My area of expertise. Not really, I'm just an enthusiast.
A lot of people have chalked up our financial crisis to greed. In fact, this morning, the news was crowing over the bonuses of several companies on Wall Street in the wake of one of the biggest economic downturns in the last 100 years. Most reporters are asking what government can do to curb these excesses, and the answer is short of a frightening seizure of new powers over our ability to exercise commerce [somewhat] freely, there is nothing that they can do.
But why is this such a problem? I don't think that most people when asked point blank, 'what caused our financial crisis' would directly blame bonuses, though they may point to them as some sign of endemic greed. Instead, ask this: should a private business be allowed to squander its money as stupidly as it sees fit? Should Joe Schmoe who runs the lawn mowing business be allowed to give six figure bonuses to his employees free of government scrutiny ? (Questions of where this kind of revenue would come from for a lawn service aside).
The other thing that I notice in talk about 'Wall Street' is that there should be sweeping new regulations to prevent this kind of situation in the future. Fair enough, but again the question to ask would be, 'have regulations prevented economic trouble in the past?' It is hard to say because the greatest motivator for market regulation, the Great Depression, has yet to be, and God willing will never be, equalled.
In cursory terms, I would like to examine our market situation and all the talk of hybridizing our economy into a semi-free, heavily regulated marketplace. For the sake of the discussion, I will assume that the majority of economists are right, and that free market forces provide all of the incentive necessary to self regulate. This is not entirely the case, but it will make the exercise considerably simpler. Also, let's set aside greed as the prime reason for our recent woes, and rather pin it for what it is: motive.
Let's begin with a balanced economy where the price is a perfect reflection of supply and demand and that the ebbs and flows of the economy are suspended for a steady state. In other words, prices are not fluctuating, but everything is in equilibrium. In this economy, an investor is faced with a new opportunity unfamiliar to the economy at large. It is a speculative endeavor (Oooh! Scary!!) and nobody can really be sure what the accurate price of the completed product will be. The investor evaluates the pro forma, becomes familiar with the risks involved, and decides that the potential gains are worth assuming the risk. At this point, it is perfectly reasonable to conclude that a different investor would arrive at an entirely different conclusion, and pass on the opportunity. It is also reasonable to conclude that the risk involved would restrict the amount of money the investor is willing to commit to the project. After all, he knows what his money can earn elsewhere due to our static state environment. His only motive is the potential of greater gains.
The real life analog to this scenario was the CDO, or securities based on the mortgage. The major difference is the investor, not the risk or the return potential of an investment. Rather than examine details on the investment, people deferred their due diligence to a rating agency and failed to understand, or even attempt to understand what this investment was. But it goes further because this was a double decker of failure. Just as 'Wall Street' sold these CDO's, people having no business obtaining loans for homes and absolutely no grasp on the unchecked growth in home prices which greatly exceeded the rate of inflation, entered into investments of their own. Consider this a rickety piece of shit investment structure on a poorly laid foundation of American trustworthiness to pay back loans.
Few people, other than Donald Trump and compulsive gamblers are willing to put everything at risk on a single investment, and so they diversify (Benjamin Graham, anyone?) into several securities and investments with differing risks and returns (as a rule of thumb, greater risk=greater return potential). So, with hindsight, how could so many people invest so much money in something that was so risky? Well, personally I am left to conclude that for one reason or another, the risk was not perceived. In fact, this seems to be the case with most booms and busts. People see it go up, and for one reason or another, don't seem to recognize the increasing risk in holding these investments. This complicates things because the greater the price, the bigger the bubble, the greater the risk becomes for the stakeholder. Risk is now a moving target.
Was greed the prime motivator for entering these investments? Perhaps for some, but I would hope that this same greed would convince someone to preserve the gains they had made elsewhere. I don't know about the rest of America, but greed in my mind is synonymous with stinginess and most greedy people wouldn't simply give their money away to a risky investment. After hearing from my parents about people they knew involved with the Stanford group, the victims were not greedy, but thought they were preserving their wealth in a safe investment with a good rate of return. They simply didn't apply the rule of thumb and question the return they were receiving.
The risk was there in spades, and yet that failed to deter individual and corporate investors from investing heavily. With that being said, I suspect that no amount of regulation will prevent this from happening in the future. It will be a patch to our economic regulation that will prevent this particular investment vehicle from being used in the same way, but the basic problem remains. So what will regulation get us? I think it depends on the type. If we go the route of the FDIC in the future, where the government inherits the risks of the bank and its account holders, we will likely engage in riskier investments and see even more spectacular failures.
Imagine if there was a government agency that guaranteed that if you walked into a casino, made your way to the roulette table and bet it all on black that you would be able to recover your loss courtesy of Uncle Sam. How many people would go to the casino for the nearly 2:1 payout? I would suggest that part of why we flew so high and crashed so hard is our willingness to stupidly shift the inheritance of risk onto the government which is actually ourselves. If there is greed, it is in those who welcome regulation and a promise of economic support to engage in riskier behaviour at the expense of the tax payer (Read: Bailouts). This is a veiled attempt by the super wealthy to shift the burden of risk onto the middle class who have little clout in businesses in which they are invested, and bear a large tax burden. All the while, the wealthy have everything to gain and nothing to lose (a favourite scenario among investors)
A lot of people have chalked up our financial crisis to greed. In fact, this morning, the news was crowing over the bonuses of several companies on Wall Street in the wake of one of the biggest economic downturns in the last 100 years. Most reporters are asking what government can do to curb these excesses, and the answer is short of a frightening seizure of new powers over our ability to exercise commerce [somewhat] freely, there is nothing that they can do.
But why is this such a problem? I don't think that most people when asked point blank, 'what caused our financial crisis' would directly blame bonuses, though they may point to them as some sign of endemic greed. Instead, ask this: should a private business be allowed to squander its money as stupidly as it sees fit? Should Joe Schmoe who runs the lawn mowing business be allowed to give six figure bonuses to his employees free of government scrutiny ? (Questions of where this kind of revenue would come from for a lawn service aside).
The other thing that I notice in talk about 'Wall Street' is that there should be sweeping new regulations to prevent this kind of situation in the future. Fair enough, but again the question to ask would be, 'have regulations prevented economic trouble in the past?' It is hard to say because the greatest motivator for market regulation, the Great Depression, has yet to be, and God willing will never be, equalled.
In cursory terms, I would like to examine our market situation and all the talk of hybridizing our economy into a semi-free, heavily regulated marketplace. For the sake of the discussion, I will assume that the majority of economists are right, and that free market forces provide all of the incentive necessary to self regulate. This is not entirely the case, but it will make the exercise considerably simpler. Also, let's set aside greed as the prime reason for our recent woes, and rather pin it for what it is: motive.
Let's begin with a balanced economy where the price is a perfect reflection of supply and demand and that the ebbs and flows of the economy are suspended for a steady state. In other words, prices are not fluctuating, but everything is in equilibrium. In this economy, an investor is faced with a new opportunity unfamiliar to the economy at large. It is a speculative endeavor (Oooh! Scary!!) and nobody can really be sure what the accurate price of the completed product will be. The investor evaluates the pro forma, becomes familiar with the risks involved, and decides that the potential gains are worth assuming the risk. At this point, it is perfectly reasonable to conclude that a different investor would arrive at an entirely different conclusion, and pass on the opportunity. It is also reasonable to conclude that the risk involved would restrict the amount of money the investor is willing to commit to the project. After all, he knows what his money can earn elsewhere due to our static state environment. His only motive is the potential of greater gains.
The real life analog to this scenario was the CDO, or securities based on the mortgage. The major difference is the investor, not the risk or the return potential of an investment. Rather than examine details on the investment, people deferred their due diligence to a rating agency and failed to understand, or even attempt to understand what this investment was. But it goes further because this was a double decker of failure. Just as 'Wall Street' sold these CDO's, people having no business obtaining loans for homes and absolutely no grasp on the unchecked growth in home prices which greatly exceeded the rate of inflation, entered into investments of their own. Consider this a rickety piece of shit investment structure on a poorly laid foundation of American trustworthiness to pay back loans.
Few people, other than Donald Trump and compulsive gamblers are willing to put everything at risk on a single investment, and so they diversify (Benjamin Graham, anyone?) into several securities and investments with differing risks and returns (as a rule of thumb, greater risk=greater return potential). So, with hindsight, how could so many people invest so much money in something that was so risky? Well, personally I am left to conclude that for one reason or another, the risk was not perceived. In fact, this seems to be the case with most booms and busts. People see it go up, and for one reason or another, don't seem to recognize the increasing risk in holding these investments. This complicates things because the greater the price, the bigger the bubble, the greater the risk becomes for the stakeholder. Risk is now a moving target.
Was greed the prime motivator for entering these investments? Perhaps for some, but I would hope that this same greed would convince someone to preserve the gains they had made elsewhere. I don't know about the rest of America, but greed in my mind is synonymous with stinginess and most greedy people wouldn't simply give their money away to a risky investment. After hearing from my parents about people they knew involved with the Stanford group, the victims were not greedy, but thought they were preserving their wealth in a safe investment with a good rate of return. They simply didn't apply the rule of thumb and question the return they were receiving.
The risk was there in spades, and yet that failed to deter individual and corporate investors from investing heavily. With that being said, I suspect that no amount of regulation will prevent this from happening in the future. It will be a patch to our economic regulation that will prevent this particular investment vehicle from being used in the same way, but the basic problem remains. So what will regulation get us? I think it depends on the type. If we go the route of the FDIC in the future, where the government inherits the risks of the bank and its account holders, we will likely engage in riskier investments and see even more spectacular failures.
Imagine if there was a government agency that guaranteed that if you walked into a casino, made your way to the roulette table and bet it all on black that you would be able to recover your loss courtesy of Uncle Sam. How many people would go to the casino for the nearly 2:1 payout? I would suggest that part of why we flew so high and crashed so hard is our willingness to stupidly shift the inheritance of risk onto the government which is actually ourselves. If there is greed, it is in those who welcome regulation and a promise of economic support to engage in riskier behaviour at the expense of the tax payer (Read: Bailouts). This is a veiled attempt by the super wealthy to shift the burden of risk onto the middle class who have little clout in businesses in which they are invested, and bear a large tax burden. All the while, the wealthy have everything to gain and nothing to lose (a favourite scenario among investors)
Comments
Post a Comment