As someone old enough to have done finance in the Paleolithic pre-personal computer era (yes, I did financial analysis using a calculator and green accountant’s ledger paper as a newbie associate at Goldman), investor expectations that market liquidity should ever and always be there seem bizarre, as well as ahistorical. Yet over the past month or two, there has been an unseemly amount of hand-wringing about liquidity in the bond market, both corporate bonds, and today, in a Financial Times story we’ll use as a point of departure, Treasuries.
These concerns appear to be prompted by worries about what happens if (as in when) bond investors get freaked out by the Fed finally signaling it is really, no really, now serious about tightening and many rush for the exits at once. The taper tantrum of summer 2013 was a not-pretty early warning and the central bank quickly lost nerve. The worry is that there might be other complicating events, like geopolitical concerns, that will impede the Fed’s efforts at soothing rattled nerves, or worse, that the bond market will gap down before the Fed can intercede (as if investors have a right to orderly price moves!).
Let’s provide some context to make sense of these pleas for ever-on liquidity.
With the recent Global Crisis, the interest in systemic risk and the interconnection between financial institutions has increased. This column investigates the case of European financial firms, where several factors can jeopardise a firm’s financial health. Using data since 2000 to evaluate the firms’ systemic risk, the authors find that for certain countries, the cost to rescue the riskiest domestic banks is too high. They might be considered too big to be saved.
I received a message last week from a savvy reader, a former McKinsey partner who has also done among other things significant pro-bono work with housing not-for-profits (as in he has more interest and experience in social justice issues than most people with his background). His query:
We both know that financialization has, among so many other things, turned large swaths of the capital markets into a casino
Here’s my thought/question: is there a house?
The common wisdom is that the ‘house wins’ in casinos.
Yves here. While it remains an open question as to whether frenzied efforts to push investors even further out on the risk limb will come to fruition, the fact that so many measures are underway looks like an officially-endorsed rerun of early 2007. If the Fed indeed raises rates in the not-insanely-distant future, getting into subprime and other speculative credits is a quick path to losses. But even if the Fed and other central banks remain super-dovish, risky borrowers can and will go tits up independent of interest rates. Credit risk is not the same as interest rate risk, but the inability to get any return for the latter is producing an extreme underpricing of the former.
The Washington Post has a story that blandly supports the continued strip mining of the American economy. Of course, in Versailles that the nation’s capitol has become, this lobbyist-and-big-ticket-political-donor supporting point of view no doubt seems entirely logical. The guts of the article: Three years ago, Harvard Business School asked thousands of its graduates, many […]
CalPERS, the largest public pension fund in the US, is widely seen as an industry leader and its practices are emulated by other public pension funds. CalPERS has just announced that it is withdrawing from hedge fund investing entirely.
Yves here. The Efficient Markets Hypothesis, along with the Capital Assets Pricing Model, is one of the cornerstones of financial economics. Pity both are wrong.
Actually, it’s worse than a pity, since financial economics informs not only how professional investors construct their investment portfolios, but similarly is the foundation for orthodox thinking among retail investors. And the Efficient Markets Hypothesis and the Capital Assets Pricing Model both understate market risk, so following their dictates leads investors to take on more risk than they intended to.
Two days ago, we learned that the Chinese government was behind the bailout earlier this year of a trust product—a type of financial product that the central government has heretofore emphatically distanced itself from. Huarong Asset Management, using a 3 billion RMB loan from the Industrial and Commercial Bank of China (ICBC), the trust product seller, was the mystery lender behind the January bailout of the Credit Equals Gold trust product, the Financial Times reported on August 31. ICBC and Huarong Asset Management are both state-owned entities.
The Organised Crime and Corruption Reporting Project recently (21st August) published one of their periodic investigations, concerning a rather large moneylaundering scheme: Call it the Laundromat. It’s a complex system for laundering more than $20 billion in Russian money stolen from the government by corrupt politicians or earned through organized crime activity. It was designed to not only […]
Yves here. Readers responded positively to Pilkington’s anthropological take on the economics tribe, so we are continuing with his series. This post focuses on dodgy econometricians and economic forecasting.
Yves here. It’s a welcome surprise to see economists devise a model that delivers generally sensible results. Here, three economists looked at how financial innovation leads to an bloated financial sector as well as greatly increasing the risk of meltdown.
NC contributor Michael Crimmins flagged a Bloomberg article yesterday that described the proliferation of complex synthetic structures, depicting it as return to some of the bad risk-shifting of the blowout phase of the last credit bubble.
The amusing bit is the headline was toned down after the post was launched (you can tell by looking at the URL, which almost certainly tracks the original). The current version is the anodyne “JPMorgan Joins Goldman in Designing Derivatives for a New Generation.” But the very first paragraph flags the troubling resemblance to the last hurrah of the pre-crisis credit mania:
This is a terrific and very accessible interview with Boston College professor Ed Kane, who is a long-standing critic of the failure to rein in financial firms that feed at the taxpayer trough. At one point in the talk, Kane and his interviewer Marshall Auerback discuss how casinos are well aware of the fact that the house can lose and they monitor gamblers intensively to make sure that no one is engaging is sleight of hand. Thus if we treated our banking system like the financial casino that it has become, we’d be much better off than we are now.