Dictionary: asymmetry (ā-sĭm'ĭ-trē); noun.
Any absence of balance or equivalence between two things that are otherwise comparable.
When does a meme become a virus?
Last night, 60 Minutes ran an excellent expose called ‘The Price of Oil.’ It traced oil’s rise in a year’s time from $69 a barrel to $150, and subsequent collapse in a little over three months to under $40.
Somehow, a commodity that is theoretically priced according to supply and demand ignored a simultaneous increase in worldwide supply and a drop in global demand (according to US Department of Energy statistics) to nonetheless register the single largest price increase in history.
But there is an explanation, of course. While real demand for actual ‘physical’ oil was dropping relative to supply, investor demand for the virtual crude oil ‘asset class’ was off the charts.
In other words, just as stocks, credit swaps and other derivatives became completely unhinged from the real value of the underlying asset, so too was the case with oil.
In fact, 60 Minutes’ expose shows that this unhinging was so resplendent that 27 barrels of crude oil were trading on the commodities market for every one barrel of physical crude that was actually consumed, the very fingerprint of rampant speculation.
As should be no surprise, with high rates of flipping come increased volatility levels, and an offspring of Enron, whose sole purpose is to corner the market and control/manipulate the price, the needs of the general consumer be damned (remember the never before seen, and never since seen, rolling blackouts?).
Now I don’t know about you, but when I net out that the predominant reason that $2 gas was replaced by $4 gas was that the major investment banks, hedge funds and other speculators were playing the free market game in a manner that unquestionably comes out of the hides of many to enrich the pockets of a few, something feels terribly wrong with this picture.
Specifically, cast in doubt should be our unconditional worship of the god of free markets, our blind faith in its systemic efficiency and lamb-like trust in the immutability of the laws of supply and demand.
Enough! Quit Enabling Financial Predation
The Crude Oil Bubble that predates the Credit Bubble, which follows in the footsteps of Enron, the Internet Bubble, fall of Long Term Capital Management and the S&L Crisis before that is just the latest example of how our financial system seems tilted more towards enabling the predator than protecting the prey.
Put another way, while we as consumers may not like getting gamed an extra $2 a gallon, seeing our 401Ks wiped out and the equity in our homes vaporize, understand that this is a feature of the system, not a bug. And as they say, doing the same thing over and over, and expecting a different outcome is tantamount to insanity.
So where do we go from here? In year’s past, we turned away from allowing the robber barons to run completely unfettered; we moved instead towards embracing a public, political, proactive role for government; as the gatekeeper, the maintainer of the delicate balance between the laissez faire free market engine that we hold dear and the regulatory cop that controls, curbs and breaks up large concentrations of power when extreme imbalances occur.
How to Repair a Broken Financial World
In ‘The End of the Financial World as We Know It’ and its companion ‘How to Repair a Broken Financial World,’ author Michael Lewis and hedge fund manager David Einhorn do a really good job of spotlighting the asymmetries that currently exist within our financial system, noting that “the fixable problem isn’t the greed of the few but the misaligned interests of the many…and the lack of checks and balances to discourage it.”
As they note, the market only cares about short-term performance, and ruthlessly penalizes those who forget its eminence.
Even worse, as Lewis/Einhorn note, “The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest.”
Some examples:
- Imagine the financial services CEO who failed to jump on the derivatives bandwagon, or worse, was the whistle blower for the industry. If politics didn’t result in his/her dismissal, then a couple of quarters of under-performance relative to his more aggressive industry peers would.
- The annual bonus structure that is central to the financial services industry cares not one iota about long-term performance. Specifically, there are no bonus holdbacks or repayment mechanisms to entice rainmakers to take the long view.
- The credit ratings agencies whose job was to expose and quantify financial risk, instead systematically disguised it.
- The SEC has become so emasculated that a culture of avoiding short-term political heat and a culture that discourages active governance became institutionalized. No less of a motivator to not making waves is the knowledge that SEC personnel can look forward to high paying jobs in the private sector if they play their cards right.
While we can’t and shouldn’t try to legislate greed, we can and should kick the credit agencies to the curb; we need to regulate exotic financial instruments like credit default swaps, setting stringent capital and disclosure requirements; we need to set limits on the ability of SEC personnel to work in the same industries that they are trusted to govern (but encourage private know how to move the other direction into the public sector); we need to balance our knee jerk instincts to fund trickle-down rescues (i.e., protect the AIGs of the world) with an embrace of bottom up direct relief to homeowners (haven't we been told ad infinitum that as the consumer goes, so does our economy?).
Netting it Out
Unsurprisingly, much of this is fairly intuitive. Reward the behavior that you want to encourage. Penalize the behavior you want to discourage. Never trust the foxes to watch the hen house. Avoid obvious conflicts of interest. Set stringent, transparent capital requirements to ensure that participants in the financial marketplace can meet their commitments. And never, EVER, be afraid to use a big stick when talking softly fails to yield the desired results.
Related Posts:
- Capitalism 2.0: TED Spreads and Lessons from Japan’s Lost Decade.
- Engine Failure - When Financial Markets Fail: an analysis of the current financial crisis.
- Black Swans and Bank Runs: on why this crisis was predictable.
- Financial Tsunamis: connecting the dots in the sub-prime mess.
