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The Next Bubble
March 13, 2008 8:28 PM   Subscribe

The Next Bubble: Priming the markets for tomorrow's big crash. A layman's primer on the genesis and future of today's economic troubles, at Harper's Magazine.
posted by stavrosthewonderchicken (79 comments total) 40 users marked this as a favorite

 
Time-saving spoiler: It's alternative energy.
posted by Kibbutz at 9:04 PM on March 13, 2008 [1 favorite]


Well, in previous threads on related matters here at Metafilter, there were crowds of people begging for a clear and simple explanation of how we (or America, and by extension, the rest of us) got here. This is one of the best I've seen. So the point here is not really about prognosticating what the next asset class that will inflate is going to be, but what has happened, what's happening now, and only to some extent what may happen in the future.
posted by stavrosthewonderchicken at 9:10 PM on March 13, 2008


Paul Krugman recently recommended a new book by his old MIT classmate who went on to become the director of risk management at the hedge fund Moore Capital Management (as well working in risk management at Salomon Bros and Morgan Stanley's for over a decade).

I'm just starting it this week, but I'll pass the recommendation along as it seems appropriate to the topic

A Demon of our own Design: Markets, Hedge Funds, and the Perils of Financial Innovation, by Richard Bookstaber
posted by Auden at 9:18 PM on March 13, 2008


Alternative energy is next? Alternative energy is now. The only reason agriculture stocks and commodities are up is because of increased demand for corn as ethanol. Solar stocks were rising as momentum standbys like google and apple were imploding.

However, there is a qualitative difference between the dotcom and alternative energy booms and the housing booms. In the former, the frenzied investment created new technology and advanced the state of the art. The housing boom on the other hand was nothing but clever financial manipulation.

Finally, I'd like to point out that it isn't only the US that is subject to these booms. It remains to be seen how China would weather a recession.
posted by Pastabagel at 9:18 PM on March 13, 2008


And a bit of schadenfreude for you all - Carlyle Group bond fund teeters on the brink of collapse as it defaults on $16.6 billion of debt.
posted by Pastabagel at 9:24 PM on March 13, 2008 [1 favorite]


If only the financial world understood how badly we actually do need an alternative energy "bubble." Actually, check that. If only the government understood. Wait, check that too. If only the parasites that privatize profit and socialize the risk understood that their game can't go on much longer without an alternative energy "bubble."
posted by MillMan at 9:37 PM on March 13, 2008


An interestingly semi-related email just slipped through my spam filters:

New Platform For Trading Energy Set To Revolutionize the Market
Dear Investor,
If you are receiving this email, there's no doubt that you're in an elite class of investors**. It is for this reason that I am writing to you today. I want to invite you to view an exclusive offer available only to members of our network.
Electronic trading changed how stocks and commodities were traded and opened up new opportunities for the common man. There's a company out there looking to revolutionize the way energy is traded. You can be a part of this very unique opportunity, but it's limited to a select few investors.


Somebody's going to "revolutionize the way energy is traded"...
We.
Are.
So.
Fucked.

*A very well targeted email. For the record, my current net worth is less than what Spitzer paid for one fuck.
posted by wendell at 9:46 PM on March 13, 2008


Fundamentally, we got here by choosing fake money. When money can be created at will, in any amount, then the government and the economy can divorce themselves from reality. We need a commodity-backed money supply to return to health, and until we get one, things will just get worse and worse and worse for people who create wealth (which is most of us). Simultaneously, they will get better and better for the people that manipulate money.

Modern money is debt, not an asset, and when it can be perpetually re-invented in new and exciting ways, the people creating the debt instruments can extract real value out of the economy, leaving only woe behind.
posted by Malor at 10:06 PM on March 13, 2008 [9 favorites]


It's also worth pointing out that the sea change in the economy from production to speculation is horribly, horribly destructive.
posted by Malor at 10:08 PM on March 13, 2008


It makes sense to me that "money is debt". Of course, as long as I've been alive it's been that way. When I try to imagine what money is when it's value is attached to a mass of a mineral, I get confused.

(Malor, I owe you at least a buck for bringing the "money is debt" analogy to my attention. Never before have I been able to think about it so succinctly. Thanks.)
posted by wobh at 10:32 PM on March 13, 2008


Forget alternative energy, we need alternative economic theory. Mainstream economists are still rooted in the models of endless growth and limitless resources that grew from an earlier time when populations were much lower and resources (both renewable and finite) relatively more abundant. Whatever happened to the steady-state cycle economic theories, based on ecological models, that were proposed some years ago? Like a forest ecosystem, economic activity can produce a steady modest harvest and great diversity of activities and products indefinitely. All the talk of "sustainability" is a fig-leaf for the shameful and accelerating plundering of a one-time capital asset - the planet.
posted by binturong at 10:39 PM on March 13, 2008 [4 favorites]


If the housing boom is the consequence of the US Fed, what about the Australian, Swedish and other places' housing booms?
posted by sien at 10:53 PM on March 13, 2008


Indirectly, it's also the Fed. The Fed is printing too many dollars, and lending them at rates that are too low. Foreign banks were sopping them up (which means printing their own currency to buy ours), which causes inflation, and inflation chases appreciation. Whatever has been going up will go up even more when new money is introduced.

Additionally, because of the historically low interest rates offered by the Fed, foreign banks also offered low interest rates to prevent their currencies from appreciating too much.

So, they got mini versions of the same situation.

Now, in reality, it's a lot more complex than that, because there's a lot of money-like things (derivatives) also floating around, and they're badly distorting many markets. But when you really dig, that's what's at the core... too much currency at all-time-low interest rates compared to real inflation, so house prices skyrocketed worldwide.
posted by Malor at 11:23 PM on March 13, 2008 [1 favorite]


Oh, and as far as commodity money goes... you just have to back off a bit further to understand how it originally worked.

Way back when, before money, we had barter. You made shoes, and I raised chickens, so you'd trade me a pair of shoes for a chicken. But if you didn't need a chicken, or if I didn't need shoes, one of us had a problem. Maybe you would accept a chicken for shoes if you knew that delmoi needed chickens and offered silverware, but you had to know everyone involved, and maybe you had to go visit delmoi to see if he would indeed take the chicken for what you wanted. This was really inefficient.

But, gradually, some commodities that were in broad use started to be recognized and accepted by multiple people. Early on, this was mostly silver and copper; over time, gold entered the picture too. Lots of people liked silver and copper for different reasons, so you could often trade it to people directly for what you wanted. But if you didn't need it yourself, if you knew you could resell it, you'd accept it in trade. The network effect took hold, and pretty soon, everyone would take silver and copper even if they had no use for it themselves, because they knew someone who would.

In essence, money is just the most marketable commodity. Whatever the commodity is, and it's been different things at different times, it needs to be of direct value to a large fraction of the population, be easily transportable, easily divisible, and any piece must be substitutable for any other piece. (it must be fungible.) That's been shells in some cases, but usually it's been metal for any kind of money that had any longevity.

So all the hocus-pocus-mumbo-jumbo about money since then is mostly designed to talk you into giving power over the money supply into the hands of politicians, so that they can use it for their own benefit. (either directly, as monarchs once did, or indirectly, as modern politicians do, by buying votes.) Managing the money supply makes no more sense than managing the soap supply. But governments do it because it gives them power.

Fundamentally, with commodity money, you're just trading bits of something for other things. That's all it is. Prices still vary; an umbrella in winter is worth more money than an umbrella in summer. Things still fluctuate; economies always do. But you have a stable yardstick to measure with. Measuring prices in modern dollars is like measuring distance with a rubber band... one that just keeps stretching and stretching and stretching....

Everyone reading this thread has taken a pay cut, over the last couple of years, of close to 30%... you just don't know it yet. You've actually been taking that pay cut for the last two decades, but the government successfully hid it from you. Now, it's finally starting to become visible. And, like an iceberg, there's a lot more going on than the visible bits you're seeing.
posted by Malor at 11:38 PM on March 13, 2008 [18 favorites]


It's rather obvious how this is going to play out if you know two simple facts:
1. The banks are insolvent
2. 5 of the 12 voting seats in the Fed are comprised of bank representatives. The rest are probably friends and in the same social circle as those 5

Consequence: Massive inflation of dollars to bail out the banks. (Inflation is literally a tax on savings.) Yay corporate socialism.

All those new "actions" and blah blah blah superfund blah blah is just another word for free money. The most egregious of which was the recent $200 Bil bailout, "we take your shit loans and give you cash-money"

IMO, people are especially freaking out because in their deep subconscious, they know that with increased market efficiencies/technology, there's less of a need for a gargantuan equities market. That there will be a declining need for things like LBOs. This decade will be marking more than just peak-oil. It will be marked as the return to commodity rule. Equities let you scale. Scale doesn't matter anymore and I would be surprised if there's is ever the same kind of credit expansion in our lifetime.
posted by amuseDetachment at 12:26 AM on March 14, 2008 [1 favorite]


Here's more commentary from Eric during a recent appearance on CNBC (warning, background audio) and there's lots more interesting and insightful analysis and discussion at the online community he runs.
posted by twsf at 1:30 AM on March 14, 2008


Bubbles are indeed fascinating, but as I cited in a previous post they are far more common than Janszen acknowledges; in fact during the period from 1763 to 1975 we saw roughly 40, or on average about one every five years. Call it once a decade as sometimes you get multiple bubbles all deflating simultaneously (e.g., 1819, a collapse in shares of US manufacturers at the same time England saw a collapse in shares of commodities companies, there are other examples).

Overall I found the article interesting, however a little too emotive for my tastes - for example, the phrase hyperinflation is tossed about precisely twelve times. Without a doubt we're seeing inflation (that many folks knew was coming by the way), but I'm not sure by of the G20 economies are presently in the realm of hyperinflation. Unlike, for example, Zimbabwe, where inflation just passed 100,000% pa. That's hyperflation. None of the series he documents in the article evidence hyperinflation. Sharp rises, above the mean? Absolutely. But prolonged periods, that effectively resulted in the destruction of money (the textbook definition of hyperinflation)? Nope.

Still an interesting article overall. I agree with folks that mention alternative energy, and that the next bubble is already here. Mrs Mutant and I have been aggressively stocking upon staples as the producer side is seeing large increases which will surely ripple down to consumer side, big time in about three to six months.

Pastabagel -- "It remains to be seen how China would weather a recession."

I think they're already feeling the chill. Although I work in banking I've got a small business in the UK importing MP3 players and other low priced electronic stuff for resale. We're seeing a lot more follow up on inquires and willingness to cut deals than six months ago. My largest supplier just unilaterally cut prices on one of our more popular players by about 10%. So that's the supply side. On the demand side, we're seeing a nice rise in business so I think the UK is damn close to, if not already in, recession. After all, if someone wants an MP3 player and has lost or is worried about their job, they ain't gonna pay full retail if they can find something that looks the same and performs the same function (and offers more features) for half the price.

Malor -- "We need a commodity-backed money supply to return to health ..."

Well, I'm not sure a gold backed currency is the way to go if that's what you're suggesting. And I'm not even going to suggest what the answer is as I don't know. I just don't think backing currency by any commodity will help us. After all, The United States - and to a large extent most of the G20 - have radically advanced economies compared to other parts of the world. Ours is far more flexible, tolerant of and capable of driving change. It will be interesting to see how China and other BRIC economies weather the upcoming recession (which we all knew was coming). I suspect they'll be adopting some of our market reforms and not the opposite.

"Modern money is debt..."

Money has always been debt, based on a promise. Back during the time of commodity based currency, the US dollar was backed by gold, Pound Sterling by silver. One could approach the Central Bank of each respective nation and ask for your fiat, paper currency to be exchanged for the underlying bullion.


amuseDetachment"...they know that with increased market efficiencies/technology, there's less of a need for a gargantuan equities market."

Please explain further. Equities markets provide two functions; first they allow firms to raise funds, capital needed to fund an enterprise, equity and not debt. Secondly, exchanges provide a mechanism for the orderly trading of these shares, thus insuring that original investors can recover their capital if and when they decide to do so. I don't see less of a need at all.

And while I don't agree with your "facts" (i.e., the banks are by no means insolvent), I do agree about inflation. Check my prior posts, this is something that I became concerned about in 2004/2005, but really in response to the wars.

War is inflationary, and given the sums the US / UK, etc were spending at that time a period of inflation, engineered by the banks, was clearly on the agenda solely to reduce the magnitude of the national debt in real terms.

They historical precedent is there, look what happened after Vietnam.
posted by Mutant at 3:35 AM on March 14, 2008 [2 favorites]


The sad part--or at least, one of the sad parts to this is that the people getting fucked these days are the ones who did everything right: the savers. As your dollar becomes worth less each day, all your efforts gathering acorns for the hard winter are wasted. So, if you used your house like an ATM and pissed away your third mortgage on Plasma TVs or larger cars--you're fucked. But if, on the other hand, you recognized the stupidity of living beyond your means, and thus saved your duckets for a rainy day... well, the rainy day has come and it will wash your savings away.

At least you'll have more kindling than the other guy.
posted by Civil_Disobedient at 3:43 AM on March 14, 2008 [1 favorite]


If it was the Fed, why did Australia, the UK and some other housing booms precede the Fed's rate lowering?
posted by sien at 4:23 AM on March 14, 2008


And why were Australia's and the UK's bigger in percentage terms?
posted by sien at 4:24 AM on March 14, 2008


So, if you used your house like an ATM and pissed away your third mortgage on Plasma TVs or larger cars--you're fucked. But if, on the other hand, you recognized the stupidity of living beyond your means, and thus saved your duckets for a rainy day... well, the rainy day has come and it will wash your savings away.

It's all part of the ongoing transfer of wealth upward.
posted by Thorzdad at 5:18 AM on March 14, 2008


The sad part--or at least, one of the sad parts to this is that the people getting fucked these days are the ones who did everything right: the savers.

Depends on the currency you've been saving in. I'm still uncertain whether having my life savings in Korean won will pan out to be a good idea, but it's pretty clearly better than if I'd chosen $US.
posted by stavrosthewonderchicken at 5:43 AM on March 14, 2008


So far.
posted by stavrosthewonderchicken at 5:47 AM on March 14, 2008


What, there's going to be a crash tomorrow? I better sell today!!!
posted by grouse at 6:33 AM on March 14, 2008 [2 favorites]


Quoting from the article:

That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning. There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle.

Was not the internet bubble more of a naive, overoptimistic rave over a genuinely revolutionary new technology sector, and less a consciously orchestrated arc, complete with crash? (he asked, innocently)

I definitely see the housing bubble and the credit crunch as an orchestrated event, complete with boundless hype, the offering and market blessing of insane loan products, poor/no credit screening, and easy vehicles for disguising and selling the loan risk off to less savvy investors.

So. Any of the presidential contenders have a handle on this shit?
posted by Artful Codger at 7:20 AM on March 14, 2008


Mutant: See today's news on Bear Stearns being bailed out by JP Morgan. You think they're the only one and an isolated incident? You haven't heard a peep from them through the press (although rumors on the internets were running rampant in the past week and their stock has obviously been under performing like mad, insiders new stuff was up if you looked at their stock movement)

The banks are insolvent and they aren't telling you. The only reason the Bear Stearns news is coming out now is because all the banks are reporting earnings in the next couple weeks and they can't hide it any longer. The banks that can lie will continue to fuck with their books a la Enron -- just a few magnitudes higher.

Bear Stearns is a member of the Federal Reserve.
posted by amuseDetachment at 7:52 AM on March 14, 2008 [2 favorites]


Wait, so wait, is it even possible for our banks to fail? Or will the failure be shunted elsewhere?
posted by TwelveTwo at 8:01 AM on March 14, 2008


sien -- "If it was the Fed, why did Australia, the UK and some other housing booms precede the Fed's rate lowering?"

I don't think you can compare apples with oranges and arrive at meaningful explanations. I'm an American living in London, own property in the UK and have held investment properties from time to time in other parts of Europe - mostly emergent EU members where convergence is sure to drive a profit. I only mention this to illustrate although most of my banking expertise is in the US markets I do track carefully other markets where I'm active.

I can't comment on Oz but the UK has some peculiar drivers that render it specifically unique. For example, a buoyant "buy to let" market, net plus immigration, and a mortgage sector that (at least since 1997 when I first moved here) was already making ill advised concessions to borrowers just to help them get a loan, to get them "on the property ladder" (thats a big concern in the UK).

More generally, the UK, much like the US, held interest rates unrealistically low for too long. As folks rushed away from the dot com collapse the most popular refuge seemed to be property, and in far too many cases the buy to let sector.

This unrealistic demand sharply increased prices and drove the UK's housing bubble.

Civil_Disobedient -- "So, if you used your house like an ATM and pissed away your third mortgage on Plasma TVs or larger cars--you're fucked."

Actually, your bank is fucked, especially so if you've engaged in equity stripping, a technique previously restricted to high net worth targets of litigation (e.g, physicians) - run as close to zero equity in your primary residence as possible, and taking out as much cash as possible as often as possible. When I learned about this practice in Business School it was perfectly rational for those employing the practice; can't sue to seize your home if it's owned by the bank (i.e., an outstanding mortgage with an LTV of 98% or higher doesn't leave a tempting target for litigants to drool over).

I was surprised when on a visit back to the United States in 2000 to learn that middle class people were not only advocating but also engaging in this practice. I was criticised by kin for paying down my mortgage as fast as possible. "Not shrewd money management" I recall being lectured. (please indulge a moment of schadenfreude as I think back:well, I can pay off my mortgage this afternoon if I'd like to, and my lecturer may very well work until he's dead...)

"But if, on the other hand, you recognized the stupidity of living beyond your means, and thus saved your duckets for a rainy day... well, the rainy day has come and it will wash your savings away."

Well, it is indeed distressing to hear that folks who scrimped and saved may get screwed. But anyone of more than modest means will have their cash diversified to some extent, even if the sum total of their diversification is 401k/home/bank savings. I certainly hope, for example, that nobody has their life savings sitting around in cash.

The St. Louis Fed has
an interesting presentation
showing personal savings running in the low single digits - and even negative - over the past five years. Doesn't look like too many folks have much cash sloshing about.

Thorzdad -- "It's all part of the ongoing transfer of wealth upward."

Not really. As many other folks have already pointed out, we're not manufacturing a lot these days. So more properly the wealth has been transferred outward, to the Developing Nations who actually manufacture the televisions or cars.

Artful Codger -- "I definitely see the housing bubble and the credit crunch as an orchestrated event, complete with boundless hype, the offering and market blessing of insane loan products, poor/no credit screening, and easy vehicles for disguising and selling the loan risk off to less savvy investors."

I don't think it was a grand conspiracy, but I do believe there were multiple agents in the mix looking out for their own interests to the exclusion of others. The list is long but definitely would start with Mortgage Brokers who helped the unworthy get loans, and Appraisers who would inflate property values. Fortunately, many local authorities are now looking into this, and even The FBI is involved. So it will all come out in the wash.

That being said, I do believe that we all have to take some degree of personal responsibility; many folks purchased homes they could barely afford on introductory, artificially low rates of interest that were variable and subject to change.

I don't think they should be allowed to cry victim and be made whole.

On preview: amuseDetachment -- "See today's news on Bear Stearns being bailed out by JP Morgan. You think they're the only one and an isolated incident?"

So one bank - Bear Sterns - is being bailed out by another bank?

That's hardly evidence of insolvency.

No, in this market, like in every market, there are winner and there are losers.
posted by Mutant at 8:03 AM on March 14, 2008 [1 favorite]


Mutant: Also it's really hard to explain that move, it's a cultural sea-change that is enabled by technology. My opinion isn't all that well-articulated with that, which is why I linked to the Cory Doctorow short story (seriously give it a read, it's actually about assets and investment). It's more of the realization of a lot of things at the same time: the increasing scarcity of commodities (not money), the declining value of intellectual property, increasing ability for DIY through the internets, ability for mass collective action through the internets (which renders the current methods of collective action, i.e. large corporations, rendered inefficient), money chasing smaller and smaller assets.

When I said "less of a need for a gargantuan equities market", I did not mean that there wasn't any need for equities (although I probably didn't make that clear enough). I mean that big money is increasingly chasing smaller and smaller money.

Some of the changes are visible today. Increased interest in smaller investments in the third world (micropayments), the indie music scene, the general interest in "free" intellectual capital (open source, blogs, etc), the co-working / freelancing community, and China's obsessive investments in South America / Africa.
posted by amuseDetachment at 8:05 AM on March 14, 2008


Alternate energy isn't the bubble. Energy is the bubble. The rise in alternate energy companies is a response to the energy bubble. My feeling is that the energy bubble is a result of a President and friends who come from the oil business and have managed to create an environment that has caused oil prices to skyrocket.

You could argue that given a long-term view of oil production and how it will decline over the years, oil prices should be high. I'm fine with that--oil prices should be high. But that is not why they are high at the moment. It is an artificially created bubble.
posted by eye of newt at 8:06 AM on March 14, 2008


So. Any of the presidential contenders have a handle on this shit?
posted by Artful Codger at 10:20 AM on March 14


Mitt Romney did, but he was a Mormon, which judging by conservative voters makes him the Antichrist.

Everyone reading this thread has taken a pay cut, over the last couple of years, of close to 30%... you just don't know it yet. You've actually been taking that pay cut for the last two decades, but the government successfully hid it from you. Now, it's finally starting to become visible. And, like an iceberg, there's a lot more going on than the visible bits you're seeing.
posted by Malor at 2:38 AM on March 14


Okay, so here is the problem with commodity based money. This is going to be long, and stunningly dull, but I keep reading the same wrong things on mefi over and over.

The reason gold and silver and copper were useful as money back in ye oldern days is because they were utterly useless for anything else. The egyptians buried tons of gold underground with their dead kings. They didn't do this because gold was hard to get, they did it because gold was easy to get - they never worried that there wouldn't be enough gold for the next king.

Furthermore, believe it or not, what we now call precious metals were quite easily available in antiquity. There was no deep excavation mining or strip mining as we know it today - that wouldn't come about until much later. 80% of all the gold ever produced (i.e. obtained from the earth) was produced since 1900, and 50% of all the gold ever produced in human history was produced since 1960.

So prior to the 20th century, the cost of gold, i.e. the amount of effort required to obtain it per unit, was actually very low. Think about prospectors panning for gold in the rivers around Sutter's Mill in 1849. Today the extraction cost of gold is $238 per ounce - 25% of the price of gold is cost. And it is only that low because of the huge technological investment spread across a massive scale.

Now look at these charts

Notice how the amount of gold per person falls between 1945 and 1985. Prior to that, there amount of gold per person was increasing every year. But these are years that coincided with the gold standard - in other words, there was still inflation. Your ounce of gold in 1835 isn't worth as much as in 1885 simply because there is a lot more gold around.

In the period from 1945 to 1985, when countries adopted fractional gold standards or dropped the gold standard completely, gold's only use was in jewelry. Why the uptick in the late 1980s? Because that coincided with the semiconductor boom and the blossoming of the hi-tech age, when gold found significant uses as an industrial metal in semiconductor deposition, electronics, optics and medicine.

Furthermore, when the US was solidly on the gold standard in the 18th and 19th centuries there were nine serious recessions. And this is at a time when the US was not dependent on global markets for trade.

Under the gold standard, you still had unpredictable inflation, and you still had recessions. You had runs on banks, and wars over resources. Furthermore, it would be impossible to return to the gold standard because gold has industrial uses, and its demand as an industrial metal is only increasing as fabrication pushes technology beyond the physical limits of copper and aluminum. You can't base your money on something that people need to use as something other than money.

That said, 3% of all the gold ever mined in the history of the world is in Fort Knox, and another 3% in held by the Federal Reserve. The all time high price of gold was set in 1980. In terms of 2007 dollars, gold hit a prices of $2300/ounce in 1980. Now it is less than half that.

The reason you have a financial crisis, any financial crisis is because of a money market imbalance, usually demand for money rising far more than the supply of it. Now the problem is that banks have taken on debt that they likely won't ever collect on and they no one will by from them. These banks need to pay out on other instruments (or worse, instruments derived from the busted debts themselves), and they need money to do that, but there isn't any money. So the Fed is trying to (a) create the money, and (b) get it to these banks in a way that does not perpetuate the spiral.

Is it a mess? Yep. Is it the end of the capitalist system? No. Consider that given the problems, we have a government that is detached and disinterested, and a newbie Fed Chairman whose not sure how to do his job. These two problems at least, will not persist in to next year.
posted by Pastabagel at 8:11 AM on March 14, 2008 [15 favorites]


So you think that the world's largest banks are being honest right now? Are you saying that Ambac, et al. shouldn't be bankrupt? That they deserve even an A rating (or for that matter BBB)? Because we all know that if Ambac was downgraded that would've caused a massive cascade in default, which is one of Roubini's steps to financial disaster. The banks have been lying and playing games time and time again. Every day news comes out with some kind of action by the Fed, banks bailing out other banks/insurances, or foreign "investment". I think that the banks are really insolvent if you take an honest traditional accountant point of view. I don't think the banks are going to go bankrupt. As I mentioned earlier, they're all members of the fed so they're going to inflate their way away. Which means any of us without hedged savings are all poorer. Because they're taxing anyone with savings to give it to the banks that underwrote/issued bullshit "high-interest" securities to make themselves all rich. Fuck them.
posted by amuseDetachment at 8:13 AM on March 14, 2008


Since this seems to be the bad economic news thread: Dollar's Clout Sinks Worldwide.
posted by drezdn at 8:19 AM on March 14, 2008


amuseDetachment -- "I mean that big money is increasingly chasing smaller and smaller money."

Ah, fair enough - I think you're describing what we call disintermediation; definitely a big concern in certain parts of banking, mostly (I think) in lending. I say "I think" as this isn't really my part of the field. In the UK Zopa has been messing about wit this model for a while now. Not sure how successful they've been, but they're still in business. So that tells you something.

That being said, your point was about equities, and I'm not sure that we could use this model to capitalise a business. I do know folks have experimented with this model from time to time with varying success.


"So you think that the world's largest banks are being honest right now?"

I know that banks are highly regulated and in fact regularly audited. They can't just decide one day to cover up the truth. Doesn't work that way. Far too many people looking at their books & records for the type of chicanery you're describing to take place.

"I think that the banks are really insolvent if you take an honest traditional accountant point of view. I don't think the banks are going to go bankrupt. As I mentioned earlier, they're all members of the fed so they're going to inflate their way away."

Please define this "honest traditional accountant point of view". I'm a part qualified Management Accountant (CIMA), I've looked at the books of banks as part of my day job and I don't believe the institutions I've looked at are insolvent. I'm hardly an auditor, I've looked at the books from another point of view, but I do know the Fed or BOE or ECB (I've looked at banks in all domiciles) would put an insolvent institution out of business quickly, LTCM style, lest it threaten the stability of other institutions and the wider financial system.

I'm always willing to entertain other viewpoints and learn, but I just don't see evidence of systemic banking insolvency from your statement.
posted by Mutant at 8:33 AM on March 14, 2008


These threads are always great. Many thanks to Malor, Mutant et al for the stimulating discussion.

Mutant: re: "all money is debt". Perhaps Gold-backed currencies represent a form of debt, but what about the coins themselves? Before paper money, was money still debt (assuming unadulterated coins, if that makes a difference)?

and thus saved your duckets for a rainy day...

Ducats?
posted by adamdschneider at 8:54 AM on March 14, 2008


adamdschneider -- "Perhaps Gold-backed currencies represent a form of debt, but what about the coins themselves?"

Well, in the strictest form of the definition, money is a promise of value, so I'd argue it is debt by another name. Even gold coins will have some negotiated rate of exchange, a promise of goods & services that will be exchanged for the money.

Malor raises a good question about fiat currencies in general, and although I don't believe backing modern currencies with gold (or another commodity) is the answer, I'm not really sure what the answer is. I just work here and try to make money whichever way the markets go.

"These threads are always great. "

Agreed. I always try to learn one thing a day, and if I see a finance thread on MeFi my search is usually over.
posted by Mutant at 9:13 AM on March 14, 2008


Pastabagel -- Hardly long and not at all stunningly dull (are you sure you weren't describing one of my comments?) -- great post by the way.
posted by Mutant at 9:18 AM on March 14, 2008


Marlor, RE: "Traditional Accounting":

By traditional accounting, I mean that the primary concern is with "Level 3 Assets" where the banks not only haven't been pricing them on their books, a lot of the time, they can't. If you have bought certain mortgage insurance contracts over-the-counter that is functionally a derivative of a derivative (of a derivative?) to hedge your investments in which the primary risk is counterparty risk (because the insurance company is insuring 100x their own equities), that makes things really messy really fast. I'm not sure I fully understand this area, so do correct me if I'm wrong. Summary: Black Swan, etc. etc. etc. ;-)
posted by amuseDetachment at 9:46 AM on March 14, 2008


So, ah, when I said this oil market was a bubble last week, and everyone shit on me for it, I take it none of the people commenting here were involved in that? Or did it change in the last week, such that I was obviously and laughably wrong then, but perfectly correct now?
posted by rusty at 10:56 AM on March 14, 2008


And hats off to inflation! Like most Americans, I have nothing but debt. Inflation is my buddy. I'm gaining equity in my house just wriitng this comment.
posted by rusty at 11:01 AM on March 14, 2008


amuseDetachment -- "I mean that the primary concern is with "Level 3 Assets" where the banks not only haven't been pricing them on their books, a lot of the time, they can't."

Well, I do have some familiarity with FASB 157, and believe this accounting standard to be stressing the balance sheets of some of the lesser capitalised banks, but not systemically to point of insolvency.

Earlier you pointed out one bank acquiring another. That proves there are winners in this arther treacherous market, and there are losers.

And without a doubt as some banks are forced to mark to market - not model - their seeing balance sheets shrink, and thus are (sometimes frantically) looking for capital infusions.

So while we probably will see an increase in outright failures (sidenote: banks fail all the time, even in robust market conditions), The Feb, BOE, ECB and even BIS by no means will entertain systemic insolvency. There more than likely will be some - maybe a distressingly large number - of shotgun weddings arranged by The Central Banks.

"If you have bought certain mortgage insurance contracts over-the-counter that is functionally a derivative of a derivative (of a derivative?) to hedge your investments in which the primary risk is counterparty risk (because the insurance company is insuring 100x their own equities),..."

I understand Credit Derivatives but (I'm sorry!) not your reference to "100x their own equities". And a credit derivative is NOT a derivative of a derivative of a derivative. And even if it was - what's the problem? We have models that can value such instruments. Nobody really trades them because, as you've alluded to, they're too damn complicated.
posted by Mutant at 12:27 PM on March 14, 2008


The banks are insolvent and they aren't telling you.

Really?

Bear Stearns is a member of the Federal Reserve.

Oh. You're one of those guys who thinks that the Bilderbergers control the world, aren't you?
posted by Kwantsar at 1:22 PM on March 14, 2008


amuseDetachment: Some of the changes are visible today. Increased interest in smaller investments in the third world (micropayments), the indie music scene, the general interest in "free" intellectual capital (open source, blogs, etc), the co-working / freelancing community, and China's obsessive investments in South America / Africa.

I really enjoyed that Doctorow story (gasp!), and I appreciate the point you raise, but I'm really very unsure.. For one thing, it is all too utopian to me. In the future, there are still going to be big monopolies and power hungry bastards trying to take all your time/money. And, there are lots of opposite pressures to the movements you are talking about: Apple proprietary connectors, printers sold as loss leaders for the chipped replacement ink/toner cartridges, IT businesses married to Microsoft. I mean, I enthusiastically embrace the business model you are talking about (I think), but..
posted by Chuckles at 2:58 PM on March 14, 2008


Sorry I haven't had time to get back to this until now.

Bubbles are indeed fascinating, but as I cited in a previous post they are far more common than Janszen acknowledges; in fact during the period from 1763 to 1975 we saw roughly 40, or on average about one every five years.

Those weren't bubbles. Those were the more ordinary boom/bust cycles that markets tend to go through. I've seen it argued that the business cycle causes this, and that the business cycle is caused by fractional reserve lending, but it's pretty normal overall, and something that we obviously can easily handle.

A bubble isn't just a little boomlet in one area, even if it's very high in percentage terms. Bubbles sweep an economy's consciousness; they 'change everything'. One of the first things to look for is the claim that the old rules don't apply anymore. In the Nasdaq bubble, you saw it with the capitalized New Economy, which was completely stupid, but everyone took it at face value. I can't think of anything quite so clear about the housing bubble, but the general wisdom that housing only goes up and that it should be your major investment were strong signs. It didn't LOOK as bubbly, consciousness-wise, as the Nasdaq, but in size it (and the paired debt bubble) both absolutely dwarf that earlier bubble.

Another way of putting it: Fleckenstein says that bubbles BECOME the economy. None of the examples you cited reach that level. Only stocks in 1925-29, stocks in 1995-99, and real estate in 2002-2007 really fit the bubble definition.

I don't think any bubble can last very long where people think it's a bubble ahead of time. Why? Because the fundamental consciousness shift requires that people believe they can't lose in a market, and that takes a long period of going up and providing fabulous returns. Markets depend on a greater fool theory, and they pop when there's nobody even stupider to sell to. If bubble awareness is widespread, no 'new economy paradigm' will attract enough fools to reach bubble proportions; market participants will be too smart to be taken in to the degree necessary.

Well, I'm not sure a gold backed currency is the way to go if that's what you're suggesting. And I'm not even going to suggest what the answer is as I don't know.

I don't know either. Gold's fine with me. We just need SOMETHING that can't be handwaved into existence. Hell, it could be cocaine, I don't care. Just something that can't be invented out of nothing. It's a reality check that can't be ignored by politicians.

Money has always been debt, based on a promise. Back during the time of commodity based currency, the US dollar was backed by gold, Pound Sterling by silver. One could approach the Central Bank of each respective nation and ask for your fiat, paper currency to be exchanged for the underlying bullion.

Here we sharply disagree on terms. Marker paper may be debt between you and the holder of the marker, but if the mint involved is honest, it doesn't matter. If it isn't honest, you get inflation just like you would with fiat currency, because that's what those extra bills are -- empty promises with no real backing. The problems we've had with inflation in this country were always from exactly this kind of playing with the money supply, and eventually the crisis in 1971 forced the US to declare bankruptcy. They don't like to paint it that way, of course, but at that point we reneged on our promise to pay gold in exchange for our notes; we went bankrupt. But a properly managed commodity currency is not debt; if you hold commodity dollars, it's the same as holding the commodity itself. The economy as a whole doesn't owe you anything; the Mint owes you some metal. It's a very different thing.

Fiat money isn't a claim on anything directly; it's a "commodity" with no inherent worth at all, and with no direct claim on anything. They can be issued at will, and used to extract value out of the economy, at will. Further, because there's no way for them to be 'cashed in', there's no quick and easy way to see if there are too many floating around. When they can be poofed into existence, the people who deal in derivative paper can take absolutely insane risks, because they can't write a deal that can't be covered; no matter how many zeroes are on that paper, if the Fed feels threatened by the paper failing, they can bail it out. Period.

With a commodity currency, that's just not an option. Bad players fail because hard physical reality forces them into failure. It makes money managers prudent. In this era of nothing failing ever, there's no such thing as risk management, because Uncle Ben will bail you out. And the system has gone entirely rotten with risk.

This is getting long, so I'll go ahead and post this and then keep replying.
posted by Malor at 7:48 PM on March 14, 2008 [3 favorites]


The reason gold and silver and copper were useful as money back in ye oldern days is because they were utterly useless for anything else.

I'd like to see some backing for that, Pastabagel. I won't just flatly contradict you, because I know you're a smart guy and you know which end of the stick is pointy, but that appears entirely ludicrous. Why on earth would anyone accept, as payment for goods, something that had no worth to anyone? WE do it because we've been conditioned in steps away from taking goods of actual worth, but ... you'd have to be pretty crazy to accept copper coins if the copper wasn't worth anything.

Remember that ancient coins competed for purity and correctness of weight, and they were traded all over the world. If they really had no value, it wouldn't matter how pure the coin was, now would it?

It's also worth pointing out that, over the long span of history, the health of a nation and the health of its currency are very closely correlated. It's only in the last thirty years that this has really diverged from past history, and I think it's catching up with us now.

Under the gold standard, you still had unpredictable inflation, and you still had recessions. You had runs on banks, and wars over resources. Furthermore, it would be impossible to return to the gold standard because gold has industrial uses, and its demand as an industrial metal is only increasing as fabrication pushes technology beyond the physical limits of copper and aluminum. You can't base your money on something that people need to use as something other than money.

I'm not saying that the gold standard was perfect. I never have. You still have problems. Economies are always out of balance, and always adjusting, and things break. Frequently. But they gradually get better and better.

I don't care what gets used, it just needs to be something. Platinum would be fine. Silver would have been great, but we've sold off the five billion ounces of the stuff we used to have, and lord only knows where it's all gone.

I will, in general, agree with you about problems with commodity money standards. You're right that they exist. It's not a panacea. But fiat money gives us an unlimited-length rope to hang ourselves with. It lets wishful thinking instead of reality rule the day. We've been doing that for an entire generation now, and we are so fucked. That would not have been possible with commodity money; we'd have known we were in trouble twenty years ago.

So, ah, when I said this oil market was a bubble last week, and everyone shit on me for it, I take it none of the people commenting here were involved in that? Or did it change in the last week, such that I was obviously and laughably wrong then, but perfectly correct now?

Well I didn't contribute much to that thread and didn't really follow it, but no, oil is not in a bubble. It's gone on a bit of a tear, sure, but it's just one commodity. Bubbles BECOME the economy, and oil going up too much will WRECK the economy, so I don't think a bubble in oil is possible. A boom, yes, sure, but it would do too much immediate economic damage to be sustainable into full bubbledom.
posted by Malor at 8:03 PM on March 14, 2008 [1 favorite]


One of the things that I would heartily approve about a gold-backed currency is that it would force politicians to be honest about spending.

President Bush would have to go on national TV and say "Well folks, *smirk*, we can either have a perscription drug benefit for our nation's seniors, or we can continue to have the war in Iraq. It's your choice."

As of right now, we just pretend that we can afford both, when, in reality, we're really just paying for one and printing money to fund the other.
posted by Avenger at 8:13 PM on March 14, 2008


Finally, a thought has been tickling around in the back of my head for a couple of days, and I thought I'd throw it out here.

In Confessions of an Economic Hitman, by John Perkins, he talks about how he was recruited by the CIA to wreck foreign economies. He would do this by going in with a team and conducting an 'economic analysis', showing that if the country took on a large debt to build infrastructure, they would then generate enough tax revenue from all the ensuing economic growth to pay for it. This was a total lie. They would take on the debt, and, as part of the package, they would be required to buy all the infrastructure from American companies.

Now, from what I can tell, we did a good job and delivered exactly what we said we would; well-built, high-quality infrastructure. But the projects never resulted in the kind of tax revenue we claimed, and the country would inevitably descend into poverty. We would also have set it up so that a ruling junta became fabulously wealthy, and they would use their wealth to maintain power, plunging the rest of the country into absolute economic misery. They became client states of the American Empire, simply by taking on too much debt, and we were able to get access to their resources for ludicrously low rates, and, apparently, get them to vote the way we wanted in the UN.

For other external support, look at the World Bank and IMF... both American-run organizations. Whenever they get involved with a country, that country mysteriously fails to thrive, and after reading this book, I no longer think that's accidental.

Well, anyway... so it appears likely that the CIA has been deliberately enslaving countries of interest by convincing them to take out unpayable loans. So, the thought occurs... what if those same guys are doing exactly the same thing to the United States itself?

If you wanted to destroy this country, I simply can't imagine a better way of going about it than what I've been seeing for the last two decades. Talk the country into taking on debts it can't pay, get a strong ruling class in place with control over the military, and you own it.

Just a thought. It's pretty uncomfortable, but... I think it might be possible.
posted by Malor at 8:17 PM on March 14, 2008 [2 favorites]


Oops, hit post too soon. I dunno if there's anything to this, but.... geeze, the stupid shit we're doing sure looks awful familiar.
posted by Malor at 8:19 PM on March 14, 2008


So, ah, when I said this oil market was a bubble last week, and everyone shit on me for it, I take it none of the people commenting here were involved in that? Or did it change in the last week, such that I was obviously and laughably wrong then, but perfectly correct now?
posted by rusty at 10:56 AM on March 14 [+] [!]

I wasn't there or I would have agreed with you. But I think we are alone. This, like most bubbles, is a blindspot--until the bubble bursts. You could never convince people during the dot.com or telecom boom that it would soon be over. They'd call you crazy or laugh at you like many posters apparently did in response to your previous post.

Even the Harper article on bubbles is missing the obvious one right in front of their nose.
posted by eye of newt at 8:35 PM on March 14, 2008


It's nowhere near big enough to be a bubble, eye. It would have to be like $500+.
posted by Malor at 2:13 AM on March 15, 2008


Perhaps another way of looking at what Malor's talking about would be to say that the USA bubble has burst. It's just as scary really, but less conspiracy-theory-esque. That's pretty much what the Harper's article says happened in 1971 when we went off the gold standard, but there's been a lot of denial since then.
posted by wobh at 2:38 AM on March 15, 2008


Malor -- "Those weren't bubbles."

Who says? Lest we drift into semantics - you've now introduced "boomlet" - I'll start by pointing out that considering finance as a field can't readily agree on the definition of a bubble, it's unlikely we'll hash it out to everyone's satisfaction on MeFi. But, let's talk a a few points and look at the fallout of a few of the (I say) bubble / (you say) non bubbles.

Ok, I never included tulipmania in my prior post as it's so well known. And I wanted to illustrate, contrary to what's been posted here, bubbles are startlingly common, and for those who study the history of finance, not a surprise at all.

To set the stage, in the 1600's The Dutch were one of - if not the - preeminent economic powers. Their economy, however, had stalled in the 1620's due to a war with Spain (after a prolonged, I believe twelve year truce). Once the conflict had been cleared however, the Dutch trading based economy roared back to life.

As a yardstick, shares in The Dutch East India Company doubled in value between 1630 and 1639 (sidenote: this was a very, very impressive milestone as equity culture was hardly as pervasive as it is today), putting on an additional 20% in 1640 alone.

House, art and other non liquid assets - e.g., tulip bulbs - showed similar and sometimes sharply higher increases in value.

In 1623 a tulip bulb cost about one thousand florins. As speculation became mainstream, folks started diverting their time away from productive endeavors and focused on trading tulip bulbs (i.e., speculation - does any of this sound familiar? It sure does to me, as the same themes play out time and time again over the history of bubbles). As my source cites, good traders "could earn six thousand florins a month", at a time when the average income was a mere 150 florins pa.

By 1635 the top price recorded was some 6,000 florins. The bubble was truly in place and growing fast. In increasingly large numbers people quit their jobs to focus on trading tulip bulbs. The effect on the overall economy - waves of inflation as the prices of real goods adjusted to match the volumes of speculative money chasing a limited supply.

By 1636 students of financial history will note that speculative pressures had grown to such an extreme that folks were now buying and selling bulbs that hadn't even been planted yet. Once again, to illustrate these same themes play out time and time again, I'll focus your attention on "off plan real estate" and the (currently deflating) G7 Real Estate speculation bubble.

Anyhow, the party was over by 1637 and a depression soon gripped The Netherlands. Thousands of businessmen - not all speculators in tulip bulbs, mind you - were bankrupted. Homes were seized, and folks were so destitute they resorted to eating the very bulbs they traded houses and other tangible assets for a few short months ago.

So how can this not be considered a bubble? Savings were destroyed. Productive capacity forever lost. Folks lost their homes. Quality of life decimated.

But it's your position so please back it up. Given theses aftermath how you can you say - so definitively mind you, with such certainly - "Those weren't bubbles." It's almost as if an arbitrary distinction has been drawn between the well known stock and real estate events you admit are bubbles, and their historical predecessors.

These events that you've admitted were bubbles aren't new. They're variations on a theme that we've seen time and time again in financial history.

It seems to me that many posting here fall victim to feeling these are unique times, that somehow "it's different this time" (the old adage about falling prey to investment advise). It isn't. Over a long horizon we see the same themes arising time and time again.

The currently deflating Real Estate bubble? We've seen it before, and back when commodity based currencies were the norm.

As I closed my my prior post on the topic of bubbles, we're programmed on some level for irrational behaviour..

Commodity currency or not.



"Fleckenstein says that bubbles BECOME the economy. None of the examples you cited reach that level. Only stocks in 1925-29, stocks in 1995-99, and real estate in 2002-2007 really fit the bubble definition."

Sure, I've read Fleckenstein's articles on MSN Money and I'm aware that he's got a couple of popular books kicking about as well. He raises some interesting points, and Tulipmania certainly did become the economy. As did the other bubbles cited.

"...and eventually the crisis in 1971 forced the US to declare bankruptcy."

Well, that's only one view of taking the United States off the gold standard. Other economists don't see it that way, and in fact I've never run across one at any University or Financial Institution that I've been associated with that hold this view. Of course things are different on the internet ...

"I'm not saying that the gold standard was perfect. I never have. You still have problems. Economies are always out of balance, and always adjusting, and things break. Frequently. But they gradually get better and better."

No, the rate of growth of your economy is tied to the amount of gold you hold. And where did you get the idea that things "gradually get better and better"?

Keep in mind the primary reason The Spanish went to The New World was to seize gold. Not to bring Christianity to the masses, not to explore. But to loot.

Avenger -- "One of the things that I would heartily approve about a gold-backed currency is that it would force politicians to be honest about spending."

Well, modern economies abandoned the gold standard for very good reason, so I'm not sure a return to any commodity based currency would be a good idea.

What I do like, however, is the fundamental difference between how the United States and The United Kingdom regulate their markets.

The United States is rules based. Given a situation, write a rule.

The United Kingdom is principles based. Given a situation, define a principle intended to deal with that problem.

The issue with a rules based regulatory environment is that you end up with a large number of rules, one for each and every situation. And there are always loopholes.

A principles based regulatory environment, however, judges by the spirit not the letter of the law. Big difference, and I think it would help with Macro economic policy.


Malor -- "so it appears likely that the CIA has been deliberately enslaving countries of interest by convincing them to take out unpayable loans. So, the thought occurs... what if those same guys are doing exactly the same thing to the United States itself? "

Uhhm, wow, so who do you believe would benefit from this?
posted by Mutant at 4:39 AM on March 15, 2008 [3 favorites]


Ah! Not to beat a dead horse, but someone just mailed me this link, raising a point I have to admit I had totally forgotten about.

Bubbles are so damn common throughout the history of finance, that Britain in 1720 actually passed a act - "The Bubble Act of 1720" - requiring all company's that issued shares to have a Royal Charter, in a attempt to stamp bubbles out once and for all.

This prohibition arose due to the fall out from The South Sea Bubble, the deflation of which, by the way, drove the deflation of other asset bubbles in Amsterdam Paris and Frankfurt. These were preceded by the Collapse of The Mississippi Company bubble in distant The United States. All different asset classes but all undeniably bubbles.

And all these disparate bubbles had one thing in common - thousands, sometimes tens of thousands of investors and speculators were wiped out, bankrupt. There is no denying the fact that bubbles are amazingly common to any student of the markets with a long term perspective.

Stocks in 1925-29? Stocks in 1995-99? Real estate in 2002-2007?

Sure they were bubbles. But as I mentioned previously, they were not a surprise. They were merely variations on a theme that we see repeated time and time again in the history of finance.
posted by Mutant at 5:46 AM on March 15, 2008


Very good article. I've believed for a long time that the US population vacuum behind the baby-boomers would "bring the house down", so to speak. This credit crisis mess is just extra snow on the roof. I've always encouraged people to get a McDonalds Mortgage- a home mortgage with a payment manageable enough that you could still pay it even your only employment was a job at McDonalds.
posted by Rafaelloello at 6:14 AM on March 15, 2008


Rafaelloello -- "Very good article. I've believed for a long time that the US population vacuum behind the baby-boomers would "bring the house down", so to speak. This credit crisis mess is just extra snow on the roof. I've always encouraged people to get a McDonalds Mortgage- a home mortgage with a payment manageable enough that you could still pay it even your only employment was a job at McDonalds."

Overall not a bad read, but as I previously mentioned, a little too emotive and hyperbolic for my tastes - for example, he did use the word hyperflation no fewer than a dozen times.

There is absolutely NO hyperinflation in any asset class today in the G20, nor has there been (systemic) hyperinflation in any single asset class for a long time now.

A few other points : Janszen mentions publications by The Cato Institute as "evidence" of an elite sector seizing control of the economy, while blissfully ignoring (or willfully omitting) the fact that a large nunmber of very, very influential market participants and academics - Warren Buffet (Berkshire), Bill Gross, Paul Volker to name but three - were all decrying deficits and reckless monetary expansion.

Looking deeper at the article, we find mixing and matching of losses and write offs.

"In the United States, Merrill Lynch took a $7.9 billion hit from its mortgage investments and experienced its first quarterly loss since 2001; Morgan Stanley, Bear Stearns, Citigroup, along with many other U.S. banks, have all suffered major losses The Royal Bank of Scotland Group was forced to write down $3 billion on credit-related securities and leveraged loans, and Japan’s Norinchukin Bank suffered $357 million in subprime-related losses in the six months prior to September 2007."

Putting my Management Accoutant hat on for a second, I'd like to illustrate that an operating loss is very, very different from a write down. But he's mixing them in this paragraph - and others - to prove his point. I have a problem with one sided arguements.

Janszen raises other points of questionable veracity -- "And the FIRE economy—which depends on the free flow of credit—will experience its first near-death experience since the sector rose to power in the early 1980s."

Now my earlier comments about emotive, hyperbolic turns of phrase aside (i.e., "near-death"), would Janszen have us believe there hasn't been a credit contraction since the early 1980s? Hancock, Laing & Wilcox studied sharp contractions in lending in the late 80's / early 90's, and they certainly didn't reach that conclusion. Follow up research by Hancock and Laing in 1998 reiterated their earlier conclusion that the credit cycle was alive and well, and contraction, sometimes sharp contractions, followed expansion. In other words, the free flow of credit was periodically and routinely, it would appear, mitigated. Contrary, I might add, to Janszen's view.

HANCOCK, D., LAING, A., WILCOX, J. 1995, "Bank Capital Shocks: Dynamic Effects on Securities, Loans, and Capital." Journal of Banking and Finance 1995 (June): 661-77. )
HANCOCK, D., WILCOX, J. 1998. "The `Credit Crunch' and the Availability of Credit to Small Business." Journal of Banking and Finance 1998 (August): 983-1014.


I've seen other papers on this topic, but don't have them to hand.

And you've gotta love lines like this -- "and the FIRE sector know that a debt-deflation Armageddon is nigh, and both are praying for a timely miracle,...".

Well, I work in banking, teach finance at a University part time and all I can say is SON OF A BITCH!. I must have missed the memo, 'cause I certainly didn't know that "Armageddon is nigh".

Overall an interesting read but one has to be very careful about accepting all of Janszen's points at face value.

Good advise by the way on the mortgage. When I purchased my flat in London in 2001 I paid 115K, financing it at 80% LTV, 25 year term fixed. I aggressively paid down principal until last year I owed only £20K. I liked having a mortgage payment that roughly the same as dinner for two with wine at a nice restaurant.
posted by Mutant at 7:11 AM on March 15, 2008


It's nowhere near big enough to be a bubble, eye. It would have to be like $500+.
posted by Malor

Oil is nowhere big enough to be a bubble??? Oil is not the economy of the US???

Like I said, like all bubbles, it is a blindspot. Gas was something like $1 a gallon in 1980s. The price of just about everything you buy has included in it extra costs for transport because of the artificially inflated price of oil. The Harpers article said that alternative energy was the latest bubble, a market which is not even in the shadow of the oil industry.

But heck, that's the whole point of a bubble. If anyone believed it was a bubble, it wouldn't exist.
posted by eye of newt at 10:52 AM on March 15, 2008


eye of newt -- "Like I said, like all bubbles, it is a blindspot."

You do have a good point here that bubbles are rarely recognised until the late stages.

Given the well documented frequent occurrence of financial bubbles in the past four hundred years or so, there has been significant research into this area. Bubbles (and other systemic pricing distortions) are one of my areas of interest, so I've pulled a few relevant papers out of my research pile here. This list is illustrative only, and by no means exhaustive.

A few points are worth noting: Anyhow, if folks are interested in bubbles here is a subset of research I've found worthwhile reading (time and again, as it were). And I don't think I'd agree with the assertion "It would have to be like $500+." in reference to the price of oil; not only has the number (apparently) been plucked from air, it also ignores your point that the visible price may be a relatively small part of the overall impact of these shocks.
posted by Mutant at 11:39 AM on March 15, 2008


eye of newt - Like I said, like all bubbles, it is a blindspot.

When people make this statement I often wonder. It was pretty obvious the housing bubble was occurring years ago. Before that, the tech bubble was obvious. Before that the precious metals bubble, etc. Sure, some people don't see it, perhaps because they don't want to. But even non-financially savvy people such as myself could see the last two big bubbles.

A good rule of thumb these days is to believe the opposite of what Larry Kudlow says. No housing bubble? You better believe there's a bubble in housing. A bubble in the price of gold? Time to stock up on more gold. When Kudlow says that gold is a good investment and there is no commodities bubble, that's my cue to sell.
posted by ryoshu at 3:47 PM on March 15, 2008


Mutant, I used slightly sloppy wording, but you mistook my argument. Yes, there have been other bubbles besides the three I mention, in all of world history. But they don't happen often, certainly not every five years. They tend to be once every two- or three-generation events, because they burn the participants so, so badly that nobody will fall for the same thing a second time in their entire lives.

Yes, the tulip craze was a bubble. It's the canonical example. Holland didn't have any more bubbles for a long, long time after that. Maybe not at all.

Bubbles are extraordinary events, they're not a simple boom in smething. The Nifty Fifty idea was a delusion and dumb, but it didn't become the economy. Gold in the 1970s went on a huge tear, but it wasn't a bubble because it stayed a very small fraction of the total economy.

Stocks in 2000, and real estate now, are most certainly bubbles, so huge that differentiating them from the main economy is impossible.

In the United States, there have been only three true bubbles I know of; stocks in 1929, stocks in 1999, and housing/debt now. All share monetary dysfunction at their core. It appears to take government involvement to make a bubble happen.

Bubbles are extraordinary events and leave behind devastation. Little boomlets in particular asset classes are, relatively speaking, unimportant. They are, in fact, how the truly savvy investor makes money consistently over time... spotting these patterns and riding them.

But using the 'bubble' tag on any asset class that's performing unusually well cheapens the term and makes it useless. A bubble sucks the entire economy into its reckless expansion, to the point that it's touching virtually everyone and everything in it.
posted by Malor at 9:44 PM on March 15, 2008


Great comments mutant.

It's great when people with real expertise comment on these things here.
posted by sien at 9:57 PM on March 15, 2008


Malor -- "But they don't happen often, certainly not every five years."

But once again I ask - Who says?

The papers cited above are a very, very small subset of the literature covering this particular area of finance. So I previously asked - and now I ask again - what is your source for this conclusion, this determination?

'Cause there are a large number of academics - and industry practitioners as well - out there studying nothing by your account (a position which wouldn't surprise critics of the dismal science by the way...).

But do keep in mind the long term view. As previously mentioned, bubbles are so so common throughout the history of finance that Parliament actually passed an act - "The Bubble Act of 1720" - in a feeble attempt to legislate them out of existence.

Unsurprisingly, neither Bubbles nor irrational speculators paid this Royal Decree any mind, and in fact over the next hundred years in England we observed at least five subsequent bubbles i.e., 1793, collapse of a speculative bubble related to the financing and construction of canals, 1797, a broad equity market collapse, 1810, a crash in the shares of firms providing financing and export to South America, 1816, a collapse of a speculative bubble in the shares of companies exporting commodities to The United States, 1819, another bubble burst, again in the shares of commodity mining companies. I've kept this to one hundred years in the interest of brevity; there were, of course, many other bubbles observed in England, right up until present times ...


You are attempting to impose on us a very insular, very narrow definition of what constitutes a bubble. Bubbles do happen with alarming regularity. Bubbles will continue to happen. And that's whether or not we're backing our currency with a commodity, by the way. These assertions are supported by the literature cited above, they are not my own opinion, interpretation or definition, rather the conclusion of a wide range of researchers, each working largely independently over a period of time.

As a field we still don't precisely understand how or why bubbles happen - not completely, not with any certainty, but we do know they happen with alarming regularity. And we still have difficulty recognising them when they occur, as objective and quantitative tests seem to be market / asset class specific, and not terribly efficient sometimes.


"Holland didn't have any more bubbles for a long, long time after that. Maybe not at all."

Again, sorry to differ, but there most certainly were additional bubbles in The Netherlands (Holland is particular part of Nederlands, by the way, not the entire country).

The Seven Years War saw a the emergence of speculative bubbles in many commodities. As The Dutch were neutral, Amsterdam was the natural focal point of a speculative bubble in sugar (sidenote: I previously mentioned my long held belief that wars are inflationary; this too, is a theme we see played out time and time again in financial history).

When The Seven Years War ended commodity prices widely cratered and the bubble in sugar collapsed. Hard. The Dutch economy suffered as a result, with the complete bankruptcy of some 38 financial institutions, of which no fewer than seven were major merchant banks (Cottrell, P. L., 2002, 'Clustering As an Economic Phenomenon', Working Paper No. 25, A Diebold Institute Entrepreneurship and Public Policy Seminar, Downing College, Cambridge, UK).

As The Dutch have few natural resources, relying largely upon trading and other economic activities, the loss of so many financial institutions, so much financial capability was a very, very heavy blow in this small nation. Especially so considering central banking as a discipline was relatively undeveloped at that time, and tools we take for granted today weren't then available.

It wasn't until the Bank of England stepped in as lender of last resort - across pretty much the entire continent, mind you as the war was widespread - that we saw first stablisation then a return to growth.

So yes, bubbles most definitely were observed in The Netherlands after tulipmania. And bubbles were certainly observed in The Netherlands before tuplimania.

We could, of course, talk about the 1772 speculative bubble focused on shares in The East India Company, the collapse of which hit Amsterdam very, very hard as well, or the 1848 collapse of a speculative bubble centered around potatoes that ... but I'm sure my point is clear ...


"In the United States, there have been only three true bubbles I know of; stocks in 1929, stocks in 1999, and housing/debt now."

Perhaps only three that you know about, but that doesn't change the fact that speculative bubbles in the United States have been legion, not rare. Rather than repeat (what again?), please look back at my prior post on this topic. Once again, we see bubbles happening every five to ten years or so, with disastrous results for those involved.


"But using the 'bubble' tag on any asset class that's performing unusually well cheapens the term and makes it useless."

No, that's how we in finance have defined such things.

Once again, you're trying to impose a definition of bubbles on us that incorporates a possible side effect of bubbles, namely grand scale economic destruction. Not all bubbles result in such wide ranging effects, the musings of that single MSN Money commentator previously cited aside.

But let me close this by putting back to you two questions that have been previously raised but not addressed :

First, you've disagreed with the bubbles I've cited, stating, rather definitively mind you -- "Those weren't bubbles."

So what test have you applied to make this determination?

Hint - citing an MSN Money commentator isn't conclusive evidence.

Secondly, when discussing the price of oil you stated - again, very confidently, very definitively, "It's nowhere near big enough to be a bubble, eye. It would have to be like $500+."

Same question. What test have you applied to make this determination? How did you arrive at this price?

There are quantitative and objective tests that we apply to answer both questions. Some of these tests are described in the literature cited above. This part of finance is an area of interest for me, and I'm genuinely curious about the methodology, the thought process that was utilised to reach these conclusions.

I do, however, suspect these conclusions are subjective, and opinion only.
posted by Mutant at 6:23 AM on March 16, 2008


but that doesn't change the fact that speculative bubbles in the United States have been legion,

You are misusing the term.
posted by Malor at 6:41 AM on March 16, 2008


Oh, and oil's not in a bubble because speculation in oil and oil-related industries doesn't dominate the economy.

You are using the term wrong. Bubbles are financial manias, not just price increases.
posted by Malor at 6:44 AM on March 16, 2008


Ok, one more thing. Let me state this more directly. I don't know what it is you're trying to prove, but it's not working. You're waving your hands in the air about bubbles and definitions and bullshit, pure and simple.

What you SHOULD be looking at is that the economy is unbelievably maladjusted, on a scale that has not been seen in this country since 1929. Whatever word you want to use, this is not common, this is not normal, and IT IS NOT BUSINESS AS USUAL.

I'm pointing, and have been for the last six or eight years, at a financial the storm the likes of which we have not seen in almost three generations, a hurricane that fills most of a goddamn ocean, and you're handwringing and being pedantic and pointing at the fact that we have tornadoes.

Yes, tornadoes are storms. No, they are not hurricanes. They're related only in the sense that they're both circular air movements. That's what you're doing here; you're trying to redefine the word bubble to cover things we see all the damn time.

This isn't one of those things.
posted by Malor at 7:04 AM on March 16, 2008


Malor, thanks for your comments but we're getting off topic.

My questions, however, still stand open, and in absence of supporting arguments we can only conclude the positions were your opinion only.

Not a problem, but I've seen lots of your opinions presented - not only in this thread mind you - as fact when I long suspected they were not.


I've mentioned several times on MeFi that systemic pricing distortions aka "bubbles" are a particular area of interest for me. And I've very politely, very respectfully asked that you cite your source and provide evidence of the process that was employed to reach your conclusions if, for no other reason than to help all of us to understand and perhaps learn something.

After all, Sir, you contradicted me , very strongly, very decisively. And when asked to provide proof of your assertions you change the subject (you & I agree on the money supply, by the way ...), resort to personal attacks ("waving hands in the air" , "bullshit") and even profanity. Hardly appropriate.

Wow I do like to keep these things civil, and I certainly hope I haven't responded to one of your - or anyone else's posts - in such a manner. I have to say, I don't like the way this is going - folks can disagree without such nastiness.



"You are misusing the term." -- Bubbles? I think not. I'm using the term bubble in manner consistent with industry and academic practice, as cited in this post and others.

As I previously pointed out, you've been widening the defintion of bubbles to include a possible side effect that sometimes - but not always - is observed.

Not all bubbles collapse in global economic calamity, a Great Depression, as the citations and links I've provided prove.
posted by Mutant at 7:55 AM on March 16, 2008


You're arguing with me about whether the immense storm is a hurricane or a tornado. That doesn't matter. It's not important. All you have to do is take a step back and THINK about this a little. You don't need much in the way of hard numbers, just some vague estimates, and you'll get an idea of what a terrible position we're in.

First: we're running a two billion dollar a day trade deficit. That's about 7% of official GDP, and the modern GDP numbers are very bogus. The real figure is probably more like 9 or 10%.

Second: most of that money has come from the housing ATM; people took loans and spent the money on consumption. We have been absorbing the savings of the entire world, the vast majority of which has been going to fuel our immense housing bubble and spendthrift consumption, not for productive investment.

Third: our savings rate is strongly negative. The last numbers I saw suggested that consumers would have to cut discretionary spending by about 30% just to get back to break-even level.

Fourth: the government, per its own GAO, is over fifty trillion dollars in debt.

Fifth: foreign entities hold absolutely massive dollar reserves; this is another form of debt. They are claims on our assets and production, and the Chinese and Japanese central banks alone hold just about $2.5 trillion worth.

Sixth: a very large fraction of our manufacturing has gone overseas. We are now over 80% 'service economy', aka jobs that don't directly produce anything.

So, in other words, imports need to drop by 7%, exports need to increase by 8 or 9%, or some combination of the two. The consumer has to cut spending by about 30%, and our government needs to double its tax collection to pay its known debts. And we don't have much manufacturing capacity left to make goods for the world to take in exchange for our dollars.

And all of this has happened because the Fed disconnected the financial system from the economy by printing too many dollars and ignoring -- nay, fomenting -- bubbles.

And I haven't even touched the derivatives mess yet... this is just the basic economic facts on the ground.

How can you know these things and think anything but 'colossal disaster'? You're arguing about penny-ante little boomlets and getting your knickers in a twist about minutiae. Pay attention to the big picture. Any one of these things, on its own, would be a huge challenge... all of them together are a lethal brew.
posted by Malor at 10:02 AM on March 16, 2008 [1 favorite]


Malor, please, once again with your most recent reply you're getting seriously off topic; please just answer the questions.

When I posted a brief list of what many of us in finance generally accept as bubbles, you stated - very definitively, very directly mind you -"Those weren't bubbles.". Once again according to who?

Further, someone opined about the price of oil, perhaps that its explosive appreciation constituted a bubble, and you - once again, definitively, confidently, stated "It would have to be like $500+" to constitute a bubble. So why this price? Are you saying prices of $550, perhaps $510 would constitute a bubble, but at $500 or $499 there is not a bubble? I still maintain you've pulled this number out of the air, that there is no justification for your estimate. And yet you described my posts in this thread as "hand waving"?

I've mentioned that bubbles are a research interest of mine, so as well as contributing a lot to this topic (e.g., journal citations, book references, a minor amount of clearly identified personal opinion) I merely asked about your sources and the methodology you employed to reach your conclusions. Which, by the way, directly contradicted my own.

Further, almost every time you've contradicted me you've done so based on personal opinion and not fact; for example, "Holland didn't have any more bubbles for a long, long time after that. Maybe not at all.".

Well Sir, I pointed out just two post-tulipmania bubbles, one of which had devastating consequences (economic data from that period is spotty, but some believe the bubbles aftermath approached an economic depression) for The Dutch.

No Sir, its clear these "conclusions" are solely your opinion, and not fact. I've suspect this in other threads, but it never came that I could raise the topic directly. And as per my earlier comments, there is absolutely nothing wrong with having opinions, except when they're presented as some type of factual conclusion.



"You don't need much in the way of hard numbers, ..."

Again, sorry to disagree, but actually, we do.

Grab a few of the papers (Adam & Szafarz, 1992 'Speculative Bubbles and Financial Markets' is a good start) I've cited, academic research focused on bubbles and you'll find that most detail econometric models requiring hard numbers - data, in other words - to objectively and quantitatively classify pricing distortions as bubbles. That is, of course, what we're working towards - objective tests. Otherwise we're back at personal opinion.

And no, the pornography test made famous by Justice Stewart " - hard to define, but I know it when I see it." - doesn't readily apply to finance. We do have empirical, statistically valid tests, at least for some asset classes and some markets.

And if the pornography test did apply, with all due respect I'm not totally comfortable with having yourself as the self appointed judge of what pricing distortions constitute a bubble and which ones do not.


"Pay attention to the big picture. "

Look I have to say this - I find the lecturing counterproductive. I've been working in banking for about twenty five years and feel that my posting history - in this thread and others - speaks for itself in terms of academic rigour and depth. And what I've posted in this thread alone should suffice to prove I have strong insight into the topic of bubbles. After all, I'm not citing the MSN weatherman to substantiate my statements.

And the big picture you ask? Yes Sir, I like to think I've got a good overview of the big picture.

But I'm always open to learning. However the crux of your position in this thread (as well as others) seems to be a lot of personal opinions tossed about in a factual manner.

And that is why you haven't provided answers to my totally reasonable queries.
posted by Mutant at 11:31 AM on March 16, 2008 [2 favorites]


You are not arguing honestly. You're arguing to 'win', not to discover. In some threads, you talk about "bubbles" every five years, which aren't at all. I'm saying that bubbles are generational events, and the current oil price is not a bubble.

Same question. What test have you applied to make this determination? How did you arrive at this price?

Very simple. The dollar has dropped by nearly half since 2001; a Euro was worth 80 cents when I first started looking, and it's now worth $1.57. The dollar has also dropped about 35% versus the yen since 2002.... and that's with active, massive intervention on the part of the Japanese central bank. In 2001 dollars, the price of oil is somewhere between $55 and $60.

You want to see bubbles everywhere. They are generational events in a given economy, not something that happens every five years, and it requires a major rejiggering of the economy to support the speculative financial mania. A very large part of the economy has to be involved in the speculation, and it just isn't. You don't get bubbles until you have a Widows and Orphans phase: only when the least financially savvy in the economy are participating in the speculation do you have a true mania/panic/crash.

Oil's not in a bubble; it hasn't gone up enough, and speculation in oil isn't a significant part of day-to-day life. Get it to the point that traders are hawking oil futures to retirees by visiting their houses, and late night tv is covered in infomercials about buying shares in new oilfields... that might be a bubble. Get it to the point that oil is trading at 10x or more of its actual worth as well, and I'd be pretty convinced that it was a bubble. (that's why I said $500... I figure $50 is a fair price for the amount of energy in a barrel of oil... and that's thinking with older, higher-value dollars. $80 and $800 might be more useful benchmarks with today's dollar.) But high prices alone don't a bubble make, it requires a systemic speculative frenzy.

What we have now is currency devaluation and real demand increase, not a bubble. It could BECOME one, but it's not there yet.
posted by Malor at 4:37 PM on March 16, 2008


"I'm saying that bubbles are generational events..."

Well Malor, thank you for being honest.

YOU are saying. Not referencing a book. Not pointing us to a journal. Not bringing our attention to a body of research. But you, and (apparently) you alone have decreed that of these 40 or so systemic pricing anomalies referenced (there are more by the way), you have decided they are not bubbles. Choosing to ignore the copious and relevant literature, the conclusions and views of a number of academics and industry professionals who over decades have concluded these were in fact bubbles, you have somehow concluded they are NOT bubbles? And yet you still decline to provide evidence beyond your view that "bubbles are generational events".

I'm sorry, but the original question still stands. If you have applied a test to arrive at this conclusion please cite it. Otherwise this is (as a depressingly large number of your comments turn out to be) personal opinion.

Keep in mind that it was previously pointed out the pornography test wouldn't be accepted as an answer. Clearly this is your personal opinion, not objective, verifiable fact. A body of academic and professional research exists to objectively identify and classify bubbles. And you would have us ignore this prior research in favour of your personal opinion?

Uhhmmm, no. Those events are generally accepted as bubbles. Some of this research has been in place, unchallenged for twenty plus years. Why should we reject this broad consensus in favour of your personal opinion?

Well, I'll choose to recognise your personal opinion for what it is, acknowledge your view but value it accordingly, and in the end I'll base my beliefs on objective, verifiable tests, backed up by a body of independent research, thank you very much. I don't much like being told what to think ... and especially don't like it when reasonable questions aren't answered.


"You want to see bubbles everywhere. "

Absolutely not. The broad body of academic research, which I (with all due respect, Sir) value higher than your personal opinion claims bubbles are far more frequent than you would have us believe. And not all bubbles deflate in end of the world scenario; sometimes the fallout is highly localised, as a wide body of accepted research shows us.

Once again, you're attempted to hijack the definition of a bubble to suit your own, oft expressed personal view that all will end in tears. As mentioned before, as the journal citations show, as books of financial history illustrate, not all bubbles collapse violently, with the broad economic upheaval you've often gravely warned us all, is "inevitable" (I believe "fucked" is the phrase typically employed at this point, as in "we're all fucked").


"Oil's not in a bubble; it hasn't gone up enough, ... "

Wrong answer. As previously detailed , quantitative and objective tests of financial bubbles tend to look at volatility and change of the underlying price series over time, NOT absolute prices. If oil went from $30 to $500 overnight would that constitute a bubble?

By your warm and fuzzy, highly subjective and personal opinion driven metrics, no, as it "hasn't gone up enough" - that absolute price ceiling again (and please don't waffle in a followup; you haven't made any reference to time in your original response so I don't expect one now thank you very much). But clearly under these conditions oil would, indeed, be in a pricing bubble, and those were the points raised by Rusty and eye of newt.

Each raised points they thought had merit. Points that I certainly thought valid of further discussion. Points that perhaps on some level might be valid. But you authoritatively - and now we learn baselessly - dismissed these queries in favour of your own personal opinion.

I say "baselessly" because on further examination, we find there wasn't a great deal of thought involved while rendering this judgement - "I figure $50 is a fair price...". Based on what? You've modeled price / demand curves? Across the entire G7 and The Developing World? You took into account interest rate differentials? Inflation rate differentials? Projected GDP rates across the term?

Hardly. You've pulled this number - $50 - out of the air, much like the $501+ figure was pulled out of the air. No solid justification - exchange rates are a small part of this pricing exercise - except personal opinion. And no small degree of hand waving, to adopt your phrase.

And by the way, I'm not taking a view either way on oil; I haven't looked at the data of the pricing series (and I'm pretty sure neither have you). But you're consistently presenting your own personal opinions as fact, demonstrative, certain fact, to the point of open and direct contradiction. With myself and others.

Well, fair enough. I'm open minded. But when asked for elucidation, you've changed or otherwise broadened, the subject, engaged in personal attacks, suggested that I've got some problem with debate ("arguing for a win" -- I just asked a question!) and generally avoided or otherwise declined to answer the question.

No, the two questions still stand unanswered at this time.
posted by Mutant at 6:20 PM on March 16, 2008


It's educational as all hell (and I must admit I was hoping for this sort of discussion when I posted the link, beyond thinking that the article itself would be interesting and helpful for people trying to figure all this out, so my hopes have been richly rewarded), but I hate when you guys argue about definitions. Disputes over terminology are always the least rewarding aspect of technical discussions for everybody concerned, I think, although they to often do seem to be something that people with expertise in a given field end up in. Nature of the beast, I guess.

Still, mild rancor aside, thanks to you and everyone else for your contributions to the discussion so far.
posted by stavrosthewonderchicken at 6:26 PM on March 16, 2008


Mutant - thanks, as always, for your view. Interesting to note the testosterone levels kicking up a notch in this discussion - very common in bear markets ;-) Don't have the time to craft anything of substance here, but I'd left a late response on a previous thread that remains somewhat relevant, though events have moved forward in the three weeks or so since I'd posted. After all, we've just lost an investment bank ...

Interested in your perspective, and particularly in the assumptions you make as an accountant in determining fair value for credit derivatives / securities. I'd assume you effectively mark to some modelled present value, but to remain relevant doesn't this require a belief that matters get no worse? (housing, credit, interest rate spreads etc). If so, you're always going to be one step (really one quarter) behind the market. At book value Bear looked a great buy all the way down, and up until last Thursday was solvent. By Friday: gone. I'd be turning a very curious eye toward LEH and others in the space on that evidence alone.

One further point: markets can get as irrational on the downside as they can on the upside. In a mass credit unwind / deleveraging, people sell because they have to, not because they want to. Valuations become irrelevant as the market scrambles for safety. This creates opportunities (just ask Buffett) but you have to be brave ...


Previous post as follows -

Thanks for the response M. How abnormal? We’re witnessing a developed world banking crisis. The mirror image of 1997, down to the need for the EM / Asian Governments to come to OUR rescue. Ahh the irony. I’ll concede (what I think is) your point – I’d guess it’s a once a decade event on a global scale (ie somewhere you’re going to have an analogous event once every ten years or so), so of itself not that unusual. But that is up to the present – you’d be a brave punter to suggest this is as bad as it’s gonna get. The russian debt crisis in 1998 nearly overturned the applecart. But – and again I’ll concede your point – it didn’t. Solutions are always found, the dude will always abide, it was ever thus, yeehah.

There’s no doubt a US equivalent is, in scale and effect, an entirely different animal, but that doesn’t mean we (and more particularly, everyone but the US) won’t come through the other side more or less intact.

I have some sympathy for the decoupling view – it’s hard not to living in Australia, with the economy through capacity, unemployment at generational lows, interest rates at decade highs and climbing. So Chinese growth slows from 10-12 to 8-10 for awhile. Big deal. The BRICS and EM world may just drag us kicking and screaming through what will be nothing more than a period of adjustment – everyone getting used to the idea that the USA is no longer the centre of the economic universe and that their populace is going to have to accept a reversion to the mean, suffering a marked decline in living standards and economic growth relative to the rest of the globe. Maybe I give this more significance than it deserves purely because of where it is happening, rather than because of what is happening.

Personally though – and particularly given the supply-side issues with commodities going forward – I think the world a decade from now is going to be a much more contentious, fractious, antagonistic place. We need to relearn that scarce resources are not just dry academic theory – they are reality for much of the globe, and at least part of the western world will rediscover this the hard way. The issues we face are much broader than just some exotic derivatives crisis, but if I start on that I might as well GMOFB.

The upshot? I have no idea where this all ends up, but like Malor I fear left unchecked this time around is of more significance - I believe a once in three-generation event. To me that’s abnormal. You and I will be lucky (unlucky?) enough to witness two events of this magnitude in a lifetime. It’ll end up being taught to uninterested fifth-graders fifty years from now. So yeah, significant.

I think the difference between your perspective and mine is that you are (very sensibly) marking events from observation, not from forward projection. I’m getting jumpy because I look at where things might go, not just because of where they are – but there is a danger in doing this. Things might get worse, they might not. All I know is that I – and I suspect Malor – have been waiting on this turn of events for the better part of a decade. It’s not purely a market phenomenon – it is a sociological, political, economic event with many historic analogies. The wheels have been in motion for some time, and watching the entire process unfold is fascinating.

I’ll try and wind up before this gets stupid again. I agree the Fed has responded admirably – and if you read Bernanke’s research on combating deflation, they have plenty of ammunition left should it be required. There are of course other costs and dislocations and ineffiencies created by doing so, but given the stakes I suppose that is by-the-by. And the ECB? Heh. Like the Fed, I suspect that when push comes to shove all their talk about inflation is just that – talk. They’re just running six-twelve months behind. If you remember, the Fed wasn’t exactly keen to cut in December – yet 30 days later they’d cut by another 125bp. The market ain’t always right, but they’re pricing ECB cuts this year and the curve has steepened markedly. One look at Spain and Ireland (and the UK) housing market should be enough to scare anyone.

My real concern with Europe is that they have no central mechanism to bail out banks in the same manner as the Fed – can you imagine the uproar if German and French taxpayers are asked to fund Spanish and Irish banking problems? You’re now seeing the EU convergence trades being unwound, with (for example) default rates on Italian bonds being priced well through German etc etc. Warning flags. Again, this comes from me looking forward and projecting what might be, rather than observing where we are now. The danger in doing so is that I might be entirely wrong, but I don’t see any other way of avoiding landmines than looking ahead. I may of course end up the classic economist predicting nine of the last three recessions …

Your faith in the system is justified. After all, it can only unwind once. Every other crisis ends up an opportunity. The only solution I see is a government bailout – either of the banks, the mortgage servicers, the monolines, or all three – that short-circuits the credit destruction and gets the wheels turning again. There are some very interesting parallels with the Skandies’ banking crisis in the 1980’s (Norway, Sweden, Finland) – well worth chasing down.
posted by bookie at 7:20 PM on March 16, 2008


A body of academic and professional research exists to objectively identify and classify bubbles. And you would have us ignore this prior research in favour of your personal opinion?

How does this objective research do at predicting bubbles (by your definition, or Malor's)?
posted by Chuckles at 8:06 PM on March 16, 2008


Too late, I suppose, but I just thought I'd chime in to say that by Malor's definition I agree oil is assuredly not a bubble, and by Mutant's it is. My original statement was made in the spirit of Mutant's definition -- I certainly didn't mean to assert that oil pricing was a widows and orphans economic storm. Just that the price of oil futures was out of line with any reasonable assessment of their value, and being largely driven by speculation.

Perhaps we need capital-B Bubble and small-b bubble terminology or something here. For all the tedium of semantic wrangling, it does seem like what Mutant and Malor are arguing about are differences of scale extreme enough to become differences of kind. Like (to go back to the storm metaphor) a hurricane is sort of just a big thunderstorm, but meteorology would be hamstrung if it didn't possess the terminology to distinguish the two events. Mutant wants "bubble" to be analogous to "storm" while Malor wants it to be analogous to "hurricane."

Somebody's going to have to adopt a new word to describe the phenomenon they are interested in. I would encourage Mutant to, since it seems like the economist and layperson understanding of "bubble" doesn't carry all of the baggage he wants it to. "Hyperbubble?" "Macrobubble?" Something like that. What we need is the opposite of the scale distinction between "slowdown," "recession," and "depression."

Perhaps this terminology exists already. I'm not, and never have been, a student of economics.
posted by rusty at 8:55 AM on March 17, 2008


I don't know either. Gold's fine with me. We just need SOMETHING that can't be handwaved into existence...

Why on earth would anyone accept, as payment for goods, something that had no worth to anyone? WE do it because we've been conditioned in steps away from taking goods of actual worth, but ... you'd have to be pretty crazy to accept copper coins if the copper wasn't worth anything.


Nothing has inherent "worth". "Value" just refers to what human beings value. It is just what is useful to us. Food and air have immediate worth, and clothing and shelter have secondary worth based on our survival needs. But what value does copper have? Basically that it is easy to carry around, doesn't rot, and can be portioned into standard amounts easily - as a symbol of "worth". (Paper money wouldn't have worked then because it would be too easy to counterfeit, and would too easily decay).

Since coins were first coined, it's not hard to see them as symbolic money. And to suggest that we only became conditioned to accept symbols as having worth in recent years is ridiculous - is the piece of paper itself what is valuable about a diploma? Is it the type of cloth of a flag that causes men to tear up? We have no problem transferring value to objects based on what they represent, in this case, the agreement of a community for a certain quantity of goods or services.

I'm not saying there wasn't a stronger connection with the symbolic at one time, so that people may have more fully believed in the worth of money or of flags or contracts for that matter - we may be a little too aware of the fact that it all rests on "normative agreement" - and in a way it's an interesting question how people respond differently to money when it's gold vs paper vs electronic (is it easier to spend money when it's just bank account numbers fluctuating as opposed to cash in hand, for instance?). But you can't escape the problem that the economy is just people making promises to each other, and that the more complicated we get, the more convoluted those promises become.
posted by mdn at 3:16 PM on March 17, 2008 [1 favorite]


It can be anything that can't just be made like magic, that has to be created using energy, labor, or some combination of both. I don't care what it is. Gold's fine, but if you have a better idea, that's fine too. Fundamentally, money is a commodity; we just need it to actually BE a commodity instead of trading like one without any actual value.

We need to prevent the politicians from being able to handwave 'value' into existence, and use that to extract goods from the economy. It's a hidden form of taxation.

Hell, it's getting so blatant now, with the Fed bailouts, that it's not even hidden anymore.

But you can't escape the problem that the economy is just people making promises to each other, and that the more complicated we get, the more convoluted those promises become.

That's a good observation. Commodity money makes sure that, when a promise is made in terms of money, it's kept in those actual goods, of the same real value. Truth is absolutely fundamental to the proper operation of free markets, and fiat money is, very simply, a lie. And if we DO go to a commodity money standard again, we have to watch the issuers like freaking hawks, because that's easy to mess with too. It's so, so tempting to issue more certificates than the commodity backing them.

Money is just an abstraction of commodity trading, and it needs to be held at precisely at that level, with no further engineering. Other forms of trade, more advanced form of debt, have to be clearly delineated as such. All participants need to understand that promises aren't dollars, and dollars aren't promises.... dollars ARE the good in question, absolutely. It's an abstraction for the convenience of trade, but it needs to be a perfect abstraction, with no leakage.

We can get into whatever weirdness we want, but if that absolute is kept at the core, it'll keep us from getting too far off track in any particular direction. It limits growth somewhat, but in exchange, it's a safety net that keeps us from making Really Big Mistakes... like 1995-2006.
posted by Malor at 3:39 PM on March 17, 2008


I made this jokey comment earlier: What, there's going to be a crash tomorrow? I better sell today!!!

Looks like I should have done that.
posted by grouse at 4:07 PM on March 17, 2008


Have to admit I rather dislike the idea of creating another dumb reason to dig up more wilderness looking for more shiny metal, and using more rotten chemicals to process it. The last thing the world needs is more resource extraction.

Malor's not exactly a lone voice in the wilderness suggesting that a cozy relationship between the financial industry and the Fed may have resulted in monetary policy that was too loose. The jump to commodity-backed money, though, isn't a logically parsimonious response.
posted by ~ at 6:03 PM on March 17, 2008


Bookie -- "Interesting to note the testosterone levels kicking up a notch in this discussion - very common in bear markets ;-) "

Hey I'm making money in this market, although I haven't established new positions, just added to existing ones. Also, reinvestment risk seems to be rising and although I'm not totally comfortable sitting in cash, govies are too damn dear (3M TBills at <>) at this point in time.


"I'd assume you effectively mark to some modelled present value, but to remain relevant doesn't this require a belief that matters get no worse? (housing, credit, interest rate spreads etc). If so, you're always going to be one step (really one quarter) behind the market. "

Well, I'm not really an accountant in my day job (I'm a member of
CIMA, part qualified, but Management Accounting is one of my side interests ... )

And yeh, before FASB 157 that was the practice, and then your only (external at least) challenge was convincing the regulators of your models effectiveness; detail it's assumptions, provide input data sets, expected results, etc. As long as your modeled value didn't differ significantly from observed losses (perversely, that's all I've ever seen regulators ask about ... )

Now, however, Level 3 assets have to be marked to market, and as liquidity is suspect in many instances (not systemically however) sometimes we're seeing quotes of 20% or less of what we know to be fair value. Interesting times. But I still maintain some folks will make lots of money in this market.


"At book value Bear looked a great buy all the way down, and up until last Thursday was solvent. By Friday: gone. I'd be turning a very curious eye toward LEH and others in the space on that evidence alone."

Ha funny you should mention Bear, some of us were looking at it last week - the buildings alone were worth $8 / share liquidation value - and I mentioned to the wife that we might want to take a (very) small position, track it tightly and buy if / as it creeps back up. Obviously we didn't do that as I tend to move very slowly in matters financial. But boy I can only imagine the roar of the crowd, as it seemed a lot of money was indeed moving into Bear shares last week, especially so as some of senior management had expressed "confidence" in their firm's future.


"One further point: markets can get as irrational on the downside as they can on the upside."

Absolutely, and that's why there is a family of models known as Asymmetric GARCH or, (I realise that you're knowledgable about these models bookie, but lets define for the benefit of others) Generalised Autoregressive Conditional Heteroscedasticity that allow us to model the sharp, downward breaks in value we see in the markets. (autoregressive meaning the model is based on a linear combination of prior observations ("auto-"), conditional heteroscedasticity implying both the mean and variance of the data generating process change over time, and forecasted values are conditional upon prior observations -- compare with linear regression, or OLS, which assumes homoscedasticity, or a constant mean and variance with respect to time).

As good as A-GARCH models are, we still can't model the emotionally driven selling one sees in sharply declining markets, at least NOT by looking at the single data series (a few of us have been messing about with GARCH like models that integrate the emotional components via data mining techniques, but as this a start up I've been incubating (that's a fancy word that means losing money by the way) for about four years I'd rather not discuss in detail - especially so as we're still unsuccessful. Heh)


"...and if you read Bernanke’s research on combating deflation, they have plenty of ammunition left should it be required. "

I guess we'd all agree that Bernanke is well engaged at present on this specific problem. You know I was reading somebody's publication yesterday - sorry, can't recall the name - but it stuck with me as I'd previously posted that it would be ironic if Bernanke, a student of The Great Depression were handed such an event for him to handle on his own.

This guy's position? No, not ironic by any means - and I thought this part of his comment exceptionally insightful - "who would be better prepared?" Think about it.

Blindingly obvious, in retrospect. And something for both sides of the debate (i.e., conspiracy theorists and free marketers). We all suspected something might happen, and who better today to deal with it?


Chuckles -- "How does this objective research do at predicting bubbles (by your definition, or Malor's)?"

Ok, the definition I'm employing isn't mine rather the broad consensus of a relatively large number of academics. Unlike another lay opinion upthread, this definition is inclusive, covering both bubbles that are Great Depression class in term of the ramifications pertaining to deflation, as well as more local pricing distortions, that impact a subset of a market, an entire market, or perhaps several markets simultaneously, but without systemic ramifications.

And a distinction we haven't addressed yet in this thread to date is that quantitative finance defines the existence of two classes of bubbles - "traditional" bubbles and what are known as "Rational Expectations" bubbles.

The difference is worth noting, and might have some relevance on the price of oil today; sometimes we do see explosive change in price in short periods of times that are justified by a simultaneous change in underlying fundamentals when compared to the market as a whole. A "Rational Expectations", or RE bubble, in other other words.

Blanchard & Watson did the seminal work in defining the mathematical structure of bubbles (Blanchard, O. and Watson, M. (1982). 'Bubbles, Rational Expectations and Financial Markets', NBER Working Paper No. 945.), defining a model of a bubble as two parts - a deterministic (or justified by fundamentals / market forces) and a stochastic (or random) parts.

Back testing is something that is done in finance to prove that a model has predictive power, and adaptations of Blanchard & Watson's basic representation can indeed model Tulipmania, The South Sea Bubble (an excerpt from Mackays 1841 classic 'Memoirs of Extraordinary Popular Delusions and the Madness of Crowds ', can be found here) as well as The US Railroad crash of the 1830's amoung others.

There has been a great deal of work done since the late 1980's in this area - Rational Expectations models, or RE Models, in an attempt to address concerns that could lead to an erroneous bubble / no bubble classification. After all, both outcomes are inherently bad if we consider that all rational market participants will always seek to preserve capital and make money; in other words, and this is a cornerstone of modern finance, rational market participants will always prefer increased wealth to the alternative.

So a long winded (sorry!) answer to your query - "How does this objective research do at predicting bubbles?"

Across the board, I haven't seen any research showing bubble prediction is possible - maybe someone else has, but I haven't. Identification is a different, and that objective, statistically significant capability does exist to some extent in various markets. For example, Evans (1986) had some success in the US / Sterling exchange rate market (Evans, G., W. 'A Test for Speculative Bubbles in the Sterling-Dollar Exchange Rate:1981_84.' American Economic Review 76, September 1986) as did Woo (1987) in the broader FX markets ( Woo, W., T., "Some Evidence of Speeuiative Bubbles in the Foreign Exchange Markets."Journal of Money, Credit and Banking, 1987), Payne & Waters (2007) quantitatively identified a bubble in the mortgage market (Payne, J., Waters, G., A., 'REIT markets and rational speculative bubbles: an empirical investigation', Applied Financial Economics; Jun 2007, Vol. 17 Issue 9) but in general these objective and quantifiable tests are asset class - and at times we find market specific - and not broadly applicable.

That's why I was so surprised when someone posted "those weren't bubbles", referring to a list of generally accepted bubbles. There aren't any generic tests that can be applied, broad brush. Except subjectivity.

Malor -- "We need to prevent the politicians from being able to handwave 'value' into existence, and use that to extract goods from the economy. It's a hidden form of taxation."

See, once again we agree more than disagree. As I previously posted, the UK's principles based regulatory approach, applied to macro economic policy would judge by the spirit not the letter of the law. Big difference, and one that I think would help rationalise Macro economic policy.

But given that the US, the G7 (and most of the G20 perhaps) have radically advanced economies when compared backwards in time to the US pre-1971 economy, for example. We simply can't go back and most here wouldn't want to. If you've limited growth in money supply to a commodity, any commodity than if the United States has to raise money to fight a war they have few options available, one of which is to raise taxes.

Keep in mind that in the United States the top tax rate peaked at 94% in 1945, and stayed above 90% until 1964 when it was reduced to a mere 70%. Although I agree it would be transparent (and hence fair I suspect) I doubt many reading this would accept such confiscatory rates of taxation.

So the masses would probably vote no war on the basis of their pocketboots, not their hearts.
posted by Mutant at 7:11 AM on March 18, 2008


Ouch! Sorry. Everything looked fine - my apologies to the admins for making work ... .
posted by Mutant at 7:13 AM on March 18, 2008


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