Same Economy, Different Bubble
from the and-it's-going-to-pop dept
Last year, The Onion (which has a knack for predicting the future in really scary ways) had an amusing article: Recession-Plagued Nation Demands New Bubble To Invest In. In the immortal words of Homer Simpson: "It's funny 'cause it's true." And, indeed, one of the big fears we've had since the beginning of the government's response to the financial crisis is that it hasn't been doing anything to solve the real problem of a lack of transparency. Pumping more money into the system without fixing that simply meant that we'd repeat the cycle, with the money eventually finding some bubble again.At this point, it's worth taking a step back, and understanding why these sorts of bubbles occur. Sometimes, investment bubbles can actually be quite beneficial. In markets of true innovation, where a clear success story or business model hasn't yet been worked out, a bubble allows a lot of money to be thrown at the problem at once. From that, you get a lot of ideas tested in the marketplace very rapidly. Many of them fail once the bubble collapses, and many investors lose money, but the ideas that do work and do stick around tend to takes us forward in leaps and bounds. Bubbles in innovative technologies function as a form of speeding up the innovation process and getting lots of infrastructure built and ideas tested rapidly. It's no fun if you're caught on the wrong side of the investment, but for society, it can be a net gain.
However, that's not what happened in the last economic crash. That was built on a different sort of bubble, based not on funding innovation, but on a series of arbitrage plays where bankers actively worked to obfuscate risk, so that it could be passed on to the latest sucker. Basically, they kept taking riskier and riskier assets, and packaged them in a way that they looked less risky. Then, by making it so no one could really look at (or understand) the true risk, they could sell these super risky investments off to suckers at prices as if they were safe. And, since such a house of cards takes a while to collapse, it doesn't take long for everyone to pile in, feeling like they have to match those returns.
So, the answer to this is to increase transparency. If you could really get the information out there, such that people could look at the underlying details and properly calculate the risk, not based on random clueless rating agency employees, but in a true market, then it would be that much more difficult to pass off and misprice super risky vehicles as safe.
But that's not what's happening. Without any efforts at increasing transparency, combined with pumping a ton of new cash into the market, we're getting another bubble. The bankers are still operating the same way they did in the past -- which is looking for ways to obfuscate the risk and find new suckers to take the risk off their hands without really understanding how to price that risk. It may be securitizing life insurance or it may be in the carry trade. It doesn't really matter. The money is looking for a new bubble and a focus on short term profits over long term sustainability -- and that's enabled by allowing banks to play "hide the risk."
This is really quite worrisome. It's been over a year since the financial crisis went into panic mode (even if the actual recession and problems significantly predated that). And while the "worst case scenario" did not occur, there's been little evidence of real fixes to the economy or any attempt to really fix the factors that resulted in the original problem. Instead of creating transparency and a long term strategic focus, we're just pumping cash into the economy to try to help suckers find the next bubble.
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Filed Under: bubble, economy, financial crisis, radical transparency, transparency
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Also a political failure
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Speaking of artifical markets...
But hey, why let the facts stop a good boondoggle?
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Deja Vu all over again
A list of some problems not being addressed: http://www.marketwatch.com/story/well-great-depression-2-2011
No one seems to heed the age old saying: Caveat emptor. Why didn't those in charge of the people’s money do any homework on the investments that turned out to be shams, because they're morons and should be put in jail.
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Re: Also a political failure
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Re: Speaking of artifical markets...
You seem to assume that both the total cap and the number of allowances offered for sale on the market will be constant over time. Neither is true.
Whether the reduction of CO2 emissions is beneficial to society or not and whether it's worth the cost is another question, but that's probably beyond the scope of the subject of this blog.
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A relevant, shameless plug
I really got the feeling that Moore's researchers troll here. If they do, well, kudos on the film, guys.
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Re: Re: Speaking of artifical markets...
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Re: Re: Also a political failure
True, Fannie and Freddie were put under pressure. But let us not forget passage of the 1999 Republican Financial Services Modernization Act that repealed Glass-Steagall, supported by Joe Biden, Robert Rubin and Larry Summers, signed by President Clinton. It passed the Senate with 90 votes.
Then the 2001 Commodity Futures Modernization Act sponsored by Republications and signed by Clinton. This gave birth to the securitization of bundled loans making it effortless to pass risky loans to suckers and insure that risk with the infamous credit default swap.
Lastly, the lax regulation from the Securities and Exchange Commission in 2004 that allowed investment banks to increase leverage from 12-1 to 40-1. This meltdown seems to be a truly epic governmental failure and the only true bipartisan thing our government has done is sometime.
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Re: Re: Re: Also a political failure
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Re: Re: Re: Speaking of artifical markets...
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Re: Re: Re: Re: Also a political failure
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Re: Re: Re: Re: Re: Also a political failure
The world is not defined by Democrat/Republican. Addressing both sides of that coin does not "cover" or "balance" the issue. There are plenty of other options such as thinking for yourself and not letting any party, even a small underdog, do your thinking for you. The problem with political parties is that they all, yes ALL, want to legislate their version of an ideal world. What they all fail to notice is that we don't live in an ideal world, and we never will. Good governance should observe reality and work from there rather than decide what reality SHOULD be and attempt to cram the world into their box.
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Re:
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Transparency is not the issue
However, regarding the subprime market's effects on the investment market, transparency only does so much. Poorly conceived regulations have done so much to create bad incentives such as valuing debt over equity, forcing recognition of Moody's and other fallible ratings agencies under threat of penalty, giving out bad homeownership loans under threat of penalty, and extensive implicit government bailout guarantees that it becomes more advisable in the long run to invest in the bubble than to actually make sounder investments in other ventures.
Transparency is great, but that has nothing to do with the bubble itself, and the compulsions to invest poorly exist independent of it. Many people at the heart of this issue knew the market was risky and they did it anyway because the government created moral hazards and incentives to pass the buck.
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Re: Re:
I agree, Ima, but the tech industry survived, and was partially financed thru the insurance industry. Having insurance on employees is a quick way for the company to self-fund itself. After all, there are multiple hurdles that need to be overcome for companies to satisfy certain capital requirements for going public or otherwise.
So the way the current system works, new tech companies often take out a life insurance plan on it's employees and claim the say, $1.5M policy as an asset of the company in order to meet certain financial and regulatory hurdles. Thusly, the assets of the company include what is routinely called "Peasants Insurance" in the industry. Today, some 20% of all life insurance plans written are of this "Peasants Insurance" flavor, and The Company is named as the beneficiary.
If the company goes under, The Company could still list the plan as an asset in bankruptcy filings, and the policy can be transferred or otherwise.
A few years ago, I was doing some research, and learned that I have a $10M policy a previous employer took out on me. I suppose I should just commit suicide or something. But fixing the problem is more fun. :-)
See the Michael Moore Movie.
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Scary Onion
Do they put on Halloween masks before they make their predictions?
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Re: Re: Re:
If regulatory capital requirements are compelling companies to take out stupid life insurance policies to inflate their worth in court, then that seems to me a good reason to relax or eliminate a lot of those requirements and allow investors to determine the worthiness of their investments themselves--nobody else will be more thorough or discerning in rating worthiness. But what does all that have to do with VCs and their potential usefulness for entrepreneurs?
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Re:
Now, to address your separate point(s): "Why don't we just educate ourselves before we sign up for things, like interest only or adjustable rate home loans?" Okay, to a degree, you're right. Caveat emptor. However, there are several reasons why that is not a valid argument in this instant.
First, mortgage companies were downright deceptive in their practices: hiding costs; encouraging buyers to take out arm loans and "refinance" later, which the mortgage company later refused to do; changing loan terms at the closing table; impossible rate hikes at the end of arms; preying on those without the education/ability to understand the ramifications of long-term interest; etc.
Second, Americans tend to trust experts. When a doctor provides a diagnosis, we can do a little research, but we are not expected to have knowledge equivalent to 12 years of medical school. We generally trust the diagnosis. The law recognizes this and holds the doctor accountable through malpractice liability. If we go to a mechanic and they say we need such-and-such repair, we generally trust that. Again, we can do a little research, but we wouldn't need the mechanic if we had their level of knowledge. So, we go ahead with the repair. If we later find out the mechanic lied or misdiagnosed the problem, we can take them to court for it.
The problem is, there is no real legal check for mortgage companies. People assume the agent is an expert, and when they say the person needs such-and-such a loan, the person generally trusts them in the same way as above. Unfortunately, there are no protections for the consumer when the loan turns out the bankrupt them later. I agree that it is the consumer's responsibility to know the terms presented to them. However, regulations need to be in place so that those terms are clear and easy to decipher. Something like the mandated Nutrition Facts label ought to be a required first page on any loan, so that consumers can easily compare. All possible rate hikes and the associated payment increases should have to be disclosed ahead of time. Finally, further restrictions on interest rate hikes should be in place. The fact is, there are loans available that are purely predatory and a losing deal for any consumer. Those types of loans should not be legal.
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Re: Re: Re: Re: Re: Also a political failure
While they have us fighting back and forth amongst ourselves, they are taking our liberties and freedoms away and ruining this country.
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The Great American Bubble
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Not Transparency
Bad government policies caused this mess. From forcing financial institutions to loan money to people who could not possibly pay it back, to encouraging HLTV lending without down payment, to encouraging lending without due diligence, to mandating one-size-fits-all capital requirements and defining asset classes with credit ratings, to empowering the credit agencies and encouraging the use of modeling that is necessarily backward-looking, to providing implicit and explicit government guarantees of private debt, to acting in an arbitrary and panicked manner while controlling the fate of private institutions, etc, etc, etc. . .
All of this was blatant and extensively disclosed. Transparency was not lacking, except when the government was debating which companies would be propped up and which were allowed to fail and which got billions in taxpayer funding.
The idea that the 535 least qualified people in this country could manage the financial system to their political goals is what caused the financial crisis and will cause the next.
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