Friday, August 17, 2007

Bailing Out The Rich

The Federal Reserve is cutting the discount rate to make things easier for the credit markets. Exactly the wrong move.

Yes, the markets have had a rough week. Yes, they're dragging everything down. Yes, including stuff I own.


The problem is that there has been absolutely insane risk-taking in the mortgage and credit markets, mostly with borrowed money. Bad practices that a first-year business student would know were ridiculous. As long as markets keep going up, everyone makes money. But if the markets dip, margin calls get made, and all of that leveraging has to be dealt with in a hurry.

The only way the situation will get cleaned up is by market discipline. The only way people learn is by dealing with the pain of mistakes. Yes, some hedge-fund millionaires are hurting. The entire point of hedge funds (much less regulated than mutual funds) is that 'high-net-worth' individuals are able to make riskier investments in search of higher rewards; that if you're investing a few mil, you presumably can do (or hire) the kind of due diligence not feasible for Joe Retail Investor.

Note the key word there--riskier.

By trying to prevent the inevitable, all Ben's doing is dragging it out, postponing the day of reckoning. Yes, the losses are real. They knew the risks when they bought. If I invest in something and it goes up, I get the profit. If it doesn't, I eat the loss. I don't ask for (or expect) a bailout.

But again, the hedgies play by different rules. And the rest of us deal with the messy aftereffects.

A more thorough discussion is here.

Update: Allan Sloan calls it correctly here.

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