Monopoly and Large, Large Waves…

We are in an official financial crisis. Sometimes I am master of the obvious. Let's explore so that we can relate this back to your bond portfolio in the next entry.

A crisis typically starts as a shock to player and escalates to shocking many players. The really smart people call this contagion and say that this results from systematic interdependence among players. Players do business with each other. One bank loans funds to another.  An insurance company loans funds to a bank. A bank co-ops with an insurance company and to a hedge fund to purchase a building by borrowing from another bank, and the list goes on.  Ultimately, when a shock to one occurs and any sort of intervention to offset the shock doesn't work, we are in crisis.

As we have seen recently, interventions can come in several forms. They can be restrictive or stimulative monetary policy. There can be overwhelming fiscal policy (e.g.TARP), confusing fiscal policy (just watch the nightly news to see how confused even the media is) and no fiscal policy. During this crisis the primary forms of monetary and fiscal policies have been flooding the market with dollars to avoid deflation and a series of pending, potentially severe, regulations on industry.

Along the way a couple of large auto companies were essentially annexed by the US government and many bondholders in the way of those seizures lost their investments. If you ever wonder whether or not there is risk in investing in even blue chip companies, just ask any of your friends who bought General Motors bonds. Most investors could never have imagined that General Motors would default.

As a society we have been erroneously convinced that riskless investments, or even a riskless society can be had for the asking. Society should  may be (???) realizing the hard way that it has made a series of huge mistakes. To its defense, it is understandable to some extent why it has been so easily taken advantage of. Everyone wants to not have to worry over their money. When an authority figure (government) offers to grant an ever more riskless society, it is difficult to say no. Over the years it was easy to rely on past experience (everything has been all right so far, right???) rather than to evaluate objectively where the small steps taken to a point in time will eventually lead. Money management boils down to hopes, fears, and human behavior.

The Wave

The current credit cycle is one measurement of human behavior.

 We are in roughly the bottom of a very large credit wave (cycle). In fact, you could call it a credit depression. Credit expanded dramatically over the last 40 years and more than dramatically over the 10 or so years leading up to 2008. The mechanism that was used to increase credit was primarily the housing market. Congress expanded several programs that targeted home buying as a behavior of choice and blew the doors off through unprecedented credit availability. The mechanisms leading to this were somewhat involved. But know that when Congress wants something it incents the daylights out of the system to get it. It did just that and everybody in the housing credit business had to decide whether to play along or go out of business. As you can guess, most people chose to play along. A few were very good at playing along and made huge profits.

Monopoly… Thank You Parker Brothers!

What we got for our participation was like a seat at a very expensive and costly Monopoly tournament. At the beginning of a Monopoly game everyone starts out flush with cash. Then as fast as they can they purchase properties, followed by homes, followed by hotels. Their hope is that their friends around the table land on their properties, owe them rent, and make them Monopoly money RICH!

Timing is Everything!

Landing on a property with hotels happens precisely at the time when everyone is cash poor. Their money has been spent buying homes and hotels. When one of the cash poor lands on Boardwalk , they must begin liquidating properties to pay the rent. Ring a bell? In the world we call that "price clearing in the marketplace", or being “upside down”. Eventually, enough properties are landed upon and players, one by one, leave the game to watch TV or munch comfort food on the sofa while licking their wounds. Eventually, two players are left. They battle it out until one leaves in disgust heading for the comfort food.

Imagine if this game were played on credit. Prices would blow up even higher and the gains made would be higher and the ultimate crash in prices would be even more dramatic. Welcome to our world. Actually, welcome not exactly to our world. Spice this up with the general feeling that if something goes wrong the government will make it right, so full speed ahead!

Society really wanted to believe that money is risk free. Individuals, in their hearts of hearts, know that human nature makes this impossible. But, they really wanted to believe it. As a result, we are at the bottom of a credit depression.

This scenario should and does impact how we manage money.

Chris

T
he opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investingBonds are subject to market and interest rate risk. It sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price.

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