45 Percent of the World's Wealth

When I think of wealth destruction, I think of fires, floods, wars, and hurricanes. Steven Scharzman of Blackstone said “Between 40 and 45 percent of the world’s wealth has been destroyed in little less than a year and a half." Given that you'd think a meteor struck Earth or something of that scale.

The most relevant concern is the real wealth that has been destroyed. Paul Graham tells us, "Wealth is the fundamental thing. Wealth is stuff we want: food, clothes, houses, cars, gadgets, travel to interesting places, and so on. " Nominal dollars are not irrelevant altogether. If you have a mortgage, it is still due on the nominal amount you agreed to pay. Negative equity may induce people to stop paying their mortgage and the property will have to be foreclosed upon. This situation can result in inefficiencies as a result the destruction of real wealth.

I agree that some real wealth could have declined through:

• Depreciation in excess of gross investment. Left alone, wealth will decay and continual investments must be made to maintain that wealth.
• Inefficiencies in the transfer process from debtor to creditor where the collateral is damaged through poor maintenance or malice.

I certainly agree that the pace of wealth creation is slowed and that there may even be some wealth destruction, but I doubt that it 45 percent of all wealth in the world.

The fact that people paid too much for assets a few years ago, and that now the assets are worth much less does not mean real wealth is reduced. I suspect this wealth that Schwarzman talks about is from on 1s and 0s on a computer system. Your house is not any less of a house now because it would sell for a third less dollars. The 3 bedrooms, 2000 square feet, 2 car garage, granite countertops, etc. are still there for your use.

I doubt that 45 percent of the world's wealth has been destroyed with most buildings still standing that were there 2 years ago, airplanes still taking you where you want to go, and your computer accessing a global network that is better than ever.

Speculator, you say that like it's a bad thing

I guess you would say I'm a speculator. I have some assumptions about the world and I look for pricing that differs from those assumptions. If I win, I get to keep my profits. If I lose, I don't get bailed out by anyone. (The same can't be set for some major investment banks with proprietary trading arms)

Speculators have been blamed for rises in oil prices, driving down stock prices through short-selling, market crashes, etc. The reality is that we need speculators able to act on their beliefs, to buy or to sell. Politicians often judge that one price is too high or another is too low. I think it would be foolish after what we have seen over the last couple years to say that the market always get the "right" price at every point in time. However, the alternative is the government setting prices, which I have far less confidence in than the market.

A restriction on the activity of speculators would severely reduce liquidity in markets. Information would travel slower and those with the best estimates of the future would be less able to bring a market back to equilibrium.

The Biggest Borrower in the History of the Universe

I suppose it should be no surprise that yields on the treasury bonds are rising again, particularly on the long end of the curve. In the later part of 2008, we saw a panic in every other part of the market and a bubble in Treasuries that seemed to contradict the fundamentals. The US government was the running large deficits over the last few years, and all indications are that they will get even larger. With this massive supply of Treasuries, sooner or later the prices would have to fall as there is not limitless demand for US government's promises to pay.

While a technical default is not conceivable in my mind over the term of the long bond, investors realize that the probability of increasing inflation and the spectre of unfunded social security and healthcare obligations is very real. Even the Chinese might think that there has to be other places to put their dollars.

An Option to Buy Insurance

An option to buy insurance

An interesting concept. Most of the time you don't need insurance. Most of the time it is easier just to pay the doctor in cash and not worry about claim forms. Other than the tax advantage, why should you fill out forms and have a third party payer for routine medical care. We do not fill out forms, show a food insurance card, and have a third party write the check at the grocery store. Insurance should protect against low probability, catastrophic risks in the tail of the distribution. When you really need insurance with this concept, you can acquire it.

The Truth About Regulation and the Financial Crisis

I was trying to start an argument about the financial crisis. A person I know on the far left blamed deregulation. She has next to no knowledge of financial markets, and she is simply wrong on the record of deregulation under Bush. Without evidence she assumes two things:

1. Substantial deregulation of financial markets took place under Bush
2. This deregulation in large part caused the current financial crisis

I recently found a prescient article from the Wall Street Journal dated November 11, 2003.

Mr. Mankiw did taxpayers a service by wading into the debate over how to monitor these companies that have become repositories of enormous financial risk. Fannie in particular has marshaled its political troops to stop a bill in Congress that would transfer its regulation to the Treasury Department from a feckless unit of HUD. Fannie prefers feckless.

Specifically, "the subsidy creates a source of systemic risk for our financial system." This is because "the subsidy has allowed" the companies "to become gigantic," with their debt more than tripling to $2.2 trillion from 1995 to 2002."

Oh, but it gets better. "But especially notable is the support for Fannie and Freddie from liberals who normally detest corporate welfare. In this case, Congressman Barney Frank criticized Mr. Mankiw because he is worried about the tiny little matter of safety and soundness rather than "concern about housing."

Link to the article

For a problem as complicated as the financial crisis, it is not likely to be the only major cause. Looking at the evidence we see evidence that regulation was actually increased on Wall Street. The deregulation that did happen in the recent past probably prevented even worse consequences. One, Sarbanes-Oxley substantially increased the regulatory burden on companies. Under SarbOx, companies must mark certain assets to market. Even performing assets have been marked down substantially by banks. Since many of these assets are illiquid and difficult to value, they are often marked to a model rather than an actual market price(since a market price does not exist). Two, a substantial deregulation, the Gramm-Leech-Bliley Financial Services Modernization Act, enacted in 1999 under Clinton probably helped prevent an even worse disaster. This act repealed substantial parts of Glass-Steagall, and it allowed commercial banks and investment banks to combine. The universal banks have fared better in the recent crisis. I have a few more comments and links on another post.


I don't expect everyone to be an expert on regulation of financial markets. I certainly am not one myself. However, I do expect someone to actually have some facts about a situation before they argue a position. Remember, "Everyone is entitled to his own opinion, but not to his own fact"

I will continue to research this issue, and keep my readers updated.

VIX Rises Above 70

The volatility index has sharply risen today to 72.85 the last time I checked.
http://blogs.wsj.com/marketbeat/2008/10/10/the-soaring-vix/

We have gone from the VIX being at 10 in early 2007. Basically, the market didn't see risk anywhere. Now, under every rock and behind every door is more risk. Every major central bank and government is trying to fix this mess.

http://www.businessweek.com/investing/insights/blog/archives/2008/10/the_vix_could_t.html
Is it a bottom?


The decoupling of financial and real markets across the world was a myth. Every stock market that I can think of has fallen in the last couple weeks. Germany, Russia, Brazil, India, Iceland.
The real economies of emerging markets are still growing, but it is clear that they are slowing resulting in downward pressure on oil prices. Yet for some reason US Dollars and Treasuries are still in demand. Dare I say it, the long-term fundamentals of the United States are still good.

What to say

Lehman had its long slow, descent into bankruptcy. It makes you wonder why Bear and not Lehman. Part of it is that Bear failed first. The other is that Lehman's troubles were relatively well known for months and the market had time to absorb the news. If anybody else some better ideas, please comment.

We are seeing the 3 month treasury bond yield at near zero.
When the government can borrow for nearly free and a nominal basis and a negative real interest rate, it's not a good sign. You cannot help but think of Japan when you see the rates this low. There are some parallels, but the actions taken recently have been different than Japan in the 1990s. In Japan, bad banks were propped up by the government. At least the bailouts here seem to be designed so that the common stock holders do not receive much. I believe the goal of the recent bailouts is different than the bailouts in Japan. I hope the goal here is to assist an orderly liquidation of assets rather than to protect the older and established companies and to keep up appearances.

AIG received an $85 billion loan from the Fed in return for 80% of the equity. The Fed now has control over AIG. The effects of this are being felt by the financial markets today.
"Banks abruptly stopped lending to each other or charged exorbitantly high rates Tuesday, threatening to spread the troubles of American International Group Inc. and Lehman Brothers Holdings Inc. to a broad range of financial institutions and the global economy."

"The depth of the money-market problems became clear at lunchtime in London, when the British Bankers' Association published Tuesday's Libor borrowing costs. Every day, 16 banks report what it would cost them to borrow at certain maturities and currencies. Overnight dollar Libor soared to 6.4375% from 3.10625%, the largest jump on record. Three-month dollar Libor rose to 2.876% from 2.816%."

If you are relatively informed on the recent events, I'd enjoy having a conversation about it to see what you think.

A Few Observations on Financial Markets

These observations are nothing new.

Liquidity is not there when you most need it - In good times, there is liquidity for most people. Unless you are a giant player in the market, most of the time you can buy and sell without affecting the price much. You more or less know what something you own is worth. In times of poor liquidity, you have no idea what something is worth. When you are subject to regulatory requirements like banks or use high levels of leverage, you sell what you can sell as quickly as you can sell it.

Models are always wrong when they most need to be right - Models do not hold up under times of market stress. Maybe it is getting better, but knowledgeable people like Alan Greenspan basically say economic models are not any better than they were years ago. These models do not have much predictive power for the correlations between returns in situations of market stress. Remember that LTCM should have never lost so much money as it did in the history of the universe.

Similar things happen, but different enough where we don't know how to correct it in the future - All regulation tries to fix the last crisis in the markets. We never really know if a regulator was correct, but we know when they were wrong. We can never know the cost of lost opportunities due to excessive regulation and it is impossible for government to keep up with the dynamic free market. About every ten years, there is some new disruption in the market. Commodities in the late 1970s and early 1980s, leveraged buyouts in the late 1980s and early 1990s, Dot-com stocks in the late 1990s, and credit right now(also commodities and housing). Ultimately, we need creative destruction and it must be allowed to take its course rather than protecting everyone who lost money or might lose money.

Valuations come back to reality, but sometimes it takes longer than you can stand - Whether it is Dutch Tulips, Beanie Babies, or Internet stocks valuations will reflect fundamentals eventually. It is a question of when. Keynes said, "the market can stay irrational longer than you can stay solvent." Ask anyone who shorted Internet stocks in 1999. Within a bubble, many people know the prices do not make sense. They hope to make a profit according to the "greater fool theory" and get out before the prices fall back to reality. Not all bubbles could mean higher prices. The extremely low oil prices of the late 1990s did not seem to reflect the rising cost of exploration and production and the lack of new discoveries amid growing demand for oil.

I may develop these points in further blog entries with better examples and analysis, but this is a start.