May 07

image thumb7 Gambling with OPM 
Not going to end well

Russ Roberts, of GMU, has a cogent take on why we had a financial crisis, and unfortunately, whey they aren’t done yet.   Gambling with other people’s money (as provided by government):

How did this happen? Whose fault was it? Some blame capitalism for being inherently unstable. Some blame Wall Street for its greed, hubris, and stupidity. But greed, hubris, and stupidity are always with us. What changed in recent years that created such a destructive set of decisions that culminated in the collapse of the housing market and the financial system?

In this paper, I argue that public-policy decisions have perverted the incentives that naturally create stability in financial markets and the market for housing. Over the last three decades, government policy has coddled creditors, reducing the risk they face from financing bad investments. Not surprisingly, this encouraged risky investments financed by borrowed money. The increasing use of debt mixed with housing policy, monetary policy, and tax policy crippled the housing market and the financial sector. Wall Street is not blameless in this debacle. It lobbied for the policy decisions that created the mess.

In an update he clarifies where we are in the present European mess:

Rescuing Greece isn’t the end of the problem, it’s more akin to the Bear Stearns rescue of March 2008. It’s just the beginning of something that won’t end well.

In the short run this means the US dollar will perk up, but the bond and stock market will be volatile. Why? Much of the market rise of 2009 depended on people leveraged off falsely cheap debt (OPM again!) and arbitraging the dollar. When the dollar rises, they are on the short side of a long bus and have to get rid of something – currently stocks.  Arbitrage is fun and can make you occasionally look like a genius, but leverage works in both directions and there is also no limit on how much you can lose. Expect big swings and then….

The whole thing explodes… my guess – Sept 2010.

Leading up to that expect employers, especially ones like me with large export businesses to Europe, to watch the hiring. Unemployment will stay at 10%, mainly do to give ups, and the U6 underemployment index will continue to rise.

As Russ says… It ain’t gonna end well.

Comments are closed.