Tuesday, May 12, 2009

insatiable demand for safety in general, and triple-A risk in particular, which caused this financial crisis

From Reuters:

Felix Salmon

preferred, not common

May 12th, 2009

How we super-seniored the entire financial system

Posted by: Felix Salmon
Tags: felix, ,

Gillian Tett was just in the office to talk about her new book; I interviewed her for Reuters TV, and the results should be up soon. But we got to chatting afterwards, and she made a great point which we didn’t cover in the more formal interview and which she says she would have liked to have put in her book. But since it’s not there, I can at least put it on YouTube. She talks about the Bistro deal (see Jesse for background on that), and how it can be seen as a metaphor for the financial system more generally:

The point is similar to the one I made in my speech to the regional bond dealers: we were far too worried about risk, and not nearly worried enough about safety. And really it was the insatiable demand for safety in general, and triple-A risk in particular, which caused this financial crisis."


When I look at health care in the US, I agree with Milton Friedman, that we should either have much more govt or much less. Because I favor a guaranteed income with health insurance, and doubt that much less govt is a real option, I am in favor of much more govt. But our problem is that we want the best and most expansive health care for the cheapest price, or, at least, at a price that shifts our costs to somebody else. Hence, we have a tug of war between conflicting desires and possibilities, which leads us to an expensive and inefficient mess. It happens to play out through proxies like insurance companies, but they just ride the same wave as everyone else.

In your example, we have investors who want high returns without risk. That’s the only way that I can make sense of this desire for safety. I’ve just seen a Flight to Safety, but nobody was kidding themselves that they weren’t avoiding risk. I’m not even sure how you can want safety but not want to avoid risk, other than saying that you want high returns for low risk, which is hard for me to understand.

I can understand Japanese investors, unhappy with low interest on bonds, and a stagnant market, deciding to buy bonds in other countries and get a higher return. I can’t imagine them not understanding that it’s a lot riskier than just buying a Japanese bond.

I’m still not able to understand how investors can create investments with lower capital requirements, and not see them as riskier. The regulations were intended to lower risk by demanding more collateral. If you’re trying to get around those regulations,then how can you not know what they’re intended for?

Also, for the life of me, I can’t see what just occurred as anything but a desire for better returns during a time of low interest on govt bonds. Investors didn’t like the paltry yields.

Looking for safety in CDSs,CDOs, etc., anything that increased leverage, is like looking for virginity in a brothel. You’re not in the right place to find what you’re looking for.

- Posted by Don the libertarian Democrat

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