Monday, August 13, 2007

Financial markets: Chickens swept under the rug in 1998 come home to roost

What's going on in the financial markets? It's not just about liquidity and asset bubbles. We've long been conditioned to think the stock market is relatively safe because of all the reforms and regulations implemented since 1929. Sure, the market might go up or down hundreds of points in a day -- but off a 13,000-plus Dow that's nothing. Most people think a 1929 style crash couldn't possibly happen now.

From the inside, things are not as all that certain. The Australian writer Kate Jennings offered a wonderful snapshot in her novel Moral Hazard. The protagonist, Cath, is a feminist, a veteran of the radical politics of the sixties, and an admitted financial idiot: “I could barely tell a stock from a bond. Balancing my checkbook was beyond me, much less understanding option trees.” A friend finds her a well-paid job as a speechwriter for a prominent Wall Street investment bank (mirroring Jennings' own experience).

The protagonist's outsider status makes her all the more effective a mole for the rest of us in as she burrows into “a firm whose ethic was borrowed in equal parts from the Marines, the CIA, and Las Vegas. A firm where women were about as welcome as fleas in a sleeping bag.”

The novel spans six years and concludes with a banking industry crisis involving hedge fund Long Term Capital Management that almost blows up the entire financial system, although the perturbation scarcely is noticed by the general public and nothing really changes.
“To date, no follow-up. Nothing. Nada. As if afflicted with Alzheimer’s, the Fed remains adamant that banks can police themselves,” Cath muses after the collapse of a hedge fund modeled on Long Term Capital Management. The spectacular demise of LTCM in 1998 was an eye-opener for industry insiders, but after a bailout arranged by the Fed it was quickly forgotten. “Deregulation rackets along like a runaway train, banking lobbyists clinging to its side, climbing into the cab, waving from the windows, hollering in their exhilaration. Hoo-ha.”
Hoo-ha, indeed. To mangle a metaphor, you might say that the chickens swept under the rug in 1998 have come home to roost.

Much of our securities trading now takes place under the totally unregulated umbrella of the hedge funds, which have been operating on a laissez faire frontier for a long time now. They should have learned -- and been regulated -- after LTCM in 1998, but that didn't happen.

Now, nobody knows what's going on behind their walls. There's no way to know, with their very limited reporting requirements. The bottom could fall out tomorrow, and the damage would be done before anything could be done about it.

1 comment:

Dr Diablo said...

I'm no detached observer, since the action of the financial markets will determine whether I eventually live in a skilled care facility with bingo and string quartets featured in the commons area, or whether I will be ensconced in a trailer at the back of my daughter's yard.

However, here's my opinion. I do not view the stock market as safe, nor do I believe the Fed can prop it up no matter what. A tidal wave of selling pressure will overwhelm the bags of sand placed in its way by the Fed.

At the same time, let's note that the bottom doesn't generally fall out against a backdrop of jeremiads, bad news, and investor panic. My prediction is that the market will soon find a bottom and believe this is a good time to buy. Specifically, I am asking people to purchase Uranium One (SXR.T) on the Toronto Exchange so I can sell into the rise.

Good luck, MadGuy. Remember that piling ingots in your shoe closet or staying in money market funds carries its own kind of risk.