Monday, September 22, 2008

Gears and Levers buried at the Roots

I can't help but stick my neck out here to clarify one thing. The root cause of our current predicament is not evil lenders, stupid homeowners, bad regulations, greedy bankers, "hocus pocus" derivatives, markets, meltdowns, mania, panic, capitalism (or any other ism), Glass-Steagall, Wall Street, Main Street, Countrywide, Lehman, Bernanke, Bush, or even Greenspan.

We would not be where we are today ... markets would not be dry ... banks would not be belly-up if we did not have the ridiculous current levels of ...


aka leverage
aka mortgage
aka credit
aka gearing

Debt is a multiplier on both upside profit and downside losses. It's an inflator of risk ...

... as I've been trying to convince people for quite some time. For example:

April 18, 2008 Blog Entry:
An investment bank borrows heavily and throws the funds into risky investments. The investments go south, the bank can't pay its loans, and the whole market panics, making it impossible for other, sound banks to continue their activities... nationalizing is bad when Chavez and Castro do it. Bad when Musolini and Mao did it. Why, then, should it be any different for us?

April 13, 2008 Blog Entry:
I-Banker's bag-o-tricks: ... Leveraging: This must be the oldest trick in the bag. ... When in doubt, borrow to take risk. Even better - use the fail-safe "steroids for investments": borrow some money and dump it into your wimpy underperforming investment. Suddenly your measly 1% return on initial investment looks like 10%. As long as the interest you pay is less than the return you make, you look like Midas.

Thankfully, with tonight's announcement that Morgan Stanley and Goldman have been persuaded to become regulated as banks, their leverage ratios will climb down the stairway to heaven a bit, but the notion that we EVER had ANY firm (or individual) geared to 50x assets is ridiculous. If that's what it takes to get the life-blood of profit from their industry, then it has already turned to stone. Nouriel Rabini correctly called such arrangements a "Ponzi Game" "pyramid scheme" and "house of cards" back in a blog from January 2007 with help from Gillian Tett.

Nobody in the industry, the government, or the media can credibly say they weren't warned.

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