Risk Won't Get Repriced

One of the problems with the credit crunch was that risk wasn't proportionately priced. Relatively risky investments didn't pay all that much more than safer ones, and so investors couldn't get that last visceral hint that they were writing a check for real danger. The problem was that there is just too much money in the world seeking a home, and that hasn't changed. For example, D&O (directors and officers) insurance premiums have actually been dropping in price for years, even though the chances of corporations getting sued by shareholders aren't dropping equally quickly. According to brokers I've spoken to, the reason is that there are always new sources of money trying out this type of investment, creating competitive pressures. I've heard the same from an economist who consults to upper management at large corporations.

And that money hasn't all disappeared in the recent market thrashings. Look at a Wall Street Journal article today about hedge funds bouncing back:

Through the end of the third quarter, hedge funds have seen $164 billion in new asset flows this year, already a record for a full year, according to Hedge Fund Research Inc., based in Chicago. The previous record year was 2006, with $126 billion in new asset flows. As much as $45 billion was invested in hedge funds in the third quarter, when markets were the most turbulent. Some 71% of that went to big hedge-fund firms -- those managing more than $5 billion each.

A lawyer at a major real estate firm told me that his clients in Europe were about ready to start a buying spree in the US because they have cash and because the exchange rate between the Euro and dollar gives them even more leverage.

The money goes pouring in, and it all has to find homes, so the differential between high risk and low risk will continue to remain small, not because the risks are that close in nature, but because the supply of money outstrips the demand. So people will continue to invest, largely ignoring the real risks, because they can't afford to be picky. They're all at a dance where they want to get picked, it's getting late, and being choosy means being alone. It's only in the morning that they see what they've done, but by then it's too late.

Is Making Money Self-Defeating Strategy?

This is one of those times that I wonder if I'm slipping off the edge of reason. But in a number of articles I'm currently working on, I keep coming back to various people in a range of financial fields making the same point: there's too much capital. Money's supposed to be good for economies, you'd think, but when you have a surplus of cash, the results are interesting. Too much money is one of the big reasons, apparently, that the credit crunch came about. Because so many nations, corporations, and wealthy individuals are trying to invest at a time when companies are not necessarily expanding, or when adding value might be comeing up with new code (low capital investment) rather than building new plants (high capital investment), we have one of the oddest examples you might find of high supply and low demand.

Risky credit became cheap becuse so many entities wanted to put their money into something, and stays cheap because companies don't need to expand. To need to expand, there would have to be wealth spread among a greater number of people who could then generate sufficient demand. In short, by having money concentrate at an ever greater level among a small group of people, there is less demand for investing that money, because most people don't have the money to spend on the things that drive business investment, and there aren't enough of the super wealthy to make up for it. So the accumulation of capital seems to limit its own growth potential, which makes some sense. But, my, who would have ever thought that capitalism could be its own worst enemy?