Wednesday, June 13, 2007

Flat-Earth Finance

In Euclidian geometry the two most important axioms are:

1) The shortest distance between two points is a straight line and,
2) Parallel lines never intersect.

In finance, the equivalents are:

a) Money makes the world go round and,
b) Interest rates regulate the amount of money.

Following logically from (a) and (b), when interest rates rise, money creation is reduced and the world spins slower.

Now, the money crowd is so tightly wrapped around itself, so myopically attached to the micro-reality of markets, that it believes that the whole world is defined by the ups and downs of a couple of share indexes and the pronouncements of a few central bankers. In that, they are just a bunch of flat-earthers scared silly of getting too close to the edge, dropping off their pancake world and vanishing forever. Unlike geometry, finance unfortunately never progressed past Euclid.

Fact is, finance is not even a science at all. It is not ruled by natural law, but by a near-religious belief system, complete with priests and rituals, gods, demi-gods, fallen angels and devils. Marx had it wrong: money is the opium of the people - and this is why communism failed so miserably in practice. Just try taking away that drug from the addicts. But, I digress...

Every major move in financial markets that I have experienced in the past 25 years has come from a shift in interest rates, up or down. As the winds we call interest rates get stronger, the ship of finance-fools gets pushed further away from the safe haven of the pancake's center and closer to the presumed abyssal edge. The sailors first try to row harder and then make sacrificial offerings to the gods, but eventually panic takes over and they just jump ship. Some drown, others get devoured by sharks and a few make it to shore, cursing the gods for their wretched fate. The ship sails on, of course... the winds eventually shift, the ship gets back closer to the "center", some sailors get aboard and the whole process starts all over again. The Earth is in fact round, after all.

Right now, the winds are getting stronger and the sailors are getting antsy. Some are mumbling about their mates that already jumped ship (they call them sub-primates). Others bring out their amulets, talismans and charts; yet more beseech the on-board diviner to tell them what is to be. Even Greenspan is heard from, free from his curse to speak solely in gobbly-gook and mumbo-jumbo.

With long rates reaching 5-year highs and credit spreads widening once again (eg see the ABX and CDX indexes), I sense a good old fashioned "panicke" coming on, something perhaps straight out of the South Seas; after all, that particular bubble had everything to do with debt, too.


  1. Right after I read your post I found this

    some of these who tried to jump ship at Bear Stearns were not allowed to as this

    "But in a June 7 letter to investors, Bear Stearns says it's suspending redemptions because the "investment manager believes the company will not have sufficient liquid assets to pay investors."

    seems a perfect "Socratic Irony" to me.

  2. The sooner, the better..IMO.

  3. Re: hedge fund redemption moratorium

    If you read the article very carefully, towards the end you will discover the real reason for the redemption suspension.

    The hedge fund sold some of their riskier CDO's to a BSC affiliate in exchange for shares in the unlisted affiliate, which BSC is trying to sell to the public via an IPO.

    Get the picture? $400 million of the funds' assets are in non-marketable securities (the said unlisted shares)...assuming the valuation holds up when/if the IPO takes place as planned.

    Thks vm for the link.

  4. Ahhhhh! Sometimes I should read slower! Am I correct that 400 million dollars of original leveraged asset shares were traded for a "parity" of unlisted affiliate shares? Or could there be some more leveraging going on(sarcasm)? Not that I need to know but as you continue to "paint" the economic landscape the details tend to make my head spin. Keep up the great work!

  5. Re: "parity"

    Since the funds sold debt (CDO's) and got shares in return, there is definitely some leveraging going on, if only through the earnings multiplier (P/E) being applied to the shares.