Today you have the following: trade protectionism and asset protectionism (the increasing restrictions to foreign direct investments in the United States); hedgy and trigger-happy investors and rising geopolitical risks; the risk of a disorderly fall in the U.S. dollar that is now sharply weakening; a slush of financial and credit derivatives that are a black box of opaque financial innovation that no one truly understands; increasingly risky investment strategies based on growing levels of leverage (i.e. the ability to multiply risk bets by borrowing a lot to finance such bets); frothy markets where years of easy money created bubbles galore—the latest in housing—that have now started to burst; greater opacity and lack of transparency as there is no supervision or regulation of the activities of many highly leveraged and opaque financial institutions; risk management techniques in financial institutions that fail to truly test the risk of large losses in extremely rare events (such as a major market meltdown like in 1987 or in 1998 at the time of the near collapse of Long-Term Capital Management, then the biggest U.S. hedge fund); risk-hedging strategies that—like in 1987—can hedge nothing once everyone is rushing to the doors and dumping assets at the same time (with this summer’s liquidity crunch a perfect example of the vulnerabilities associated with the poor management of liquidity risk); a housing market whose rout has already triggered systemic effects through the subprime carnage; and the fact that subprime mortgages had been pooled in mortgage-backed securities and that these in turn were repackaged in other risky, complex, and illiquid securities (the various tranches of collateralized debt obligations) that were then given a misleadingly high rating by the rating agencies.Don't let anyone get away with acting surprised if the meltdown comes....
Monday, December 03, 2007
The pessimistic take:
Posted by Nils at 12/03/2007 07:59:00 AM