The current state of affairs feels different from 2008, when the crash was caused by the overexposure of banks to the US housing market, and turbocharged by the widespread use of new financial instruments that were supposed to reduce risk but did the opposite.
Everyone in financial markets knows you cannot reduce risk. You can, however, slice and dice it and spread it. Thereby reducing the risk to any one specific position or market participant. That also means that you can concentrate risk in a position to to a particular market participant which may or may not be one of those grand ideas.
Those mortgage pools with the income streams sliced and diced by risk. Worked exactly as they were supposed to. The risk of non-patyment was concentrated into those C tranches – the “equity” tranches. The AAA tranches were supposed to be credit risk free. Because the C, then B., then A etc tranches would all have to go bust first.
This all worked exactly as planned. The C tranches all did fall over. The AAA tranches kept paying out and some of them are even still doing so – tho’ getting to be pretty small now as repayments/remortgages happen.
Risk was spread – that’s why German banks went bust when American mortgages soured – they’d bought C tranches perhaps. You know, spreading that risk?
There was also concentration. No rational bugger wanted to buy thsoe C tranches but given the risk they paid higher rates than it cost to finance them with wholesale money on a bank balance sheet. So, banks loaded up with them. Vast, vast, piles teetering on tiny capital bases. So, when they all went bust – both dispersion and concentration of risk, see – then the banks were, umm, in serious trouble.
Everyone agrees you cannot reduce risk. But you can allocate it. The error was in who piled in to carry that risk, not the slicing and dicing of it. If those C tranches had been in hedge funds, backed by proper capital bases, no GFC. Of course, hedge funds weren’t stupid enough to take that risk but that’s another matter.
Here’s my general take on what is going on with “ai” tech stocks, and it’s mostly not being driven by Wall Street. There are two things going on which are driving the current US market: ETFs like VOO and QQQ, and cheap app trading.
I think Covid caused it, because once people couldn’t go to Vegas, or to a local Indian casino, they had to find another place to gamble. Which co-incided with the rise of cheap trading on stocks, options, crypto. The USA really don’t like online gambling, as in, roulette apps, so how do you get your fix? Why not trade crypto or stocks. Especially as the casino isn’t taking much of a cut. And once this habit started, lots of people continued with it. You can gamble on anything. Why not dogecoin instead of Red Rum?
So you get this huge influx of new, retail money. And it pushes up things that lots of retail investors are into. And as that’s young men, it’s not Walmart or Estee Lauder, it’s technology, cars. So money piles into the likes of Tesla, and now Nvidia and Oracle.
Then you have the ETFs. Because people got ripped off by financial advisors, because no-one particularly trusts all those banks, because ETFs got created and could be easily traded, people started buying them. Not a half bad idea. But a lot of money is going into 2 particular: funds based on the S&P 500 and Nasdaq, VOO and QQQ. And this has pushed both up a lot. Not just the tech companies, but also, the likes of Walmart and Estee Lauder. But the tech companies are a huge chunk of the market now. The ETFs then feed back into share prices. Blackrock etc have to buy more shares as more money goes into ETFs, shares go up. People see Tesla going up, they buy more Tesla, the ETF rises in price. People are just saying “put your money in VOO and leave it” all over stock forums.
The S&P 500 is generally high. Take the measure of P/E or Graham Number, it’s high. P/E of 28. Dotcom bubble levels. I’m mostly out of there, except a little UNH. I’m sure I’m missing out on gains but something is going to trigger a crash and I’d rather not be around when it happens.
I thought one of the problems was that the rating companies were in effect rating for cash? That the designations A, B or C etc were (to quote The Big Short) dogshit?