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Housing crash payoff, financial meltdown, risk and more
  (week of August 12, 2008)

Harun I.

RE: The Housing Crash Payoff: More Affordable Housing, More Disposable Income (August 11, 2008)

"Rather than wringing our hands in horror at the crash of housing prices, we should be cheering wildly and hoping they drop another 50%. Why?"

This is a great question. When I read it I thought that is like asking what is bad about getting rid of a malignant cancer? The treatment will most likely make you sick at first but when the cancer is gone you will feel much better.

If the economy was built on manufacturing production housing woes, bank and investment bank bailouts would not be an issue. But this economy and all other western economies are built on debt as a means of fueling growth. But don't blame the governments. We all get what we deserve. If the citizens of these nations think at the level of bobble heads then they will eventually wind up with leadership attuned to their level of thought.

Some many are speaking of recovery. Mr. Obama seems to think another $50 billion giveaway will tide us over until all this bad stuff passes. This rhetoric may be a ray of hope to bobble heads but it is nothing more than misguided foolishness. We have become a nation that believes that consumptive debt is wealth. Recovery currently means getting back to consumption via debt expansion. When the paradigm shifts to: we have to become competitive at making and selling things (manufacturing), then we will have a true economic recovery.

But there will be pain at first. The decoupling from the idea that consumptive debt equals wealth will cause a dark age to descend on most as standards of living decrease and governments can give handouts to everyone. But this is a price that has to be paid. Katrina was a harbinger of things to come, i.e., that government at all levels had made promises it couldn't keep. Mr. Brown was castigated by the media as an incompetent oaf but Meredith Whitney, the sage analyst from Oppenheimer said, "you don't have to know the business but you better have the numbers down cold."

Mr. Brown didn't need to know the minutiae of FEMA, he knew and stated that FEMA couldn't handle an event the size of the UK. But in true lynch mob fashion people wanted blood instead of reason. Never was a critical eye cast upon the idea that states have become dangerously dependent on a Federal government that is taking in too little revenue to keep its promises. The centralization of power would greatly disturb the Founding Fathers; it is not what they designed and had good reasons for not doing so. But the bobble heads don't seem to care about the wisdom of men who were geniuses with a knowledge and understanding history unmatched by anyone today.

Fast forward to the present. People are resistant now as then to the idea that the government can't deliver on its implicit promise to maintain the illusion of wealth but we are hoping. This is why, we the people, are mute when acts of desperation that will encumber generations with mountains of unrepayable debt are taken on what they think is their behalf.

I have seen far too many intelligent people go bust trading because they simply couldn't let go of losing trades quickly. They couldn't understand that it was okay to have an opinion and express it in the form of a taking a position in the market with the caveat that, if it was empirically proven wrong, they should exit the position immediately. When the position went against them, instead of exiting, they refused to admit they were wrong and began to hope as the losses mounted. As this drama played out they become angry and defensive, often lashing out at friends and family or avoiding them. When they were winning they were euphoric to the point of being insufferable. But this manic behavior is as exhausting to the individual as it is to those they encounter. Eventually they go bust financially. With ego and dreams of great wealth dashed, they quit.

America has no shortage of intelligent, good, hard working people. But instead of admitting our mistake and exiting this long bad trade we are being sold and buying into the idea of hope that the market will turn and we will at least exit the trade break even. This is an extremely dangerous mindset. I have not met one successful trader who engages in this and I strongly suggest that as a nation we too will fail should we persist along this line of thought.

The way to wealth is through sound economic growth fueled by savings and investment and true competitive productive output. If we are to compete in a global environment wages must fall along with asset prices, savings must occur and credit must contract and the artificial setting of interest rates must end. Government entitlement spending must contract as well. The idea of government spending beyond its collection of revenue has to be seen as absurd and completely denounced. If we want a service then we must be willing to pay taxes to support it. Balanced budgets should be legislated for Federal government. But there will be more pain.

The pain will be the realization that not everyone can own a half million dollar home as well own several $50,000+ auto's and SUV's and retire to a life of luxury at 55. Our use of resources has to become exponentially more efficient with time if population growth is to be sustained, and time is not on our side. There has not been and never will be a permanent empire. We must embrace the idea that war is not an answer to resource depletion. Only empires and imperial has-beens keep military outposts all over the world to protect their "interests".

Nature does not guarantee anything to any particular species. Each must work with its specialized tools in order to survive and even then nothing is assured. The American standard of living is not non-negotiable, we will get what we work for and we will get what we deserve.

Harun I.

Re: The Paradox of Risk: How Limiting Risk Actually Increases Risk
(August 12, 2008)

Today's post is excellent as usual. One note, as a practitioner of the game of chance called speculation, I do know the risk of ruin and so do the MIT quant jocks on Wall Street. They are willing to take those risks because they know that, done on a large enough scale, they can't lose. The government via the taxpayer will backstop their losses because they will be large enough to cause a systemic meltdown. In short we have accepted moral hazard.

Every serious trader knows his systems win/loss ratio as well as its largest losing trade and largest winning trade and can model the frequency of the size and frequency of the drawdown. Most will manage risk conservatively based on the fact that, when that big loss or series of losses (draw down) will occur is unknowable. I don't know where it first appeared but it seems that Greenspan's intervention every time the market was faced with collapse sent the message that bailouts are to be expected if the conflagration is large enough, hence the Greenspan put.

John Merriweather's (LTCM) contention that on any given day in the fall he could predict the the distribution of fallen leaves around any given tree, and that it is not his fault if the wind blows, is exactly the mindset prevalent on Wall Street. They know, they just don't care because the stakes are such that they will get ridiculously wealthy while the music is playing and when the 100-year flood hits, it is the taxpayer, who didn't even know he was playing the game, that will be left without a chair.

Thank you, readers, for such thoughtful contributions.

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