Saturday, 30 January 2010

Who’s to blame for the crisis / Cherish the bearish!

Ask an economist a question and they’ll answer: “It depends”. The question for today concerns Barack Obama’s plans to impose precautionary regulations on banking industry. Many opponents and commentators say this is the revenge for bankers’ to the latest financial crisis. The others say we have to prevent societies from the disasters reckless bankers may trigger.

Bankers became a scapegoat of the crisis, but the question who is to blame is multi-faceted, but can be boiled down to a simple dilemma: the market or the people? This single problem could be a great topic for a separate post – maybe one day…

If the people, you’ll probably blame the bankers and the factor that has always driven them – the greed. But please note dear reader that the bankers acted within a certain system, which created incentives to what you call immoral behaviours. The main pillars of the system were too loose monetary policy, lax regulations and certainly flawed remuneration schemes, under which bankers got paid generously for profits made on taking excessive risk and the burden of losses was carried by shareholders. When the banks were bailed out by the states, the governments stepped in as owners. A lot of free market advocates pulled the governments up for their disagreement for big bankers’ bonuses. Didn’t they notice the governments many times acted not as the states but as owners and exercised owner’s right to influence executives’ pays?

I would sooner incline towards a notion that the institutional framework is to blame. Bankers behaved rationally, if they could profit from the situation, they just did it. Many times I heard it was the greed that brought about the crisis. “Greed is bad” – the leftist organisations chanted on Canary Wharf on Halloween 2008. Greed itself, as an axe is not bad. Axe itself is evil when you use it to kill your mother-in-law. Greed is what propels development, boosts effectiveness, makes people strive for perfection, moves the world along.

But now add to this reasoning that markets are driven by two factors: greed and fear. Fear was taken away from global financial markets for a few years prior to the crisis. The moment market participants forgot about the links between expected profits and risk and believed prices could rise endlessly, they hammered a nail to their coffin. Financial markets should always be in the shadow of fear. They should always reckon with the worst scenario and must not expect that anyone, particularly the governments will come in aid. Conclusion. The crisis was caused by LACK OF FEAR, not by greed.

When the markets function without fear, the disaster in inexorable. That is why I welcomed the proposal of American president. Mr Obama brought back fear to the markets and restored the balance, I received it with a sigh of relief, the current correction proves markets stay sound.

What will happen in the coming weeks? There is one reason why the stock prices could go up – low interest rates, but I see several reasons, why this can be a long awaited correction:
- stock markets had been rising rapidly for eleven months and they simply deserve a decent correction,
- stocks are overvalued, but it’s not an argument, stock markets do not rely on rational arguments, but on power of demand and supply,
- big speculators will take profits and buy back the same securities in a few weeks at the lower price,
- those who’ll lose on this shrewd move will be small investors who believed in the bull market just before the trend reversed – history repeats itself, but few are sadder but wiser,
- stock exchanges have already discounted the scenario of V-shape recovery, now everything indicates we revival will be rather slower, the big vulnerability of economies to stimulus packages and too loose monetary policy has been recognised, now the valuations should reflect this scenario.

Dear readers, see you in a few weeks (in early March 2010) somewhere below 2000 points on WIG20, 32000 points on WIG, 900 points on S&P500, 8500 points on Dow Jones or somewhere else, if time proves me wrong. Today I estimate the chances my forecast is flawed are 35 per cent. Yesterday they were around 50 per cent, but after the markets rallied after the publication of USA GDP data and totally ran out of steam within just four hours, I’m quite convinced we’re heading south.

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