Thursday, October 16, 2008

A Day At The Races - A Credit Crunch Demo

One of the websites that has become a regular read for me this summer is Seeking Alpha up until August it was for analysis and opinion on the energy markets, looking for clues as to trends not so much for investment purposes but to get an idea what this consumer can expect with regards to energy prices. Good site, with lots of wide ranging opinion, from people believing we have passed peak oil to those who think we have some more time to hit peak oil.

However, of late, the energy section of Seeking Alpha has slowed down and the financial section is busy. So a lot of what I am going to discuss here is based on my readings of the analysts at Seeking Alpha.

A lot of people don't understand the problems our economy is facing, that is not to impugn anyone's intelligence as the reading at Seeking Alpha indicates the problems are not simple and involve areas of human endeavor far removed from most of our experience.

In a nutshell the problem is the gamblers were given too big of a credit line and then encouraged to take gambles on longshots with little chance of losing. However, it isn't the gamblers who are losing it goes up one or two levels.

Think of it like this. You go to the horse track with a buddy he tells you he will buy your bets on good horses for cost + 5% of the winnings, but in turn he gets to keep the proceeds from the winnings. So on a normal day you may put $100 on the favorite, pocket the cut of the winnings and your buddy may takes the rest.

However, today your buddy is in a good mood. He removes the good horse condition. So what do you do? You bet on the longshot hoping to maximize your cut of the winnings, why not? You don't lose your initial bet so you start picking the longest long shots. You are a lucky dude and your longshot bets are paying off real well.

Now, let us say your buddy is in REAL good mood and invites other freinds along and sets up the same conditions, they bet, he buys the bets, and pays a cut of the winnings. For a while the picks keep winning and then the longshots revert to form and start losing, but before your buddy realizes what is going on he has to purchase thousands of dollars of bets, has only hundreds in his pockets, and the horses are no longer winning. To add to the mix, your friend owes a few thousand dollars to his buddies who helped set him up. Now the question becomes who gets paid and who does not, or do his partners pony up more money? Or do him and his partners approach someone else for a quick infusion of cash. Of course, by the time your buddy can consult his partners or the guy with the real big bucks, the bets all become worthless.

The problems is the longshots stopped paying off and even those who were not so long started to lose, and at one time even if they lost, you had a piece of property worth more than the loan, all of that is reversed.

Of course no analogy is perfect but this is a good description.