assets, not risky assets.'
What they were looking for was yield in a yield-starved world, which existed because of demographics on the demand side, and on the supply side, rates were held artificially low.
I don't see how these sophisticated models could ignore what every trader should know: if you take an intrinsically low-beta investment and leverage up on it XX: 1, it changes the beta.
Even a little retail rookie like me who's done any research on hedge funds knows that, historically, you're almost statistically certain to go bust at 11x leverage.
How on earth could you be leveraged 35:1 like Carlyle and not run stops tighter than a fist? I choose that example because they had Ginnie Maes on; it's not like these guys were in illiquid paper.
Liquidity should never be an excuse anyway. Anybody who's ever bought a small-cap stock and woken up with a mohawk learns that lesson in his first couple of months of trading.
Rookies, morons, losers all. Put on your big girl panties and deal with your losses.
Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and ineffectiveness of al traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation.
hey bought those houses because they thought they could make insane profits for very little effort
Um no tranches. Most people bought because, you know, they wanted a house of their own. Don't make a minority phenomenon into a bigger deal than it is. That's what Tanta argues against in her posts about the media...especially about the "walk-aways". Speculation was only a small part of this, and certainly not where I live because you can't build a lot. It was about buying a house, or buying a house now before they went up even further, etc. Most of the people that are suffering now, especially here, just wanted a house.
I disagree with Waldman's main point here. People took all kinds of ungodly risks during the boom. Buying 10 houses in Vegas? Insanely risky for both the buyer and lender. But it happened.
tol, i think waldman's point rests in part on defining where risk must be taken.
i think it is an unpopular given that a great many individual people will take all the rope the bank will give them to hang themselves with. that is why underwriting standards are and always have been important. and a great many banks chafe under the regulatory restrictions that have been placed on them since the 1930s. they too are always more than happy to take the risks that must destroy them in the end if they are allowed to.
what was new about this boom was the ability of wall street to intermediate through securitization a linkage of global institutional capital and western mortgage markets. previously, institutional capital had as a rule been too risk averse to play in mortgages.
the truth which securitization hid was that institutional capital remained at all times too risk averse to actually play in mortgages -- it was only by the obfuscation of securitization that the capital tap could be opened. and that flow -- magnified by the operation of foreign central bank vendor finance -- of course overwhelmed the market with credit supply, creating the bubble.
i wouldn't pretend that institutional capital was smart or even competent in allowing itself to be deceived so. but all securitization had to do was offer a plausibility of concept vis-a-vis safety for all the players to forget themselves and what they were really doing. these are the parties whose demand for at least a superficial safety while desiring greater risk and yield created the need for securitization.
seen as such, i think waldman is narrowly missing something of the point. we have indeed become a culture of safety -- i think frank furedi has amply demonstrated and dissected its emergence. but that safety is often purposefully superficial -- a slogan, a cover for truly reckless action that, being purposefully cloaked in the perception and verbiage of safety, escapes necessary critical evaluation. and in the end, as waldman notes, the false cries of a pact of safety violated offers an again-uncritical and uncriticized recourse to legal action for institutional investors who were finding ways to excuse themselves of their fiduciary responsibility.
Ohio made it among the fastest dying cities -- murdered by joblessness, economomic downturn, and Cash-Schiller! Ironically, a presidential candidate will discuss potential job losses in Ohio, although his prior actions helped eliminate those jobs. Amazing!
I would dedicate to them the song "Town Called Malice" by The Jam; but alas, it's for a different country and era.
I just think it's funny that this story about not taking on enough risk ends with: "But until owners of capital stop hiding behind cleverness and diversification and take responsibility for the resources they steward, finance will remain a shell game, a tournament in evading responsibility for poor outcomes."
It ends there as if people have a choice in how they take responsibility with investing, and that is why, when I post about pension funds, people go huh, what, so, next cool story, what was that about, duh.....
Now, on to your reply, which was the only one, but maybe the off topic nature of pension fraud is unwelcome... so who do we trust? We know, or least I know that SIFMA would like to use your collective retirement funds as collateral for the next round of SIVs, CDOs, MBS, repos, etc, and everything off balance sheet that looks like Level 3 trash -- because retirement money is safe. The safe nature of pension money that sits around making a safe return is the point and connection here that seems to go over the heads of everyone. Safe pension money is to SIFMA what shooting fish in a barrel is to hedge funds.
In the case of MBS, though, investors were clearly defrauded by Standard & Poors, Moody, and Fitch. Now I suppose that on Wall Street everyone knew what was going on (wink, nod) but that doesn't absolve the rating agencies of their responsibility.
One more thing Ipod, Tanta's post is about investors and the financial services insdustry, not about the average janes and joes who bought homes to live in.
Since you were lecturing me about what the topic of the post is.
This kind of crap has been coming on for 30 years, ever since companies -- even tech companies -- stopped looking more than a quarter ahead. Long-term risks require long-term planning and long-term payoffs, and American corporate management wants quick profits -- often at the expense of long-term viability. Why not, that's what they're incented for.
Cooking the books, legally or otherwise, is just an extension of these ethnics. And of course the big boys all expect to have moved on by the time the chickens come home to roost.
Call for Lenin....Call for Lenin.... Will Mr. Vladimir Ilyich Lenin please report to the Central Planning office. Free Markets don't know how to allocate capital efficiently anymore, according to Calculated Risk.
10 house in Vegas? Of their own? That's the part of my post you quoted.
Tranches I quoted that to my point about securitization and risk. My second post was that it is different for most people who are now collateral damage. The vast majority of people were not speculating. They were buying houses. The speculators were allowed to do so because everyone believed the risk was small and diffuse. It wasn't. And this is very different from what happened with the dot com bust.
"Free Markets don't know how to allocate capital efficiently anymore, according to Calculated Risk."
Since when have markets been free? I'd really, really like to know.
Bob Dobbs' comment above is closer to what this is really all about. Frankly, I don't think most of you have given any thought to what Waldman is saying.
Of course you're right. But the actors play to the audience, don't they? And if people who buy stock are looking for results, like, NOW, then, by god, that's what they'll get. So everyone that is chasing yield is guilty, because that's the behavior they're encouraging like it or not. So if you think you're going to get double-digit returns on your portfolio, you're enabling this behavior. Because, I can tell you from first hand experience, it's frightfully hard to grow a company by double digits a year, or even at an 8% clip a year.
As power becomes more concentrated in ever larger and fewer corporations, the system becomes less robust to large negative shocks. At some point, the burden of fewer but larger entities will crash the system. The larger the entity, the more precarious is it's survival in an ecology under stress.
The biggest deterent to long term capital investment that generates real wealth not paper profits is the carry trade. They are only interested in short term reward. ''The flavor of the minute" All this wealth management does not create anything because they refuse to hang onto it long enough.
Tax the carry trade as ordinary income and make LT capital gains over five years free. ZERO tax.
Unemployemt might be high for awhile but then maybe our best brightest will be interested in other pursuits besides flipping money.
More on topic, who needs to take risks on that questionable sandwich shop on the corner when the central bank is serving up a great lunch for free? But as it turns out, Greenie didn't have his food handlers license, and now I've got the runs.
"No, see, what the point of the post is, is that this was possible because there is no risk in RE, and the risk in the loans was always going to be small because of securitization. So it is the exact opposite from what you are thinking."
Umm, was that the royal "you"? And my point was I was DISAGREEING with Waldman's point, so hence my point was opposite his.
"At some point, the burden of fewer but larger entities will crash the system. The larger the entity, the more precarious is it's survival in an ecology under stress."
You basically described the GSE's. Although apparently the Fed/SEC thinks any of 19 institutions are too big to fail.
Our country wasted a boatload of financial and human capital (and time before 2017!) on building large single-family homes in the middle of nowhere. Everything else (securitization blowups, bad loans, bailouts, etc) is just how those bad decisions come home after the fact.
I'm wondering, though, if the environment of high employee taxation, governmental regulations, environmental-protection regs, health care costs, tort law and liability, and the rest, are partially to blame for the mess. Who in the world wants to invest in some new venture, start a business that actually employees people or makes things, or pour their life savings into an idea in an environment like that? Much easier to buy financial products or lever-up and bet on rising asset values it seems to me.
We need to encourage and foster innovation and make it safer to bet on new ideas before the money will go there.
The only companies who really invested in plant and people (not "human capital") fly under the radar--they're generally privately owned, which is why they're our clients. They actually think ahead and modernize for the long term. What a concept. Oh, and energy efficiency (or our national lack of it)...don't get me started.
"Most people bought because, you know, they wanted a house of their own. "
If ownership was the only reason, then why did they trade up to mcmansions? Why did granite become a must have commodity? Why did they cash out at every opportunity?
If you take this line of thought to the 'obvious' endgame, it's not pretty: Capital flight from the US as investors remove their money (slow and steady at first, then in a panic) and the US economy stops.
The smart/big money has been bailing out for many months, seeking safety in anything but the USD.
To avoid the collapse, you'd have to redistribute the money, rebuilding the American middle class.
That ain't gonna happen. That's like saying: We need the investor class to stop thinking about profits and start thinking about people.
Because, I can tell you from first hand experience, it's frightfully hard to grow a company by double digits a year, or even at an 8% clip a year.
Don't tell that to google..
BobD-So true..
I remember joining a new secondary lender in the 90's, yield was important but because we wanted to grow returns out 5-10 years, mgmnt stressed credit quality was more important.
Yield floats around if your buying A-C paper, you could always get it with A the volume and c the yield. It only worked if you could keep credit quality yield low..charge offs under 4..We did.
The stock grew and company sold because of a mgmnts long term commitment and plan..
I'm a little unclear on who Waldman thinks should change their behavior and what the new outcome should look like. For example:
"But until owners of capital stop hiding behind cleverness and diversification and take responsibility for the resources they steward, finance will remain a shell game, a tournament in evading responsibility for poor outcomes."
I think he may be confusing the "owners" of capital with agents who manage it for others. "Owners" don't "steward" (here's the definition of steward: a person who manages another's property or financial affairs), they "own" the gains or losses and feel the consequences of their decisions directly.
Perhaps what he's asking for is the bondholders of Freddie, Fannie and some large banks to take a major haircut.
I agree with some of the comments above that enormous risks were taken, knowingly, by many investment professionals during the bubble, it is just that the risks were taken with OPM (other people's money) whether that be a CDO manager buying crappy mortgages on behalf of some pension fund, the banker at Merrill who kept warehousing dubious mortgages, with the shareholders' money, while the market weakened , or the guys at Freddie and Fannie buying all those suspect mortgages in 07 with a taxpayer backstop behind them. The problem is that none of these people had any real skin in the game.
If people with fiduciary responsibilities were required to put a meaningful portion of their own net worth (like a half or a quarter) into whatever assets they are managing on behalf of someone else (that's the OPM) much of this nonsense would stop in a heartbeat.
One of the first questions I ask any person who wants me to invest in their fund is "how much of your net worth is invested in the fund?", and most successful investors eat their own cooking in large doses. If the intermediaries that allocate capital put this question at the top of their list when they interview invesment managers, we would all be a lot better off.
One more thought, we as a society would be much better off if we didn't have a political class running around pretending that their constituents can and should be shielded from most big risks in life. Real life is messy, things don't always go according to plan and sometimes you lose money, and planning for or mitigating such risks entails some sacrifice usually in the form of delayed or avoided consumption. They have done everyone a huge disservice by pretending otherwise.
Ipodius, even most people who were buying a house "for themselves" were buying speculatively. Almost nobody really needs a big house. People wanted to own a nice big house because everybody knew it was worth a lot. It was a giant status symbol. In addition to indicating current wealth, it indicated you were sharp enough to get in early enough or cleverly enough. Even now my comparatively modest and indifferently decorated house gets a lot of complements.
I'm noticing a big shift in my circle (DINKs, basically). Now that owning a house indicates you were too much of a fool to get out near the top, suddenly all these DINKs are losing interest in their 3000 sq. ft. houses and talking about what a chore they are to take care of and commute from. They were driven by the money too, they just wanted to use that money for a status symbol.
I don't pretend to know where all that capital, that incredible swell of human energy and physical resources, ought to have gone.
That's just it, it wasn't a "swell of human energy and physical resources" which led all the various bubbles, it was an absurd growth in debt.
While hundreds of billions of dollars were poured into new suburbs, very little capital was devoted to the alternative energy sector...
Of course, hundreds of billions were also poured into what I would think the author would consider "greener" inner city condos...
That is what I would call the typical blog posting (something close to a fact here, a lot of hyperbole there, all tied together with a thread of self-righteousness), and why I don't visit many blogs.
CR has managed to keep his eye on the ball and his ego in check. As far as I've seen, he's the only one who's managed to do both.
I beg to differ. To me, it is not a question of too much or too little risk, it is more of a mismatch between the time period for risk and rewards. If you have two investments, 1) the rewards are immediate but the risk is spread over a long period of time, and 2) where the risk is immediate but the rewards are spread over a long period of time, what will you choose?
1) is an example of all that went into securitization, 2) is an example of alternate energy.
No, Ipod, they bought those houses because they thought they could make insane profits for very little effort, in a very short span of time. Time is the issue. Productive investment in say, alt energy, takes time. This is a get rich quick society.
Or because they believed the realtors when they said 'Buy now or be priced out forever'.
What possible value was added by "greener" inner city condos over the triple-decker apartments that they were created from? 20005 did not represent a global boom in blown-in insulation.
And the flip side of debt is lending. Somebody was writing real checks during those years.
What they were looking for was yield in a yield-starved world, which existed because of demographics on the demand side, and on the supply side, rates were held artificially low. I would argue that in part this is s symptom of the greater concentration of wealth in the last ~decade. Give a poor man 5% more moeny and he'll spend it. Give a rich man 5% more money and he'll invest it. This was the justification for decreasing taxation rates on the well off and on capital gains. Unfortunatly, most of that money ended up chasing itself around Wall Street while doing little to improve productivity. Most of the "growth" that we were promised turned out to be an illusion.
The other demographic trend was the Boomers trying to save up for retirement in their peak earning years. This might have worked if their deferred gratification had gone for productivity improvements instead of just bidding up a huge financial bubble.
We've trained a generation of professionals to forget that investing is precisely the art of taking economic risks, then delivering the goods or eating the losses.
I think it goes a bit deeper than that even. We've got an entire society focused on the very short term. In business today, the focus is on establishing the highest short term growth possible while ignoring the long term.
The housing bubble is a prime example of this. People were speculating on real-estate, buying and selling homes in months rather than seeing them as long term investments. There's no way people would have been doing what they were doing if they were planning to hold the inventory for even a mere 5 years.
Most investing is rewarding risk, but only in the short term. Long bets are largely derided because it doesn't yield the dividends now. The worst part is that this is even true in the day to day operations of business, not just investment. How many businesses now outsource their core business to 3rd parties in the interests of short term costs savings but end up creating their own long term competitors and undermine their intellectual capital?
tranches of lunacy said: "I don't buy that most of these people didn't know there was risk, they were just overconfident on their ability to pass the hot potato to the next sucker."
I completely agree! I personally KNOW a lot of people who are completely willing to step into Multi-Level Marketing crap and Pyramid Schemes.
When I talk to them they're not stupid and they know EXACTLY what these schemes are.
The mentality is to pass on the problems and they get a profit out of this system before it collapses.
No.Ethics.No.Conscience.
These are the same people who want to Get Rich Quick, and are in Real Estate Bubble head over heels.
Everytime I talked to someone like that who sold during the heights, he snickered at the sucker who bought it from him, because he knows full well that sucker cannot pay.
These are the kind of people buying houses. What I'm surprised is that they're NOT in small numbers!
When I ask how can they do so much harm conscientiously -- They look to me like I'm an idiot.
The risk is the US government defaulting on it's debt trying to prop up insolvent banks and keep overvalued assert prices inflated along with the unfunded liabilites of SS and Medicare. Plan accordingly as time is short.
The biggest con of all was the absolute "lack of risk" in the stock market.
This mindset, like this post points out, actually increases the risk.
The very fact that it was "common knowledge" that stocks outperform over the long term meant that stocks reamined overvalued.
Stocks are not a good investment per se, but only a good investment if you are able to buy low and sell higher.
The very fact that the entire wallstreet mantra that longterm buy and holders are guaranteed 8-11% interest meant that stocks were never sold off to any degree to allow people to actually buy some cheap stocks.
By definition stocks will underperform longterm precisely due to the near universal belief that stocks outperform over long periods.
Just as the mantra that "housing never goes down" is dying a slow death, so too will the mantra that those who faithfully plug away bi-weekly in their 401k will be handsomely rewarded.
Perhaps some historians can research periodicals for the existence of the mantra "buy and hold", "invest for the longterm", "stocks always go up over time" during past periods where it truly was smart to continually accumulate stocks for the long haul.
Opportunities for real long-term growth in the developed world are rather dependent on a thriving middle class. Unfortunately the program of the ultras to impoverish labor while enriching themselves has short-circuited that engine. Which is why all that money has been chasing unproductive asset bubbles instead. They're not creating any wealth, just leveraging it and passing it around.
I don't really expect the rich to hold onto their money. Sure, extreme disparaties in wealth are sustainable in countries without a large, stable middle class, such as Mexico, as long as you are happy with the levels of wealth and wealth creation found in Mexico. Unfortunately that's not enough to support today's ultras.
We have, over the last 20+ years, transformed our society into investors rather than producers. The logical consequence of this democratization of investing is that the tolerance for risk goes down. Social Security privatization is controversial because - right or wrong - SS is seen as the last safety net. To put the last safety net at risk seems inappropriate.
Our pensions have changed into 401(k) that are subject to losses. Our homes have similarly become susceptible to loss - at least it seems that way now more than before.
Not everyone is able to deal with such high stakes gambling with their future, but they are forced into it. I just don't think that's healthy for our society.
The naked guy is right. Our short term focus is not helpful to our long term security.
"Give a rich man 5% more money and he'll invest it."
The definition of the word 'invest' is the heart of the matter, isn't it? To be blunt, we have a wealthy upper class now in the US who is not smart enough to invest, so they gamble instead. They have so much liquidity that it cannot be put to good investment use - it swamps the market, it chases diminishing prospects... so they levered up and went for broke. And got there.
I think we are also missing another aspect of the securitization mess. Wall Street is associated with not only greed but also hubris. Some of the people involved in this asset slicing are very smart, but a lot of their bosses are not too bright. However, what they lack in intelligence they make up for in arrogance. Train coming down the tracks? No problem, just gun the Beemer...
It seems I drew something different out the original article than others.
My take was that most investors are unwilling to take a risk on an actual physical product. There is a love affair with investing based on financial models, not products. The financing then drives the products.
The housing bubble didnt arise because lots of builders planned to build the burbs. It arose because many investors felt home mortgages in the burbs were a safe bet. This gave the builders the money to build the safe product. The same goes for pharmacuetical companies that spend about 10 times as much on marketing as on new products, for car companies churning out the same products (only with new trim), and for oil companies that spend far more on stock buy backs than on drilling for oil.
Many investors at the institutional level wont risk their money on anything that does not fit into their mathematical models, things like new products, new technologies, or actual production plants. In todays market, the funding that years ago helped start Ford would have gone instead to the buggy whip makers and horse farms (based of course on triple AAA solid gold analysis of historical returns for buggy whips versus the unquantifiable returns for the newfangled car.)
I appreciate that the dot-com bubble was the reverse. But it seems that many have learned the lessons of the dot-com bubble all too well. And given the "risk" of investing in a new product, versus the "risk" of trying to squeeze extra return out of existing products, I would go for the former every time.
I'm sorry, but the idea that investors took on "too little risk" is just inane, as is the idea that "The banks and SIVs that bought up 'super-senior AAA' tranches of CDOs were looking for safe assets, not risky assets."
The banks and SIVs and conduits that gobbled up super-senior AAA tranchs of structured dogs-breakfast were NOT looking for safe assets, THEY WERE LOOKING FOR YIELD. AND for regulatory reasons they needed the AAA fig-leaf to hide behind, but all they were doing was an absurdly leveraged carry trade off the balance sheet.
So on the investment side of this debacle, the problem WAS people taking on way too much risk, mostly in pursuit of yield because you have to have positive carry to make a leveraged carry trade work . . . . . . . too much leverage, combined with too much credit risk and a bit of maturity risk thrown in is the stinky old rot underneath the porch eating away at the foundation.
Bubbles are a collective lack of imagination in capital allocation.
Not so sure about the idea some posters have blaming short-termism. The US is supposedly obsessed with quarterly results and getting it all today. There's some evidence of that - e.g. underinvestment in infrastructure is probably underdone because the IRR looks poor.
Yet we have the largest biotech sector in the world. And that is anything but a quarterly based business - more like decades. And don't give me the free and liquid markets explanation - I;ve spoken to lots and lots of foreign institutional investors/funds and the appetite for long-dated and uncertain payouts is simply lower overseas. Perhaps we are simply greedier - so we are more likely to look for both quick flips in LBOs and lottery style payouts in venture capital.
Another possible explanation for a lot of capital misallocation (besides lack of imagination) is our bizarre inability to see and weigh externalities. Building extra power lines may be unpleasant for those whose yards they pass by, but the total social cost of a blackout is far higher.
Stocks are not a good investment per se, but only a good investment if you are able to buy low and sell higher. Not really. There is a methot to give returns on investment in the absence of stock price appreciation. They're called divedends. If the equity is priced right, then divedends provide reasonable returns.
On the issue of biotech, ie "Yet we have the largest biotech sector in the world. And that is anything but a quarterly based business - more like decades", I can't speak to the risk perspective of foreigners, but in the US, there's ample evidence of systematic risk-seeking behavior regarding long-shots.
Multiple studies of pari-mutual wagering show that long-shots are systematically overbet to the point where (on average) the favorite in horse races is the best bet. Similarly, lots of analysis of CBOE option pricing back in the 1980s and 1990s showed that far out of the money call options were systematically overpriced.
The idea that "too little risk" contributed to this debacle is just silly. Capital was badly allocated, for sure, but the problem wasn't anything like taking too little risk.
Well, the essay is interesting because it's certainly true the risk taking that occurred for housing was not random risk taking and (maybe) was motivated by desire for a "sure thing" -- another form of greed.
Randomized risk taking is safer for the financial system (if not individuals) and such random risk taking possibly did diminish when so much investment money was concentrated in building, houses and empire.
When everyone piles on the same safety raft, at some critical point it ceases to float. And instead of random drownings, there's a uniform drowning of all. Equilibrium is disturbed beyond recovery.
So who exactly aggregated all the risk behavior into the same kind of risk? It takes an unregulated industry. That's who.
Quirk's Marketing Research Review has this cute article by Jim Berling about why industries fail to learn -- it's called on the job learning. "Learning is often passed on from one researcher to the next by telling them to review old reports, projects and questionnaires for future studies, not realizing that errors made in the past are now being repeated over and over. The cycle of reproducing the same errors continues until someone within the organization takes a stand and challenges the status quo." Who wants to challenge the status quo, get ridiculed and fired? Its a rare soul.
Interest rates are a barometer of risk. Given they have been historically so low, perhaps is a good indicator of a low-risk environment which indirectly supports Waldman's argument. If people were taking on truly courageous risks, wouldn't interest rates be higher to match that level of risk? Wouldn't ordinary savers who are unwilling to take courageous risks themselves expect a higher rate of return from the bank?
This article by James Fallows, written for the Atlantic Monthly back in 2005, holds up remarkably well. There are some things that have broken a bit differently, but he's nailed most of it.
why hope that the inevitable will not occur. why are we saving a flawed system to begin with. let it burn to the ground. why does everyone hope for the best? i hope to get back into US equities at some point in time but no where even close to current levels.
Well, the gummint promised them your Social Security funds, and they were expecting that money five or six years ago. If they'd gotten what they were promised, they could still be bubbling.
Now they're scared of the upcoming election and they know they were promised a big bundle of money.
Where else would the government get it, if not your pension money?
Ey? Ey?
It's very important to restore the confidence of Wall Street.
This article is interesting, but it engages in a lot of blaming people for doing what they are supposed to be doing, rather than predicting the future perfectly.
On the asset management side, the reason why mortgages were preferred as the "safe" security was the mistaken belief that they could not all go TU at once. As a result, the hope was that you could tranche the mortgages, and create the needed "safe" assets at the senior levels. That did not work.
But his alternative, capital investment, is an even more dubious means to generate a safe asset. If you have a large junk bond backed by a speculative investment, it's either gonna work, or be a complete write off. No realistic way of converting it into a safe security. (Yeah, there was an attempt to do that with corporate CDO's, but that was largely investment grade underlyers.)
End investors do actually put money in money market, bond funds etc. They want safety and liquidity, which trumps the expected return. The manager of a government bond or money market fund is not going to be employed long if he starts plowing his assets under management into internet and solar energy start ups. For all I know, he could even be jailed for doing that.
And complaining that the corporate managers were not investing in useful projects, that's just plain silly. They were - in China. Given the record corporate profits seen in the 2005-2006 period he highlights, why would corporations go out and borrow to invest? They were swimming in cash flow, and corporate bond investors were a lot harder to deal with after the Enron and Parmalat incidents.
What savings glut? Undischarged bank credit is always going to end up in some account. The idea this was a savings glut is insane, as that would imply what was spent in the first place was saved. Monetization of future income is more like it.
Steve Waldman says the notion that the financial system took on "too much risk" in recent years. I think it is equally accurate to suggest that the financial system took on too little risk. That notion might be true on some level, but it might be more accurate to suggest that the reason the system bubbled and misfired was because of flawed policy coming out of Washington. At even, when we concluded major trade agreement with potential competitors, the financial system still failed to take on the the right kind of risk as we opened the door to job and technology transfer.
Think of the Global- WTO agreement, the Regional-FTAA(Free Trade Area of the Americas ), NAFTA(North American Free Trade Agreement), APEC(Asia-Pacific Economic Cooperation),MEFTA(Middle East Free Trade Area Initiative), etc. , the Bilateral-(Malaysia, Singapore, Colombia, etc.) trade agreements.
Michael E. Lewitt, seems to concurs as he writes In addition, unstoppable economic and historical trends such as globalization caused a shift of jobs and factories to geographic locations with lower labor and materials costs, resulting in a transformation of the U.S. economy from one that manufactures goods to one that traffics in intangible items. At that time, could the capitalists have taken the risk of mothballing rather than dismantling factories and maintaining critical human capital through the temporary downspike? Woe unto those who don't understand the economic life cycle of production systems, one tends to look backward when one should look forward.
Why didn't we make policies that would have compelled the financial system to take the kind of risk to break our fatal addiction? In a word: greed.
Grownups should have taken to heart what their moms used to tell them: "Strangers offer the best candies."
If it's too good to be true...
It is risky to follow a herd off a cliff.
No such thing as too much or too little. The risk is always there. The only variable is the window of risk we humans chose to act on. Key decision makers and people in positions of power have paid little or no attention to our long term future.
We are now entering the fringes of that long ignored "previously ignored future window of time" and sure enough we all completely unprepared.
Those same people that saw fit to steal prosperity from ALL of OUR futures will see their ill gotten gains eroded much more so than the rest who have much less to lose.
And those with less to lose are sure to behave like it.
We live in a closed system, regardless of what our policies assume.
OT: Anybody looked at this yet?
Wall Street Execs Weigh in on Securitization Accounting : HousingWire || financial news for the mortgage market
Apparently a group of wall streeters were supposed to issue a report on the subject of QSPEs... and get this, they recommended that all off-balance sheet assets be forced back on. This includes GS execs and the like. Quite a change in philosophy for the Street.
I would also guess that the recent bubble was the triumph of historical statistical modeling over common sense. FICO scores were valued over verifiable income and cash downpayments.
Everyone gets a trophy!!!
Ofcourse...harder to beg for a complete bailout if no one can tell how hard you f**ked up.
Oh the humanity!
I love this commentary. Thanks for posting it.
Seems to me, the players weren't trying to reduce risk, but hide it. No honest person with a brain could really believe that investors were entitled to the returns they were getting on such supposedly low-risk positions. That's why there's still such desperation to avoid writedowns as long as possible--it's just a continuation from a half-decade-long binge of risk denial.
There's no way to move forward until a lot more capital is destroyed. One of the promises of the free market is to allocate capital efficiently. Those who prove they can handle money intelligently, automatically get more of it. Those who can't are quickly relieved of their burden. Isn't that the way it's supposed to work?
If so, the basic rule of thumb is, if you made a ton of money in this game over the past few years, you're gong to have to lose it. There's no alternative.
wow. That nails it.
MUST READ!!!!!!!!
Now Wall Street Wants Your Pension, Too
JPMorganChase, Citi, Cerberus, and Morgan Stanley are among the firms lobbying Washington to let them take over and run corporate pension fund
Now Wall Street Wants Your Pension, Too
The Treasury Dept. on Aug. 6 offered a blueprint for lawmakers on Capitol Hill to allow "financially strong entities in well-regulated sectors" to acquire pension plans , after the IRS ruled that the concept needed legislative approval. "The Administration's proposal says these deals should only be permitted when the acquiring entity has a higher credit-rating than the seller," says Charles Millard, director of the Pension Benefit Guaranty Corp. (PBGC), the federal insurer of last resort of corporate pension plans. "Such a transaction creates greater security for retirees and the pension system." The issue will now, no doubt, move to Congress after the election.
THIS IS VERY BAD!!!!!!!!!! PLEASE WATCH THIS!!!
WMT lowering Q3 revs estimates & wall st is clammoring for more stimulus from Treasury so consumers can buy more crap from China.
Seems to me that it would be far more efficient that we ask China supply the stimulus checks directly and we cut out the wasteful overhead of the 3rd party intermediary (US Treasury) that is likely to default anyhow.
I think the case is well made as a criticism of US manufacturing and production. They should have been innovating instead of whining.
However, I think a different criticism is appropriate for financial businesses: they were greedy, seeking ever more returns while becoming blind to the fact that risk must have a cost attached to it. They expected to do nothing but be 'clever' and then to become rich thereby.
That's a fine read. And a fresh perspective on malinvestment.
I really can't beg enough (on my knees here) Please help spread that link and comment on this pension topic; IMHO, we do not want hedge funds playing casino with pension funds any more than they already are!!!
Please do me a favor and spread that link, talk about it, watch it, call your corrupt Congress or Senate connection, but PLEASE don't let this slip!
Now Wall Street Wants Your Pension, Too
DOL already grants underwriters exemptions from prohibited actions related to hedge fund derivatives, but this is an amazing attempt to allow the Bush Coup to privatize social security and to steal pension cash! PROTECT yourselves and do your DD!!!!!
I disagree with Waldman's main point here. People took all kinds of ungodly risks during the boom. Buying 10 houses in Vegas? Insanely risky for both the buyer and lender. But it happened.
The difference between these risks, and - say - the risks of alternative energy investment, is that for the former the payoff for a correct bet is much more immediate. People are willing to risk much more for a relatively quick payout versus an investment that takes years to develop.
Wow! The deep thinkers are still around. I thought they had all become real estate agents. Good stuff.
Markel writes:
ys capital must be destroyed, but unfortunately it is your capital
Wally,
Some of the US' manufacturers were innovating. Many were private companies that are now making piles of money on exchange rates' effects.
Few businesses are mismanaged like Detroit's. There are some bright spots out there...not enough.
No, Fred, it is not my capital. Do not buy into the players' propaganda that I have enough to bail them out.
Damn that is good and well written.
Maybe this comes from giving everyone a participation trophy in school and sports now? No real extraordinary effort is required.
anyone know why the 10-year treasuries being bid up??
They took tons of risks, just that they didnt bear the negative reward if the risk turned out to be a bad decision. They grabbed the easy pickings while they were within reach, and when the rickety stool they were standing on collapsed, we were the catch them. The question is, what do we do now? Seems like instead of extracting some fruit from their pockets, we are gathering up what they didnt steal and nicely putting it into baskets for them.
There is always risk, but the important thing is that the person who takes the risk has some reasonable belief that they arent just going to get the upside reward. That is partly where we failed.
"Very few brave capitalists took the risk of mothballing rather than dismantling factories and maintaining critical human capital..."
I did, but forget the "human capital" shit. To me, they're "human beings" with knowledge and expertise.
Investors have come to believe that high yields are available with no risk. Their first impulse will be to sue the bankers, brokers, portfolio managers, etc. when they lose their expected gains and perhaps then some.
Time to get a clue, the rich are going down with the rest of us and while everyone is partly to blame for this mess, the Wall Street gang that worked so hard to buy the Congress and deregulate their industry did commit actual criminal acts for which they should be prosecuted. SIV's only exist because of the "tax advantages" of incorporating them in the Cayman Islands far from the IRS's normal reach. These companies and their CEO's have been living large because they evaded our tax laws, and regulations that were designed to protect the public and the system. They should pay the price.
The bank did not admit wrongdoing in agreeing to settle. It estimated the size of the buyback at $7.3 billion.
Citigroup and Merrill to buy back auction-rate debt
| Reuters
Same crap that went on after the dot.boom rip off. Upper management and anyone who was in it for the last 5 years needs to be in a cell with Bubba the booty bandit for a night hot fudge packing. Fines don't mean squat to the guys.
deuces...there was a big auction today and a ton of presumably foreign central bank demand, probably because they were so nicely appeased recently with US taxpayers money.
Not Even 2% Fed Funds Help Munis Amid Record Rates (Update1)
By William Selway and Martin Z. Braun
Aug. 7 (Bloomberg) -- The Oakland, California, agency that runs toll bridges across the San Francisco Bay is proving that the era of cheap money for municipal borrowers is over.
This week the Bay Area Toll Authority sold more than $700 million of bonds at rates as high as 5.34 percent to refinance debt that cost 4 percent last year. That leaves less money to finance projects, such as bridge improvements.
The cost of money just went way up,'' said Brian Mayhew, the agency's chief financial officer.You may have projects on the cusp that are going to be difficult to do.''
Almost a year after the Federal Reserve began to cut its target rate for overnight loans between banks to 2 percent from 5.25 percent, borrowing costs for states, cities, hospitals and municipal authorities are going in the opposite direction.
[snip]
"If you lost money investing in mortgages or housing, it must be because someone defrauded you."
We're all victims now.
The question is one of risk perception. I think sensible people should be able to see the risk of investing in a bubble. They should have seen it in the dotcom bubble and the biotech bubble, etc. The "risk" of investing in something that doesn't at the time make economic sense is quite different. Should we now take the "risk" for example of preparing for an alien invasion? I doubt sensible people would see that as a sensible "risk" to take and in the past investing in "alternate energy" was also not a very sensible "risk" albeit not quite as foolish as investing to confront aliens. I might add that the lesson not to invest in alternate energy came from the lesson of 1979/80 when people bought little cars and other things were done that quickly seemed silly when the price of oil declined.
Once burned, they weren't about to repeat the mistake.
Very good points by Waldman and Tanta.
I'd add that this would all be a good market lesson, but for the government interference. If the big failures are allowed to happen, people would learn, be cautious, and reward those that took productive risks.
Instead we have entitlement on all sides, with bailouts, lawsuits, and criminalizing losses. All the spoils go to the successful conmen - everyone else is left poorer.
anyone know why the 10-year treasuries being bid up??
Well my calendar says the 30-year bond results were reported at 1:00 pm EST. Must have been one hell of an auction.
Denial
Anger (blaming)
Denial
Anger (blaming) (we're here now)
Negotiation
Depression
Acceptance
A lot of new people today...
Heard on CNBC the US should teach China how to run their markets...Golden China might tell them that banning short sales doesn't work.
Thanks Geoff and AC.
Must be the coat tail effect...that was one huge move!
By Tony Crescenzi
RealMoney.com Contributor
8/7/2008 1:22 PM EDT
URL: Financial Investments and Stock Market Tips for Real Money - TheStreet.com
As with yesterday's $17 billion auction of 10-year notes, results of the Treasury's $10 billion auction of 30-year bonds were stronger than expected, as evidenced by the very high amount of bids submitted, the aggressive bidding seen in the auction yield and solid amounts of indirect bids, which gauge end-user demand.
The results are good news for those who are worried about the possibility of interest rates rising, but bad news if one thinks of why it is that investors showed such a strong preference for Treasuries over everything else.
The auction yield was 4.609%, 5 basis points lower than expected -- an unusual amount, indicating aggressive bidding. The bid/cover ratio was 2.40, beating normal levels (dating back to 2006 when the Treasury reintroduced 30-year bond auctions following a five year hiatus) of about 2.16. The cover ratio is all the more impressive when considering that the auction size was above normal and the most in two years.
Viewed by dollar amount, it is notable that the total amount of bids submitted was about $24 billion, about 50% more than the average of 30-year refunding auctions dating back to 2000.
The percentage of bids awarded to indirect bidders was 42.89%, much more than the 27% average of the past two years, indicating that the Street's distribution burden will be light.
Tim,
Been here off and on for over a year - still one of the new peeps!
mp writes:
"Very few brave capitalists took the risk of mothballing rather than dismantling factories and maintaining critical human capital..."
I did, but forget the "human capital" shit. To me, they're "human beings" with knowledge and expertise.
Amen, mp. I'm getting quite disgusted with use of the phrases "human capital" or "human resources" as if flesh and blood human beings with dreams and desires are nothing but commodities to be used to further someones wealth creation scheme.
Buying 10 houses in Vegas? Insanely risky for both the buyer and lender.
No, see, what the point of the post is, is that this was possible because there is no risk in RE, and the risk in the loans was always going to be small because of securitization. So it is the exact opposite from what you are thinking. So someone buying 10 houses on they buy side was thinking little risk because, historically, RE doesn't lose value. The people on the securitization side was thinking, who cares because we're slicing and dicing and spreading out the risk, so that even if something happened the loss would be quite mitigated.
So, you see, everyone was buying these thinking there was low risk. On all side of the sales. And that desire to hear "low risk" is actually what drove the behavior. If you had said "high risk" none of this would have happened.
And those with less to lose are sure to behave like it. -- Kneel before Zod
So in other words, "On n'a rien a gagner a emmerder les gens qui n'ont rien a perdre."
No one cares about pensions right?
Who has a pension these days. your lucky to have a 401K that's not been tapped yet.
Not Even 2% Fed Funds Help Munis Amid Record Rates (Update1)
I forget who is the muni bond person around here... but this story is great... might even be worthy of CR post?
Tantas going to get me but what the heck
OT:
Citigroup to Unfreeze $19.5 Billion of Auction Debt
Citigroup to Unfreeze $19.5 Billion of Auction Debt (Update2)
synthetic-guarantee groupie writes:
No one cares about pensions right?
Who can we trust with pensions? IBs, the government, private pension companies,...the public? So far none of these candidates looks good.
The story about too little risk, i.e, the financial system took on too little risk. I guess it doesn't take an Einstein to see that more risk might compound the problem of speculation!
Same crap that went on after the dot.boom rip off.
Not at all! In the dot com situation, everyone was trying to place bets on a new technology and who was going to be the next IBM, Microsoft, etc. So more and more money was tossed at companies because no one knew which horse would win, and if it did win it would be BIG. Turns out that bad business models don't work no matter what the technology and if you made the bet you lost. But to lose you had to make the bet, so there's the risk. If you didn't understand that, don't cry to me, although I did enjoy the fabulous catered lunches, outrageous pay, and my Herman Miller desk chair a lot.
This is completely different because, to lose money, you didn't have to place a bet. You are collateral damage because if you bought a house in most areas in the last few years, you're going to be screwed too. Furthermore, you're now being punished by the lack of credit, even though you may be completely credit worthy. Also your job is at risk because, you know, they just cut off all lending for other items too, not just houses. Oh and your kids can't go to that nice school anymore because, even if you can afford the loans comfortably, they won't make them. So this is WAY different than the dot com issue.
Excelent post!
No, Ipod, they bought those houses because they thought they could make insane profits for very little effort, in a very short span of time. Time is the issue. Productive investment in say, alt energy, takes time. This is a get rich quick society.
I don't buy that most of these people didn't know there was risk, they were just overconfident on their ability to pass the hot potato to the next sucker.
There's an extent to which I call BS on this.
'The banks and SIVs that bought up "super-senior AAA" tranches of CDOs were looking for safe assets, not risky assets.'
What they were looking for was yield in a yield-starved world, which existed because of demographics on the demand side, and on the supply side, rates were held artificially low.
I don't see how these sophisticated models could ignore what every trader should know: if you take an intrinsically low-beta investment and leverage up on it XX: 1, it changes the beta.
Even a little retail rookie like me who's done any research on hedge funds knows that, historically, you're almost statistically certain to go bust at 11x leverage.
How on earth could you be leveraged 35:1 like Carlyle and not run stops tighter than a fist? I choose that example because they had Ginnie Maes on; it's not like these guys were in illiquid paper.
Liquidity should never be an excuse anyway. Anybody who's ever bought a small-cap stock and woken up with a mohawk learns that lesson in his first couple of months of trading.
Rookies, morons, losers all. Put on your big girl panties and deal with your losses.
Waldman is definitely right on one thing: all of this financial engineering bullshit has been skewing the numbers.
People have come to expect so much they aren't being rational any more. The market is a perfect example of this.
If this country wants to survive, they must get back to basics and respect things like quality, longevity, stability, and so forth.
Hell, I could write volumes on this subject, but I'd only make you cry.
Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and ineffectiveness of al traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation.
Jens O. Parsson Dying of Money.
hey bought those houses because they thought they could make insane profits for very little effort
Um no tranches. Most people bought because, you know, they wanted a house of their own. Don't make a minority phenomenon into a bigger deal than it is. That's what Tanta argues against in her posts about the media...especially about the "walk-aways". Speculation was only a small part of this, and certainly not where I live because you can't build a lot. It was about buying a house, or buying a house now before they went up even further, etc. Most of the people that are suffering now, especially here, just wanted a house.
"I did, but forget the "human capital" shit. To me, they're "human beings" with knowledge and expertise."
Good for you.
'Human capital' is next door to 'low-use human resources.'
I disagree with Waldman's main point here. People took all kinds of ungodly risks during the boom. Buying 10 houses in Vegas? Insanely risky for both the buyer and lender. But it happened.
tol, i think waldman's point rests in part on defining where risk must be taken.
i think it is an unpopular given that a great many individual people will take all the rope the bank will give them to hang themselves with. that is why underwriting standards are and always have been important. and a great many banks chafe under the regulatory restrictions that have been placed on them since the 1930s. they too are always more than happy to take the risks that must destroy them in the end if they are allowed to.
what was new about this boom was the ability of wall street to intermediate through securitization a linkage of global institutional capital and western mortgage markets. previously, institutional capital had as a rule been too risk averse to play in mortgages.
the truth which securitization hid was that institutional capital remained at all times too risk averse to actually play in mortgages -- it was only by the obfuscation of securitization that the capital tap could be opened. and that flow -- magnified by the operation of foreign central bank vendor finance -- of course overwhelmed the market with credit supply, creating the bubble.
i wouldn't pretend that institutional capital was smart or even competent in allowing itself to be deceived so. but all securitization had to do was offer a plausibility of concept vis-a-vis safety for all the players to forget themselves and what they were really doing. these are the parties whose demand for at least a superficial safety while desiring greater risk and yield created the need for securitization.
seen as such, i think waldman is narrowly missing something of the point. we have indeed become a culture of safety -- i think frank furedi has amply demonstrated and dissected its emergence. but that safety is often purposefully superficial -- a slogan, a cover for truly reckless action that, being purposefully cloaked in the perception and verbiage of safety, escapes necessary critical evaluation. and in the end, as waldman notes, the false cries of a pact of safety violated offers an again-uncritical and uncriticized recourse to legal action for institutional investors who were finding ways to excuse themselves of their fiduciary responsibility.
"Um no tranches. Most people bought because, you know, they wanted a house of their own. "
10 house in Vegas? Of their own? That's the part of my post you quoted.
In other news (hopefully topic-related):
Ohio made it among the fastest dying cities -- murdered by joblessness, economomic downturn, and Cash-Schiller! Ironically, a presidential candidate will discuss potential job losses in Ohio, although his prior actions helped eliminate those jobs. Amazing!
I would dedicate to them the song "Town Called Malice" by The Jam; but alas, it's for a different country and era.
There must be a few fables about the search for safety and security leading to the most risky disastrous behavior of all.
And I don't mean the modern one of Homeland Security/Patriot Act.
sdtfs,
Who can we trust with pensions?
I just think it's funny that this story about not taking on enough risk ends with: "But until owners of capital stop hiding behind cleverness and diversification and take responsibility for the resources they steward, finance will remain a shell game, a tournament in evading responsibility for poor outcomes."
It ends there as if people have a choice in how they take responsibility with investing, and that is why, when I post about pension funds, people go huh, what, so, next cool story, what was that about, duh.....
Now, on to your reply, which was the only one, but maybe the off topic nature of pension fraud is unwelcome... so who do we trust? We know, or least I know that SIFMA would like to use your collective retirement funds as collateral for the next round of SIVs, CDOs, MBS, repos, etc, and everything off balance sheet that looks like Level 3 trash -- because retirement money is safe. The safe nature of pension money that sits around making a safe return is the point and connection here that seems to go over the heads of everyone. Safe pension money is to SIFMA what shooting fish in a barrel is to hedge funds.
I'm bored too, who gives a fuck
In the case of MBS, though, investors were clearly defrauded by Standard & Poors, Moody, and Fitch. Now I suppose that on Wall Street everyone knew what was going on (wink, nod) but that doesn't absolve the rating agencies of their responsibility.
OT?
How are MBIA and Ambac still alive again?
One more thing Ipod, Tanta's post is about investors and the financial services insdustry, not about the average janes and joes who bought homes to live in.
Since you were lecturing me about what the topic of the post is.
This kind of crap has been coming on for 30 years, ever since companies -- even tech companies -- stopped looking more than a quarter ahead. Long-term risks require long-term planning and long-term payoffs, and American corporate management wants quick profits -- often at the expense of long-term viability. Why not, that's what they're incented for.
Cooking the books, legally or otherwise, is just an extension of these ethnics. And of course the big boys all expect to have moved on by the time the chickens come home to roost.
Call for Lenin....Call for Lenin.... Will Mr. Vladimir Ilyich Lenin please report to the Central Planning office. Free Markets don't know how to allocate capital efficiently anymore, according to Calculated Risk.
10 house in Vegas? Of their own? That's the part of my post you quoted.
Tranches I quoted that to my point about securitization and risk. My second post was that it is different for most people who are now collateral damage. The vast majority of people were not speculating. They were buying houses. The speculators were allowed to do so because everyone believed the risk was small and diffuse. It wasn't. And this is very different from what happened with the dot com bust.
What % of the capital seeking low risk investments was foreign central banks/SWF's?
Maybe this isn't a commentary on risk taking in the US so much as a commentary of what foreign actors are doing...
Since you were lecturing me about what the topic of the post is.
Tranches, my response actually was a follow-on to something you said not a lecture. It always isn't about you, you know
"Free Markets don't know how to allocate capital efficiently anymore, according to Calculated Risk."
Since when have markets been free? I'd really, really like to know.
Bob Dobbs' comment above is closer to what this is really all about. Frankly, I don't think most of you have given any thought to what Waldman is saying.
stopped looking more than a quarter ahead.
Of course you're right. But the actors play to the audience, don't they? And if people who buy stock are looking for results, like, NOW, then, by god, that's what they'll get. So everyone that is chasing yield is guilty, because that's the behavior they're encouraging like it or not. So if you think you're going to get double-digit returns on your portfolio, you're enabling this behavior. Because, I can tell you from first hand experience, it's frightfully hard to grow a company by double digits a year, or even at an 8% clip a year.
As power becomes more concentrated in ever larger and fewer corporations, the system becomes less robust to large negative shocks. At some point, the burden of fewer but larger entities will crash the system. The larger the entity, the more precarious is it's survival in an ecology under stress.
The biggest deterent to long term capital investment that generates real wealth not paper profits is the carry trade. They are only interested in short term reward. ''The flavor of the minute" All this wealth management does not create anything because they refuse to hang onto it long enough.
Tax the carry trade as ordinary income and make LT capital gains over five years free. ZERO tax.
Unemployemt might be high for awhile but then maybe our best brightest will be interested in other pursuits besides flipping money.
More on topic, who needs to take risks on that questionable sandwich shop on the corner when the central bank is serving up a great lunch for free? But as it turns out, Greenie didn't have his food handlers license, and now I've got the runs.
Ipod said, in response to my earlier post
"No, see, what the point of the post is, is that this was possible because there is no risk in RE, and the risk in the loans was always going to be small because of securitization. So it is the exact opposite from what you are thinking."
Umm, was that the royal "you"? And my point was I was DISAGREEING with Waldman's point, so hence my point was opposite his.
"At some point, the burden of fewer but larger entities will crash the system. The larger the entity, the more precarious is it's survival in an ecology under stress."
You basically described the GSE's. Although apparently the Fed/SEC thinks any of 19 institutions are too big to fail.
Very good post.
Our country wasted a boatload of financial and human capital (and time before 2017!) on building large single-family homes in the middle of nowhere. Everything else (securitization blowups, bad loans, bailouts, etc) is just how those bad decisions come home after the fact.
I'm wondering, though, if the environment of high employee taxation, governmental regulations, environmental-protection regs, health care costs, tort law and liability, and the rest, are partially to blame for the mess. Who in the world wants to invest in some new venture, start a business that actually employees people or makes things, or pour their life savings into an idea in an environment like that? Much easier to buy financial products or lever-up and bet on rising asset values it seems to me.
We need to encourage and foster innovation and make it safer to bet on new ideas before the money will go there.
The only companies who really invested in plant and people (not "human capital") fly under the radar--they're generally privately owned, which is why they're our clients. They actually think ahead and modernize for the long term. What a concept. Oh, and energy efficiency (or our national lack of it)...don't get me started.
"Most people bought because, you know, they wanted a house of their own. "
If ownership was the only reason, then why did they trade up to mcmansions? Why did granite become a must have commodity? Why did they cash out at every opportunity?
If you take this line of thought to the 'obvious' endgame, it's not pretty: Capital flight from the US as investors remove their money (slow and steady at first, then in a panic) and the US economy stops.
The smart/big money has been bailing out for many months, seeking safety in anything but the USD.
To avoid the collapse, you'd have to redistribute the money, rebuilding the American middle class.
That ain't gonna happen. That's like saying: We need the investor class to stop thinking about profits and start thinking about people.
Too late.
Ipod-
Because, I can tell you from first hand experience, it's frightfully hard to grow a company by double digits a year, or even at an 8% clip a year.
Don't tell that to google..
BobD-So true..
I remember joining a new secondary lender in the 90's, yield was important but because we wanted to grow returns out 5-10 years, mgmnt stressed credit quality was more important.
Yield floats around if your buying A-C paper, you could always get it with A the volume and c the yield. It only worked if you could keep credit quality yield low..charge offs under 4..We did.
The stock grew and company sold because of a mgmnts long term commitment and plan..
I'm a little unclear on who Waldman thinks should change their behavior and what the new outcome should look like. For example:
"But until owners of capital stop hiding behind cleverness and diversification and take responsibility for the resources they steward, finance will remain a shell game, a tournament in evading responsibility for poor outcomes."
I think he may be confusing the "owners" of capital with agents who manage it for others. "Owners" don't "steward" (here's the definition of steward: a person who manages another's property or financial affairs), they "own" the gains or losses and feel the consequences of their decisions directly.
Perhaps what he's asking for is the bondholders of Freddie, Fannie and some large banks to take a major haircut.
I agree with some of the comments above that enormous risks were taken, knowingly, by many investment professionals during the bubble, it is just that the risks were taken with OPM (other people's money) whether that be a CDO manager buying crappy mortgages on behalf of some pension fund, the banker at Merrill who kept warehousing dubious mortgages, with the shareholders' money, while the market weakened , or the guys at Freddie and Fannie buying all those suspect mortgages in 07 with a taxpayer backstop behind them. The problem is that none of these people had any real skin in the game.
If people with fiduciary responsibilities were required to put a meaningful portion of their own net worth (like a half or a quarter) into whatever assets they are managing on behalf of someone else (that's the OPM) much of this nonsense would stop in a heartbeat.
One of the first questions I ask any person who wants me to invest in their fund is "how much of your net worth is invested in the fund?", and most successful investors eat their own cooking in large doses. If the intermediaries that allocate capital put this question at the top of their list when they interview invesment managers, we would all be a lot better off.
One more thought, we as a society would be much better off if we didn't have a political class running around pretending that their constituents can and should be shielded from most big risks in life. Real life is messy, things don't always go according to plan and sometimes you lose money, and planning for or mitigating such risks entails some sacrifice usually in the form of delayed or avoided consumption. They have done everyone a huge disservice by pretending otherwise.
Ipodius, even most people who were buying a house "for themselves" were buying speculatively. Almost nobody really needs a big house. People wanted to own a nice big house because everybody knew it was worth a lot. It was a giant status symbol. In addition to indicating current wealth, it indicated you were sharp enough to get in early enough or cleverly enough. Even now my comparatively modest and indifferently decorated house gets a lot of complements.
I'm noticing a big shift in my circle (DINKs, basically). Now that owning a house indicates you were too much of a fool to get out near the top, suddenly all these DINKs are losing interest in their 3000 sq. ft. houses and talking about what a chore they are to take care of and commute from. They were driven by the money too, they just wanted to use that money for a status symbol.
I don't pretend to know where all that capital, that incredible swell of human energy and physical resources, ought to have gone.
That's just it, it wasn't a "swell of human energy and physical resources" which led all the various bubbles, it was an absurd growth in debt.
While hundreds of billions of dollars were poured into new suburbs, very little capital was devoted to the alternative energy sector...
Of course, hundreds of billions were also poured into what I would think the author would consider "greener" inner city condos...
That is what I would call the typical blog posting (something close to a fact here, a lot of hyperbole there, all tied together with a thread of self-righteousness), and why I don't visit many blogs.
CR has managed to keep his eye on the ball and his ego in check. As far as I've seen, he's the only one who's managed to do both.
Since the author likes to play semantic games, let me correct his statement.
It's not that the financial system took on too much or too little risk, it's that it took on the WRONG risk.
Anyone with a brain and who didn't stand to gain from a 6-7 figure non-clawback bonus could see the real estate collapse on the horizon.
The underlying risk of real estate collapse was a problem, compounded by orders of magnitude due to leverage and "investment vehicles."
I beg to differ. To me, it is not a question of too much or too little risk, it is more of a mismatch between the time period for risk and rewards. If you have two investments, 1) the rewards are immediate but the risk is spread over a long period of time, and 2) where the risk is immediate but the rewards are spread over a long period of time, what will you choose?
1) is an example of all that went into securitization, 2) is an example of alternate energy.
We all know the answer of course.
They were driven by the money too, they just wanted to use that money for a status symbol.
Exactly. They weren't just DINKs. My older sibling, friends were part of it.
tranches of lunacy writes:
No, Ipod, they bought those houses because they thought they could make insane profits for very little effort, in a very short span of time. Time is the issue. Productive investment in say, alt energy, takes time. This is a get rich quick society.
Or because they believed the realtors when they said 'Buy now or be priced out forever'.
What possible value was added by "greener" inner city condos over the triple-decker apartments that they were created from? 20005 did not represent a global boom in blown-in insulation.
And the flip side of debt is lending. Somebody was writing real checks during those years.
What they were looking for was yield in a yield-starved world, which existed because of demographics on the demand side, and on the supply side, rates were held artificially low. I would argue that in part this is s symptom of the greater concentration of wealth in the last ~decade. Give a poor man 5% more moeny and he'll spend it. Give a rich man 5% more money and he'll invest it. This was the justification for decreasing taxation rates on the well off and on capital gains. Unfortunatly, most of that money ended up chasing itself around Wall Street while doing little to improve productivity. Most of the "growth" that we were promised turned out to be an illusion.
The other demographic trend was the Boomers trying to save up for retirement in their peak earning years. This might have worked if their deferred gratification had gone for productivity improvements instead of just bidding up a huge financial bubble.
We've trained a generation of professionals to forget that investing is precisely the art of taking economic risks, then delivering the goods or eating the losses.
I think it goes a bit deeper than that even. We've got an entire society focused on the very short term. In business today, the focus is on establishing the highest short term growth possible while ignoring the long term.
The housing bubble is a prime example of this. People were speculating on real-estate, buying and selling homes in months rather than seeing them as long term investments. There's no way people would have been doing what they were doing if they were planning to hold the inventory for even a mere 5 years.
Most investing is rewarding risk, but only in the short term. Long bets are largely derided because it doesn't yield the dividends now. The worst part is that this is even true in the day to day operations of business, not just investment. How many businesses now outsource their core business to 3rd parties in the interests of short term costs savings but end up creating their own long term competitors and undermine their intellectual capital?
tranches of lunacy said: "I don't buy that most of these people didn't know there was risk, they were just overconfident on their ability to pass the hot potato to the next sucker."
I completely agree! I personally KNOW a lot of people who are completely willing to step into Multi-Level Marketing crap and Pyramid Schemes.
When I talk to them they're not stupid and they know EXACTLY what these schemes are.
The mentality is to pass on the problems and they get a profit out of this system before it collapses.
No.Ethics.No.Conscience.
These are the same people who want to Get Rich Quick, and are in Real Estate Bubble head over heels.
Everytime I talked to someone like that who sold during the heights, he snickered at the sucker who bought it from him, because he knows full well that sucker cannot pay.
These are the kind of people buying houses. What I'm surprised is that they're NOT in small numbers!
When I ask how can they do so much harm conscientiously -- They look to me like I'm an idiot.
The risk is the US government defaulting on it's debt trying to prop up insolvent banks and keep overvalued assert prices inflated along with the unfunded liabilites of SS and Medicare. Plan accordingly as time is short.
The biggest con of all was the absolute "lack of risk" in the stock market.
This mindset, like this post points out, actually increases the risk.
The very fact that it was "common knowledge" that stocks outperform over the long term meant that stocks reamined overvalued.
Stocks are not a good investment per se, but only a good investment if you are able to buy low and sell higher.
The very fact that the entire wallstreet mantra that longterm buy and holders are guaranteed 8-11% interest meant that stocks were never sold off to any degree to allow people to actually buy some cheap stocks.
By definition stocks will underperform longterm precisely due to the near universal belief that stocks outperform over long periods.
Just as the mantra that "housing never goes down" is dying a slow death, so too will the mantra that those who faithfully plug away bi-weekly in their 401k will be handsomely rewarded.
Perhaps some historians can research periodicals for the existence of the mantra "buy and hold", "invest for the longterm", "stocks always go up over time" during past periods where it truly was smart to continually accumulate stocks for the long haul.
S&P offers more risk opportunities!!! Downgrades continue on European corporate credit
What is the difference between "investing" and "betting"? Why do Americans now refer to buying an equity as "betting".
what is difference between synthetic debt and nominal debt?
Jim A., that was part of my point.
Opportunities for real long-term growth in the developed world are rather dependent on a thriving middle class. Unfortunately the program of the ultras to impoverish labor while enriching themselves has short-circuited that engine. Which is why all that money has been chasing unproductive asset bubbles instead. They're not creating any wealth, just leveraging it and passing it around.
I don't really expect the rich to hold onto their money. Sure, extreme disparaties in wealth are sustainable in countries without a large, stable middle class, such as Mexico, as long as you are happy with the levels of wealth and wealth creation found in Mexico. Unfortunately that's not enough to support today's ultras.
We have, over the last 20+ years, transformed our society into investors rather than producers. The logical consequence of this democratization of investing is that the tolerance for risk goes down. Social Security privatization is controversial because - right or wrong - SS is seen as the last safety net. To put the last safety net at risk seems inappropriate.
Our pensions have changed into 401(k) that are subject to losses. Our homes have similarly become susceptible to loss - at least it seems that way now more than before.
Not everyone is able to deal with such high stakes gambling with their future, but they are forced into it. I just don't think that's healthy for our society.
The naked guy is right. Our short term focus is not helpful to our long term security.
"Give a rich man 5% more money and he'll invest it."
The definition of the word 'invest' is the heart of the matter, isn't it? To be blunt, we have a wealthy upper class now in the US who is not smart enough to invest, so they gamble instead. They have so much liquidity that it cannot be put to good investment use - it swamps the market, it chases diminishing prospects... so they levered up and went for broke. And got there.
I think we are also missing another aspect of the securitization mess. Wall Street is associated with not only greed but also hubris. Some of the people involved in this asset slicing are very smart, but a lot of their bosses are not too bright. However, what they lack in intelligence they make up for in arrogance. Train coming down the tracks? No problem, just gun the Beemer...
It seems I drew something different out the original article than others.
My take was that most investors are unwilling to take a risk on an actual physical product. There is a love affair with investing based on financial models, not products. The financing then drives the products.
The housing bubble didnt arise because lots of builders planned to build the burbs. It arose because many investors felt home mortgages in the burbs were a safe bet. This gave the builders the money to build the safe product. The same goes for pharmacuetical companies that spend about 10 times as much on marketing as on new products, for car companies churning out the same products (only with new trim), and for oil companies that spend far more on stock buy backs than on drilling for oil.
Many investors at the institutional level wont risk their money on anything that does not fit into their mathematical models, things like new products, new technologies, or actual production plants. In todays market, the funding that years ago helped start Ford would have gone instead to the buggy whip makers and horse farms (based of course on triple AAA solid gold analysis of historical returns for buggy whips versus the unquantifiable returns for the newfangled car.)
I appreciate that the dot-com bubble was the reverse. But it seems that many have learned the lessons of the dot-com bubble all too well. And given the "risk" of investing in a new product, versus the "risk" of trying to squeeze extra return out of existing products, I would go for the former every time.
To be blunt, we have a wealthy upper class now in the US who is not smart enough to invest, so they gamble instead.
As I said, it's the job of a free market to find those who don't know how to handle their money, and relieve them of it.
I think this will happen, one way or another.
I'm sorry, but the idea that investors took on "too little risk" is just inane, as is the idea that "The banks and SIVs that bought up 'super-senior AAA' tranches of CDOs were looking for safe assets, not risky assets."
The banks and SIVs and conduits that gobbled up super-senior AAA tranchs of structured dogs-breakfast were NOT looking for safe assets, THEY WERE LOOKING FOR YIELD. AND for regulatory reasons they needed the AAA fig-leaf to hide behind, but all they were doing was an absurdly leveraged carry trade off the balance sheet.
So on the investment side of this debacle, the problem WAS people taking on way too much risk, mostly in pursuit of yield because you have to have positive carry to make a leveraged carry trade work . . . . . . . too much leverage, combined with too much credit risk and a bit of maturity risk thrown in is the stinky old rot underneath the porch eating away at the foundation.
Too little risk my left foot.
Bubbles are a collective lack of imagination in capital allocation.
Not so sure about the idea some posters have blaming short-termism. The US is supposedly obsessed with quarterly results and getting it all today. There's some evidence of that - e.g. underinvestment in infrastructure is probably underdone because the IRR looks poor.
Yet we have the largest biotech sector in the world. And that is anything but a quarterly based business - more like decades. And don't give me the free and liquid markets explanation - I;ve spoken to lots and lots of foreign institutional investors/funds and the appetite for long-dated and uncertain payouts is simply lower overseas. Perhaps we are simply greedier - so we are more likely to look for both quick flips in LBOs and lottery style payouts in venture capital.
Another possible explanation for a lot of capital misallocation (besides lack of imagination) is our bizarre inability to see and weigh externalities. Building extra power lines may be unpleasant for those whose yards they pass by, but the total social cost of a blackout is far higher.
Typo - should read
"investment in infrastructure is probably underdone because the IRR looks poor"
Stocks are not a good investment per se, but only a good investment if you are able to buy low and sell higher. Not really. There is a methot to give returns on investment in the absence of stock price appreciation. They're called divedends. If the equity is priced right, then divedends provide reasonable returns.
On the issue of biotech, ie "Yet we have the largest biotech sector in the world. And that is anything but a quarterly based business - more like decades", I can't speak to the risk perspective of foreigners, but in the US, there's ample evidence of systematic risk-seeking behavior regarding long-shots.
Multiple studies of pari-mutual wagering show that long-shots are systematically overbet to the point where (on average) the favorite in horse races is the best bet. Similarly, lots of analysis of CBOE option pricing back in the 1980s and 1990s showed that far out of the money call options were systematically overpriced.
The idea that "too little risk" contributed to this debacle is just silly. Capital was badly allocated, for sure, but the problem wasn't anything like taking too little risk.
Well, the essay is interesting because it's certainly true the risk taking that occurred for housing was not random risk taking and (maybe) was motivated by desire for a "sure thing" -- another form of greed.
Randomized risk taking is safer for the financial system (if not individuals) and such random risk taking possibly did diminish when so much investment money was concentrated in building, houses and empire.
When everyone piles on the same safety raft, at some critical point it ceases to float. And instead of random drownings, there's a uniform drowning of all. Equilibrium is disturbed beyond recovery.
So who exactly aggregated all the risk behavior into the same kind of risk? It takes an unregulated industry. That's who.
Quirk's Marketing Research Review has this cute article by Jim Berling about why industries fail to learn -- it's called on the job learning. "Learning is often passed on from one researcher to the next by telling them to review old reports, projects and questionnaires for future studies, not realizing that errors made in the past are now being repeated over and over. The cycle of reproducing the same errors continues until someone within the organization takes a stand and challenges the status quo." Who wants to challenge the status quo, get ridiculed and fired? Its a rare soul.
Dot com= risky and sexy
Mortgages= safe and sound
That herding behaviour will always happen and in this case, it went manic depressive in less than a decade. Wow.
Next up...CDS.
Interest rates are a barometer of risk. Given they have been historically so low, perhaps is a good indicator of a low-risk environment which indirectly supports Waldman's argument. If people were taking on truly courageous risks, wouldn't interest rates be higher to match that level of risk? Wouldn't ordinary savers who are unwilling to take courageous risks themselves expect a higher rate of return from the bank?
this article is nonsesne. it was a complete misallocation of capital in search of fantasy yiels above tresuries
here is a question posted by a blog. would chuck prince be fired even earlier than when he was dancing
That was the Internet bubble.
This article by James Fallows, written for the Atlantic Monthly back in 2005, holds up remarkably well. There are some things that have broken a bit differently, but he's nailed most of it.
Countdown to a Meltdown - The Atlantic
(July/August 2005)
I sure hope he's wrong about where this all ends up (not good) but I suspect not.
Countdown to a Meltdown - The Atlantic
(July/August 2005)
why hope that the inevitable will not occur. why are we saving a flawed system to begin with. let it burn to the ground. why does everyone hope for the best? i hope to get back into US equities at some point in time but no where even close to current levels.
Well, the gummint promised them your Social Security funds, and they were expecting that money five or six years ago. If they'd gotten what they were promised, they could still be bubbling.
Now they're scared of the upcoming election and they know they were promised a big bundle of money.
Where else would the government get it, if not your pension money?
Ey? Ey?
It's very important to restore the confidence of Wall Street.
This article is interesting, but it engages in a lot of blaming people for doing what they are supposed to be doing, rather than predicting the future perfectly.
On the asset management side, the reason why mortgages were preferred as the "safe" security was the mistaken belief that they could not all go TU at once. As a result, the hope was that you could tranche the mortgages, and create the needed "safe" assets at the senior levels. That did not work.
But his alternative, capital investment, is an even more dubious means to generate a safe asset. If you have a large junk bond backed by a speculative investment, it's either gonna work, or be a complete write off. No realistic way of converting it into a safe security. (Yeah, there was an attempt to do that with corporate CDO's, but that was largely investment grade underlyers.)
End investors do actually put money in money market, bond funds etc. They want safety and liquidity, which trumps the expected return. The manager of a government bond or money market fund is not going to be employed long if he starts plowing his assets under management into internet and solar energy start ups. For all I know, he could even be jailed for doing that.
And complaining that the corporate managers were not investing in useful projects, that's just plain silly. They were - in China. Given the record corporate profits seen in the 2005-2006 period he highlights, why would corporations go out and borrow to invest? They were swimming in cash flow, and corporate bond investors were a lot harder to deal with after the Enron and Parmalat incidents.
What savings glut? Undischarged bank credit is always going to end up in some account. The idea this was a savings glut is insane, as that would imply what was spent in the first place was saved. Monetization of future income is more like it.
tanta, you just keep racking up the points. outstanding! thanks
Frankly, I don't think most of you have given any thought to what Waldman is saying.
mp | 08.07.08 - 2:18 pm | #
Exactly. Also liked & agreed w/ the 'human capital' comment.
:::::
Excellent post Tanta - one of the very best of the many good ones you've posted lately.
One of my mfg profs (ran a couple half billion dollar a year companies before going academic) used to say about risk...
"Nothing wrong with putting all your eggs in one basket... but then YOU had better take damned good care of YOUR basket."
He thought that while this strategy wasn't without risk it was still better than 'diversified neglect'.
Steve Waldman says the notion that the financial system took on "too much risk" in recent years. I think it is equally accurate to suggest that the financial system took on too little risk. That notion might be true on some level, but it might be more accurate to suggest that the reason the system bubbled and misfired was because of flawed policy coming out of Washington. At even, when we concluded major trade agreement with potential competitors, the financial system still failed to take on the the right kind of risk as we opened the door to job and technology transfer.
Think of the Global- WTO agreement, the Regional-FTAA(Free Trade Area of the Americas ), NAFTA(North American Free Trade Agreement), APEC(Asia-Pacific Economic Cooperation),MEFTA(Middle East Free Trade Area Initiative), etc. , the Bilateral-(Malaysia, Singapore, Colombia, etc.) trade agreements.
Michael E. Lewitt, seems to concurs as he writes In addition, unstoppable economic and historical trends such as globalization caused a shift of jobs and factories to geographic locations with lower labor and materials costs, resulting in a transformation of the U.S. economy from one that manufactures goods to one that traffics in intangible items. At that time, could the capitalists have taken the risk of mothballing rather than dismantling factories and maintaining critical human capital through the temporary downspike? Woe unto those who don't understand the economic life cycle of production systems, one tends to look backward when one should look forward.
Why didn't we make policies that would have compelled the financial system to take the kind of risk to break our fatal addiction? In a word: greed.