"So where is it all going? Someone has to be winning!" I got this recently from a coworker. He was figuring someone had to be on the getting side of all this money that is fleeing the market. After all, there is that whole first law of thermodynamics thing. Exactly what you'd expect from an engineer! :) But alas, the financial world doesn't live by the same rules as the physical world.
No. That is just it. The money is in fact disappearing -- into The Past. It is going back in time, as it were, to pay for the things everyone bought before it (the money itself) either existed or before it was even conceived-- that is what using credit is, spending money that doesn't yet exist. The problem is, we don't have enough of the stuff to pay The Past back. The Past likes to collect interest and we can't even make those payments. That is why we are defaulting on our obligations to ourselves that we created in The Past as we fail to meet the debt service obligations created in The Past for payment to The Past from here in The Present, which at that time in The Past, was The Future.
Get it?
OK, let's try to be a bit more linear here... if you think of the financial world as a boat and all of us as passengers, imagine this: the boat has leaks and that is to be expected, all boats do. We bail out the boat regularly to keep the bilge level tolerable. That is our ordinary borrow-and-repay analogy. Now imagine we decide to let loads of water into the boat for some bizarre reason. Who knows, maybe we think the boat will move faster if we do. Or better yet, let's say we think the boat will get bigger and better if we can quickly let in a lot of water, then pump it out real fast. So, we let in loads of water and then, after we see that this isn't working as expected, we then decide to pump it all back out. The problem is, the boat is now so heavy with water that we can't pump it out fast enough before the water line crests the top of the main deck.
That's the analogy to use. It incorporates all the right factors-- time being the most crucial to understanding what is happening to our financial markets.
But some people are indeed making some money-- shorts have been making money. However it's a scary game, shorting. It has its own set of rules and challenges and it is possible for short contracts to decline in value even as the shorted security declines in value. How? Repayment. The contract has to be honored. If a short-writer can't pony up, the contract loses value-- fast. After all, the short contract is only as good as the ability of the writer thereof to make good on it. Most writers of short contracts are, not surprisingly, market makers-- eg: brokerages, other financial institutions of various kinds (ones that are licensed to deal in securities-- and you wouldn't believe how many of them are), etc. And many of the biggest names of these are in serious danger, not just from their toxic CDOs but of course, because they wrote all sorts of short contracts they may not be able to cover.
So if you are having trouble getting your short notes paid, what to do? Go talk to the SEC. They'll get to you -- in about 5 years or so. Stand in line, pal, there's a long wait these days.
So this is the answer to the question, "How is it that so many different kinds of securities, pretty much all of them, can all lose so much value with nothing seeming to be up side of all this?" Based on the foregoing, the answer is: we are -- "we" who borrowed for our houses or private planes under crazed loan terms that required no real commitment to re-payment of principal. "We" who maxed out our credit lines thinking the fun would never end. "We"-- institutions and individuals alike. The past 20 years, and esp. the past 5 years, we have been living on borrowed money (and borrowed time) -- money borrowed from ourselves, the selves of the future-- and we can't pay ourselves back now that the future has become the present. Our chickens have come home to roost.
*Cluck* *cluck*!
No. That is just it. The money is in fact disappearing -- into The Past. It is going back in time, as it were, to pay for the things everyone bought before it (the money itself) either existed or before it was even conceived-- that is what using credit is, spending money that doesn't yet exist. The problem is, we don't have enough of the stuff to pay The Past back. The Past likes to collect interest and we can't even make those payments. That is why we are defaulting on our obligations to ourselves that we created in The Past as we fail to meet the debt service obligations created in The Past for payment to The Past from here in The Present, which at that time in The Past, was The Future.
Get it?
OK, let's try to be a bit more linear here... if you think of the financial world as a boat and all of us as passengers, imagine this: the boat has leaks and that is to be expected, all boats do. We bail out the boat regularly to keep the bilge level tolerable. That is our ordinary borrow-and-repay analogy. Now imagine we decide to let loads of water into the boat for some bizarre reason. Who knows, maybe we think the boat will move faster if we do. Or better yet, let's say we think the boat will get bigger and better if we can quickly let in a lot of water, then pump it out real fast. So, we let in loads of water and then, after we see that this isn't working as expected, we then decide to pump it all back out. The problem is, the boat is now so heavy with water that we can't pump it out fast enough before the water line crests the top of the main deck.
That's the analogy to use. It incorporates all the right factors-- time being the most crucial to understanding what is happening to our financial markets.
But some people are indeed making some money-- shorts have been making money. However it's a scary game, shorting. It has its own set of rules and challenges and it is possible for short contracts to decline in value even as the shorted security declines in value. How? Repayment. The contract has to be honored. If a short-writer can't pony up, the contract loses value-- fast. After all, the short contract is only as good as the ability of the writer thereof to make good on it. Most writers of short contracts are, not surprisingly, market makers-- eg: brokerages, other financial institutions of various kinds (ones that are licensed to deal in securities-- and you wouldn't believe how many of them are), etc. And many of the biggest names of these are in serious danger, not just from their toxic CDOs but of course, because they wrote all sorts of short contracts they may not be able to cover.
So if you are having trouble getting your short notes paid, what to do? Go talk to the SEC. They'll get to you -- in about 5 years or so. Stand in line, pal, there's a long wait these days.
So this is the answer to the question, "How is it that so many different kinds of securities, pretty much all of them, can all lose so much value with nothing seeming to be up side of all this?" Based on the foregoing, the answer is: we are -- "we" who borrowed for our houses or private planes under crazed loan terms that required no real commitment to re-payment of principal. "We" who maxed out our credit lines thinking the fun would never end. "We"-- institutions and individuals alike. The past 20 years, and esp. the past 5 years, we have been living on borrowed money (and borrowed time) -- money borrowed from ourselves, the selves of the future-- and we can't pay ourselves back now that the future has become the present. Our chickens have come home to roost.
*Cluck* *cluck*!
posted by Matt Campbell at 5:55 PM
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