Like a lot of people, I’ve been struggling to understand this financial crisis over the past few weeks. I don’t pretend to be an economic expert – I’ve always been more interested in foreign policy, politics and history – but the issue of this crisis is obviously so important, it seems that it is everyone’s responsibility to find out what went on, what caused this.

I also feel that this is an issue which is confusing our politics, our partisan impulses. Both the right and the left have many reasons to hate the bailout – yet the pragmatists on both sides agree that something must be done. Everyone is angry. Very few predicted this. I only came across a few who prominently warned about a crisis such as this – subscribers to the Austrian school of economics such as Ron Paul; liberal capitalists such as Warren Buffet and George Soros; and economists like Nassim Nicholas Taleb.

This crisis has succeeded in confusing ideological categories – which is probably part of the reason it has spwarned so many interesting and non-ideological takes, as people struggle to understand these momentous events in terms they are familiar with. (Here’s one ingenious example.) On the whole, Republican politicians instinctively trusted the market and although some attempted to reign in Fannie Mae and Freddie Mac, they saw no imminent threat to the financial system. A few Democrats saw the need for more oversight to prevent excessive risk-taking that might endanger the financial system; many more Democrats (especially as the party in Washington is dominated by neo-liberals), didn’t see the profit in warning of an unknowable future catastrophe. Those financial firms whose main purpose was to minimize risk and maximize profit accomplished this by reducing the risk of any individual transaction while placing greater and greater stress on the system – trading many small risks for a giant catastrophic risk. But theyse firms didn’t know this because the entire system was opaque and oversight was minimal. As long as things were going well, there was no reason to figure out what was going on.

Now, here we are today.

I don’t pretend to understand the cause or the cure of this crisis. But here are 10 things I’ve learned, 10 things worth sharing, in my attempts to figure out what’s going on:

  1. The “real” Great Depression of 1873: “[T]he current economic woes look a lot like what my 96-year-old grandmother still calls ‘the real Great Depression.’ She pinched pennies in the 1930s, but she says that times were not nearly so bad as the depression her grandparents went through. That crash came in 1873 and lasted more than four years. It looks much more like our current crisis.” This depression also featured mortgage issues, a housing bubble, an emerging economy undercutting global prices (America instead of China), amd a lack of transparency leading banks to refrain from lending. From Scott Reynolds Nelson in the Chronicle of Higher Education.
  2. The Martingale. Wall Street fell for a 400 year old sucker bet, the martingale. You always win in this betting game – as long as you can cover your losses. But once your losses are too great, this “double-or-nothing” game leads to catastrophe. The formula to understand this is simplified as:

    (0.99) x ($100) + (0.01) x (catastrophic outcome) = 0

    In other words, playing for $100, there is a 99% chance that you will make at least $100 dollars playing this game. But there is a 1% chance of a catastrophic outcome. If you never stop betting, the catastrophic outcome is inevitable.

  3. April 28, 2004. Stephen Labaton of the New York Times examines the SEC decision to relax regulations and create an exemption for the biggest investment banks (those with assets over $5 billion) that would allow them increase their leverage ratio, and borrow as much as 33 times their assets as Bear Stearns did. This made the big investment banks especially susceptible to any downturns, as if their overall investments declined by even 3%, they would lose all their assets.
  4. Goldman Sachs always wins. David Weidner of MarketWatch explains how Goldman Sachs looks to come out of this crisis stronger - and why their political connections had nothing to do with it. (Really. It’s just a coincidence that their main competitors have been ruined, the institution they relied on most was bailed out, and the Treasury Secretary is a former CEO.)
  5. Financial Interdependence. Which means that if one bank trips, the entire financial system falls down. Why? Because the key innovations of the past thirty years in the financial markets have been geared towards reducing risk. Often this was accomplished by spreading risk among many actors. An investor would borrow money to invest in some security; to hedge in case the investment went south, an investor would buy insurance; to hedge against the insurance company not being able to pay, they would purchase a credit default swap. Mark Buchanan described in a New York Times editorial how some economists had begun to create models of markets which projected the actions of many agents acting independently. As the economists allowed greater interdependence in these models: “The instability doesn’t grow in the market gradually, but arrives suddenly. Beyond a certain threshold the virtual market abruptly loses its stability in a ‘phase transition’ akin to the way ice abruptly melts into liquid water. Beyond this point, collective financial meltdown becomes effectively certain. This is the kind of possibility that equilibrium thinking cannot even entertain.”
  6. The American System. The American economic system is not and has never been pure capitalism. As Robert J. Schiller wrote:

    No, our economy is not a shining example of pure unfettered market forces. It never has been. In his farewell address back in 1796, 20 years after the publication of Adam Smith’s “The Wealth of Nations,” George Washington defined the new republic’s own distinctive national economic sensibility: “Our commercial policy should hold an equal and impartial hand; neither seeking nor granting exclusive favors or preferences; consulting the natural course of things; diffusing and diversifying by gentle means the streams of commerce, but forcing nothing.” From the outset, Washington envisioned some government involvement in the commercial system, even as he recognized that commerce should belong to the people.

    Capitalism is not really the best word to describe this arrangement. (The term was coined in the late 19th century as a way to describe the ideological opposite of communism.) Some decades later, people began to use a better term, “the American system,” in which the government involved itself in the economy primarily to develop what we would now call infrastructure — highways, canals, railroads — but otherwise let economic liberty prevail. I prefer to call this spectacularly successful arrangement “financial democracy” — a largely free system in which the U.S. government’s role is to help citizens achieve their best potential, using all the economic weapons that our financial arsenal can provide.

    Americans may assume that the basics of capitalism have been firmly established here since time immemorial, but historical cataclysms such as the Great Depression strongly suggest otherwise. Simply put, capitalism evolves. And we need to understand its trajectory if we are to bring our economic system into greater accord with the other great source of American strength: the best principles of our democracy.

  7. The Shadow Banking System. Existing alongside the regulated banking system is what is called a shadow financial system – including money market accounts, hedge funds, investment banks, and countless other financial creatures. This system was invented in order to avoid government regulation of various sorts. This crisis has been mainly but certainly not exclusively in this shadow system – and those regulated banks have been the big winners in all of this (aside from Goldman Sachs.) Even the remaining independent investment banks – Goldman Sachs and Morgan Stanley have chosen to be subject to greater regulation. Nouri Roubini speaking at the Council on Foreign Relations explained that the shadow banking system is on the verge of collapse because of their lack of transparency and because they took risks they would not have been able to if they were subject to regulation.
  8. Market Fundamentalism. I am a person suspicious of fundamentalism of any kind – and perhaps that makes me more prone to see reflections of the true believers in Communism during the collapse of the Soviet Union in the true believers in capitalism during the current crisis. The difference of course is that we today are not in a pure capitalist system – which is at least part of what has prevented this crisis from destroying our economic system so far. The government shored up essential institutions and is taking various measures now to restore liquidity to the markets – from the bailout to the Federal Reserve’s unprecedented actions. But what is evident to most observers – that the market failed to regulate itself, that the market mispriced risk, that short term profits were prioritized over long-term value, that the actions of thousands of individual actors acting for their own best interest created a systematic risk – is not clear to market fundamentalists. They insist that it was the fact that the government was involved in the market at all that led to these risks – specifically in the form of Fannie Mae and Freddie Mac. They have a point – in that Fannie Mae and Freddie Mac were only lightly regulated in recent years, and that though they got into the subprime lending market late and were forced out by regulators early, they underwrote a significant amount of these loans during that time, and that these institutions were able to overleverage themselves because of an assumed implicit government guarantee. All of this is to say that Fannie Mae and Freddie Mac were part of the problem. They weren’t the first companies to be hit by the crisis; and other companies came quickly afterward. Perhaps it is because of my limited experience, but I haven’t heard any serious economists on the right or left pushing forward the theory that this was all Fannie and Freddie’s fault – only right-wing partisans trying to throw some political blame the Democrats’ way. What these market fundamentalists want to insist is that though even the remaining investment banks have taken themselves out of the shadow banking system and voluntarily subjected themselves to regulation, what we really need is less government intervention in the market. All this is based on the distinction between economic activities of the government as decided in a democracy by the people, which in market fundamentalism are inherently oppressive, and economic activities of private individuals and corporations, which are free. Which means that a single individual controlling hundreds of billions of dollars is freedom while a government of the people controlling a similar amount is oppressive.
  9. Cognitive errors. Megan McCardle of The Atlantic has compiled a useful list of cognitive errors that seem to have played a role in the crisis – both in creating the conditions that led to it and in compounding it. For example, she discusses the recency effect:

    People tend to overweight recent events in considering the probability of future events. In 2001, I would have rated the risk of another big terrorist attack on the US in the next two years as pretty high. Now I rate it as much lower. Yet the probability of a major terrorist attack is not really very dependent on whether there has been a recent successful one; it’s much more dependent on things like the availability of suicidal terrorists, and their ability to formulate a clever plan. My current assessment is not necessarily any more accurate than my 2001 assessment, but I nonetheless worry much less about terrorism than I did then.

  10. The Black Swan. Nassim Nicholas Taleb is my kind of economist. The basis of his philosophy is that, “The world we live in is vastly different from the world we think we live in.” He advocates “tinkering” as our best mean to change the world – and his theory of the markets take into account many of the previous points. While he was running his own hedge fund in the 1990s, he turned his own knowledge of his lack of knowledge – and others’ lack of knowledge – into enormous profits. It came at the expense of losing a little money 364 days of the year – but making enormous profits in that one remaining day. He would bet on market volatility – which he understood financial firms repeatedly underestimated. Taleb’s key insight is that we know very little of the world itself – and will be more often fundamentally wrong than right. The example he uses is the Black Swan as described by David Hume:

    No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.

    This fundamental unknowability of the world must inform our actions, and perhaps points to some solutions. We must attempt to resolve this crisis by tinkering with different solutions, and seeing what works, while being mindful that our actions will inevitably have consequences we do not imagine. And remember – at any point – a black swan could come around and reshape our world suddenly – as 9/11 did, as the assassination of the Archduke Ferdinand to start World War I, as did the invention of the personal computer, as has this financial crisis. The solution will not come from our determined application of fixed ideas, but by our openness to the possibility that we may be wrong, even as we are determined to act. We must see the shades of gray and acknowledge that we do not fully understand the world, yet still act – tinker, if you will.

  11. Damn, it feels good to be a banksta!

Related articles


 
Like a lot of people, I’ve been struggling to understand this financial crisis over the past few weeks. I don’t pretend to be an economic expert – I’ve always been more interested in foreign policy, politics and history – but the issue of this crisis is obviously so important, it seems that it is everyone’s responsibility to find out what went on, what caused this.

I also feel that this is an issue which is confusing our politics, our partisan impulses. Both the right and the left have many reasons to hate the bailout – yet the pragmatists on both sides agree that something must be done. Everyone is angry. Very few predicted this. I only came across a few who prominently warned about a crisis such as this – subscribers to the Austrian school of economics such as Ron Paul; liberal capitalists such as Warren Buffet and George Soros; and economists like Nassim Nicholas Taleb.

This crisis has succeeded in confusing ideological categories – which is probably part of the reason it has spwarned so many interesting and non-ideological takes, as people struggle to understand these momentous events in terms they are familiar with. (Here’s one ingenious example.) On the whole, Republican politicians instinctively trusted the market and although some attempted to reign in Fannie Mae and Freddie Mac, they saw no imminent threat to the financial system. A few Democrats saw the need for more oversight to prevent excessive risk-taking that might endanger the financial system; many more Democrats (especially as the party in Washington is dominated by neo-liberals), didn’t see the profit in warning of an unknowable future catastrophe. Those financial firms whose main purpose was to minimize risk and maximize profit accomplished this by reducing the risk of any individual transaction while placing greater and greater stress on the system – trading many small risks for a giant catastrophic risk. But theyse firms didn’t know this because the entire system was opaque and oversight was minimal. As long as things were going well, there was no reason to figure out what was going on.

Now, here we are today.

I don’t pretend to understand the cause or the cure of this crisis. But here are 10 things I’ve learned, 10 things worth sharing, in my attempts to figure out what’s going on:

  1. The “real” Great Depression of 1873: “[T]he current economic woes look a lot like what my 96-year-old grandmother still calls ‘the real Great Depression.’ She pinched pennies in the 1930s, but she says that times were not nearly so bad as the depression her grandparents went through. That crash came in 1873 and lasted more than four years. It looks much more like our current crisis.” This depression also featured mortgage issues, a housing bubble, an emerging economy undercutting global prices (America instead of China), amd a lack of transparency leading banks to refrain from lending. From Scott Reynolds Nelson in the Chronicle of Higher Education.
  2. The Martingale. Wall Street fell for a 400 year old sucker bet, the martingale. You always win in this betting game – as long as you can cover your losses. But once your losses are too great, this “double-or-nothing” game leads to catastrophe. The formula to understand this is simplified as:

    (0.99) x ($100) + (0.01) x (catastrophic outcome) = 0

    In other words, playing for $100, there is a 99% chance that you will make at least $100 dollars playing this game. But there is a 1% chance of a catastrophic outcome. If you never stop betting, the catastrophic outcome is inevitable.

  3. April 28, 2004. Stephen Labaton of the New York Times examines the SEC decision to relax regulations and create an exemption for the biggest investment banks (those with assets over $5 billion) that would allow them increase their leverage ratio, and borrow as much as 33 times their assets as Bear Stearns did. This made the big investment banks especially susceptible to any downturns, as if their overall investments declined by even 3%, they would lose all their assets.
  4. Goldman Sachs always wins. David Weidner of MarketWatch explains how Goldman Sachs looks to come out of this crisis stronger - and why their political connections had nothing to do with it. (Really. It’s just a coincidence that their main competitors have been ruined, the institution they relied on most was bailed out, and the Treasury Secretary is a former CEO.)
  5. Financial Interdependence. Which means that if one bank trips, the entire financial system falls down. Why? Because the key innovations of the past thirty years in the financial markets have been geared towards reducing risk. Often this was accomplished by spreading risk among many actors. An investor would borrow money to invest in some security; to hedge in case the investment went south, an investor would buy insurance; to hedge against the insurance company not being able to pay, they would purchase a credit default swap. Mark Buchanan described in a New York Times editorial how some economists had begun to create models of markets which projected the actions of many agents acting independently. As the economists allowed greater interdependence in these models: “The instability doesn’t grow in the market gradually, but arrives suddenly. Beyond a certain threshold the virtual market abruptly loses its stability in a ‘phase transition’ akin to the way ice abruptly melts into liquid water. Beyond this point, collective financial meltdown becomes effectively certain. This is the kind of possibility that equilibrium thinking cannot even entertain.”
  6. The American System. The American economic system is not and has never been pure capitalism. As Robert J. Schiller wrote:

    No, our economy is not a shining example of pure unfettered market forces. It never has been. In his farewell address back in 1796, 20 years after the publication of Adam Smith’s “The Wealth of Nations,” George Washington defined the new republic’s own distinctive national economic sensibility: “Our commercial policy should hold an equal and impartial hand; neither seeking nor granting exclusive favors or preferences; consulting the natural course of things; diffusing and diversifying by gentle means the streams of commerce, but forcing nothing.” From the outset, Washington envisioned some government involvement in the commercial system, even as he recognized that commerce should belong to the people.

    Capitalism is not really the best word to describe this arrangement. (The term was coined in the late 19th century as a way to describe the ideological opposite of communism.) Some decades later, people began to use a better term, “the American system,” in which the government involved itself in the economy primarily to develop what we would now call infrastructure — highways, canals, railroads — but otherwise let economic liberty prevail. I prefer to call this spectacularly successful arrangement “financial democracy” — a largely free system in which the U.S. government’s role is to help citizens achieve their best potential, using all the economic weapons that our financial arsenal can provide.

    Americans may assume that the basics of capitalism have been firmly established here since time immemorial, but historical cataclysms such as the Great Depression strongly suggest otherwise. Simply put, capitalism evolves. And we need to understand its trajectory if we are to bring our economic system into greater accord with the other great source of American strength: the best principles of our democracy.

  7. The Shadow Banking System. Existing alongside the regulated banking system is what is called a shadow financial system – including money market accounts, hedge funds, investment banks, and countless other financial creatures. This system was invented in order to avoid government regulation of various sorts. This crisis has been mainly but certainly not exclusively in this shadow system – and those regulated banks have been the big winners in all of this (aside from Goldman Sachs.) Even the remaining independent investment banks – Goldman Sachs and Morgan Stanley have chosen to be subject to greater regulation. Nouri Roubini speaking at the Council on Foreign Relations explained that the shadow banking system is on the verge of collapse because of their lack of transparency and because they took risks they would not have been able to if they were subject to regulation.
  8. Market Fundamentalism. I am a person suspicious of fundamentalism of any kind – and perhaps that makes me more prone to see reflections of the true believers in Communism during the collapse of the Soviet Union in the true believers in capitalism during the current crisis. The difference of course is that we today are not in a pure capitalist system – which is at least part of what has prevented this crisis from destroying our economic system so far. The government shored up essential institutions and is taking various measures now to restore liquidity to the markets – from the bailout to the Federal Reserve’s unprecedented actions. But what is evident to most observers – that the market failed to regulate itself, that the market mispriced risk, that short term profits were prioritized over long-term value, that the actions of thousands of individual actors acting for their own best interest created a systematic risk – is not clear to market fundamentalists. They insist that it was the fact that the government was involved in the market at all that led to these risks – specifically in the form of Fannie Mae and Freddie Mac. They have a point – in that Fannie Mae and Freddie Mac were only lightly regulated in recent years, and that though they got into the subprime lending market late and were forced out by regulators early, they underwrote a significant amount of these loans during that time, and that these institutions were able to overleverage themselves because of an assumed implicit government guarantee. All of this is to say that Fannie Mae and Freddie Mac were part of the problem. They weren’t the first companies to be hit by the crisis; and other companies came quickly afterward. Perhaps it is because of my limited experience, but I haven’t heard any serious economists on the right or left pushing forward the theory that this was all Fannie and Freddie’s fault – only right-wing partisans trying to throw some political blame the Democrats’ way. What these market fundamentalists want to insist is that though even the remaining investment banks have taken themselves out of the shadow banking system and voluntarily subjected themselves to regulation, what we really need is less government intervention in the market. All this is based on the distinction between economic activities of the government as decided in a democracy by the people, which in market fundamentalism are inherently oppressive, and economic activities of private individuals and corporations, which are free. Which means that a single individual controlling hundreds of billions of dollars is freedom while a government of the people controlling a similar amount is oppressive.
  9. Cognitive errors. Megan McCardle of The Atlantic has compiled a useful list of cognitive errors that seem to have played a role in the crisis – both in creating the conditions that led to it and in compounding it. For example, she discusses the recency effect:

    People tend to overweight recent events in considering the probability of future events. In 2001, I would have rated the risk of another big terrorist attack on the US in the next two years as pretty high. Now I rate it as much lower. Yet the probability of a major terrorist attack is not really very dependent on whether there has been a recent successful one; it’s much more dependent on things like the availability of suicidal terrorists, and their ability to formulate a clever plan. My current assessment is not necessarily any more accurate than my 2001 assessment, but I nonetheless worry much less about terrorism than I did then.

  10. The Black Swan. Nassim Nicholas Taleb is my kind of economist. The basis of his philosophy is that, “The world we live in is vastly different from the world we think we live in.” He advocates “tinkering” as our best mean to change the world – and his theory of the markets take into account many of the previous points. While he was running his own hedge fund in the 1990s, he turned his own knowledge of his lack of knowledge – and others’ lack of knowledge – into enormous profits. It came at the expense of losing a little money 364 days of the year – but making enormous profits in that one remaining day. He would bet on market volatility – which he understood financial firms repeatedly underestimated. Taleb’s key insight is that we know very little of the world itself – and will be more often fundamentally wrong than right. The example he uses is the Black Swan as described by David Hume:

    No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.

    This fundamental unknowability of the world must inform our actions, and perhaps points to some solutions. We must attempt to resolve this crisis by tinkering with different solutions, and seeing what works, while being mindful that our actions will inevitably have consequences we do not imagine. And remember – at any point – a black swan could come around and reshape our world suddenly – as 9/11 did, as the assassination of the Archduke Ferdinand to start World War I, as did the invention of the personal computer, as has this financial crisis. The solution will not come from our determined application of fixed ideas, but by our openness to the possibility that we may be wrong, even as we are determined to act. We must see the shades of gray and acknowledge that we do not fully understand the world, yet still act – tinker, if you will.

  11. Damn, it feels good to be a banksta!

Related articles




11 Things I Learned While Trying to Figure Out the Financial Crisis


By Joe Campbell
October 9th, 2008


 
Like a lot of people, I’ve been struggling to understand this financial crisis over the past few weeks. I don’t pretend to be an economic expert – I’ve always been more interested in foreign policy, politics and history – but the issue of this crisis is obviously so important, it seems that it is everyone’s responsibility to find out what went on, what caused this.

I also feel that this is an issue which is confusing our politics, our partisan impulses. Both the right and the left have many reasons to hate the bailout – yet the pragmatists on both sides agree that something must be done. Everyone is angry. Very few predicted this. I only came across a few who prominently warned about a crisis such as this – subscribers to the Austrian school of economics such as Ron Paul; liberal capitalists such as Warren Buffet and George Soros; and economists like Nassim Nicholas Taleb.

This crisis has succeeded in confusing ideological categories – which is probably part of the reason it has spwarned so many interesting and non-ideological takes, as people struggle to understand these momentous events in terms they are familiar with. (Here’s one ingenious example.) On the whole, Republican politicians instinctively trusted the market and although some attempted to reign in Fannie Mae and Freddie Mac, they saw no imminent threat to the financial system. A few Democrats saw the need for more oversight to prevent excessive risk-taking that might endanger the financial system; many more Democrats (especially as the party in Washington is dominated by neo-liberals), didn’t see the profit in warning of an unknowable future catastrophe. Those financial firms whose main purpose was to minimize risk and maximize profit accomplished this by reducing the risk of any individual transaction while placing greater and greater stress on the system – trading many small risks for a giant catastrophic risk. But theyse firms didn’t know this because the entire system was opaque and oversight was minimal. As long as things were going well, there was no reason to figure out what was going on.

Now, here we are today.

I don’t pretend to understand the cause or the cure of this crisis. But here are 10 things I’ve learned, 10 things worth sharing, in my attempts to figure out what’s going on:

  1. The “real” Great Depression of 1873: “[T]he current economic woes look a lot like what my 96-year-old grandmother still calls ‘the real Great Depression.’ She pinched pennies in the 1930s, but she says that times were not nearly so bad as the depression her grandparents went through. That crash came in 1873 and lasted more than four years. It looks much more like our current crisis.” This depression also featured mortgage issues, a housing bubble, an emerging economy undercutting global prices (America instead of China), amd a lack of transparency leading banks to refrain from lending. From Scott Reynolds Nelson in the Chronicle of Higher Education.
  2. The Martingale. Wall Street fell for a 400 year old sucker bet, the martingale. You always win in this betting game – as long as you can cover your losses. But once your losses are too great, this “double-or-nothing” game leads to catastrophe. The formula to understand this is simplified as:

    (0.99) x ($100) + (0.01) x (catastrophic outcome) = 0

    In other words, playing for $100, there is a 99% chance that you will make at least $100 dollars playing this game. But there is a 1% chance of a catastrophic outcome. If you never stop betting, the catastrophic outcome is inevitable.

  3. April 28, 2004. Stephen Labaton of the New York Times examines the SEC decision to relax regulations and create an exemption for the biggest investment banks (those with assets over $5 billion) that would allow them increase their leverage ratio, and borrow as much as 33 times their assets as Bear Stearns did. This made the big investment banks especially susceptible to any downturns, as if their overall investments declined by even 3%, they would lose all their assets.
  4. Goldman Sachs always wins. David Weidner of MarketWatch explains how Goldman Sachs looks to come out of this crisis stronger - and why their political connections had nothing to do with it. (Really. It’s just a coincidence that their main competitors have been ruined, the institution they relied on most was bailed out, and the Treasury Secretary is a former CEO.)
  5. Financial Interdependence. Which means that if one bank trips, the entire financial system falls down. Why? Because the key innovations of the past thirty years in the financial markets have been geared towards reducing risk. Often this was accomplished by spreading risk among many actors. An investor would borrow money to invest in some security; to hedge in case the investment went south, an investor would buy insurance; to hedge against the insurance company not being able to pay, they would purchase a credit default swap. Mark Buchanan described in a New York Times editorial how some economists had begun to create models of markets which projected the actions of many agents acting independently. As the economists allowed greater interdependence in these models: “The instability doesn’t grow in the market gradually, but arrives suddenly. Beyond a certain threshold the virtual market abruptly loses its stability in a ‘phase transition’ akin to the way ice abruptly melts into liquid water. Beyond this point, collective financial meltdown becomes effectively certain. This is the kind of possibility that equilibrium thinking cannot even entertain.”
  6. The American System. The American economic system is not and has never been pure capitalism. As Robert J. Schiller wrote:

    No, our economy is not a shining example of pure unfettered market forces. It never has been. In his farewell address back in 1796, 20 years after the publication of Adam Smith’s “The Wealth of Nations,” George Washington defined the new republic’s own distinctive national economic sensibility: “Our commercial policy should hold an equal and impartial hand; neither seeking nor granting exclusive favors or preferences; consulting the natural course of things; diffusing and diversifying by gentle means the streams of commerce, but forcing nothing.” From the outset, Washington envisioned some government involvement in the commercial system, even as he recognized that commerce should belong to the people.

    Capitalism is not really the best word to describe this arrangement. (The term was coined in the late 19th century as a way to describe the ideological opposite of communism.) Some decades later, people began to use a better term, “the American system,” in which the government involved itself in the economy primarily to develop what we would now call infrastructure — highways, canals, railroads — but otherwise let economic liberty prevail. I prefer to call this spectacularly successful arrangement “financial democracy” — a largely free system in which the U.S. government’s role is to help citizens achieve their best potential, using all the economic weapons that our financial arsenal can provide.

    Americans may assume that the basics of capitalism have been firmly established here since time immemorial, but historical cataclysms such as the Great Depression strongly suggest otherwise. Simply put, capitalism evolves. And we need to understand its trajectory if we are to bring our economic system into greater accord with the other great source of American strength: the best principles of our democracy.

  7. The Shadow Banking System. Existing alongside the regulated banking system is what is called a shadow financial system – including money market accounts, hedge funds, investment banks, and countless other financial creatures. This system was invented in order to avoid government regulation of various sorts. This crisis has been mainly but certainly not exclusively in this shadow system – and those regulated banks have been the big winners in all of this (aside from Goldman Sachs.) Even the remaining independent investment banks – Goldman Sachs and Morgan Stanley have chosen to be subject to greater regulation. Nouri Roubini speaking at the Council on Foreign Relations explained that the shadow banking system is on the verge of collapse because of their lack of transparency and because they took risks they would not have been able to if they were subject to regulation.
  8. Market Fundamentalism. I am a person suspicious of fundamentalism of any kind – and perhaps that makes me more prone to see reflections of the true believers in Communism during the collapse of the Soviet Union in the true believers in capitalism during the current crisis. The difference of course is that we today are not in a pure capitalist system – which is at least part of what has prevented this crisis from destroying our economic system so far. The government shored up essential institutions and is taking various measures now to restore liquidity to the markets – from the bailout to the Federal Reserve’s unprecedented actions. But what is evident to most observers – that the market failed to regulate itself, that the market mispriced risk, that short term profits were prioritized over long-term value, that the actions of thousands of individual actors acting for their own best interest created a systematic risk – is not clear to market fundamentalists. They insist that it was the fact that the government was involved in the market at all that led to these risks – specifically in the form of Fannie Mae and Freddie Mac. They have a point – in that Fannie Mae and Freddie Mac were only lightly regulated in recent years, and that though they got into the subprime lending market late and were forced out by regulators early, they underwrote a significant amount of these loans during that time, and that these institutions were able to overleverage themselves because of an assumed implicit government guarantee. All of this is to say that Fannie Mae and Freddie Mac were part of the problem. They weren’t the first companies to be hit by the crisis; and other companies came quickly afterward. Perhaps it is because of my limited experience, but I haven’t heard any serious economists on the right or left pushing forward the theory that this was all Fannie and Freddie’s fault – only right-wing partisans trying to throw some political blame the Democrats’ way. What these market fundamentalists want to insist is that though even the remaining investment banks have taken themselves out of the shadow banking system and voluntarily subjected themselves to regulation, what we really need is less government intervention in the market. All this is based on the distinction between economic activities of the government as decided in a democracy by the people, which in market fundamentalism are inherently oppressive, and economic activities of private individuals and corporations, which are free. Which means that a single individual controlling hundreds of billions of dollars is freedom while a government of the people controlling a similar amount is oppressive.
  9. Cognitive errors. Megan McCardle of The Atlantic has compiled a useful list of cognitive errors that seem to have played a role in the crisis – both in creating the conditions that led to it and in compounding it. For example, she discusses the recency effect:

    People tend to overweight recent events in considering the probability of future events. In 2001, I would have rated the risk of another big terrorist attack on the US in the next two years as pretty high. Now I rate it as much lower. Yet the probability of a major terrorist attack is not really very dependent on whether there has been a recent successful one; it’s much more dependent on things like the availability of suicidal terrorists, and their ability to formulate a clever plan. My current assessment is not necessarily any more accurate than my 2001 assessment, but I nonetheless worry much less about terrorism than I did then.

  10. The Black Swan. Nassim Nicholas Taleb is my kind of economist. The basis of his philosophy is that, “The world we live in is vastly different from the world we think we live in.” He advocates “tinkering” as our best mean to change the world – and his theory of the markets take into account many of the previous points. While he was running his own hedge fund in the 1990s, he turned his own knowledge of his lack of knowledge – and others’ lack of knowledge – into enormous profits. It came at the expense of losing a little money 364 days of the year – but making enormous profits in that one remaining day. He would bet on market volatility – which he understood financial firms repeatedly underestimated. Taleb’s key insight is that we know very little of the world itself – and will be more often fundamentally wrong than right. The example he uses is the Black Swan as described by David Hume:

    No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.

    This fundamental unknowability of the world must inform our actions, and perhaps points to some solutions. We must attempt to resolve this crisis by tinkering with different solutions, and seeing what works, while being mindful that our actions will inevitably have consequences we do not imagine. And remember – at any point – a black swan could come around and reshape our world suddenly – as 9/11 did, as the assassination of the Archduke Ferdinand to start World War I, as did the invention of the personal computer, as has this financial crisis. The solution will not come from our determined application of fixed ideas, but by our openness to the possibility that we may be wrong, even as we are determined to act. We must see the shades of gray and acknowledge that we do not fully understand the world, yet still act – tinker, if you will.

  11. Damn, it feels good to be a banksta!

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42 Responses to “11 Things I Learned While Trying to Figure Out the Financial Crisis”

  1. Isaw Itcoming Says:

    I take exception to this statement:

    “Very few predicted this. I only came across a few who prominently warned about a crisis such as this – subscribers to the Austrian school of economics such as Ron Paul; liberal capitalists such as Warren Buffet and George Soros; and economists like Nassim Nicholas Taleb.”

    No, many more people predicted the current crisis.

    You just didn’t hear them.

    If you did, you and the other media blabbermouths called them crazy and discounted their ideas.

    This whole meltdown was foreseen years ago by countless numbers of people. Unfortunately, they aren’t the people you damn optimists and policy makers want to listen to.

  2. joe@2parse Says:

    I agree that many more people than I listed saw this coming. I read a few pieces that caused me to question whether what was going on was sustainable. I thought the pieces were probably right – and that some day some sort of reckoning was coming – as I mentioned to my friends. But I didn’t really understand what was going on because finance wasn’t my chief area of interest.

    My point in listing here wasn’t to be exhaustive. My point was that there were many, many people participating in the financial system to varying degrees – regulators, trader, lawyers, bankers, stockholders, etcetera, etcetera. Of those, only a few people made prominent warnings about the what was going on.

    I listed four prominent individuals who did.

    Who would you add, as I’m sure I’m missing people…

  3. Isaw Itcoming Says:

    Off the top of my head, I can think of a few who saw the crash coming years in advance:

    Gary North
    George Ure http://www.urbansurvival.com
    Gary Shilling http://www.safehaven.com/article-6329.htm
    David M. Walker, Former comptroller general of the United States
    Peter Schiff, president of Euro Pacific Capital Inc

    The article written by Gary Shilling was penned over two years ago. It clearly layed out what would happen. And it has. Follow the link I included above.

    Peter Schif of Euro Pacific Capital has been warning of a crash for three years. He is often invited onto Financial talk shows to be ridiculed by other guests….guests who even now won’t admit he was right and they were wrong. Just go to Youtube to see what I mean.

    George Ure of Urbansurvival has also been warning his readers of things to come for years based on his reading of Kondratieff Long Wave theory.

    David Walker, former Comptroller General of the US also sounded the warning years ago. Nobody listened. He resigned his post before things got really out of control earlier this year.

    There are countless more experts who saw it all coming. However, they were often ignored or shouted down by the mainstream media as being out of touch or loony tinfoil hat wearers.

  4. Pramod Biligiri Says:

    I think you are missing the structures of power and incentives that make up financial systems. I am sure everyone not associated with government and its fiat money (the Austrians being just one example) clearly knew that this thing is a house of cards. The government’s sole interest is to spend on populist/socialist schemes, maintain an empire and capitulate to whichever lobby pays them the most. So you’d never hear a peep as decades of deficit spending and low interest rates set the country on the course for destruction. The media is the only odd man out, but they have no incentive to be anything but shallow as otherwise their ratings will tank.

    Unfortunately, economic laws are inexorable and had to catch up sometime.

    The fact that this is global shows people and governments all over the world are the same.

    Look at it this way. You’ll never hear the truth about things from the following sources: Government, a political party, a media outlet, any company of any kind. There simply is no incentive for any of the above to tell the truth.

  5. Daniel Says:

    One more driver is the government incentives and pressure to loan money to people who were previously considered credit risks. I knew there some pressures, but Russ Robert’s article in the WSJ explains that there are far more than I had realized: http://online.wsj.com/article/SB122298982558700341.html The real point is that not this is just the government fault, but we need to understand that well-meaning programs are now hurting us.

    Also, something else I learned recently 1 in 6 homeowners are “under water” on their loans. http://online.wsj.com/article/SB122341352084512611.html

  6. jason Says:

    While a lot of people certainly saw it coming, many of them have been stating “It’s here!” for years (or even decades). As someone pointed out, even a broken clock is right twice a day (analog only of course;).

    Which group one chooses to listen to (if any) often says more about one’s own predilections toward optimism or pessimism than anything else, so personally I find it hard to criticize anyone who’s only recently awoken to the problems facing the US & global financial systems.

    As somewhat of a pessimist I have been expecting this for about two or three years. People who clued me into this include Peter Schiff (see him in Aug 2006 here: http://www.youtube.com/watch?v=LfascZSTU4o, and another here (not sure of date): http://www.youtube.com/watch?v=iR_ssZzQyYQ). Also William Bonner/Addison Wiggin; I read their book ‘Financial Reckoning Day’ several years ago and that was probably my first exposure to many of these ideas which now seem to be in full play: http://www.amazon.com/Financial-Reckoning-Day-Surviving-Depression/dp/0471696587/ref=sr_1_3?ie=UTF8&s=books&qid=1223662780&sr=8-3. And of course Ron Paul whom you mentioned and the Austrian School economists to whose theories he subscribes.

    And one of the final wake-up calls for me, though it isn’t particularly about economics, was The Fourth Turning by William & Howe (http://www.amazon.com/Fourth-Turning-Str-William/dp/0767900464/ref=sr_1_1?ie=UTF8&s=books&qid=1223662996&sr=8-1). Their thesis is that these sorts of crises (political, financial, etc.) are cyclical and based upon broad generational tendencies…quite a fascinating hypothesis, and pretty well dead-on considering it was copyrighted 1999.

  7. John Jones Says:

    Wow, what an enlightening article. very nice! Well done.

    jiff
    http://www.anonymity.at.tc

  8. bbb Says:

    Thank you for this; I especially appreciated #3, #5, #9 as they are quite useful.

    Some of your points need to be corrected (Taleb actually lost money and shuttered his Hedge Fund) and you neglect the reason we use markets in #8 (but it’s true that externalities and other instances of market failure must be corrected).

    Thanks again.

  9. joe@2parse Says:

    According to Bloomberg, Empirica – Taleb’s hedge fund – was closed down in 2004 having profited in every year except 2002, in which it did 5% better than the Dow but still lost money. Overall, the article suggests that Empirica outperformed the market overall.

    http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=aHfkhe8.C._8

  10. EJ@smalltown Says:

    Another error in your story. Goldman Sachs is now in the dumper, ready to be rescued by the government.

  11. joe@2parse Says:

    What was the first error?

    And although I saw CNBC report that too, their only source on that story is one CEO. And no one else that i’ve seen is picking the story up.

    I’m not sure that this will be the case – but nothing’s impossible these days…

  12. Mr. Money Says:

    One point that I’ll agree with you 100% on is that none of us can, on our own, really know what’s going on. That thought applies not just to this crisis but to most things in life. It just so happens that with economics we can model out where a trend is going, and with ever increasing consumerism reliant upon constantly loosening credit there is an endgame. When all that debt is called in, the house of cards falls apart.

    What I find interesting and very telling of this crisis is that the markets did not truly begin reacting until President Bush alerted the whole nation to the credit crunch. At that point, the jig was literally up and we’re now seeing everyone simply trying to cash out while the gettings still somewhat good.

    As to point #8, the market fundamentalist belief is that if the government did not bailout out these banks and allowed them to fail, we would still have seen the job layoffs and stock market decline, however the U.S. government would still have its trillions of dollars and we would not be on the verge of hyper-inflation. As an economic geek, I understand the belief in the free market, however I also understand that the greed of man will overcome the free market and institute shackles on it. That greed is why regulations must exist, not to patrol the free market but to patrol man himself.

    One last note, when you state “…economic activities of the government as decided in a democracy by the people…” keep in mind that this situation did not occur, as opponents of the bailout amongst the people outnumbered proponents by a huge, huge ratio. The government chose to go against the will of the people. As you’ve noted, we do not live in a fully capitalist society, and neither do we live in a fully democratic society.

    Great post overall.

  13. joe@2parse Says:

    Mr. Money,

    True – we live in a republic – not a democracy. And certainly, the levers of democracy are a bit rusty – and often are hijacked by outside forces.

    But – re. bailout – as I recall – opinion shifted significantly after Congress voted against the bill, and most people wanted something to be done even if they opposed the bailout as it was proposed initially.
    http://www.usatoday.com/money/economy/2008-09-25-poll-results_N.htm

    And I agree with your points about how market fundamentalists did not want the bailout. And I understand to some extent the theoretical beauty of the free market – and many of it’s practical applications. My point here was to point out how silly those who blamed Fannie Mae and Freddie Mac were – and how their beliefs seemed similar to me, to ideologues throughout history.

    re. we can never know what’s going on – agreed it applies to the rest of life. it was there that i first came to agree with this sentiment – and only later, in Taleb discovered someone applying it to economics.

    Thank you for your thoughtful response.

    joe@2parse

  14. L Says:

    Two relatively short points.

    1.) “I am a person suspicious of fundamentalism of any kind – and perhaps that makes me more prone to see reflections of the true believers in Communism during the collapse of the Soviet Union in the true believers in capitalism during the current crisis. The difference of course is that we today are not in a pure capitalist system”

    Communism has never existed. From what I understand, the Soviet Union government was supposed to “ease” the transition towards communism but once in power, only sought to perpetuate itself, and became totalitarian. Funny how people get to power and don’t want to give it up. So “the difference” cited is actually a similarity.

    2.) “…..the market mispriced risk….”

    Citing the S & L scandal from the 80′s as an example, I’d say they were not mis-pricing so much as avoiding the consequences of risk. The deregulated banking activity back then encouraged nominally poor investments. I say nominally poor investments because when the risky investments failed and banks started to fail, many of the bankers turned to their political contacts in the government and convinced them to put together a bail-out, which meant that the risk was essentially passed on to taxpayers.
    This is similar to what has happened with the recent situation/bailout.

    Its part of the corporate model to avoid cost; it makes sense. People try to avoid cost and maximize profit. Risk can be costly, so people try to avoid to cost and maximize the up-side. For example, things like pollution which are, at times, by-products of industry and business, are often defined as “externalities” to justify the passing on of the costs they represent.

    Risk/cost is supposed to be part of the checks & balances of a free market system that is invoked when corporations advocate “deregulation” (which is kind of a misnomer, but I digress). Having allowed people in the pursuit of making a living, to pass on the costs and risks (i.e., responsibilities) of that pursuit onto others, is a significant problem, if not the heart of this problem. We have a economy that lives like a good-time lemming, disregarding the fact that it has to live in the world it does business in.

    Overall, I also appreciate your post; I got a special kick out of #11. :)

  15. L Says:

    Ok, they weren’t short. ^_^;;;

  16. Mr. Money Says:

    I agree with you that we cannot place the blame solely on Freddie Mac and Fannie Mae, and that those who do are not taking into account all the variables of the actual situation. From my understanding of the situation, banks used the loans from Mac & Mae as near guaranteed moneys and with the relaxation of rules by the SEC (your #3) parlayed those guarantees into offshoot after offshoot. My point is that the firms in any market will seek out as much profit as possible and that it is the duty of government to ensure that the arena upon which these firms, their employees and their customers play on is the same for everyone involved.

    The free market is OK with regulations, as long as everyone is regulated the same. Such was not the case here as government gave large firms more trust and more help than smaller firms. Those firms who skirted regulations, via the shadow banking system encouraged by the lax SEC regulations, are the same ones receiving bailouts. Meanwhile, banks that played by the rules and stayed afloat get pushed aside and in effect hurt by seeing their foes get help while they get nothing.

    In the end, my main issue with the bailout is that it actually encourages risky behavior, as firms can now act as recklessly as possible, knowing that if a catastrophe happens the government will step in and save them. Now, why should any business follow the rules when they can instead break all the rules and aim for the stars, knowing that if they ever tumble we’ll be there to catch them?

  17. heri Says:

    Thanks for the Banksta link.

    For the crisis, I only hope people learn their lesson with credit and its limits. For the past 8 years, America has been living artificially on credit, funded by foreign money. This has to be stopped.

  18. wcarss Says:

    As a Canadian youth, I can’t pretend to have a justified opinion on large scale economics. Fear excepted.

    Due to that, I thank you for your collection of interesting, important, and amusing information. Some I’d seen and some I hadn’t – but I am wiser now for the exposure. The commentary following has been superb as well; thank you all. I wish that this were the internet’s status quo.

  19. Mark Radziwon Says:

    Thanks for trying to figure this out – as someone who is not an expert in Economics. I am trying to do the same – and have read many of the same things you have. I loved The Black Swan. If I had to pick one other significant event – that may have contributed heavily to this- it is the US coming off of the Gold Standard – I think, in 1971. Does anyone out there have any light to shed on this? Thanks.

  20. EqualTime Says:

    While I agree with much of what is presented here, I have to shake my head in disbelief that commentators feel compelled to address the far-right’s desperate rhetoric as though it was some valid opinion that would disappear once a rational argument to the contrary is presented. It’s not a legitimate opinion, it’s neo fascist propaganda.

    The arguments that loans to poor blacks were the root of this crisis are such blatant attempts at fascist ideology it really gives me a great measure of disgust to see an attempt at a well-researched reflection to consider it necessary to repeat such vile racist attacks as though they were valid points that needed addressing.

  21. Trish Says:

    It is not the truth it is an accumulation of opinions. All that is needed is to alter the wording (the language) to generate alternative illusions.

  22. Steven Says:

    Great article: I like best the first point. I think the news story focus is way out of hand. And where’s the…things you should do to live through an impending depression?! When will we get those stories from media outlets. Never I suppose.

    Thanks again. Some of it’s over my head; none of it’s surprising. The big gamblers (should have) lost.

  23. Prakah Says:

    Thanks for sharing this wonderful insight.

    But, do we know how to get out of this? I have seen this wonderful website: http://anilselarka.wordpress.com/ which tries to explain exactly this. The blogger saw it coming.

    Regards,
    Prakash

  24. Charissa Says:

    “You have made this world and you can change it. The world, of which you are the only source and ground, is fully within your power to change. What is created can always be dissolved and re-created. All will happen as you want it, provided you really want it. You have created the world’s sorrows out of your own desires and fears, you deal with them. All is due to your having forgotten your own being. Having given reality to the picture on the screen, you love its people and suffer for them and seek to save them. It is just not so. You must begin with yourself. There is no other way.”

  25. interested Says:

    The Troll under the Bridge that still is not being discussed anywhere is Naked Short Selling (NSS). The serial implosion of the investment banks, and brokers in addition to all the known conditions, is being accelerated by NSS. NSS is where the large players sell stock they do not own nor borrow. Short Selling is legal, where the stock is borrowed, sold, repurchased and returned, is just fine. However NSS is essentially watering the stock as was done back in the 20s and 30s. It adds “phantom” or “counterfeit” shares to the market.

    One way to execute NSS is via the option market. Trader buys 10,000 puts. The Option Market Maker sells the puts, but in order to hedge his position also creates 1,000,000 shares out of thin air (via the Option Market Maker’s position) and gives them to the buyer. This essentially moves the risk to the market in general. The Trader takes the puts and the stock, immediately dumping the stock on the market – creating additional downward pressure. Take a look at the trading of Bear Sterns, Lehman Brothers, Merrill Lynch, AIG, Wachovia and the rest. Huge increase in Put options and volume prior to the price plunge, along with a sudden set of negative news stories.

    Studies have been done in shareholder over voting. During the annual elections there are more votes than shares by a large margin. I wonder how that happens?

    One of the VERY popular reasons for NSS is that if the target actually goes under – then the phantom or counterfeit shares never have to be repurchased. The buyer of this toilet paper no longer cares. But it is VERY important to the Trader, why – because they NEVER have to close their position. Since the position or trade is never closed – they owe the IRS NO TAXES on their profit.

    You take a company, destroy their stock price, whereby it can not raise capital, its demise is certain.

    http://www.deepcapture.com/dave-patch-keeps-it-simple-ok-then-just-settle-the-trades/

    The “failure to deliver” or “failure to receive” stock is epidemic on wall street. There are very few certificates these days. Everything is a book entry at the brokerages and at the DTCC. The system is very easy to game.

    This has happened before. Clients of Morgan Stanley purchased gold to be stored by the broker who charged storage and security fees. The gold was paid for in full. However, MS did not buy the gold and just pocketed the funds, “owing” the gold, since it was reflected on the client statements. MS was good for it – until MS fails. I wonder what is in store for MS in the next week or so? Will it make it or will it fail? Note in the news story below, this lack of holding actual gold goes back to 1986!!!!!

    http://www.reuters.com/article/fundsFundsNews/idUSN1228014520070612

  26. Constitutional Republican Says:

    > True – we live in a republic – not a democracy.

    I have a Collie, not a Dog!

  27. Mr. Money Says:

    @Mark Radziwon – Going off the gold standard laid the groundwork for our current predicament. Essentially, without the gold standard (or any standard) we can just keep printing money until we run out of ink and paper. It is precisely what we are doing now to “solve” the bank crisis. The Paulson plan and the Federal Reserve are adding some 3-4 trillion dollars into the money supply, thus causing every other dollar that already existed to lose value. This fast track to inflation is also partly responsible for the large swings in the stock markets, the traders, speculators and analysts do not like the fact that each dollar is now worth a lot less and thus each point in the stock markets is also now worth much less. The 7-800 point drops are really like 4-500 point drops a year ago.

    @EqualTime – Blaming the housing crisis on race is despicable, but there is a valid argument that poor people should not have been given mortgages with high interest rates. Such a plan is literally asking for most of those mortgages to fail. Instead of the government forcing Fannie Mae and Freddie Mac to give out over 50% of their mortgages to low income individuals, the federal government should have set up its own agency to give out no interest or low interest loans to the poor.

    @interested – You’re 100% right, naked short selling helped pump stock prices down, thus validating the “phantom” short positions. Regular short selling is all well and good because the shares must be found and it is simply a part of the marketplace, but naked short selling is a fancy scheme, nothing more. It is a shame that the regulators have banned regular honest short selling at a time when it is needed to signal the market’s outlook.

  28. Mark Radziwon Says:

    Thank you,Mr.Money, for explaining more about coming off the Gold Standard. This thread seems to have a good proportion of educated, thoughtful participants. (The NYT comment section even seems to have a great number of fairly crazed commenters.) Anyway, I want to get people’s reading on next couple of weeks – not as interested, right now, on what caused all this – but more on how it is going to proceed. My take is that vast numbers of people worldwide are panicking – and vast sums of money are going into cash and Gold. This is showing up in the media – for example, yesterday, on Bloomberg – there was talk of rowdy lines at coin shops in London – but, I guess the point I am getting at is a lot of us are trying to kinda apply Rational thinking to what is – increasingly – an IRRATIONAL situation – panic. I am sensing that, because World Markets are, right now, inactive – that we have a short interlude but, because there are fewer and fewer interventions possible – that we are rapidly approaching a “Prarie Fire” of panic. Anyone else got a sense of what next few weeks are gonna be? Thanks.

  29. Mark Radziwon Says:

    Also, re-reading the original blog piece, and the comments – I don’t see much discussion of the rough idea that all this “printing of money” by the Treasury – will devalue the dollar; or, rather, – the general controversy about whether this will lead to hyperinflation – or hyperinflation, then, as demand drops due to no one actually having any available money – a resulting huge DEFLATION. My sense is that that is what will happen – a rapid increase in price, then a spiral down as demand drops off – isn’t that is what is happening with oil right now?

  30. Mr. Money Says:

    The way I see it Mark, we’re teetering between a number of scenarios. Deflation is a very, very realistic possibility. One could argue quite successfully that we’re already in an over-inflated state and the Fed’s cash infusions and the bank bailouts are (feeble) attempts at propping up existing high prices. One big thing holding back hyper-inflation right now is that employee wages have stayed consistent for a while now and that if retailers begin raising their prices, demand would drop after an initial surge for essentials, thus leading to deflation as you say. The hyper-inflation still could happen if speculators and investors start rushing out of US dollars and towards gold and other metals or currencies, thus leaving a ton of dollars on the market.

    Deflation is very likely as consumers are starting to cut back on spending and as we’re entering the huge christmas retail season, we should see many retailers slashing prices in an attempt to entice consumers. Still, there’s a strong argument that buying essential “stuff” now is a good move. The situation is not a mere economic one but also a geopolitical situation where if confidence in the US dollar drops all hell could literally erupt. Peter Schiff, who foresaw the current credit crisis, is predicting civil unrest as a very likely possibility.

    I hate to be the one wearing the tinfoil hat here, but for once it’d be irrational to not consider the worst case scenario. The huge uncertainty of the situation is the variable that can swing this thing a number of ways. As always being diversified is your best bet. If you have a fair amount of assets, I’d recommend buying gold coins (in case panic and unrest lead to the sh*t hitting the fan), holding a fair amount of cash in US dollars (in case there is a run and to buy stocks when the bottom arrives –I see 5k as a realistic level) and foreign currency and heavily consider weapons and bicycle(s). On my blog next week I’ll be recommending my readers buy a bicycle for a number of reasons (health, low maintenance costs) but chief among them is that it is a self-sufficient mode of transportation. In my amateur opinion, we’re going to see a lot more Americans bootstrapping over the next few weeks and relearning how to be independent.

  31. Mark Says:

    One thing I did -a few months ago – is buy 4 fifty foot lengths of razor wire – and put them in my garage. I also bought 40 cinder blocks, and 40 bicycle locks, and also put them in the garage. Now if things get a little dicey – I can – in a matter of an hour, put out the cinder blocks, and attach the razor wire to them with the bicycle locks. PreFab Perimeter. Anyone have simple ideas for getting through things if they get chaotic?

  32. sean Says:

    I just want to say that Point #2 is an awesome way to say whats been on my mind about 401k investors. I too am a supporter of the Black Swan theory and feel that all of the current mess is a realization of that reality. The black swan probability might not have even been as low as 1%, It might have been more like 5 or 10%. I had a post about the risk/reward concept hinting at the example you gave here: http://seansrant.com/risk-aversion-complacency-mutual-funds-and-the-status-quo-market/

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  41. Francais Porno Says:

    Thank you,Mr.Money, for explaining more about coming off the Gold Standard. This thread seems to have a good proportion of educated, thoughtful participants. (The NYT comment section even seems to have a great number of fairly crazed commenters.) Anyway, I want to get people’s reading on next couple of weeks – not as interested, right now, on what caused all this – but more on how it is going to proceed. My take is that vast numbers of people worldwide are panicking – and vast sums of money are going into cash and Gold. This is showing up in the media – for example, yesterday, on Bloomberg – there was talk of rowdy lines at coin shops in London – but, I guess the point I am getting at is a lot of us are trying to kinda apply Rational thinking to what is – increasingly – an IRRATIONAL situation – panic. I am sensing that, because World Markets are, right now, inactive – that we have a short interlude but, because there are fewer and fewer interventions possible – that we are rapidly approaching a “Prarie Fire” of panic. Anyone else got a sense of what next few weeks are gonna be? Thanks.

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