Wednesday, November 19, 2008

Wall Street Lays Egg



Romance without finance is no chance. The Dow Jones industrial average is what economists call a leading indicator. It reflects investor confidence in future economic activity.

The reigning emotions are greed on the upside and fear on the downside.

Words are important. I used the courteous term "lays egg" to title this article. The creator of the graph calls what happened to the market this year a slump. In baseball terms, the market's batting average dropped from .280 [14] to .160 [8]. This is not a slump, but a one way ticket to the minor leagues.

The savvy investor at the end of 2007 could have purchased a put option, which would have allowed him to sell his stock at the high 2007 price to a loser in 2008. The investor was betting the price of the stock would fall in 2008, so he could buy it at the low 2008 price and sell it at the much higher 2008 price. In the Wall Street parlance, he was taking a short position.

After the 1999 deregulation, investment bankers pushed subprime mortgages to home owners who did not qualify for normal lending. The bankers anticipated a time when housing prices would fall, the owners unable to resist foreclosure. In effect, the lenders were shorting the housing market the borrowers losing their home equity and the roof over their heads.

After the government loaned the banking industry $trillion to ease the credit situation, the banks have effectively stopped making loans to individuals and to small businesses. Foreclosures and unemployment have increased. Consumer spending has decreased accordingly. These ailments have spread to the world economy.

The 'slump' is the worst decline since the Great Depression and there is little likelihood it will abate. After three generations of trickle down economics and supply side thinking, we have little ability to define the situation and even less acumen to solve it.

No comments: