Mr. Market, from Edward Talisse

October 10, 2008 |

skullI note with a certain degree of gallows humour that today's villains are highly regulated institutions like commercial banks, insurance companies and broker dealers. Ten years ago, the LTCM debacle had the wolves crying for greater regulation and transparency of fast money. Now the hedgefund community is relatively healthy and will attract huge inflows once the dust settles. The key is that most are not publicly traded (though some are) and have reasonabe lockup periods and few disclosure requirements. In short, they are nimble. The big boys lke GS, MS, JP etc… insist on being global banks and hence require massive amounts of capital accessed via the capital markets. I wonder what Mr. Market will think is the most appropriate market intermediation model 10 years from now?

Philip McDonnell adds:

Regulation is a dirty word to most free market fans. It always entails cost, both to the operating businesses and to the tax payer. After all running a regulator involves an expenditure of public dollars. Having said that some sort of independent oversight is necessary so that the con men and charlatans do not dominate the market place.

However a large part of the responsibility for the current financial crisis can also be attributed to the current regulatory environment. In particular FASB, the Financial Standards Accounting Board changed the rules in the middle of the game. FASB promulgated that the banks had to revalue their sub-prime assets this past summer. Particularly hard hit were the securities which had to active markets. The net result is that banks which were caught 'holding' found huge swaths cut out of their portfolios. This was true whether or not the underlying mortgages were performing or not.

Strictly speaking FASB is not a government entity but it is as least partly government funded. The directors include people from government and the private sector. Mainly they are accountants.

What is needed in the current environment is less restrictive regulation not more. If anything we need to undo the draconian measures which are killing bank asset valuations. To be fair FASB is now quietly revising its earlier directive of only 90 days ago. The original directive was undoubtedly intended to strengthen the banking system. Yet the proximate result was to topple the House of Morgan and WAMU and to bring the entire banking system to the precipice within 90 days. What were they thinking?

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Stefan Jovanovich responds:

The House of Morgan" would, by Morgan Sr. and Jr. and Mr. Peabody's calculation, be J.P. Morgan Chase, not Morgan Stanley. The idea of looking elsewhere for the funds to support your positions in the market would have seemed to them incredible; even as a market maker you always had to be in a net cash position. (The reason Ron Chernow's book on Morgan is good only for pulping, in spite of the author's extraordinary industry, is that he can only see the Morgan Bank with modern eyes. Whatever Morgan, Peabody and J.P. Morgan & Co. were, they were not a 19th century Bear Stearns with the added advantage of being Episcopalians.) The Morgans and their original partner would have found the Treasury's current rescue plans to be fundamentally wrong-headed. They would have wanted the Federal Reserve and the solvent member banks to buy the failing and failed banks' non-speculative liabilities - the savings and transaction deposits - and left the shareholders, derivative claimants and creditors to liquidate the assets on their own, with or without the help of the bankruptcy court. M Sr.,M Jr. & P would have scoffed at the idea that governments should, would or could reset asset prices in the midst of a panic by writing checks based on their ability to issue sovereign debt. That fantasy is one that only the 20th and 21st centuries have accepted as wisdom.





Speak your mind

6 Comments so far

  1. Sam Kumar on October 10, 2008 12:51 pm

    This will probably be censored but

    the combination of market collapse, key resource shortages and environmental degradation is telling us that capitalism has to change drastically.

    greed and predatoriness cannot be regulated = they will invariably lead to catastrophes like this.

    If Russia and the U.S. had played international politics like financial institutions played finance recently, we would have had a nuclear exchange by now.

  2. Evan McKeown on October 10, 2008 4:21 pm

    It is a sad day for me to finally reach the conclusion that Wall Street will never return the confidence to the average investor to encourage them to invest in retirement plans or trade in the markets. The folks on Wall Street that run money are for the most part only concerned for their own profits. They are paid to simply invest and only make more money if those investments are fortunate enough to actually turn a profit. To see the S&P at the same or below the level it was 10 years ago is disappointing. We have all been brain washed into believing that it is American to invest in this great Country and we must do so in order to beat inflation and the erosion of purchasing power in keeping our money in CD's or safer investments like Treasuries. So many retired people have had their hopes and dreams dashed and must now return to work only to find that McDonalds is the best they can do. This Country has let the average citizen down. Hank and Ben are clueless. A student of the depression they say Ben is. This is not an educational exercise for his experiments. Ben will lead us into a depression with Hank at his side. I'll give some advise to Ben…(1) cut interest rate to zero (2)Federal Reserve to guarantee every banking transaction for retail and commercial transactions alike (4)Bring back the uptick rule and (5) Ben, Hank and Bush…stay off the air and keep your thoughts to yourself because your not doing this market any favors. There you have it…a plan for the Washington idiots to implement!

  3. George Parkanyi on October 10, 2008 7:57 pm

    “Alas, poor Europe, I knew him well”

  4. JK on October 11, 2008 7:02 pm

    To Sam Kumar You write: "key resource shortages and environmental degradation." I live in Norway, a socialist/social democratic country, where those in power are very concerned with relative poverty, and as Norway is quite rich from natural resources, the relative standard of living is quite high from redistribution, etc. And having a system where the government is so concerned with everyones standard of living being the same/close to the same, the consumption/pollution becomes quite large. So what exactly do you propose instead of the capitalism (the kind that does not allow the market to be free) we've had up to now. A true capitalist system where property rights are enforced ie no redistribution etc. where a few will be very rich (perhaps deserved) and consume accordingly or a socialist system where the total waste in society might be a lot higher?

  5. Sam Kumar on October 11, 2008 10:32 pm

    To JK:You obviously subscribe to the Ayn Rand view with respect to capitalism — which is of course a farrago of ugly thought driven by her personal issues (There is some irony in my using the space provided by this strongly pro Ayn Rand website).You probably can't even begin to understand the answer — it lies in understanding that human desire is ultimately a trap — we have real objective needs that can be satiated and obsessive compulsive desires that cannot and capitalism doesn't distinguish between the two (don't ask the obvious and ugly question who decides what is a sane need and what is insane — the answer is to be perceived from living and not to be gotten from a book). The financial engineers in the canyons of Wall Street were pursuing obsessions — but unfortunately the collapse of their obsessions is threatening the sane, mundane aspects of the every day economy.

  6. JK on October 12, 2008 5:52 am

    To Sam Kumar

    So you`re saying that a socialist collective should guarantee that everyone should have all their objective needs given to them without them having to make any effort in acquiring the goods to satify their needs? I thought people were born naked into the wilderness, that fulfilling needs, required hard work/suffering, why should some people be allowed to live of of other peoples hard work?

    How do you propose relative poverty should be tackled, by holding back the people who raise their living standard, thereby making others envious, or let all people be responible for producing the goods they need to satisfy themselves/their own needs/desires?

    And again how should capitalism/society change for the better?


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