A World Without Consequences?

Leverage:

"In finance, leverage is borrowing money to supplement existing funds for investment in such a way that the potential positive or negative outcome is magnified and/or enhanced. It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity. Deleveraging is the action of reducing borrowings." Wikipeida

Why is the world shedding millions of jobs?

It's all about leverage, and as we are now seeing, deleveraging. The world is deleveraging. Deleveraging is a nice way of saying we are up to our eyeballs in debt and now we're screwed.

Getting into to debt takes very little time. Getting out of debt takes a very long time. If the world's economy was set up to service the demands of a leveraged society than we are going to need much less capacity to service the needs of a deleveraged society.

How did we get into this mess?

Did the world just want to increase its return on equity?

This leverage became the norm rather than the abnormal. No more $20 used couches, used cars, and ratty apartments for couples just starting out. No, we wanted everything new and now. Equity? We don't need no stinkin equity. No money down, no payments for 12 months, it's just that easy,

This went way beyond a return on equity.

We as a society have lost a respect, or fear, or knowledge, or something, about the dangers of leverage. People who should have known better also forgot, or never knew in the first place.

There is no industry that understands leverage better than the commodity futures business. All participants are well versed in the dangers of leverage. Leverage is what makes futures trading so lucrative and so dangerous. If you don't understand this you won't be in the business for long.

Maybe the banking industry could have learned something from their commodity brokerage peers, or in some cases subsidiaries. The commodity futures trading industry has been living with huge amounts of leverage for decades and as far as I know without too many problems.

Oh sure traders go broke all the time, lol, little traders and some very big traders but the industry, the backbone so to speak remains intact. That's what the banks could have learned from the commodity brokers. The banks took on the traders (home owners / speculators) risk. They took that risk and lost.

My commodity broker would never do that.

They monitor my position constantly, they monitor the volatility in the market, they change the amount of leverage available whenever they see fit, and they will sell my position out from under me if they see any possible risk to themselves.

They don't care if I make money, their only concern is that they don't lose money on my leverage. There is nothing wrong with that. They have to operate that way.

So what could the banks have learned from the commodity brokers?

They can't just up and sell your house if they feel threatened can they?

No.

They could have monitored their position though. Their position is held in trust by you the mortgagee living in their house. They need you to keep making those payments. They could monitor your bank account for any signs of decreased revenue, they could have monitored the market place to better determine value, they could have used sector caps (position sizing) to mitigate risk, they could have placed location caps on their portfolios, they could have done many things.

Why didn't they?

They felt secure, they had a mortgage, not a "risky" crude oil position on the books. They had insurance. Or so they thought, it turned out they only had a worthless "swap".

Risk management is a frame of mind, commodity brokers live with it every day, and traders live or die with it every day. It's a frame of mind that thinks along the lines of, capital is scarce, treat it as such. :)

Banks thought they understood this. They did not.

I think consumers, businesses, and banks all get it now.

Does your government?

Governments around the world believe that they can leverage themselves by the trillions to increase demand for products in order to keep the world employed.

They certainly have the ability to borrow, the question is what will they do next year, and the year after that. The world's consumers cannot deleverage in 1 or 2 years, it may take 5, 10, or 20 years.

Will governments just keep borrowing?

When will governments have to start deleveraging?

What will that do to the economy?

Is this a world without consequences?

I think not, we just keep delaying them.

Maybe we should just take our medicine now instead of passing it on to our kids.

Oops

There is always a battle raging in a bank with the sales side vs. the risk management side and when one of those entities gains an upper hand bad things happen.

Back in the olden days when I was a banker we would actually go look at a property before we put a mortgage on it. I always asked the question would I (I being the bank) ever want to own this property? As the banker it was your reputation and credibility within the organization at risk, along with your bank's capital.

Maybe humans still have a place in the whole credit risk process.

Buy Low, Sell High

Nothing happening for me today in the crude oil market. The oil inventory report has been moved to Thursday due to the Labour day holiday, so hopefully that gets the market moving.

This is an interesting read, smart people making good decisions.

Jamie Dimon's swat team
How J.P. Morgan's CEO and his crew are helping the big bank beat the credit crunch.
By Shawn Tully, editor at large

"Dimon and his team are on top today because they took a daring stance at the height of the credit bubble. J.P. Morgan mostly exited the business of securitizing subprime mortgages when it was still booming, shunning now notorious instruments such as SIVs (structured investment vehicles) and CDOs."

Click on the read more icon for the full Fortune story.
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