Rajiv Sethi Mon 2010-09-20 10:04 EDT

An Extreme Version of a Routine Event

Rajiv

The flash crash of May 6 has generally been viewed as a pathological event, unprecedented in history and unlikely to be repeated in the foreseeable future...far from being a pathological event, the flash crash was simply a very extreme version of a relatively routine occurrence...the flash crash can provide us with insights into the more general dynamics of prices in speculative asset markets...The crash revealed with incredible clarity how (as James Tobin observed a long time ago) markets can satisfy information arbitrage efficiency while failing to satisfy fundamental valuation efficiency...Aside from scale and speed, one major difference between the flash crash and its more routine predecessors was the unprecedented cancellation of trades...this was a mistake: losses from trading provide the only mechanism that currently keeps the proliferation of destabilizing strategies in check...

extreme version; Rajiv Sethi; routine event.

Tue 2010-08-03 14:34 EDT

Rajiv Sethi: The Economics of Hyman Minsky [2009-12-03]

There has been a resurgence of interest in the economic writings of Hyman Minsky over the past few years, and for good reason...Minsky's theoretical framework combines a cash-flow approach to investment with a theory of financial instability...expectations of financial tranquility are self-falsifying. Stability, as Minsky liked to put it, is itself destabilizing...An essential feature of Minsky's financial instability hypothesis is that a long period of sustained stability gives rise to changes in financial practices which are not conducive to the persistence of stable growth...A sustained period of stability gives rise to optimistic expectations and a rise in speculative financing...if a large number of investments which are prompted by the availability of speculative finance are found to be inept, so that immediate cash flows are significantly lower than expected, then the need for short-term refinancing becomes acute while at the same time banks are less willing to roll over existing debt. A sharp rise in short-term interest rates occurs which can lead to present value reversals, a rush towards liquidity, a plunge in the prices of illiquid assets, both real and financial, and a corresponding drop in new investments...described as a credit crunch, a state of financial distress, or a financial crisis...

2009-12-03; economic; Hyman Minsky; Rajiv Sethi.

Social Democracy for the 21st Century: A Post Keynesian Perspective Thu 2010-07-22 16:00 EDT

Fractional Reserve Banking: An Evil?

Lord Keynes

Hostility to fractional reserve banking is ubiquitous. The Austrians hate it and regard it as a type of fraud. There are even a good many people on the left who despise fractional reserve banking as an evil institution. However, a careful look at fractional reserve banking suggests that it is not necessarily a problem with modern fiat money, a well-regulated financial system, deposit insurance and a central bank ready as the lender of last resort. Fractional reserve banking without these safeguards can be extremely destabilizing and has often led to disastrous bank collapses and depressions...

21st century; evil; fractional reserve banking; Post Keynesian Perspective; social democracy.

Rajiv Sethi Tue 2010-06-15 14:25 EDT

Defenders and Demonizers of Credit Default Swaps

Rajiv Sethi

The recent difficulties faced by Greece (and some other eurozone states) in rolling over their national debt has let some to blame hedge fund involvement in the market for credit default swaps...Leaving aside the question of whether naked CDS trading has been good or bad for Greece, it is worth asking whether there exist mechanisms through which such contracts can ever have destabilizing effects. I believe that they can, for reasons that Salmon and Jones would do well to consider...such contracts allow pessimists to leverage (much more so than they could if they were to short bonds instead). The resulting increase in the cost of borrowing, which will rise in tandem with higher CDS spreads, can make the difference between solvency and insolvency. And recognition of this process can tempt those who are not otherwise pessimistic to bet on default, as long as they are confident that enough of their peers will also do so. This clearly creates an incentive for coordinated manipulation...

Credit Default Swap; defending; demonic; Rajiv Sethi.

Wed 2010-06-09 18:56 EDT

Rajiv Sethi: The New Market Makers

...the SEC's preliminary report on the flash crash...led me to believe that most of this activity was caused by algorithmic trading strategies placing directional bets based on rapid responses to incoming market data. Two strategies in particular -- momentum ignition and order anticipation -- were explicitly mentioned as potentially destabilizing forces in the SEC's January Concept Release on Equity Market Structure. The SEC invited comments on the release, and dozens of these have been posted to date. There is one in particular, submitted by R.T. Leuchtkafer about three weeks before the crash, that I think is especially informative and analytically compelling...Leuchtkafer traces the history of recent changes in market microstructure and examines the resulting implications for the timing of liquidity demand and supply...The standard argument against increased regulation of the new market makers is that it would interfere with their ability to supply liquidity. Leuchtkafer argues, instead, that the strategies used by these firms cause them to demand liquidity at precisely those moments when liquidity is shortest supply...

New Market Makers; Rajiv Sethi.

Jesse's Café Américain Tue 2009-09-22 09:15 EDT

Confessions of a 'Flationary Agnostic

Jesse

I have no particular allegiance to either the hyperinflation or the deflationary camps. Both outcomes are possible, but not yet probable. Rather than being a benefit, occupying the middle ground too often just puts one in the middle, being able to see the merits in both arguments and possibilities, and being unwilling to ignore the flaws in each argument...The growth rate of dollars is slowing at the same time that the 'demand' for dollars, the velocity of money and the creation of new commercial credit, is slowing. GDP is negative, and the growth rate of money supply is still positive, and rather healthy. This is not a monetary deflation, but rather the signs of an emerging stagflation fueled by slow real economic activity and monetization, or hot money, from the Fed. The monetary authority is trying to lead the economic recovery through unusual monetary growth. All they are doing is creating more malinvestment, risk addiction, and asset bubbles...Using money as a 'tool' to stimulate or retard economic activity is a dangerous game indeed, fraught with unintended consequences and unexpected bubbles and imbalances, with a spiral of increasingly destabilizing crises and busts. The Obama Administration bears a heavy responsibility for this because of their failure to reform the system and restore balance to the economy in any meaningful way.

confessed; Flationary Agnostic; Jesse's Café Américain.

Thu 2009-09-17 10:36 EDT

Milton Friedman and the Economics of Empire

Greg Grandin

Excerpt from Greg Grandin's Empire's Workshop. (Milton Friedman, Chile, Arnold Harberger, General Augusto Pinochet's military government, shock treatment) Not only had Nixon, the CIA, and ITT, along with other companies, plotted to destabilize Allende's "democratic road to socialism," but now a renowned University of Chicago economist, whose promotion of the wonders of the free market was heavily subsidized by corporations such as Bechtel, Pepsico, Getty, Pfizer, General Motors, W.R. Grace, and Firestone, was advising the dictator who overthrew him on how to complete the counterrevolution -- at the cost of skyrocketing unemployment among Chile's poor. The New York Times identified Friedman as the "guiding light of the junta's economic policy," while columnist Anthony Lewis asked: if "pure Chicago economic theory can be carried out in Chile only at the price of repression, should its authors feel some responsibility?"

economic; Empire; Milton Friedman.