The third step is to recognise reflexivity – that is to say, the mispricing of financial instruments can affect the fundamentals that market prices are supposed to reflect. Nowhere is this phenomenon more pronounced than in the case of financial institutions, whose ability to do business is dependent on confidence and trust. That means that “bear raids” to drive down the share prices of these institutions can be self-validating. That is in direct contradiction to the efficient market hypothesis.
Putting these three considerations together leads to the conclusion that Lehman, AIG and other financial institutions were destroyed by bear raids in which the shorting of stocks and buying of CDS amplified and reinforced each other. Unlimited shorting was made possible by the 2007 abolition of the uptick rule (which hindered bear raids by allowing short-selling only when prices were rising). The unlimited selling of bonds was facilitated by the CDS market. Together, the two made a lethal combination.
Update: Eric Savitz at the Barron's Tech Trader blog
Recently I bought some U.S. stocks for the first time in a long time. If you buy Intel, Cisco, Yahoo!, Oracle and Microsoft, you will do much better in the next 10 years than you would with Treasuries. These stocks will double and even triple -- before going to zero.
I got a little thrown by the “before going to zero” bit, so I checked in with my colleague Lauren Rublin, who edits the Roundtable, who explained that he was kidding about that part.
As of yet, there is no sign of a similar effort to maintain wages, although we did see Barry Diller raise the argument. Perhaps this could gain momentum, especially with a Democrat Congress and Democrat President, but I expect intervention to come in another form, such as increased wealth transfers.
What I did worry about and do expect are anti-trade policies. Last week, we read that Timothy Geithner and the Obama administration consider China a currency manipulator. Last night on Bloomberg, Peter Morici gave this interview regarding China and its currency policy.
I don't fully agree with his economics (the part about the U.S. printing to buy Treasuries is factually correct though not at all desireable), but what struck me was the tone and also the political viability of this argument. Americans will only become more angry as unemployment climbs close to or into the double digits. The Democrat Congress already put pressure on Bush to officially declare China a currency manipulator, Obama used protectionist rhetoric during the campaign, and now his administration has unofficially called China a currency manipulator. Perhaps as early as this summer, the GOP will be hammering Obama and the Democrats on the economy and they could be in a position to retake the House in 2010. Framing the GOP as the defenders of free trade and Chinese Communists (not communists) who steal American jobs would be a good issue for Democrats to deflect attention from the unmitigated failure of all their economic policies and placate their base of union voters and angry anti-war voters, who will be dissatisfied with Obama's foreign policy.
Events are progressing along a path that leads to confrontation with China.
My Marketocracy China fund continues to move up the rankings, thanks to a timely exit in November 2007 when I moved to 40% cash. Currently the fund has less than 40% of assets in equities, as can be seen by the milder losses in the one-year chart. I wish ProShares Ultra Short FTSE/Xinhua China 25 (FXP) was a better vehicle to short with, but overall the returns are solid, especially compared to a straight China equity fund.