Fictitious money

[nancylebov]

http://metahacker.livejournal.com/487990.html?nc=15

For about ten years now, since I started understanding that market capitalization was a made-up number, a mass hallucination of value that couldn't actually be accessed, I have felt like a modern-day Cassandra.

Because it makes no sense, inventing value. The harbinger was, for me, Akamai; when it went public, its 'value' -- its market cap -- briefly soared above that of Apple. Twelve guys, some of whom I knew second-hand, were suddenly "worth" more than a decades-old, successful company with thousands of employees -- or would have been, except I think Apple bought enough Akamai stock to increase its own value. And that's when it became apparent to me this was all fictitious money. You couldn't actually convert this 'value' into real cash, or services; when you tried to sell that stock, its value would fade. It was just a fun illusion on paper, unexecutable.

####

I want betting to be illegal. It's harmful, it attracts addicts, and it's not the sort of thing I want in my (financial) neighborhood. I want the stock market to be a *stock* market. I want financial institutions to stay in touch with reality. I want to avoid successive layers of abstraction that make it harder and harder to identify when there's a problem.

I'm not sure that the solution is a feasible legal principle, but that post has good desciptions of the problems.

Comments

[chomiji]

The Mr. is fond of saying that it's all a Ponzi scheme.

[chickenfeet2003.livejournal.com]

He's right. Once currencies came off the gold standard everything became 'worth' whatever anyone would give for it. If we, collectively, believe that imaginary pink elephants are worth more than imaginary green hippos than they are. The moment the collective loses confidence in the value of imaginary pink elephants and decides they won't trade bread or oil or real estate or imaginary green hippos for them they become worthless. That's what happened to the Zimbabwe dollar. Once upon a time a piece of paper called a Zimbabwe dollar was worth more or less the same as a piece of paper called an American dollar. Now the American piece of paper is worth a billion Zimbabwean pieces of paper. For now.

[holzman.livejournal.com]

I'm afraid the post misses the underlying, inescapable problem: If you spend money not knowing the outcome of the expenditure, you're betting. The only not to have it in one's financial neighborhood is to not live in a financial neighborhood.

If you buy stock, you're betting that between dividends and stock price increases, you'll make money. The only way not to make that bet is to never buy stock. No bet, no stock market.

If you start a business, say selling caligraphic buttons, you're betting that enough people will want to buy them that you'll make a profit, or at least not lose so much that you can't feed yourself. If the bet pays off this year and you stay in business, you're betting that the demand will continue. If the bet pays off 30 years running and you do it again in year 31, you're still betting. If you go out of business and do something else instead, you're betting demand for caligraphic buttons will drop below the point at which you think it makes sense to derive income from them -- welcome to the bear market.

If you base your currency on a gold standard, you're betting that no one's going to find a huge new deposit of gold somewhere that debases your economy. Gold-based money is exactly as fictitious as fiat-based money. All financial value is invented -- it exist only when you have a buyer and a seller who agree on a price, and only for so long as that agreement holds.

[nancylebov.livejournal.com]

I agree. I think they're looking for a bright line where one doesn't exist.

On the other hand, they might have a legitimate point if you look at is as a continuum of abstraction.

[holzman.livejournal.com]

If they're simply arguing that financial institutions should maintain a practice of risk assessment and management; and that there should be legislative regulation regarding the amount and types of risks that financial institutions are allowed to take on, I'm hardly going to argue.

I am an auditor, after all.

However, I don't think that's any momentous insight. It's a lesson people have learned over and over again for centuries, generally right after a market collapsed because investors' appetites for risk became imprudent, because processes of auditing were suborned, and because people are not rational creatures who make consistently rational economic choices.

It's a lesson that gets forgotten over and over again because certain people[1] have a philosophical need to believe that the "free market" exists, let alone is inherently wise; that people are rational creatures who make consistently rational decisions; that government regulation is tyrannical on its face; and that when markets are unregulated, they'll do anything other than grow as fast as they can to a crash just like they have over and over and over again ever since Hamurabbi found it necessary to regulate the markets of his day.[2]

[1] Republicans and Libertarians, I'm looking at you.
[2] It occurs to me writing this that there may be a link between this process and the Malthusian equations of population growth.

[avram]

Has it occurred to you that some fans of deregulation are well aware that a market crash is likely, and are hoping for it? After all, the crash isn't a problem if you see it coming and put your assets someplace safe beforehand. And once the market's crashed, that's a good time to buy in. And the resulting tight labor market will drive down wages, putting those uppity poor people in their place (as long as the pesky government doesn't start coddling them with social programs).

[nancylebov.livejournal.com]

It didn't occur to me. Considering that this is the first I've seen the idea, I don't think it's obvious, though I grant it could have happened that way.

It'll be hard to distinguish between conspiracy and just taking advantage of something which was likely to happen.

[avram]

I've run into the idea -- that the ruling class likes having crashes every so often to keep working-class wages low -- before, in various political and economic writings, but I can't remember the names of any specific sources.

[nancylebov.livejournal.com]

I'm not going to say it's impossible, but here are two other scenarios I think are more likely. One is that no one knows how to reliably prevent crashes and the other is that crashes are the result of conflicts within the ruling class, with what happens to everyone else as collateral damage.

[holzman.livejournal.com]

Yes, it has. I've been vocal for some time now that the only way to make Republican actions consistent with what they say is if at the top they're really out to restore a feudal society and that every theory they espouse is intended to fool people into going along with it by convincing them that it's the path to riches instead of the path to serfdom.

Hence my Republican taxonomy: thugs, crooks, punks, and dupes.

[anton-p-nym.livejournal.com]

Truth be told, I'm sitting on a chunk of cash right now (not huge, 'cause I ain't rich*, but big in relation to my meagre portfolio) because I expected a downturn years ago and yes, I was waiting for the resulting fire sale.

Then again, I'm a very cautious investor ('cause I ain't rich; the last time I took a chance on a growth fund, I barely broke even after five years and that put the wind up me) and I've got a good twenty-five years to retirement so I'm looking at accumulating dividends and not at tomorrow's share price. A dip only helps me in the long run, because it means I get more of the dividends when things pick up afterwards.**

-- Steve's been expecting this would come ever since auto dealerships offered 0% financing as a purchasing incentive, actually, and it surprises him that this crunch has taken so long to get here.

* indeed, if I moved to a major metropolitan centre I'd actually qualify as working poor... one reason I stick it out here in a city of just over 300,000.

** after all, everyone still needs buggy whips, right?

To tip my hand slightly

[metahacker.livejournal.com]

First, bear in mind my post was partly emoting. It's not a sane policy if you stare at it too closely.

That said, it's not so much that I want an end to *all* betting, but I want to curb the extent to which people make money off of betting -- to the extent that you can, without license, run a casino and set your own odds. To push an analogy too far.

But what I really want is more clarity in the process. Clarity of the risks involved (and not just at the "This investment may lose value" level), of the ways that debt is hidden and leveraged, and so forth. It makes it easier to regulate properly, harder to game, and harder to bollux up.

None of this is a momentous insight; but I feel it is important to be explaining it to people in a language they understand (and that includes purposely including emotional overtones). Without an explanation, all people really get is that Something Bad is happening and the Government Might Save Them (except isn't the Government Supposed to Leave Business Alone?), and so forth. You're very close to the sector, and have a really sophisticated understanding of it (which I would love to ask you about at some point), but from the outside, even the basic "stocks go up when people buy" correlation is invisible to most people. All they know is they're hurting, and don't know why.

Re: To tip my hand slightly

[holzman.livejournal.com]

Alot of what you want, we already have -- or had. The problem is that Republicans, from Reagan on, dismantled as many of those protections as they could get away with dismantling.

Publically traded instruments do state their risks clearly, but clearly doesn't necessarily mean comprehensibly. To buy a stock, or mutual fund, or any other such thing one has to obtain a prospectus. The prospectus lists each of the various risks that may come into play that could make an investment lose money. Unfortunately, that's alot of very dry reading because there are alot of risks. Lots of people don't read it, or upon reading it don't take to heart that this means they could lose their money.[1] Of course, this doesn't fully explain the current situation, but it does apply more broadly.

There's supposed to be clarity, and debt isn't supposed to be hidden. That's why Bernie Ebbers is spending the rest of his life as the guest of the United States Government. Part of why we're in this mess is that people broke what few laws didn't get deregulated. I read yesterday that the FBI is investigating 26 executives at the firms that have been having trouble lately, and I am very, very curious what's going to come out of that.

Even my own field of auditing is a field already in place that's supposed to provide clarity. We now speak of the Big Four accounting firms instead of the Big Five because auditors were suborned into cooperating in fraud.

[continued in next post]

[1] My sister's Doctoral Thesis is on why HIV education fails. It turns out that HIV education fails because people learn and understand the material, but tell themselves it won't happen to them. A similar thing happens with information security and with investments.

Re: To tip my hand slightly

[holzman.livejournal.com]

The mortgage crisis, in an oversimplified nutshell, looks like this: Banks were told they could give mortgages to people who had no business having mortgages. (i.e. "the sub-prime market") So lots of people in very precarious financial positions got mortgages at high interest rates because charging a high interest rate is how a bank justifies lending money to someone who might not pay it all back. The risk is that they default on the loan, the reward is that they get a higher interest payment. The bet is that more people will pay than will default.

Here's where it gets complicated: a debt, such a mortgage, is something that can be bought and sold. If you owe me $100, I can sell that debt to someone and then you owe them $100. If I think the odds of you paying me the $100 is 50%, then the debt is worth $50 to me. If someone is willing to pay me $51 for it, I sell him the $100 debt and figure I made a buck. That's what happened to all those mortgages -- they got bundled into grab-bags and sold.

Then the economy sucked for 6 years. Enron and WorldCom happened, outsourcing happened, the dollar got weak, gas got expensive -- and therefore so did everything else. As a result, a whole bunch of people who could have just barely made their mortgage payments found themselves not able to make them.

All of a sudden, all those mortgage bundles were worth a whole lot less money. Those debts were being listed as assets on someone's balance sheet. That means the value of their company (i.e. their capitalization) dropped like a rock. Stock values plummet.

[continued]

Re: To tip my hand slightly

[holzman.livejournal.com]

To make matters worse, when there's lots of people defaulting on their loans, banks become very skittish about lending money. As we saw above, they handle this by only lending money at higher interest rates -- or they just decide not to lend money. This means that banks that could have borrowed money (banks are borrowers as well as lenders) can no longer afford the loans because there are laws that regulate how much debt a bank can have relative to their assets -- and their assets just dropped through the floor.

And if the banks can't borrow money in order to lend to customers, ain't nobody can borrow money to do things that make money. Kernel panic, core dump.

Re: To tip my hand slightly

[nancylebov.livejournal.com]

For what it's worth, This American Life had a piece which claimed there was a story behind that story-- there was more money being fed into the economy than there were good investments, so people started making stupid investments.

However (this is me, not the radio show), if it hadn't been for that particular loosening of regulations, the stupid investments might have been made somewhere less destructive.

Also, I read Rich Dad, Poor Dad well before this mess, and I noticed that it was sociopathic-- it strongly recommended finding investments where someone else took all the risk and you got all the profit. It definitely recommended real estate.

I didn't find anyone else who saw a problem with the book.

I don't know if any of the later books told people to get out of real estate in a timely fashion.

Re: To tip my hand slightly

[holzman.livejournal.com]

there was more money being fed into the economy than there were good investments, so people started making stupid investments.

That's nonsense on the it's face. For any publicly traded instrument, there's a Designated Primary Market Maker who is contractually obligated to the market to to buy and sell that instrument at any time the law permits. I've never heard of someone who wanted to buy a U.S. treasury bond but couldn't find one for sale. Or, a prime mortgage fund, to use another example.

The problem with good investments is that they're not sexy investments. Good investments make money over decades. But few people want to do that, they want to buy low and sell high -- preferably the next week. One can make alot of money that way, but it takes an army of traders, a room full of computers, and another room full of mathematicians because those resources are needed in order to manage risk effectively.

You, unlike the show, are quite correct: deregulation permitted colossally stupid investments to exist, and so people made them instead of less stupid investments. (Some people will always make the stupidest investment the law will allow, because the riskiest investment is also the one that promises the most reward.)

Rich Dad, Poor Dad took all of five seconds to peg my bullshit meter, and I would love to see the clowns who wrote it trampled by a herd of wildebeasts. I saw it in a store, cracked it open to a random page and read about how the "poor dad" owned his home free and clear while the "rich dad" had it mortgaged to the hilt so that he could use all that capital to invest -- of course into something where someone else was taking all the risk. I reflected that my millionaire grandfather never paid a penny of interest in his life; and that he would always tease my rich dad for the one time he mailed a credit card payment in late and had to pay a quarter in finance charges as a result. I put the book back down.

Of course the books marketed to the public didn't tell people to get out of real estate in a timely fashion. That doesn't sell books. Predictions like the Dow trading at 32,000 and bullshit theories about how the internet creates value and that's why the market will go up forever sells books. What's more, if the people who write the books tell everyone to get out of real estate, they won't have anyone to sell their own real estate investments off to.