Too often we view the odds or chances of a particular event happening as a gauge of reality in our own lives. We incorrectly surmise that the longer the odds of an occurrence actually happening, then the event is not likely to effect us. Thus, we believe that extremely rare bad or good things will never be personally experienced. However this analysis often overlooks our own preparations in either avoiding or engaging in a certain event.
The following illustrations help clarify this point:
The chances of being struck by lightning are 576,000 to 1. Should we interpret such long odds to mean that we continue our outdoor activities during a thunderstorm? Then why is it we seek shelter in the presence of lightning. Intuitively, we realize that we can make the odds of getting struck even longer by going indoors and avoiding electronic devices. Despite the long odds, thousands of people a year are injured or killed by lightning strikes.
The odds of becoming a professional athlete are 22.000 to 1. With odds like these, many of us find it rather silly for children and their parents spending long hours practicing free throws or thousands of dollars on private coaches. However, your odds of becoming a paid athlete become significantly better if you sacrifice great amounts of time and money than if you merely waited on fate. The fact remains that there are thousands of people who earn a living playing professional sports.
The odds of winning the lottery jackpot are 13,000,000 to 1. As the commercial for these games state; you can’t win if you don’t play. Every year hundreds of new millionaires are created because they happen to buy the lucky numbers.
Just because the odds of an event may be prohibitive, it is ignorant to believe that either through our own actions or the actions of others such events cannot occur. Financial pundits and economic gurus have touted the belief that in today’s world of financial regulations, transparent markets, and econometric modeling, the chances of the world experiencing a financial calamity like the one which occurred some eighty years ago are virtually non-existent. However, if one truly understands the causes of bubbles and the eventual collapse; then you will understand my continued fear of the current underlying economic conditions.
Jim Cramer on CNBC the other day had what can be described as a meltdown where he ranted about the inactivity of the Federal Reserve in lowering interest rates and easing money credit. Cramer, similar to many financial analysts, fails to recognize the correlation between past easy money policies of the Federal Reserve, which has caused the world to become awash in debt and malinvestment. Recently this bad debt has surfaced in the form of delinquent sub-prime loans, foreclosures, and the virtual worthlessness of several multi-billion dollar hedge-funds. With creditors now attempting to safeguard their portfolios from further bad debt risks, the Cramer solution of easing money credit simply will not stop the pending financial debacle. More financial liquidity does not alter the creditworthiness of individuals and businesses; in other words, financial institutions are not about to expose themselves to any more risk. Like the process of nuclear fission, once the malinvestment starts unwinding, there is little that can be done to stop it. Adding more liquidity would be tantamount to stopping the nuclear reaction in an atomic explosion by adding more fissionable material; you end up with a bigger explosion.
Over the past few weeks, I have heard a myriad of market analysts spout their belief that the current debt crisis will not have much of an effect on the world economies. Additionally, these same pundits portend that the recent volatility in the stock market is healthy because volatile markets indicate fear and markets tend rise in the presence of fear. I believe this is utter nonsense that again totally ignores the problems of the liquidity glut and the history of financial markets. I had a ringside seat for the stock market crash of 1987. The summer of that year the markets were extremely volatile heading into October. A few months prior to the crash, the markets had pulled back from their record levels only to erratically climb back toward the highs in September. The week before the Monday crash, the stock market had swings of several hundred points and then finally started to tumble on Thursday afternoon. At the closing bell on the following Monday, The Dow Jones Industrial Average stood approximately 35% under its record levels. Though the market bounced in the weeks following, it did not actually bottom out until late November. As crashes go, the one in 1987, though severe, was relatively brief. Looking back and knowing what I do about the relationship between money credit and economic cycles, the speculation in the 1987 stock market was not fueled by easy money. Other markets, including real estate and commodities, remained rather tame. Therefore, the conditions found in a true financial bubble did not exist.
Unfortunately, the conditions we see today mirror more closely the environment of the late 1920s than those of 1987. Prior to 1929, the country was already in the midst of a collapsing real estate bubble which threatened the solvency of several large financial institutions. In the summer of 1929 the stock market began to experience quite volatile trading sessions. Even though the market had already seen a sizeable correction, it erratically moved upward toward record highs. The initial crash in October resulted in a 40% drop in stock prices and continued to plunge through 1932 when the market bottomed 89% below its record highs. It would take over twenty years for the market to recoup its losses.
I fear the odds of such an event happening again are becoming more likely with each passing day.