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The Crisis Explained - Really

by rdf Thu Sep 25th, 2008 at 10:24:14 AM EST

Analogies are never perfect, but here's one using horse racing. Don't expect a perfect correspondence to the banking situation, but I think it is close enough for government work.

Joe goes to the track and bets $2 on a horse.


Two guys standing nearby get into a discussion and Fred says to Sam, "I'll bet you $5 that Joe wins his bet."

Next to them are Bill and Bob. Bill says: "I'll bet you $10 that Fred welshes on his bet if he loses."

Next to them is Sally. Sally says: "For $3 I'll guarantee to Bill that if Bob fails to pay off, I'll make good on the bet."

Sally then goes to Mary and borrows the $7 needed in case she has to ever pay off and promises to pay back $8. She doesn't expect to every have to pay since she believes Bob will always make good. So she expects to net $2 no matter what happens to Joe.

A quick calculation indicates that there is now 2+5+10+3+7 = $27 riding on the outcome of the horse race.

Question how much has been "invested" in the horse race?

Answer:

$50,000 by the owner of the horse who is expecting to recoup his investment from the winnings of the horse and other future deals. Everyone else is gambling, not investing.

The issue with the home market is that the only "investor" was the person who bought the home. All those engaged in the meaningless derivatives spun off from this are gambling. You can see how quickly the face value of all these side bets can exceed the underlying investment. Who is holding these side bets - not the homeowner? It is the people at the failing investment banks, hedge funds and similar enterprises. Notice that the bailout is being directed at them not the homeowners.

The real world is, of course, even more complicated. Over the last 30 years people have been allowed to place bets on everything starting with the value of stock averages. They might as well bet on the temperature in Newark at 8:00 AM.

So when you hear everybody saying this is a crisis caused by the housing collapse, be skeptical. We are in the midst of a classic pyramid or Ponzi scheme and there is no way out except for people to lose a lot of money. All that is different this time is that it is the taxpayers who are being asked for the cash.

Display:
Question how much has been "invested" in the horse race?

Answer:

$50,000 by the owner of the horse who is expecting to recoup his investment from the winnings of the horse and other future deals. Everyone else is gambling, not investing.

Right on!

A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
by Migeru (migeru at eurotrib dot com) on Thu Sep 25th, 2008 at 10:54:06 AM EST
Yep - excellent summary!

This would make a very good viral email.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Sep 25th, 2008 at 05:35:25 PM EST
[ Parent ]
Feel free to spread it around. We can never seem to have enough viruses in our environment...

Policies not Politics
---- Daily Landscape
by rdf (robert.feinman@gmail.com) on Thu Sep 25th, 2008 at 06:50:53 PM EST
[ Parent ]
spreading it as we speak.

..."a classic pyramid or Ponzi scheme"...

the turn of phrase l've been searching for for days.

well done, rdf

by town on Thu Sep 25th, 2008 at 07:02:56 PM EST
[ Parent ]
Nice summary!

Guaranteed to be plastered all over the Internet Drinking Liberally in New Milford
by Connecticut Man1 (connecticutman1 AT gmail dot com) on Thu Sep 25th, 2008 at 10:48:30 PM EST
[ Parent ]
Reminds me of the film Trading Places. The two old guys explain to Eddie Murphy what it is they do and he says "Oh I get it !! You is bookies"

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Thu Sep 25th, 2008 at 11:56:53 AM EST
And that is just how I see the "Lehman Brothers", only somehow the rich bankers at the end aren't going to end up out on the streets.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Thu Sep 25th, 2008 at 12:17:23 PM EST
[ Parent ]
Bookies don't end up on the street.  They either keep rolling, or they can't cover and end up in a dumpster.  The ultimate question in this mess is at what point people will be willing to put their lords and masters in a dumpster.
by rifek on Sun Sep 28th, 2008 at 01:38:30 PM EST
[ Parent ]
Is there no link whatsoever between how much the horse's owner gains and how much gambling is there at the hippodrome, at least at the first level (Joe's $2)?
by Deni on Thu Sep 25th, 2008 at 11:57:29 AM EST
How much is the price of admittance, a ticket or seat, at the hippodrome? And refreshments? I've never been to a track myself.

Diversity is the key to economic and political evolution.
by Cat on Thu Sep 25th, 2008 at 01:25:00 PM EST
[ Parent ]
Well at the local track here, the cheap tickets are £7 the expensive tickets £40 In general I go and stand on the city walls and watch for free

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Thu Sep 25th, 2008 at 01:35:18 PM EST
[ Parent ]
The dogs were my thing when I lived in London. I had a another thing about kennel maids.

You can't be me, I'm taken
by Sven Triloqvist on Thu Sep 25th, 2008 at 05:14:49 PM EST
[ Parent ]
You liked to watch them race too?

(sort of like a piece of benny hill fim i assume) ;-)

Any idiot can face a crisis - it's day to day living that wears you out.

by ceebs (ceebs (at) eurotrib (dot) com) on Thu Sep 25th, 2008 at 05:34:35 PM EST
[ Parent ]
It's why they called me the Electric Rabbit.

....but the East End was rather trendy in them days - cockney fashion photographers and so forth. Derby night they used to have your basic Kate Mosses of the time take over as kennel maids. Very lively were dog tracks - I loved it. Even worked on a movie about it. Did an interview with the then chairman of British Greyhound Racing, Colonel Satterthwaite. He put us in our place when we wanted a tea break during shooting. "I've never head a tea-break in my life"

Trap 6 was my favourite. Black and White stripes. But the blue dog was often good for an each way. Funny, if a dog had a shit during the parade, there'd be a sudden rush of money to the dog. They never won, or were short priced. I'm not sure what the logic behind it was.

You can't be me, I'm taken

by Sven Triloqvist on Thu Sep 25th, 2008 at 05:54:20 PM EST
[ Parent ]
I'm not sure what the logic behind it was.

Ah well theres the theory that the dogs are deeply crooked, and regular rumours pop up that someone is out to fix races. the usual method quotes is that the kennle girls are payed to "Manipulate" the dogs. in the post manipulation comedown, the dogs are sleepy and will run slower. theory goes that the one dog whos bodily functions still appear to be working normally, hasnt been knobbled. Couple of punters notice that, leap to put money on while they can still get good odds, and  the dogs price starts dropping, which makes other punters think something has been noticed, and round the vicious circle goes.

Any idiot can face a crisis - it's day to day living that wears you out.

by ceebs (ceebs (at) eurotrib (dot) com) on Thu Sep 25th, 2008 at 06:18:08 PM EST
[ Parent ]
mmm 'k. 8 month mix of that (plus refreshments sales) plus the vig from the bookies plus premium sales of annual showcase derby oughta cover distribution of the purse (daily draws and premium) to horse owners.

Diversity is the key to economic and political evolution.
by Cat on Thu Sep 25th, 2008 at 06:33:10 PM EST
[ Parent ]
It runs the other way.  The gambling pays for the track, stables, and purse and so encourages investment in race horses.  As money available from gambling increases, more people want to invest in raising horses to get a piece of it.  Then the breeders start generating increases internally by charging breeding fees to each other.  To return to the analogy, the breeders are like home buyers taking advantage of loosening mortgages to buy into the real estate boom and get their piece of the action.  Then they flip the property (charge stud fees) to get instant equity realization, which is then plowed back into the game.  Repeat until the wheels fall off the wagon.

The analogy generally works.  Except that when the breeders get in trouble, no one is passing legislation to rewrite their debt terms.  And when the gamblers get in trouble, no one proposes a trillion dollar bail-out; they just get their legs broken.

by rifek on Sun Sep 28th, 2008 at 01:29:20 PM EST
[ Parent ]
Question how much has been "invested" in the horse race?

Answer:

$50,000 by the owner of the horse who is expecting to recoup his investment from the winnings of the horse and other future deals. Everyone else is gambling, not investing.

quibble, but if we're using this as an analogy to the mortgage meltdown, shouldn't we also add whoever lent the owner the money for the investment in the horse? And then we have the problem with the bubble in horse prices, as they go up beyond whatever they can reasonably be expected to return. The horseowner keeps on 'investing' in his horse - shiny granite trough perhaps, while also buying himself a Hummer. He does this using loans secured by the unrealistic value of the horse. Eventually it all falls apart, the horse goes to the glue factory, forfeits the race, and everybody is broke.

by MarekNYC on Fri Sep 26th, 2008 at 01:06:42 AM EST
That is the nub of the real problem here.  The gamblers have queered the pitch for real people trying to do real things - and now even productive economic activity is put at risk.

The solution, however, is not to let the gamblers write off their bad bets - thus freeing them to engage in such activities again.  They should all be declared the bankrupts and frauds and confidence tricksters that they are.

The solution is to build businesses that are not dependent on bank credit to fund their operations - and alliances between cash rich and investment intensive business types.  Expect a lot of cash rich businesses to start taking over a lot investment needing businesses at bargain basement prices.

After all, if you have money, why would you put it into a bank?

Vote McCain for war without gain

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Fri Sep 26th, 2008 at 06:34:05 AM EST
[ Parent ]
Well I did say the analogy was imperfect, but the more interesting part that I left out was the racetrack operator.

They get a fraction of the original $2 bet regardless of whether the horse wins or loses. One could also include the state, since many governments tax betting. The parallel in the mortgage world is registration fees or title transfer fees.

My point really is that the side bets have nothing to do with the underlying economic activity. Furthermore, the "bailout" is not addressing these things either.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Fri Sep 26th, 2008 at 09:44:39 AM EST
[ Parent ]


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