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August 21, 2007
There is a nice account of the architecture of the financial markets by Robert Reich on his blog. Reich, who was recently in Adelaide to give a public lecture and work as thinker-in residence, is commenting on the credit squeeze or crunch.
Courtesy of The Onion
Reich says:
The system has become so fast and so loose that many of the fancy financial instruments now in use, and the mathematical models on which they’re based, are too complicated for anyone except a computer to understand. Fortunes have been made exploiting tiny opportunities for arbitrage or devising new derivatives on the basis of data and risk assessments far less certain than they’re assumed to be.
That financial markets are highly complex systems is also argued by Richard Bookstabber in this article in Time Magazine and in his book A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation.
Reich continues:
Hedge funds have been operating huge financial casinos without having to disclose what they’re betting on, or why. Credit-rating agencies have cut corners or averted their eyes, unwilling to require the proof they need. They’ve been too eager to make money off underwriting of the new loans and other financial gimmicks on which they’re passing judgment. Banks and other mortgage lenders have been allowed to strong-arm people into taking on financial obligations they have no business taking on.
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One option missing is for people to consider hedging the home price in the futures or options markets. Or they could become hedge fund managers.
On second thoughts maybe it is to late to do that, for what has been happening in the markets is bad.It is not a fun time to be either a homeowner, or a hedge-fund manager in the United States, is it?
People should be reassured by the economists saying that a nasty market contraction does not mean that the economy automatically goes down the drain. We still have China remember? And Costello is still at the helm? He won't fall asleep at the steering wheel of his finely tuned Formula 1 economic racing car.