Free markets, random walk -- are key principles in capital markets.
In free markets -- free is definitely missing. Our markets are not free. The bankers are free to take home the profits. The people are left holding the losses. Quite an equitable distribution of winners and losers.
The random walk -- that is at any given instant the price of a security can move in either direction -- randomly --. Do you know you can have the view that a stock price will appreciate -- and therefore go long? But starting today you can have the view that stock will depreciate -- and however you cannot sell? The randomness manifests only because of such diametrically opposite viewpoints are equally likely. Since only positive outlooks are actionable, the markets can only go up. Therefore, the market is no longer random. There is a bias.
Free markets are not free any more if you are an ordinary share holder. And there is no randomness to the security price movements. Keywords are mis-leading.
Wednesday, September 17, 2008
Is it or Is it Not -- Moral Hazard?
In all the public bail out designed and archestrated by elected officials and executive branch -- it has often been argued that common share holders will not be
protected because it is a moral hazard.
So what is the purpose of the bail out ? Who are we bailing out?
So let us review Bear Stearns. Bear Stearns had a lot of complex derivative positions on its books, including CDO, IRS and CDS. Scores of individuals rushed to their desk
early each weekday to make sure these instruments were properly maintained on the books. BS traded these instruments with counterparties including other broker dealers, hedge funds and investment managers. If Bear made money these counterparties lost money and vice versa. If Bear went bankrupt these counterparties cannot claim their bounties or their windfall winnings.
Let us review what the government did -- allowed Bear to fail by extending the loan after they failed to JP Morgan to buy out Bear on fire sale. Why did they extend this loan to JP Morgan...We were told without the bail out the entire system will collapse. What system? The employees lost their life savings! No that would be a moral hazard -- in other words more people would take more reckless risk without concern for the risk thinking that the government (the public and the people's printing press) would bail them out. So what is the system they protected?
Let us skin the cat another way. If Bear vanished who stands to loose. The counterparties. The people who worked lost their life savings along with their livelihood. So the government bailed out the counterparties without any consideration for moral hazard however justified bankrupting the employees with
exactly that -- you guessed it moral hazard.
So please help me is it or is it not moral hazard?
protected because it is a moral hazard.
So what is the purpose of the bail out ? Who are we bailing out?
So let us review Bear Stearns. Bear Stearns had a lot of complex derivative positions on its books, including CDO, IRS and CDS. Scores of individuals rushed to their desk
early each weekday to make sure these instruments were properly maintained on the books. BS traded these instruments with counterparties including other broker dealers, hedge funds and investment managers. If Bear made money these counterparties lost money and vice versa. If Bear went bankrupt these counterparties cannot claim their bounties or their windfall winnings.
Let us review what the government did -- allowed Bear to fail by extending the loan after they failed to JP Morgan to buy out Bear on fire sale. Why did they extend this loan to JP Morgan...We were told without the bail out the entire system will collapse. What system? The employees lost their life savings! No that would be a moral hazard -- in other words more people would take more reckless risk without concern for the risk thinking that the government (the public and the people's printing press) would bail them out. So what is the system they protected?
Let us skin the cat another way. If Bear vanished who stands to loose. The counterparties. The people who worked lost their life savings along with their livelihood. So the government bailed out the counterparties without any consideration for moral hazard however justified bankrupting the employees with
exactly that -- you guessed it moral hazard.
So please help me is it or is it not moral hazard?
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