Whilst on my drive home yesterday I listened to the daily financial show, Marketplace, that comes on at 6pm on our NPR station. The story, for which I have attached a link below, bemoaned how markets are irrational. And this contrary to the theory put forth by Milton Freidman that they should be rational. When they say rational, we mean that we expect market prices of stocks to behave in accordance with the appropriate information. If profits and revenue at Company Z are up, then the stock price should go up. If the credit rating of Company B is downgraded, then the price should go down. But this isn't bearing up in what we are seeing in the market today.
I would argue that a FREE market would more than likely be rational. The reason our markets today are not behaving rationally is because they're not free. Can anyone guess the true market value of GM stock? No. And no because the price of GM stock today has a lot more to do with what the government may or may not do in its little magic box than what GM is actually worth.
This same logic applies to any bank stock in existence today. And this spreads from there to the entire economy because of the equally magic and mysterious "securities" created by a bunch of MBAs -- otherwise brilliant people I'm sure, aside from being so stupid. Well the rest of the economy bought this financial junk, gambling on the brains of an MBA degree. Now nobody knows what they or anybody else actually owns in terms of assets.
A lot of, again, otherwise brilliant people, forgot one of the investment rules of thumbs that only applies to us individuals of little brain: if you don't understand what you are investing in, you probably shouldn't.
Here's the link to the article: http://marketplace.publicradio.org/display/web/2008/11/10/economic_theory/.
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I do not disagree with the government market-intervention comment masking a company's true value. However, before the recent crisis, the government was really hands-off (minus interest rates...which is another issue). Mortgage-backed securities, futures, credit-default swaps...all of these financial instruments are the by-product of a truly "free" market. These were not government-created, they were market created...by people who were trying to spread out and minimize investment risk as much as possible while still trying to get the highest possible yield. That, my brother, is what one should expect from a truly free-market. Look at it this way: we expect engineering companies to make cool new things, why shouldn't we expect a free financial market to make cool new things?
ReplyDeleteall of these financial instruments are the by-product of a truly "free" market.
ReplyDeleteI could not agree more. But we are not allowing them to do what they should be doing in a free market: Fail. The government is prolonging the problem by keeping the free market garbage alive at the expense of allowing the free market to find more sustainable resource allocation.
I will not argue with you if you want to state that the free market is part of the problem with how we got where we are today. But a free market that is only allowed to be free when times are good and then bailed out when times are bad is the worst possible combination, and only serves the monied interests (ie - not you and me). I have to bail out AIG and GM!? Bull crap. I'll support you in the free markete when you offer me a car worth my money, but it should be considered a crime for GM to extort my money under threat of imprisonment (which is what would happen if I didn't pay my taxes).
Its got to cut both ways. A free market HAS to allow for failure.
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ReplyDeleteAnd it is. If you don't think having numerous investment funds go bankrupt, not to mention numerous banks go belly up, then you're not paying attention. Your idea of 'failure' can be read complete and total global financial metldown. Can we say Iceland? Zimbabwe hyper-inflation?
ReplyDeleteI think I know what you're driving at...but I think a prolonged recession is MUCH preferable to a total market failure...which is what would have happened if the mortgage giants and AIG (huge underwriter of the CDSs and CDOs) had failed. [AIG is not just your typical (like car) insurance company...I actually owned some short-term stock in them for a while.] Anyway, I am a free market kinda guy- but right now the free-market is not functioning at all, because the very foundations upon which it is built, trust and lending, is not working. The markets need capital injections to keep alive (maintain their margins), or else they all go down, and our money and credit supply with them. Considering that we may be buying a house within a month or two, I would like access to credit. So maybe I'm just biased:) I like my GM Jeep too, but GM probably needs a good spanking anyway, so I'll concede GM- but I'll surely miss Jeep parts when I need them.
Government controlled failure is not free market failure. Hank Paulson and his cronies get to descide who gets bailed out and who doesn't. Whether he's being corrupt about it or not is not the point, but it shouldn't be up for the government to decide.
ReplyDeleteSo Lehman Brothers can fail but AIG can't. But now AIG is in trouble because they gambled billions that Lehman Brothers wouldn't fail. I'm already confused.
If AIG were allowed to go bankrupt, their inflated assets would get bought at their proper market value (and the buyers would either make a profit on them or not), and a court would decide how the creditors lining up would get their fair shake. There would be some pain, for sure. But I think when it all hit the fan, I think we would both be suprized. Me, at how much more painful it was and how much longer it took to work evereything out. And you, just the opposite; how is wasn't a complete meltdown, and how relatively quickly it all worked itself out.
And since you mention Zimbabwe and hyperinflation, you should probably know that Zimbabwe's problems began with Robert Mugabe, and he continues to be at the center of the problem. Also, you cannot have hyperinflation without a central bank.
Further...all the buzz on the radio in the past few days is that we're facing the potential of a dreaded deflationary cycle. Gasp! Falling prices! Run for the hills!
I have to agree with number one in this case. The free market did run, unfortunately it ran away. Due in large part to greed, one billion a year salaries (yes one billion) on unregulated stuff like derivative values and underwriting fees that were as bogus as as three dollar bills. The government failed to understand the greed factor of these insurance/ investment banker/ underwriter firms. Just look locally at the (AL) Jefferson County swewer rates and understand how far the train ran off the track. I have to blame Greenspan on that. He was to busy making his his thirty year younger spouse happy at the department stores and country club and more worried about inflation than monitoring such big investment firms. While he let the big boys go unmonitored, he continued to choke the life out of the smaller businesses by keeping interest rates artifically high.
ReplyDeleteMeanwhile the stock market takes one step forward and two steps back in its road to recovery. Equities are valued lower just for no good reasons other than consumer unconfidence.
The democrats are running to the white house scratching their heads wondering how their plan did not implode on them. Their failure to blow the election stuns them. They can no longer call NPR and rant about how bad the republicans have run the country in the ground. All the fun has been taken away from them.
The sun still came up this morning, although I can not see it to clearly today due to overcast skys. We all should be thankful for deflation, we might be able to afford ourselves this fall season. If this keeps up, I can afford to run to the coast and fire up a good fishing boat that sits unused at the marina.
Meanwhile at the country club, the republicans wonder why that light at the end of the tunnel turned into the little (democrat) train that could. I got a headache, I need a drink.