The last crash happened because systemic risk was pervasively
underpriced. People failed to discount the possibility that home prices
can move downward as well as upward. Removing this risk from the overall
pool of risk that gets sliced and diced in a billion different ways
means that there was too much risk to match the returns generated by the
system.
Now people are streaming back into debt securities that have some kind of exposure (direct, indirect, through spread, or through swap) to explicit government guarantees or to an expectation of government support. The risk management that should be imposed by people performing good old-fashioned credit-quality analysis, is instead being provided by the promise of government liquidity.
This is a system made of moral hazard. The people who benefit from it, by definition, are the ones who game the system. Traditional retail investing is now a sucker's game, and the intrinsic value of our money is now highly questionable.
It's quite possible to sustain for a very long time a system in which business and financial risk is implicitly underwritten by monetary authorities. Rather than being taken by stockholders of banks and investment firms, losses will ultimately be borne by low-end consumers, who will experience either contraction in the economy, or high inflation, or both.
It won't be sustainable if there is another bubble somewhere. Bubbles happen when the risk of loss becomes decoupled from the risk of gain. Bubbles are automatically prevented in normal times by people who stand to lose money if they make bad decisions. There's no intelligence required. It's a stable feedback loop.
But in the nascent world of socialized risk, you can easily get bubbles, and the only thing that can stop them is for government authorities to see them coming and stop them ahead of time. Much knowledge, intelligence and luck is required. It's NOT a stable system.
Now people are streaming back into debt securities that have some kind of exposure (direct, indirect, through spread, or through swap) to explicit government guarantees or to an expectation of government support. The risk management that should be imposed by people performing good old-fashioned credit-quality analysis, is instead being provided by the promise of government liquidity.
This is a system made of moral hazard. The people who benefit from it, by definition, are the ones who game the system. Traditional retail investing is now a sucker's game, and the intrinsic value of our money is now highly questionable.
It's quite possible to sustain for a very long time a system in which business and financial risk is implicitly underwritten by monetary authorities. Rather than being taken by stockholders of banks and investment firms, losses will ultimately be borne by low-end consumers, who will experience either contraction in the economy, or high inflation, or both.
It won't be sustainable if there is another bubble somewhere. Bubbles happen when the risk of loss becomes decoupled from the risk of gain. Bubbles are automatically prevented in normal times by people who stand to lose money if they make bad decisions. There's no intelligence required. It's a stable feedback loop.
But in the nascent world of socialized risk, you can easily get bubbles, and the only thing that can stop them is for government authorities to see them coming and stop them ahead of time. Much knowledge, intelligence and luck is required. It's NOT a stable system.
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