Dear Friends: A new entry fro Professor Athena, a highly placed member of the financial services community. It is a grand opportunity to learn a little about basic economics:
Let’s pretend we’re in a college-level class called “Risk/Reward 101”. The instructor is attempting to teach risk, and logically chooses gambling on the Kentucky Derby. The question leveled to the class is, “Which is the riskier $2 bet, the horse coming off the line at 20-to-1, or the one coming off at 5-to-1?” O.K., so this doesn’t take a college-level class. Just about anyone can answer this question. What may take the empirical evaluation is why certain students in the class would actually prefer to take the higher-ratio risk with their $2. They may say they like the jockey, or the horse’s previous record of wins, or they may even choose by color. But the behavior first of the pool of available bettors determines the odds and the payout. The higher the payout, the higher the risk you are taking. The lower the payout, the lower the risk you are taking.
Let’s now jump this discussion to financial markets and the inherent risk attributable to capital markets and especially with regard to institutional investments. The recent meltdown of U.S. financial markets is inaccurately attributed to subprime mortgages and greedy investment bankers. In reality, it is much more attributable to the demise of two primary dealers in that product, Bear Stearns and Lehman Bros. and the Treasury’s mismanagement of that situation within a 6-month time frame when credit markets reached such disarray as to be dysfunctional. When two major market-makers in a variety of fixed income and equity products basically evaporate within a short time frame, the change in the liquidity and inventory bubble has a ripple effect. Treasury was asleep at the switch and relying too much on empirical models and not enough on what credit markets were clearly signaling. You can learn a lot about the horses at the barn, but you won’t see many races run there. Real buyers and sellers were signaling a significant change in the real estate markets as far back as late 2005. There was time to react, and those in charge of monitoring leveraging at various Wall Street firms and of financial derivatives products being underwritten by insurers are the ones to blame for their failure to stop the exponential risk taking. This is why there is a legal limit at the betting windows.
So now we come to the repercussions of a speculative bubble in U.S. real estate markets, where history had long shown the ability of repayment of single-family mortgages within certain parameters, and where bets by Wall Street had been so placed, and we have some in Congress and in the press who are exhibiting shock and awe that regulations were not already in place to prevent such an occurrence. Further, they are expressing belief that a new Czar or Wizard or Daddy of All Bonds can come along and prevent such a recurrence. Yet the logical question has never been asked why we would assume we can
find a method to make everyone’s ticket an equal winner on race day. There is no such thing as socialism at the race track.
Capital markets are our financial horse race, and they are based upon perceived risk, just as are morning quotes on the board at the track. How accurately that is measured is something an expert might call “volatility”. But it boils down to individual choices and is the essence of how our capital markets effectively function. Without freedom from oversight and control, we don’t have those free choices determining the ratios, and instead we have artificial fixing of the odds. Who would ever bet at the track again if they thought the horses all had the identical chance to win? Leveling such a playing field to attempt to reduce risk in financial markets is equivalent to each horse receiving not a pre-race handicap, but an identical photo finish after the fact. We should instead work to make certain the betting is determined by the players in the markets, because those who lose a lot of money have typically less to play with in the future, not to mention less inclination to pick another long shot right away. We have plenty of laws and regulations to address risk within the financial system, but not enough enforcement to punish those who break the rules promptly, before the effects of their deeds punish others throughout the system, just as dirty fixes in horse racing have a detrimental effect on other participants who bet the odds honestly and who have done nothing wrong.
The Obama administration, initially sure that more regulation and a bigger all-inclusive regulator would mean speculative markets never again punished speculative investors, have today backed off their plan to re-work the myriad of federal regulators that examine and regulate U.S. financial institutions. In yet another reversal in a string of speeches that promise change, it appears the trend is keeping things more or less the same. So much for a cabinet-level position of “Director of Homeland Mortgage Securities” (Code Orange for Higher-Than-Usual Mortgage Risk). Though no one in Washington, D.C. ever mentions the U.S. housing market and its loan participants who were at the root of the problem through non-performance of their mortgage obligations, along with decades of crazy credit markets where consumers borrowed at a higher leverage ratio than did corporations, the idea that everything can be fixed by the government may be just beginning its tarnished trail into obsolescence. Anyone who watched the fabulous Calvin Borel ride the rail into a long-shot win at the Kentucky Derby on “Mine That Bird” would do well to remember that Americans like a winner only almost as much as they like a horse race.
MUT’s Money Links:
President Obama promises to create or save 600,000 jobs from stimulus funds, from Capitalist Hero Kimberly. In fact, another Capitalist hero (Lou Pritchett, a former vice president of Procter & Gamble), was inspired to write an OPEN LETTER TO PRESIDENT OBAMA that is also well worth reading. Mut’s Money Quote: Finally, you scare me because if you serve a second term I will probably not feel safe in writing a similar letter in 8 years.
There is this news from Bloomberg: Investors worldwide predict that government bond prices and the U.S. dollar will weaken as demand for better-yielding assets increases amid rising confidence in the global economy, a survey of Bloomberg users shows. According to Professor Athena: This is only the beginning of a new trend of investor awareness of governments who deficit finance. We are at the extreme now, and unless we can get OBAMA and his liberal spenders OUT, no one will finance us over other assets available.
Interestingly, Obama claims that the government has turned a profit with the bailout. How, exactly? It is because Obama says so, that’s why.
Fire Andrea Mitchell has an analysis of the Dick Morris post that indicates Obama’s Mortgage Relief Plans are an EPIC FAIL!. As a sidenote, I want to thank deeply the Anchoress for the mention in her blog (I want to note, her blending of Catholicism with current events is the direct inspiration for my blend of Egyptology with science and the news). HillBuzz also describes in further detail the corrosion of the economy. I think the Morris and HillBuzz pieces clearly prove I was prescient — Obama is Ozymandias.
Most of my California readers are aware that the big unions, and the burdensome contracts they have squeezed out of our weak politicians, are one of the key problems in our state’s finances. It turns out that Big Labor has spent soooooooo much on politics that it is in trouble. I would have more schadenfruede if it didn’t have such devastating repercussions.
Sarah Palin is a real capitalist hero, that has been demeaned and degraded by a sexist Ork passing himself off as a comedian. I think a good summary of the story, as well as a sound action plan, are presented HERE. There is this great piece from a new blogroll member (Little Miss Attila). As a history lover, how could I not blog-love someone with that name — especially as I like pearls, too.