Phantasmix

USA, 1981

Population - 229,466,000
Unemployment rate - 7.6%
Total unemployed - 17,439,416

USA, 2008

Population - 301,139,947 (July 2007 est.)
Unemployment rate - 6.1%
Total unemployed - 18,369,536

Lower unemployment rate, but more people actually unemployed.

The media reports that all mortgage defaults in the U.S. amount to approximately 1.5 or 2% of all outstanding mortgages. That doesn’t sound like much, so why is it a problem?

Banks’ leverage is 30 times - meaning that for every dollar they have, they can loan out $30. Therefore, if a bank uses its full capacity to give out loans, and then just 4% of all oustanding loans default, the bank will be wiped out. (If you have no cash on hand, how can you loan out anything?) The more loans/mortgages are in default, the less the bank can loan out, because it now has less money to leverage against.

And then it goes like this: less cash on hand -> less able to loan out -> less able to make money on the loan interest.

This is a simple explanation for the people like me, with only basic understanding of banks and credit. If I made a mistake here, please correct.

This is a re-post of an active commenter from The Big Picture blog.

“I believe there is serious misconception about what is occuring and what will occur. First and foremost, the threat forward going is not inflation or stagflation - it is deflation.

Although it is true that inflation has been understated, the cause of the inflation has been poorly analyzed. Compare M1 to M3 and you readily see that this is not monetized inflation but debt-expansion inflation.

Debt acts just like money to a point - and that point is insolvency. Debt will say that my CDO is worth $1.00, but insolvency shows that the market values my CDO at $0.27. What happened to the inflation within the CDO? It evaporated, as all mirage capital must eventually disappear.

Debt said my house was worth $500,000. Insolvency and debt contraction says it is worth $400,000 or less.

Debt said all those casinos being built in Las Vegas were worth millions, that New York office buildings could support negative cash flows, and that that copper was worth an all-time high.

False perspective can drive a false demand, leading to a bubble - a bubble being that portion of the price of an asset that is simply driven by debt - i.e., Ponzi fincance. Anyone remember 1973 and 1974 when we perceived an oil shortage when none had occured? Or when all those builders paid premium prices for undeveloped land because low interest rates had caused an artificial demand for housing?

Misallocation of assets. That is what has occured. The decoupling of the world is an illusion - serious recession in the U.S. would lead to world recession, and all those high-flying commodity prices would come tumbling down along with it.

Debt contraction is a deflationary event, and it is the threat of deflation that is propelling the Fed to slash rates - which they will continue to do until we reach a real negative interest rate.”

Posted by: Winston Munn | Jan 17, 2008 9:29:37 PM

Notice, it was written in January of this year. I’m not seeing much deflation yet, but maybe I’m looking in all the wrong places?

I’m reading Your Money and Your Brain (How the new science of neuroeconomics can help make you rich) by Jason Zweig.

“I’ve been a financial journalist since 1987, and nothing I’ve ever learned about investing has excited me more than the spectacular findings emerging from the study of ‘neuroeconomics.’ Thanks to this newborn field – a hybrid of neuroscience, economics, and psychology – we can begin to understand what drives investing behavior not only on the theoretical or practical level, but as a basic biological function. These flashes of fundamental insight will enable you to see as never before what makes you tick as an investor.” - Jason Zweig

In the very first chapter, Mr. Zweig writes about Harry M. Markowitz, winner of Nobel Prize in economics. He won the prize largely for the mathematical breakthrough that he had been incapable of applying to his own investing portfolio. Really, it’s by far easier to teach, than to do. No offense to teachers.

A few other interesting observations:

• People who keep up with the news about their stocks earn lower returns than those who pay almost no attention.
• “Professional” investors, on average, do not outperform “amateurs”.
• The neural activity of someone whose investments are making money is indistinguishable from that of someone who is high on cocaine or morphine.
• After two repititions of a stimulus - like, say, a stock price that goes up one penny twice in a row - the human brain automatically, unconsciously, and uncontrollably expects a third repetions.
• Expecting both good and bad events is often more intense than experiencing them.

This is just the beginning, and I’m already starting to understand, that to actively trade stocks successfully, one has to fight a lot of subconscious responses deep in the brain. Essentially, the task is to fight our human nature.

That’s what a lot of people like about Technical Analysis (TA). It removes all or most of emotions out of making decisions. I’m finding TA extremely useful. I’m much less emotional in my trading, but still impatient.

I’m concentrating on learning more about myself and about TA. Both help control impulses in trading and investing.

Will return to posting my P&L numbers at the end of May. It’s been a bit over a year since I started trading and investing, so a summary might be interesting. Oh, the suspense! Am I winning or losing?

This is a “must read” for anyone wanting to understand where the money comes from in the U.S.:

http://www.financialsense.com/fsu/editorials/deepcaster/2008/0104.html

I’ll still be writing about investing basics as I see them, but if you want to learn about it in a more neutral fashion, Fool’s School is a perfect start.

Can’t say I’m a dedicated fan, but I read 3 of David Bach’s books on personal finance, and even found my “latte factors”, I find his advice at times overly optimistic which makes it annoying - estimated figures are a little detached from reality, and a lot of the advice almost useless if you are already living frugally (I realize frugal people are not his target audience). But his books are still an interesting and easy read, even if just for the examples from his practice.

I just discovered that Mr. Bach offers free resources on his web site. I enjoyed some of his newsletters, you can find solid practical advice there. The writing style is obviously similar to the books but with much less “water”, they’re short and to the point.

I’m venturing out into the world of investing books, which are often technical and just plain scary to me. David Bach’s advice seems pretty basic and “feels like home” in a comforting, cozy way. When I want a break from the horrors of real life and from the books that tell me I can’t earn/save enough, I must invest… In those moments, I’ll pick up one of Bach’s books and for a couple of hours I’ll relax in knowing that “All will be well, if only we continue automatically saving 10% of what we make”.