Fooled by Randomness
- Thread starter johnny88
- Start date
They were running ads on radio & TV selling houses with ZERO down in a runaway market that had exploded to the point where payments before the reset were stretched and after (and you knew when a half trillion would reset) left millions underwater and upside down.
In the UK Northern Rock had lent tens of billions of dollars in the mortgage market at up to 117% of already pumped up prices. Their rational for going well over 100% of appraised value was that people needed to furnish a house particularly if they were stepping up market.
Long before the bust came here the UK government had gone for over $100,000,000,000 dollars on a Northern Rock bailout/takeover. This is a society a quarter the size of the US going for unprecedented sums well before Bear Sterns slipped away. Front page news (banner headlines) in every financial publication in the world.
These are not events that require a direct line to the Oracle of Delphi or a member of the power elite. These were observable events in real time not in hindsight.
A friend of mine who is a union electrician (Local 3) here in NY moved 25% of his retirement money from equities to highly rated corporates in late 2007. Days after Nothern Rock went down he moved another 50% into bonds and immediately upon his return from a visit to his family in Ireland he told me that everyone in Ireland was up to their eyeballs in debt just like here. I couldn't convince him to begin going short but he needed no convincing to get out of the final 25% in equities.
I understand every word you are saying. You are an intelligent, well spoken man. I'm not missing your points I am telling you I have a very different opinion. I disagree; not such a strange thing in a debate. I not only don't think these were observable events I think the markets were shouting at us.
That said I was still net long up until Bear Sterns went (stupidity) and not significantly short until the week before Lehman went down. The week when their stock was clearly being shorted by their own hedge fund clients. As was widely reported in the press the hedge funds were shorting the stock and simultaneously pulling massive sums in cash and securities from the prime broker relationship. Nice work if you can get it. Short it as you kick it down.
I was far too conservative and used too little leverage. I picked up more than nice bit of change but did not make a major killing. I covered in early November of '08 and am trying to turn myself into a day trader of equity indexes and currencies. Maybe crude as well at some point.
Let's debate the facts that were available to a union electrician and not those only known to the elites. If you would like to discus these points I am happy to. If you are just going to tell me I can't read the words you so clearly write than this is not the debate for me. I am not asking you to agree with me ... just that we talk about reality.
There was no noise except the 50,000 Watt All Clear Broadcast blasting us the unambigous message that the problems are so real that liquidity is drying up and both home prices and common stock prices are in decline; the deficits have gone from merely obscene to downright perverse and two wars are costing us both blood and treasure even as the UK is struggling to avoid a run on its entire banking system. In fact there was a brief run on the Bank of Scotland following the Northern Rock run.
I am a bit annoyed at myself for being semi-timid in my activities. At that time I still thought a bit like an investor. But it was there for all to see without a model just a newspaper.
I felt your first reply was a bit pretentious, and so, responded with a similar tone (something you get used to on ET). That being said, I am all for civilized discussion and I hear your viewpoints as well.
It has just been my personal experience, that while markets may be screaming one thing, it is quite possible for them to do another. In the anecdotal case you point out, with many illustrations of cracks spreading across the ship's bow, it was in no way certain at the time that events would play themselves out in the manner they did.
I can't tell you how many times I've seen similar causal events and had my head handed to me for betting in the manner you wish you had (since in many cases, the "effect" was not logical). This is why, IMO, the famous quote, "markets can remain irrational longer than you can remain solvent," is so timeless and enduring. Anyways, thanks for discussing. As always, couth speaks a thousand times louder than opinions. We can all have opinions, but not all have tact.
Respectfully, dt
Which is a fine explanation for plain vanilla options, swaps, and futures that are traded at the exchange and therefore have no real counter-party default risk (all the players pay insurance to the central broker to cover counter-party defaults). With OTC, counter-party default is a big risk. Not taking it into account is, well, quite frankly, stupid.
The inputs were lies. The assumptions used to evaluate all manner of packaged and then distributed assets did not relate to any known reality in this solar system.
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Not enough historical mortgage data. Defaults occured in the past due to high unemployement numbers and high interest rates, at the time neither of these numbers were a cause for concern.
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Not enough historical mortgage data. Defaults occured in the past due to high unemployement numbers and high interest rates, at the time neither of these numbers were a cause for concern.
Default risk on an exchange is a real risk, it's just smaller because all the brokers act like a mutual insurance company. Funny thing is though, without government bailouts do you think the collapse of major brokers would have left exchanges unscathed? The myth of exchange invincibility is just like the myth of US govt "risk-free" lending.
He is not right. Exchanges have risk only when they cannot deliver physical commodities, a totally unrelated situation to financial paper. Otherwise, they have no exposure to the instruments traded. They just collect fees by insuring sufficient counterparty collateral and adjusting it frequently based on market conditions. A real estate broker for example that has ho exposure to real estate can never fail. They may end up having no business but they can never fail due to debt accumulation.
Indirectly, he is arguing in favor of the bailout. These arguments are pure non-sense because they rest on hypothetical situations.
The fact of the matter is that probability of OTC transaction default is orders of magnitute greater than that in an organized exchange.
Again, I disagree...
1. Just saying "too big to fail = bad" is not prescriptive, very vague and hardly original. Everyone and their mother has been saying that and some, like NNT, were saying that before the crisis. The devil's in the details. How do you define "too big"? How do you prevent institutions from getting too big? How do you reconcile real "economies of scale" efficiency gains with increased systemic risks? Moreover, if there's regulation to prevent institutions from getting too big, how do you avoid regulatory capture and arbitrage? It's easy to be a 'big picture' guy and there's a lot of those around, including NNT.
2. What specifically is his approach to the mkts? That extreme events in the mkt cannot ever be predicted, that they are unknowable and therefore trying to understand what happens when things are in or near collapse is futile? I say that's either a bullsh1t copout or a publicity stunt. As I keep saying again and again, science is EXACTLY about trying to "impose structure and limit on something that inherently seems to have none". If we keep assuming that anything beyond the pale of our current understanding is unknowable, we will never get anywhere. Luckily, there are good academics out there and they keep trying (I have given examples). They're the ones that should be in the spotlight and not NNT. As to the comparison to Scholes&Merton, I don't know what that has to do with anything. That's like saying that NNT is better than Isaac Newton, just because the latter lost a fortune in the South Seas bubble. Individuals' real-life economic decisions and their contribution to human progress are two very different things.
Agree...
The issue of cp risk is a complex one. It's very true that, in the period leading up to the crisis, banks and institutions increasingly began to treat liquidity and counterparty risk as an afterthought. After all, what can possibly go wrong with a AAA-rated counterparty like AIG? The issue was further exacerbated by all sorts of fancy legal footwork that banks could use to confuse clueless regulators. In the end, at times it was completely unclear who the counterparty was (esp in the case of SIVs and other off-b/s vehicles).
Again, this to me is not necessarily a demonstration of the flaws in the model, but rather of how people misuse it. The basic idea of collateral, ISDA CSA etc is sound, at least just as sound as an idea of a central clearing cpty (e.g. an exchange). Problems start when people start abusing the idea. In the case of CDS and AIG, it's clear, for example, that tying collateral requirements to the counterparty's credit ratings can beget a negative feedback loop.