Friday, September 21, 2007

We All Fall Down

(Yes, the bear still gets BIG when you click. BIG.)

When Markets Lose Their Minds

Here's the tease. Go read the whole thing.


Free market economics is famously predicated on “market rationality,” the idea that each participant in the economy acts as a coolly reasoning “homo economicus” in purchase and investment decisions. Yet as the disintegration of the 1995-2007 credit bubble continues it is becoming more and more obvious that in several areas economic decision-making during this period has been highly irrational. There are no complete solutions to this problem, but there are palliatives.
  • Subprime mortgages themselves exemplify irrational markets, yet the participants’ activities at each stage were economically in their own rational interest:
  • Low income consumers took on mortgages they had no prospect of affording because they believed from the experience of others that house prices would rise sufficiently to bail them out. In any case being often near bankruptcy the potential profit from successful speculation appeared to them greater than the potential loss from default.
  • Mortgage brokers sold subprime mortgages because they got a commission for selling them and were not responsible for the credit risk.
  • Investment banks packaged the subprime mortgages into multiple-tranche mortgage backed securities because they received fat fees for doing so and again had no real responsibility for the credit risk.
  • Rating agencies gave the upper tranches of mortgage debt favorable ratings, because they made a great deal of money from providing ratings for asset backed securities, needed to keep in the favor of the investment banks who brought them this attractive business, and had mathematical models (either their own or the investment banks’) “proving” that the default rate of the securitized mortgages would be low.
  • Investment bank and rating agency mathematicians produced models “proving “ that default rates would be low, ignoring the real-world correlations between defaults on low quality consumer debt, because they were well paid to do so – the alternative was to return to a miserable cheese-paring existence in academia.
  • Finally the investors bought asset backed securities because they could achieve a higher return on them in the short term than their borrowing costs, and could tell their funding sources (in the case of hedge funds) or bosses (in the case of foreign banks) that they were taking very little risk because of the securities’ high rating.
Each step of the process was rational (albeit operating on imperfect information), yet because incentives were hopelessly misaligned, the final result was an irrational market, in which loans that would not be repaid were securitized and sold to investors seeking an above-market return at below market risk, a combination that in the long run ought not to exist without the application of extraordinary intelligence.

In the credit card business, currently equally likely to subside into a slough of defaults, the rationale was a little different. Here the subprime credit card consumer had no rational basis for believing that anything he bought with the card would become sufficiently valuable to pay off the card debt. Instead, the credit card business became a tribute to the power of advertising; by sending out credit card solicitations weekly to every deadbeat in the United States, the card companies were able to persuade consumers that taking on too much debt was a perfectly natural means of acquiring the consumer goods or vacations they craved. “Homo economicus” would have rejected excessive card offers; in the real world unsophisticated consumers are deluded into thinking that credit card debt is manageable, and that their income will increase sufficiently to service it. As with subprime mortgages, credit card lenders would not have been so aggressive if the assets had resided on their balance sheet, but through securitization they too could delude themselves that they were sloughing off the credit risks onto anonymous third parties.

The derivatives market was also an area in which irrationality held full sway. Here the fault was excessive belief in mathematical models. It was attractive to traders and to operating management to pretend that markets were fully stochastic random walks – after all, Nobel prizes had been given for this assertion – and to assess Value at Risk on that basis, ignoring the reality that markets often behave in a highly non-random manner. By doing this, management could claim to investors that risk positions were in reality modest, while traders could bet the future of the institution on gambles that may go spectacularly wrong every few years, but in the meantime keep the investor capital and the bonuses flowing in.
Nothing stays up forever. There's a reason a dollar in Canada is now worth a dollar in the U.S. (You didn't know? Go read that also.) The Canadian buck is equal to the U.S. dollar. Today is should happen (yesterday it was nudging against the tick.)

Gold is up, the Euro is up, the dollar is in the fucking tank.

Nothing lasts. Especially empires founded in inflated petro-dollars backed up by overwhelming military might. Our boy-king has fucking BROKEN our military, so now we can't shove our petro-dollars up the asses of the treasuries of every National Treasury in the world.

No one's pulled the rug out from under us quite yet, because a wounded Cheney can still bite plus everyone still holds literally billions and mega-billions in U.S. treasuries; they'd be causing their own net worth to be fucked. We would -- not might, would -- retaliate against anyone who started against us. But when the whole world starts selling Treasuries.

It doesn't matter much if we're attacked fast (which is what Cheney is geared up for) or nice and slow like the classic story of the Daddy Bull and the Baby Bull on the hill (someone will tell it in comments.) We're getting fucked by everyone this time. The emperor has no clothes left anymore. Because we've revealed in Iraq just how easy it is for a two-bit country to whoop our ass.

So long of course as we're not going to go in and raise them to the fucking ground and kill fucking EVERYONE leaving dust and radiation for 100 years.

There is that option. There is, always, that option. *nods a very scary hello to fucking Satan in the form of Dick Cheney and his minions*

Which is precisely why this global ass-fucking the dollar is getting is coming with the Daddy Bear (not a bull; we're switching, actually, mixing metaphors -- keep up) and the Baby Bear on the hill coming down slowly. But the United States is going to get fucked by every nation in the world -- including our special friend, England -- just the same.

Take that from the bank and sit on it.

And if you're stocking up, I'd do it in gold and silver bullion coins. Euro denominated funds in overseas accounts. And enough food, water, medicine and other critical supplies to ride out six months. Ain't life grand.

It's not if. It's when.