Iunderstand what you’re stating, that’s what the the overall macro-economic equations (uncannily like accounting identities/equations) dictate but it’ll be hard to fit the insurers’ eg MBIA into the equation, sometimes, imbalances are rarely addressed/netted off till the long term and as an economics tutor of mine used to say, in the long term,we’re all dead

The perception of risk then goes from mortgage specialist all along those paths and because of additional risk factors (not just default risk, but for example, the risk that credit ratings are no longer realistic etc), ultimately even short term funding instruments that have no connection with the mortgage industry are seen as “tainted” partly ‘cos uncertainty has now infected each part of that chain.

does that make sense to you? it’s a very abbreviated explanation but, sorry, gotta catch some lunch before the time’s up!hope the example makes some modicum of sense!

I’d have to think through a specific example to see how such a risk factor might be clearly separated out. I know it seems intuitive, but there should be a simple way of demonstrating such an effect and that’s not obvious to me.

There is such a temporary effect in marking to market or model. Actual financial asset losses aren’t known until the mortgage defaults and the residual asset value is determined (unless the financial asset is sold to somebody else, who then has that problem). Until then, banks are making estimates of the value of their own positions based on an estimate of the value of the underlying realizable real asset value. This is the case for any loan loss provisioning. Current estimates may turn out to be too low requiring further write-downs on financial assets or too high allowing loss recoveries.

>>>I don’t understand your point about losses to date equalling total losses. I’m not saying that.

erm, not saying that either, meant that as the losses on each of the elements on the chain aggregate, they do not net off or get to the total you might have expected in the beginning. I think halasz has come up with the theoretical explanation.

Interconnections might impact negatively on risk profiles partly due to credit risk but partly due to the interdependence, for example when asset y leaves A for B but the risk profile of asset y continues to be affected by the risk profile of A or the performance of quantities of asset y still remaining at A or sold by A to other parties like C. Not sure if that made sense, but simply put, as each element of the risk/product chain passes the product and some part of the risk on, it’s creating greater uncertainty and that amplifies the risk inherent in the chain, by the time it gets to the investor, the risk factors have multiplied and is almost too convoluted to be comprehended.

When risk is transferred, it affects perceptions of risk and therefore, may affect credit risk more than what is mathematically warranted, take for instance credit ratings and default swaps (which tecnically reflect perceptions of the possibility of default ) which are arguably more vulnerable to being affected by perceptions, the mistrust of ratings issued by credit agencies is arguably what is causing investors to turn risk adverse. That is what I term as the multiplier effect, for lack of technical knowledge on my part.

I know what you’re saying it’s just a difference in opinion I guess.

Actually, part of this response was already on my blog , looking forward to your response either here or on foesskewered.livejournal.com

Thanks very much for your response, which I’ve only just seen due to my unfortunate scheduling.

You’ve written something quite extraordinary. I’m saving it.

I know now I believe at least 95 per cent of what you’ve written and almost certainly approaching 100 per cent with a little more time.

I don’t think our thoughts are inconsistent. I attempted to segregate the result of pure financial intermediation and leverage effects – not the cost or effectiveness of human labour effort expended to create a (new) financial profile against underlying real assets.

The cost of financial ‘creation’ in this sense may not justify the result in terms of financial disposition of the realized risk.

I apologize if I’ve underestimated your message but I must flee.

Thanks again. Great thoughts and words on your part.

Yes,in principle, all economic exchanges are of equal values, and all attached risks sum to zero. The question is then why such exchanges and transfers of risk should occur at all. Your point can be inverted by noting that, given a pool of risks underlying a structured financial vehicle, the total risk, whether accurately modeled or anticipated or not, remains the same, regardless of how it is sliced and diced or redistributed. There is no net gain from the “enhancement” of credit; the only thing that really counts is how accurately the base-line risk of the original extention of credit is gaged in terms of the outcomes of underlying production in the real economy. The “fundamentalist” point here is that all returns to and of financial assets ultimately derive from productive surpluses in the real economy, from long-run and illiquid investment of real productive capital and the revenues realized from the sale of output. (The corollary of maturity transformation is the forward projection of economic outcomes.) And there is some indeterminate limit as to the debt-load that can be really carried and realized by the real productive economy. Which is to say that either the hyper-extention of the financial economy is redundant and superfluous,- (in which case why the tremendous investment of labor and capital resources in it?),- or it is a misguided estimation of future returns from the outcomes of the real productive economy,- (since fees are extracted with each financial pass-through from the initial assessment of risk undewriting the initial extention of credit, thus underpricing risk and distorting economic allocations),- or it is a rent-extracting activity, drawing off productive surpluses from the real economy and minting profits without corresponding costs of production. In any case, but especially the last, there are costs drawn from, but then displaced back onto the real productive economy, which may well be more than just “frictional”, distorting and disrupting the balanced reproduction, development and growth of the real economy, which through interlocking negative feedback loops, magnifies losses to the latter beyond the immediate instances of financial defaults. Money of any sort, after all, is just a semiotic instance and not a real “thing”, merely representing- (imperfectly, due to the embedding of both costs and information in production systems)- the real “things” that are produced and exchanged in the underlying real economy. And it is the provisioning, deepening and improvement of those real “things” and their means of production that is the point of any modern economy. If the self-referential operations of the financial economy are drawing of surpluses excessively from the real economy and distorting the distribution of both claims and risks in the real ecomony required for its balanced reproduction, (not least of which is some optimal balance in the distribution of income, qua claims on the real distributable surplus product, between labor and capital, wages and profits, required to sustain adequate effective demand), then it is, indeed, producing and displacing real losses greater than the initial losses on defaulted underlying assets.

I’m familiar with portfolio theory, in which total risk is less than the sum of all risks. I’m familiar with systemic risk, and there is no corresponding theory I’m aware of that suggests the reverse. I’d be interested if somebody can provide a simple conceptual example. (Analogies don’t count as examples.)

I think that you are confusing particular or idiosyncratic risk with systemic risk, as though the latter is merely an aggregation of the former rather than an essentially unquantifiable, dynamic and unintended synergism. Or simply a whole greater than its parts.