Mar

17

GregI have been thinking a lot about hands, wrists, and markets over the last three weeks. The miracle flexibility and dexterity in human hands gave our distant ancestors unmatched power over the birds and beasts. Any that early humans could not reach to club could soon be speared, hooked, or hit with arrows.

Man's hands pushed his mind forward, as any and every natural object was lifted to our gaze, rotated, pondered, and then chipped, chopped, or shaped to something useful, or else discarded. The term "dexterity" originated in the 16th Century as a "mental adroitness." Do our minds direct our hands, or do our questing hands draw our minds forward?

Launching the industrial era were modern securities that allowed investors to lift, examine, and reach in to finance an endless array of early enterprises. Enterprises could be freed from the arbitrary control of single minds, who by accident or past achievement gained dominion over productive resources. Just as yesterday's costs are today sunk, so yesterday's management has value only in looking forward. The powerful — eventually weakened from pride, sloth, age, or just error — could be separated from suffering assets. Financial capital could flow to fund brilliant but poor or outcast entrepreneurs. And when successful businessmen lost their edge, management control could be quickly shifted to new leaders.

Marketable securities gave investors flexibility and liquidity to diversify and to shift their assets among productive enterprises smoothly without disrupting the enterprises themselves.

But with the wondrous flexibility of our complex wrists and fingers comes fragility. Our knees and ankles are far less flexible joints, but can bear and launch into the air the full weight of our bodies, something I learned three weeks ago that our wrists cannot manage.

We have seen over the last few months an expected fragility in securities markets. As we search among possible causes, one seems to be a mixing of two very separate sets of games and players.

Over centuries and especially the last few decades, the securities market evolved ever more complex capabilities to deliver capital to productive enterprises. Booms and busts erupted from time to time, usually as governments changed rules, expanded money supplies, or defaulted on debts. But my thought is that though securities markets have long developed financial instruments to diversify investments in stocks and bonds, real estate-based securities were an innovation whose different nature was not fully appreciated.

Real estate assets and debts have turned out to be beasts not so easily tamed by securities and diversification. Maybe real estate play is somehow more of a brute-force game. The houses and office buildings are fashioned from the earth and there they stand for decades, their value dependent upon outside demand. The value in homes and buildings is a more inert thing, and a building will never astonish the world with a new microprocessor, search engine, jet engine, or miracle drug. Value can evaporate as fast or faster from productive enterprises, of course, and I don't suggest home mortgage debt is somehow bad while corporate debt is better. But a business is an ongoing creative enterprise that can reward investors in ways homes and office buildings cannot. All assets can as easily drop in value as rise, but not all assets though can give birth to new assets (Apple unexpectedly created iPods for example, and Microsoft created Xboxes).

So when government regulators severely limited the U.S. securities industry and sent IPOs overseas, U.S. firms vastly expanded securities derived from beastly real estate.

Securities from the somehow brute-force real estate industry flowed into the ultra-sophisticated world of modern investment and hedge funds. The mortgages (literally, from Old French: 'dead pledges') were dressed like financial securities but their nature was subtly different. They played a different game, and when push came to shove, fragile securities firms hit the wall.

So it was for me, three weeks ago this evening. I was invited to play an evening game in a 30-and-over basketball league. The opposing team wore basketball uniforms, but played rough. I scored well in the first half, but early in the second half set a screen and was pushed hard from behind. Then I was shoved again, as if I was being blocked, and was launched forward. I hit the wall hard and broke both wrists. I had surgery on both a week later. And since then I have had plenty of time to contemplate the fragility of hands, wrists, and markets.

To students attending our FEE and Economic Thinking Seminars I explain that though I am a very good basketball player, I was playing against a very good football player.


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