Sunday, April 18, 2010

Too Much Debt, Too Much Trading

Transitory matters such as an SEC wrist-slap civil action against a bank or a volcanic explosion in Iceland can lead to reflection on larger matters. The Goldman Sachs complaint by the SEC involves a credit default swap (CDS) on mortgage-related products. As Paul Volcker has opined, this sort of "innovation" or "technology" may be useless.

I am thinking that we would all be better off with the financial products equivalent of the FDA. Let a product be demonstrated to be both safe and effective before being marketed interstate or internationally. The simplest solution is to ban CDS and let insurance companies prepare such a product as an insurance product per se, with identical regulation and reserve requirements as any other insurance product.

Other, older "innovations" are harmful. Most oil should be marketed under long-term fixed-price contracts, though shipping costs would be subject to the free market, and of course inflation/deflation clauses could be involved. After all, pumping costs of discovered oil fields are known and stable. Instead we saw in 2008 the price of oil soaring to $145 per bbl and in half a year plunging below $35. How can it be a good thing that this could occur? How is it even possible, absent supply disruptions such as from war that would send the price skyrocketing? There was no force majeure, though. Year after year, the oil traders in essence take a vigorish that belongs in the pockets of producers and consumers alike.

Who has benefited from the debt explosion the past decades? The first and greatest beneficiaries are the purveyors and traders/repackagers of the debt. Thus Japan keeps selling more and more government bonds, beyond any comprehension given that doing so has not led to any obvious benefit for their economy. Yet it keeps doing so. The US public is suggested that it does so to "fight deflation". As if lower prices are not good things for a trading country.

In the US post-Civil War, the advent of industrial processes applied to farming and manufacturing, plus cheap rail access to the mineral and other wealth of the West, deflation was the order of the day, as was a general trend toward much higher living standards.

As went Japan, so went the US and the UK. It is the bankers who benefit from all the government debt. And if the debt ultimately needs restructuring, they benefit from that as well. Those who purchase the debt may or may not benefit. If the purchaser is an insurance company, it purchases the debt simply so that it can sell an insurance product at a spread profit. If the purchaser is a central bank, then the purchase may well be for political reasons. But those who sell and endlessly resell the swelling amount of debt-- whether it be on houses (mortgages) or direct claims on the Treasury-- continue to benefit from the Bushbama Continuity on bailouts and the like.

We need more equity and less debt in society. Ultimately, traders' pricing and mispricing of securities notwithstanding, investors should be in honest situations where those who price securities actually own them for real rather than acting as middlemen or, even worse, "analysts" who cleverly are forced to disclose they have no ownership of what they recommend. Far better that a bullish analyst own the security recommended and be prohibited from selling for the time frame of the recommendation. And the opposite for a bear.

Fundamentally, the allure of alternative investments ranging from precious metals to lumber is that they are what they are. You don't need an analyst to evaluate whether Oracle is going to make money from the Sun Microsystems purchase. Thus the sell-off in gold on Friday concomitant with the Goldman news appears misplaced. Was the Friday announcement on options expiration day part of market manipulation on the SEC's part, the same SEC that is now known to have sat on the Allen Stanford scam for many, many years? (Not to mention Madoff.) Considering that the pros very recently added numerous short positions in gold futures recently, one has to take this possibility seriously. It is becoming less and less of a fringe position, I believe, considering the growing evidence of governmental involvement in the bubble and cover-up.

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