Posts Tagged ‘Credit Crisis’

Imagine Multiple Outcomes

Posted by: Sam Folin

Monday, August 2nd, 2010

While we ponder  the economy and markets and equity returns it is important to be firmly rooted in probabilities rather than certainties.

The first step in this process is to be very clear what is fact, what is informed opinion and what is simply future forecasting. Forecasting the future is a fool’s errand.

Very important to understand the difference.

Some history might help me explain:

In 2007 we thought the market was going to go down in the year or two to come based on equity over-valuation, the rapid erosion of the housing bubble, and the major excesses playing themselves out in a speculative market. This was not a forecast exactly but rather we thought it was a likely outcome with a very high probability of 80%.

In our work an 80% probability is very rare. I have been conscious of this level of certainty only twice in the last 20 years.

Our current outlook for stocks to reach ridiculously cheap levels sometime in the next 5 years only has about a 60% probability. Still high but less certain and almost meaningless given the time frame.

That leads us to a discussion of risk. By 1999 (during the tech bubble) I was certain stocks were headed for a fall. I did not pretend to know when, but thought it would come within months or a year at most. Stocks were ridiculously overvalued. Managing the risk of an equity collapse was job 1. Recognize that the possible outcomes from the vantage point of 1/1/99 included a wide range of possibilities from +15% to -35%. The downside was much more severe a possibility than the possible upside would compensate for. I advised anyone who would listen to get out of stocks.

In the event stocks rose almost 24% that year. Most people who had heeded my advice thought I was nuts. Speculative fever was abroad in the land and everyone knew that the tech revolution was going to change everything. No more recessions, only growth! A couple of my friends who had reduced equity exposure actually went back into the market.

The market started its decline for real at the end of August 2000 and bottomed down 50% in March of 2003. Friends who heeded my advice in early 1999 managed to avoid a 33% decline.

The point of this story of humility and ultimate redemption is that when we look backward the outcome could have been different. The speculation might have continued for two years or more beyond 2000. Looking forward from 1/1/1999 there were myriad possibilities. The judgment made at the time was that the downside risk was A major risk and therefore that possibility required action. Owning 60% stocks in a down 50% market is devastating to wealth.

This is an important discussion that will continue in coming weeks.

OSF

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What Lies Ahead?

Posted by: Sam Folin

Tuesday, June 22nd, 2010

Donald Rumsfeld was infamous for his time as Secretary of Defense under GW Bush. Perhaps his most memorable statement was something like, “..we have the known unknowns but it is the unknown unknowns that are the problems.”

The NYTimes Blog, Opinionator, carried a wonderful description of this yesterday and I encourage you to read it. http://opinionator.blogs.nytimes.com/2010/06/20/the-anosognosics-dilemma-1/

The basic idea is that that we have blind spots -situations where we do not even know the questions to ask. There are things we don’t know such as, When and where will the next terrorist attack happen  in the world/US?

There are also things we don’t know that we don’t know. Hence Rumsfeld’s unknown unknowns. It sounded goofy at the time but it was a rather profound statement.

Looking ahead in US Economic doings one wonders what questions we are unaware of. (more…)

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Wall Street Was Regulated For 50 Years

Posted by: Sam Folin

Wednesday, April 28th, 2010

This proposed tv ad says it all. http://www.ritholtz.com/blog/2010/04/financial-reform-commercial/#more-55582

Regulation was successful for 50 odd years. A series of dereg moves by Congress and the SEC allowed the cowboys to go wild. The result has been devastation.

The next step is obvious but the banks are lobbying hard against the much needed rereg of Wall Street.

OSF

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The credit crisis and SRI

Posted by: Administrator

Sunday, September 21st, 2008

The chickens have come home to roost for our country’s most storied financial institutions, and for our financial regulators. Systemic investment in high-risk securities, left unregulated and under-capitalized, has toppled the banking giants while regulators scrambled to bail them out. This debacle in business ethics has been unique in the degree to which the perpetrators lied to themselves as well as to the public, while regulators looked on in complicity. Leading financial institutions acted against their own self-interest by ignoring not only societal expectations, but the reality of their own financial positions as well. (more…)

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Credit Default Swaps

Posted by: Sam Folin

Monday, January 14th, 2008

Talk in the financial media about the growing CDS (credit default swaps) problem has just begun.

This may be new to you but it is a growing story and a huge risk that is not well understood.

A CDS is a contract between the holder of a risky asset (say a portfolio of sub-prime loans, credit cards, etc.) and a financial entity willing to guaranteee that risky asset against default. Very similar to insurance policies except that there is no regulation and unless the protection buyer has done her homework there may not be adequate collateral to insure the risk. (more…)

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