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Posts Tagged ‘Financial crisis

“There was so much more going on than any one person could know, reality was so much bigger than the self, that it was alarming to contemplate”*…

Henry Oliver on The Panic of 1825 and the ways in which it modeled crises to come and shaped the modern world…

… the Panic of 1825… wasn’t like panics of the past. There was no external cause of this bubble — no war, no weather, no pandemic. It was not a speculative mania. It took place in many fragmented investments — loans, insurance policies — made by individuals, often in good faith, in the new economic system. At the end of the Napoleonic Wars, Britain had introduced a new gold standard. To avoid a sudden stop in loans and note issues (after running the war on cheap money) the Bank designed a transition. First, they hoarded gold like Smaug, to keep prices high and prevent a run. Second, they brought out new low-yield stocks. Third, the government issued new bonds and started a big infrastructure programme. With all the extra money in the system, backed by gold, people started investing, post-war prosperity flourished, and George IV could yap complacently about the success of the economy. Now that gold payments resumed, the market for precious metals boomed. Hence all those investments in South American gold mines. That all sent capital overseas, and so the currency was becoming, in reality, a paper system. Letters and warnings were published in The Times, but all in vain. And so when the bank drew in its horns, the crash was inevitable.

This wasn’t, then, a rampant speculative bubble. It was a diversification crisis. So many people invested in so many different things and none of them knew enough about the rest. Many investments were sound. Many participants were not speculators. “The fundamental problem in the market,” as one scholar has written, “was not that investors were over-extending themselves but rather that they did not have enough information to appreciate how over-extended everyone else already was.” After the crash, the finance system started to be centralised, to avoid such situations in the future.

1825 is known as the first modern financial crisis. No single group could be blamed for what happened. It was a systemic event. It demonstrated, quite firmly, that there is no place or person at the centre of things, no-one who runs the market. 1825 was, in some senses, the year the modern economy started. But it wasn’t just in economics that 1825 changed the world. Politics and literature were reinvigorated too…

More (including the role of Disraeli) at “1825: the first modern financial crisis,” from @HenryEOliver.

[Image above: source]

* Kim Stanley Robinson, The Ministry for the Future

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As we ponder precedent, we might recall that it was on this date in 1867 that the first stock ticker was introduced.

The advent of the ticker ultimately revolutionized the stock market by making up-to-the-minute prices available to investors around the country. Prior to this development, information from the New York Stock Exchange, which has been around since 1792, traveled by mail or messenger.

The ticker was the brainchild of Edward Calahan, who configured a telegraph machine to print stock quotes on streams of paper tape (the same paper tape later used in ticker-tape parades). The ticker, which caught on quickly with investors, got its name from the sound its type wheel made.

History

Calahan’s ticker (source)

Written by (Roughly) Daily

November 15, 2022 at 1:00 am

“The essence of investment management is the management of risks, not the management of returns”*…

Paris Bourse

In 1754, the infamous scam artist, diarist, and womanizer Giacomo Girolamo Casanova reported that a certain type of high-stakes wager had come into vogue at the Ridotto. The bet was known as a martingale, which we would immediately recognize as a rather basic coin toss. In a matter of seconds, the martingale could deliver dizzying jackpots or, equally as often, ruination. In terms of duration, it was the equivalent of today’s high-speed trade. The only extraordinary fact about the otherwise simple martingale was that everybody knew the infallible strategy for winning: if a player were to put money on the same outcome every time, again and again ad infinitum, the laws of probability dictated that not only would he win back all he may have previously lost, he would double his money. The only catch was that he would have to double down each time, a strategy that could be sustained only as long as the gambler remained solvent. On numerous occasions, martingales left Casanova bankrupt.

In modern finance, the coin toss has come to represent a great deal more than heads or tails. The concept of the martingale is a bulwark of what economists call the efficient-market hypothesis, the meaning of which can be grasped by an oft-repeated saying on Wall Street: for every person who believes a stock will rise—the buyer—there will be some other equal and opposite person who believes the stock will fall—the seller. Even as markets go haywire, brokers and traders repeat the mantra: for every buyer, there is a seller. But the avowed aim of the hedge fund, like the fantasy of a coin-tosser on the brink of bankruptcy, was to evade the rigid fifty-fifty chances of the martingale. The dream was heads I win, tails you lose.

One premonition as to how such hedged bets could be constructed appeared in print around the time when gambling reached an apex at the Ridotto casino, when an eighteenth-century financial writer named Nicolas Magens published “An Essay on Insurances.” Magens was the first to specify the word “option” as a contractual term: “The Sum given is called Premium, and the Liberty that the Giver of the Premium has to have the Contract fulfilled or not, is called Option . . .” The option is presented as a defense against financial loss, a structure that would eventually make it an indispensable tool for hedge funds.

By the middle of the next century, large-scale betting on stocks and bonds was under way on the Paris Bourse. The exchange, located behind a panoply of Corinthian columns, along with its unofficial partner market, called the Coulisse, was clearing more than a hundred billion francs that could change volume, speed, and direction. One of the most widely traded financial instruments on the Bourse was a debt vehicle known as a rente, which usually guaranteed a three-per-cent return in annual interest. As the offering dates and interest rates of these rentes shifted, their prices fluctuated in relationship to one another.

Somewhere among the traders lurked a young man named Louis Bachelier. Although he was born into a well-to-do family—his father was a wine merchant and his maternal grandfather a banker—his parents died when he was a teen-ager, and he had to put his academic ambitions on hold until his adulthood. Though no one knows exactly where he worked, everyone agrees that Bachelier was well acquainted with the workings of the Bourse. His subsequent research suggests that he had noted the propensity of the best traders to take an array of diverse and even contradictory positions. Though one might expect that placing so many bets in so many different directions on so many due dates would guarantee chaos, these expert traders did it in such a way as to decrease their risk. At twenty-two, after his obligatory military service, Bachelier was able to enroll at the Sorbonne. In 1900, he submitted his doctoral dissertation on a subject that few had ever researched before: a mathematical analysis of option trading on rentes.

Bachelier’s dissertation, “The Theory of Speculation,” is recognized as the first to use calculus to analyze trading on the floor of an exchange, and it contained a startling claim: “I have in fact known for several years that it would be possible . . . to imagine transactions where one of the parties makes a profit at all prices.” The best traders on the Bourse knew how to establish an intricate set of positions designed to protect themselves no matter which way or at what speed the market might move. Bachelier’s process was to separate out each element that had gone into the complex of bets at different prices, and write equations for them. His committee, supervised by the renowned mathematician and theoretical physicist Henri Poincaré, was impressed, but it was an unusual thesis. “The subject chosen by M. Bachelier is rather far away from those usually treated by our candidates,” the report noted. For work that would unleash billion-dollar torrents into the capital pools of future hedge funds, Bachelier received a grade of honorable instead of très honorable. It was a B.

Needless to say, Bachelier’s views of math’s application to finance [published in 1900] were ahead of his time. The implications of his work were not appreciated, much less exploited, by Wall Street until the nineteen-seventies, after his dissertation was discovered by the Nobel Prize winner Paul Samuelson, the author of one of the best-selling economics textbooks of all time, who pushed for its translation into English. Two economists, Fischer Black and Myron Scholes, read the work and, in a 1973 issue of the Journal of Political Economy, published one of the most famous articles in the history of quantitative finance.

Based on Bachelier’s dissertation, the economists developed the eponymous Black-Scholes model for option pricing. They established that an option could be priced from a set-in-stone mathematical equation, which allowed the Chicago Board Options Exchange (C.B.O.E.), a new organization, to expand their business to a new universe of financial derivatives. Within a year, more than twenty thousand option contracts were changing hands each day. Four years after that, the C.B.O.E. introduced the “put” option—thus institutionalizing the bet that the thing you were betting on would lose. “Profit at all prices” had joined the mainstream of both economic theory and practice…

From the remarkable story of the French dissertation that inspired the strategies that guide many modern investors ad al that it has wrought: “A Brief History of the Hedge Fund.”

Spoiler alert: it hasn’t always worked out so well (c.f. Long-Term Capital Management)… at least for investors. As Janet M. Tavakoli observed in Structured Finance and Collateralized Debt Obligations: New Developments in Cash and Synthetic Securitization

Hedge funds have made massive leveraged credit bets, knowing that their upside is billions in fees and their downside is millions in fees.

Benjamin Graham

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As we ruminate on risk, we might recall that it was on this date in 2020 that the Federal Reserve rode in to rescue financial markets to prevent their complete freezing up– which could have entered history books as another global mega-crash. The Dow Jones stock market index had hit an all-time record of 29,551 on February 12, 2020. Then, the coronavirus emerged in earnest in the U.S., unemployment soared, and on March 9 the DJIA took a dive of over 2,000 points; it continued to fall, down to 18,321 on March 23… at which point the Fed intervened, pouring vast sums of cash into the financial system, resulting in a stock market bonanza in the midst of the worst economic collapse since the Great Depression. The Dow stands at this writing at over 35,000.

source

“A good rule of thumb is to assume that everything matters”*…

 

Dayen-financial-climate 112019

 

Every few months, a news outlet will write a story heralding the next financial crisis, with an assumed assuredness that we should all view as suspect. Predicting the next crisis has become a sport, one that typically magnifies risks and displays an unreasonable degree of certainty. But if you had to choose a looming event that’s most likely to produce a negative shock to the financial system, it would almost certainly be the climate emergency.

That’s the takeaway from a fascinating issue brief… from the Center for American Progress’s Gregg Gelzinis and Graham Steele from the Stanford Graduate School of Business. Both worked for the Senate Banking Committee for many years, and they make a compelling case, not only that headline risks to financial stability will flow from a warming planet and the efforts to mitigate that, but that federal banking regulators have gone almost completely AWOL in monitoring or even assessing this legitimate threat.

Worse, to the extent that any financial regulators in Washington are paying attention to the climate crisis, they’re seeking to dismiss it. A subcommittee formed at the Commodity Futures Trading Commission (CFTC) to look at climate-related market risk is stacked with fossil fuel industry representatives, including several executives from climate-polluting agribusiness, banks with significant carbon-intensive portfolios, and fossil fuel giants BP and ConocoPhillips.

The committee’s clear intent is to examine the climate risks to polluting companies’ core business, not from their polluting. As one critic—Paddy McCully, the climate and energy director at the Rainforest Action Network—notes, “We should recognize that there’s risk from the climate to the economy, and that the corporate sector needs to assess their contributions to climate change and then deal with it.”

The report explains that global economic losses from a rise in temperatures of 4 degrees Celsius have been estimated at $23 trillion per year. This would pose two kinds of risk to the financial system: physical risk from natural disasters, and a more indirect risks from transitioning away from fossil fuels…

A new paper makes the case that financial regulators are ignoring the significant risks from a warming planet and even from efforts to green the economy.  The fascinating– and chilling– analysis in full at “The Biggest Threat to Financial Stability Is the Climate.”

* Richard Thaler

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As we internalize externalities, we might recall that it was on this date in 1952 that the Great Smog of London began,  A period of cold weather, combined with an anticyclone and windless conditions, collected airborne pollutants—mostly arising from the use of coal—to form a thick layer of smog over the city.  It caused far more severe disruptions than “pea-soupers” of the past,  reducing visibility and even penetrating indoor areas.  While the Underground maintained service, bus service was virtually shut down (as visibility was so severely and reduced; and thus, the the roads, congested). Most flights into London Airport were diverted to Hurn, near Bournemouth and linked by train with Waterloo Station.

Government medical reports in the following weeks estimated that 4,000 people had died as a direct result of the smog; and 100,000 more, made ill by the smog’s effects on their respiratory tracts.  More recent research suggests that the total number of fatalities may have been considerably greater, one paper suggesting about 6,000 more died in the following months as a result of the event.

The disaster had huge effects on environmental research, government regulation, and public awareness of the relationship between air quality and health.  It led quickly to several changes in practices and regulations– perhaps most notably, the Clean Air Act 1956.

Nelson's_Column_during_the_Great_Smog_of_1952

Nelson’s Column during the Great Smog

source

 

Written by (Roughly) Daily

December 5, 2019 at 1:01 am

“Emergencies have always been necessary to progress”*…

 

economy

The 2008 financial crisis continues to plague the world economy and our politics. It’s also messing with how we understand our narratives of global integration. Until recently, going global implied exuberant stories about one-world connectivity and technocratic togetherness. Now, it’s the other way around: the stories of our times are consumed with collapses, extinctions and doom. It’s a playbook for nativists, who see interdependence as a recipe for catastrophe.

Our big narratives were once capable of more nuance than the pendular swing from euphoria to dysphoria. For every 18th-century Enlightenment story of hope, there was a shadow of decline; in the 19th century, liberals had to joust with conservative and radical prophets of demise. Some even saw crisis as an opportunity. Influenced by Karl Marx, the Austrian economist Joseph Schumpeter in 1942 made a virtue out of ruin. There could be something creative about bringing down tired old institutions. The late German-born economist Albert O Hirschman thought of disequilibria as a potential source of new thinking. In 1981, he distinguished between two types of crisis: the kind that disintegrates societies and sends members scrambling for the exits, and what he called an ‘integrative crisis’, one in which people together imagine new ways forward…

Jeremy Adelman, the Henry Charles Lea professor of history and director of the Global History Lab at Princeton, argues that we should look for opportunities in our travails: “Why we need to be wary of narratives of economic catastrophe.”

See also: “The Three Revolutions Economics Needs.

* “Emergencies have always been necessary to progress. It was darkness which produced the lamp. It was fog that produced the compass. It was hunger that drove us to exploration. And it took a depression to teach us the real value of a job.”                               – Victor Hugo

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As we search for silver linings, we might recall that it was on this date in 1728 that John Gay’s The Beggar’s Opera premiered at the Lincoln’s Inn Fields Theatre in London.  It ran for 62 consecutive performances, the longest run in English theater history and second longest run in the Western world up to that time (after 146 performances of Robert Cambert’s Pomone in Paris in 1671).

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Painting based on scene 11 Act III of The Beggar’s Opera; by William Hogarth, c. 1728 [source]

 

Written by (Roughly) Daily

January 29, 2019 at 1:01 am

“Economic theory is the art of pulling a rabbit out of a hat right after you’ve stuffed it into the hat in full view of the audience”*…

 

economic-crisis

Many critics were disappointed the 2008 crisis did not lead to an intellectual revolution on the scale of the 1930s. But the image of stasis you’d get from looking at the top journals and textbooks isn’t the whole picture — the most interesting conversations are happening somewhere else. For a generation, leftists in economics have struggled to change the profession, some by launching attacks (often well aimed, but ignored) from the outside, others by trying to make radical ideas parseable in the orthodox language. One lesson of the past decade is that both groups got it backward. Keynes famously wrote that “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” But in recent years the relationship seems to have been more the other way round. If we want to change the economics profession, we need to start changing the world. Economics will follow.

From J.W. Mason‘s helpful survey of economic thought since the Crash of 2008: “How a Decade of Crisis Changed Economics.”

* Joan Robinson

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As we contemplate counting, we might send revolutionary birthday greetings to Alexander Hamilton; he was born on this date in 1755 (or 1757, there is some scholarly debate about the year, but not the date).  A Founding Father of the United States, Hamilton created the Federalist Party (proponent of stronger national government than provided by the Articles of Confederation), the United States Coast Guard, and the New York Post newspaper.  But he was probably most notably the creator of the new nation’s financial system.  The main author of the economic policies of George Washington’s administration, he took the lead in the Federal government’s funding of states’ debts, and established a national bank, a system of tariffs, and friendly trade relations with Britain.  His vision included a strong central government led by a vigorous executive branch, a strong commercial economy, a national bank supporting manufacturing, and a strong military…. in all of which he stood most frequently opposed to Thomas Jefferson, who favored agrarian and small government policies.

220px-alexander_hamilton_portrait_by_john_trumbull_1806 source

 

Written by (Roughly) Daily

January 11, 2019 at 1:01 am

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