When Finance Goes Mad

Having come uncomfortably close to working in the packaging of structured financial investments, I've been morbidly fascinated by the way in which it has led to the near-destruction of the national - if not global - economy. Here is a great article on how badly awry things went with the ratings on these instruments, and a bit of what that means for stabilizing things.

Money for Nothing and Checks for Free

If you want to understand a bit more about what is happening in the markets, I highly recommend the IMF working paper "Money for Nothing and Checks for Free". If you are pressed for time, take a look at the graphic summaries throughout the paper.

Two things strike me in all of this:

1) The leveraged positions on some of these investments (in particular in hedge funds) on securities is almost an inversion of the historical norm of banks with required asset reserves for loans. The fact that these securities were not only over-valued but in some cases are unable to be valued is alarming

2) The subprime loan segment just blossomed a few years back as the economy was coming out of a recession via a major injection of money for the central bank (of course depressing interest rates); after today's rate cut, it's unclear that what Fed policy is going to look like. Could this mean things are really that bad? Obviously the equity markets didn't think so.

PS: Mauro Guillen of the Wharton School pointed me to this paper.

Capital market credit crunch

I've had a bunch of friends asking me about what is going on in the capital markets over the last few days. If you have a wsj.com subscription or can get access to one, there was a very good article on how we got into the current credit market mess. Definitely worth a read.

As usual, there isn't only one element that bears the blame: much of this is a fall out of fed actions dating back to Greenspan's easy money policies after 2001; part of it is desperation for higher yields through fancy and often opaque securities that few purchasers really understand; part is the fact that hedge funds are able to avoid many securities regulations; and part is of course just short-sightedness. It is very hard to say what the ripple effects will be: my own take is that it would be very prudent to make sure you're not carrying variable rate debt and consider using a no-risk interest bearing vehicle for a chunk of liquid capital (the latter is what the CAPM would suggest anyway).

There also seems to be a lot of interest in hedge funds. I'll follow-up this weekend with a brief explanation of US securities laws and how a hedge fund avoids a lot of regulation.