 INSTITUTIONAL
ADVISORS
The Unholy Trinity
Bob Hoye snippet
Institutional Advisors
Jul 24, 2007
The structure of today's credit
markets is interesting. On top is the establishment's convictions
that the Fed can infallibly set the right level of interest rates
that will "keep the recovery going".
The result has been virtually
chronic lending accommodation, which has fostered the biggest
and most reckless financial party in history - the bender of
last resort.
The business of arbitrarily
manipulating interest rates has been on since the Fed opened
its doors in early 1914. Two other equally arbitrary constructs
are more recent and have become rather acute hazards. These are
the now widely discussed, and in some quarters already dismissed
as the worry-stuff that drives bull markets. The most egregious
is the notion of pricing by a mathematical model, rather than
by market transaction.
The last element in this trilogy
of artifice is that rating agencies came up with a mathematical
model to assign a credit rating to a bundle of securities of
doubtful parentage.
Professor James Tobin was a
leading interventionist economist until he passed away in 2002
at the age of 84. In the early 1980s he defined a bubble as:
"Speculations on the speculations of other speculators
who are doing the same."
No doubt he was thinking of
the 1980 binge in metals, crude oil and real estate, and with
no little irony it can be applied to the current establishment's
trilogy of artifice.
Financial innovations to create
credit out of thin air are always tempting but it takes a truly
reckless culture to make it a tool of policy makers. It seems
like another world away, but there was a time when such tools
were shunned. Brokerage bucket shops flourished during the late
1800s. These store-front operations provided the retail account
a way to play price changes of big board stocks without entering
orders through the floor. Margins offered were as low as 1%.
The operations were subject to manipulation in the "shop's"
favour.
This form of unenforceable
contract had earlier been seen as wonderful and then calamitous
in the infamous Tulip Bubble of 1637 whereby the "Lunatic
Fringe" brought down the senior economy, in a typical post-bubble
contraction.
Now it seems that an experiment
in credit innovation, that would be scorned by earlier generations
of bankers and financiers, has become the financial culture of
Academe, Main Street, as well as Wall Street. As with any intense
speculation, participants can ardently believe the most preposterous
story so long as the price is going up. Then the inevitable speculative
exhaustion is followed by chagrin.
Belief in the Unholy Trinity
of central banking, derivatives and artificial rating of credit
is dependent upon an always rising price. In one sector - subprime
- this is not the case as the BBB bond has plunged from 95 at
the first of the year to 54.
Within this the plunge from
85 in late May is becoming severe and at what price below, say
85, can a BBB still be considered investment grade?
At what point does the establishment
no longer believe that the subprime mess is isolated or can be
contained?
And, at what point does the
general public finally understand and condemn the Unholy Trinity?
July 23, 2007
-Bob Hoye
Institutional Advisors
email: bobhoye@institutionaladvisors.com
website: www.institutionaladvisors.com
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