Wednesday, September 24, 2008
Tasty Black Swans...
Some articles from seekingalpha.com on the state of the not so awesome economy... and how this massive black swan took a dump on our financial markets....
Here is part 1
Here is part 2
"As Alan Greenspan denies causing the housing crisis today, his words from November 2002 come back to haunt him, “our extraordinary housing boom…financed by very large increases in mortgage debt, cannot continue indefinitely into the future.” He then proceeded to reduce interest rates to 1%, spurring the biggest bubble in history."
"Much of the housing frenzy can be attributed to homeowners getting caught up in the media hype and the cascade of information about others getting rich buying and selling houses. But, Greenspan's 1% interest rates were the fuel for the frenzy. He knew exactly what these rates would do when he said the following words in 2005:
"Like other asset prices, house prices are influenced by interest rates, and in some countries, the housing market is a key channel of monetary policy transmission."
The final nail in the coffin of Greenspan’s legacy was his speech in February 2004. Greenspan suggested that more homeowners should consider taking out Adjustable Rate Mortgages. The Fed funds rate was at an all-time-low of 1%. A few months after his recommendation, Greenspan began raising interest rates, in a series of rate hikes that would bring the funds rate to 5.25% about two years later. Greenspan's advice came at a time when interest rates had bottomed out making it a particularly bad time to take out an ARM. The triggering factor in the current crisis was the many subprime ARMs that reset at much higher interest rates than what the borrower paid during the first few years of the mortgage. Greenspan gave the bad advice and Wall Street provided the money and derivative products which have created our worldwide meltdown."
Speaking of black swans.... Ben Stein explains credit swaps...
Although... the some blame should still be on the Investment banks that got pwn3d for selling these uncovered instruments and apparently underpricing them severely...... it is interesting how everyone automatically jumps on the 'smart people who saw that pricing of these options was way way off'. Ben in the article doesn't actually blame the smart people... "This is what the truly brilliant speculators in these instruments did not miss. " but he does blame the systemic issues with this whole exotic derivatives madness. Perhaps their perception of the implied risk was severely different than the actual risk...... Generally companies write these contracts to generate extra income... the idea is that they can calculate the risk associated with the contract and charge a premium that is in parity or more with the risk incurred... usually these options expire without any fanfare... but being on the sell side you have as it says in the article... infinite liability to an extent.... If you believe in Taleb's black swan arguments... then you would perhaps suggest that the pricing mechanisms for these securities did not account for these ridiculously 'unlikely' turn of events... since the payouts of these exotic securities is complex... Taleb argues that these types of situations are very vulnerable to black swans dropping out of hyperspace and taking a dump on your lawn..... Fat asymptotic tail events really ruin your apple pie.... now he didn't actually say anything about hyperspace or taking a dump, but you get the idea. =)