The Risk Bubble

As one may have noticed, many of the strange financial instruments blowing up world-wide deal with risk. The sheer complexity of these instruments makes understanding them completely almost impossible, but a few generalisations can be made. Typically, these exotics disassociate the risk usually connected with a certain investment, packaging them into a 'security' and selling them off as an investment in their own right.

The how and why these instruments are blowing up is not particularly important, merely that the nuclear mushroom clouds are appearing across the world. It is our opinion that these exploding instruments are indicative of a major shift in the world's economy. Namely, a shift in how investment risk is managed.

For (a somewhat oversimplified) example, to ship cheap plastic crap from China, a manufacturing company will hire a freighter from a shipping company, since the manufacturing company does not own any shipping. The shipping company, at the same time, doesn't own the ships it rents out! It leases the ships from yet another company, which only owns commercial freighters and doesn't actually operate them.

This circuitous system is, at its simplest, merely a way the manufacturing company can avoid the risks associated with owning freighters. The risk of ship ownership is held by one company, the operating risk another. This particular intermediation is already breaking down: shipping companies are losing access to credit to finance their cargoes, and having difficulty making their lease payments to the actual owners of the ships proper. At the same time, the ship owners are having trouble making their financing payments...

It is our observation that one of the effects of the 2008 Depression is the collapsing of risk. This can be seen in the shipping example, as well as exotic investment vehicles. We posit a bubble of risk intermediation is popping. The symptoms of this bubble should become more apparent in the coming months, as the companies which depend on sloughing off their risk feel the squeeze; and in the coming years, as organisations who took on the risk of others cannot meet their obligations.

On the positive side, we feel there will be opportunity in the disintermediation of risk. Having intermediated risk is similar to credit leverage, and if one can avoid it at all costs, one likely has a higher chance of economic survival in the 2008 Depression.

In an extreme example, this is why holding one's money in one's mattress may be far better than leaving it on deposit in a bank. If a true bank run develops (i.e. every bank has its own run), cash and deposits will be rationed-by-queue. One only needs to look at Zimbabwe today to see how bad that sort of thing can get. People in Zimbabwe right now are queuing up at banks every day to withdraw the equivalent of 25 cents U.S., the maximum withdraw allowed by law. One shouldn't think it will never happen in the United States, or in other developed countries.