Hidden Stab Wounds in Markets

來源:Greg Rehmke
日期:2010/04/21

Craig Mee's post noted that emergency room doctors were missing hidden stab wounds, and wondered if traders could learn from studies of such errors. I wonder too if major hidden frauds play a role in major market bubbles? Could major frauds be the hidden stab wounds that distort prices, inflate asset bubbles, and later kill these markets? We know artificial credit expansion makes long-term investments look artificially attractive by pushing down interest rates, which contributes to asset bubbles. But I wonder if major investment frauds also distort markets by creating the illusion of large and safe investment funds like Madoff's providing high and stable returns. Madoff's ever-expanding fraud was feeding false information into investment markets year after year, distorting the expectations of investors as well as influencing operations of major investment funds.

With the ongoing property bubble in China and possible return of a summer oil price bubble, it is interesting to speculate on what major firms in these markets might now be partially or largely fraudulent. How significant a role did major frauds play in past malinvestment manias? China's housing market resembles the U.S. before the crash with obvious real estate bubbles in certain overheated regions and cities. Remember that U.S. newspapers ran many major articles through 2006 and 2007 claiming U.S. real estate prices were in a bubble. People got tired of these articles as they watched prices continue to rise. Many manias and bubbles have their origins in easy money policies that artificially lower interest rates, encouraging too much long-term capital investment. The Chinese government released huge levels of easy credit intended to stimulate Chinese industry out of the 2008 crash. The last crash is often at the root of the next bubble.

Lots of this cheap Chinese government credit flowed into real estate investment and speculation. This easy money gets leveraged by local government officials with various infrastructure dreams, like the Chinese city with no people:(begins at 1:10 into the video clip). How many empty cities and airports of the future are under construction now across China? These capital investments are started on cheap credit, not enough savings will be available to complete them all. For an overview of the various interventions that fed the U.S. housing bubble and 2008 financial crash, see the FEE essay "The House that Uncle Sam Built".

Looking to the past for similar stories, an online essay argues that the British Railway mania of the 1840s was the largest speculative bubble and financial panic. I am reading Andrew Odlyzko's online essay "Collective hallucinations and inefficient markets: The British Railway Mania of the 1840s". I don't know this author, but am enjoying his essays and notes. Odlyzko argues that the railroad mania of the 1830s and the larger railroad mania of the 1840s demonstrate market failures similar to the dot.com and recent real estate bubbles in the U.S. and Europe.

I wonder to what degree major frauds played in fueling these distant and recent bubbles. Market prices can confuse and misguide investors if a significant portion of market prices are distorted by fraudulent schemes. WorldCom and Enron late in the game were both large and established firms whose fraudulently overvalued investments sent signals out to investors and other companies. These price signals and false profits continued to draw capital into a wide range of similar and complementary ventures far past the true market peak.

The Madoff fraud altered expectations for investments in large and well-regarded investment firms. How did other investment firms alter their investment strategies to provide investors competitive returns? To do this they likely took on more risk than they might otherwise in trying to match the trusted steady success of Madoff's funds. Investors who could not or did not invest in Madoff funds would expect similar returns from other established investment firms. Were the expectations created by the fast-growing Madoff funds and its feeder funds enough to distort investment behavior across the U.S., Europe, and Japan?

I don't know how large fraudulent railroad ventures were relative to the non-fraudulant (but vastly overvalued) British railroad ventures of the 1840s. The corruption generated by such frauds is portrayed in the book and BBC miniseries "How We Live Now."

The vast funds poured into fiber-optic cable networks the the late 1990s seem like similar overly optimistic misunderstanding of the possibilities of new technologies. But WorldCom and Enron's apparently massive market value for their fiber optic assets and Enron's trading operations, drew ever more funds into competitive networks and trading operations. Samuel Insull's fraud at Chicago Edison similarly misled investors in the new electric utility industry.

Trains and railroad lines, electric power and power lines, Internet firms and fiber optic lines: each share the same technology profile of major advances in transporting goods, creating vast potential gains for firms that produce and transport. Early railroads reduced transportation costs by some 70%-80%–a drop so dramatic it disrupted industry and forced quick revaluation and reorganization across a wide range of companies. But projections of railroad income would have been off if major frauds claimed much higher returns. In these new technology worlds, changing economic reality already makes valuation and prediction difficult. Which is probably why major frauds are easier to conjure, or to slide into as investment hopes go astray. So these frauds and false profits inflate new visions even further, attracting even more capital to false profit opportunities until apparent returns and risks bring them inline with other industries.

So with oil prices over $80 and major investment firms predicting over $110 by summer, we should look around to see if predictions are grounded on reasonable assumptions about the world economy. What role might environmental frauds (such as were revealed in the climate emails in regard to global warming), play in limiting or threatening oil exploration and production in the U.S. and Canada?

What if a significant percentage of cash released by the Chinese government to stimulate the economy found its way into speculating in and stockpiling oil?

Questions about oil prices arise in part because today's prices are over twice as high as equivalent energy in natural gas. Natural gas fields in Qatar next near will produce over 300,000 barrels a day of clean gasoil next year (in addition to shipping vast amounts of LNG). Some argue the gas-to-liquids technology in this $18 billion venture is too expensive and energy intensive. But if for a few million dollars a small-scale production facility could be developed and installed above a Pennsylvania shale gas field, that would be significant.

The Saudis have something like 2 million barrels a day in extra capacity they can open if they view higher prices hurting the world economy. Oil fields in Iraq are now under development and will add millions more barrels a day of production. Huge oil exploration and development projects are underway around the world, as usual.

The high oil prices of a couple years ago, coupled with the media, government, and green energy wishful thinking that high prices were here to stay, led to hundreds of billions of investment dollars poured into alternative energy technologies. And higher prices led Exxon and others to pour smart money into alternative energy, as well as ramp up traditional exploration and development.

Few fire and brimstone sermons paint Hell as horrific or as certain as the free HD Google Video documentary, Home (www.youtube.com/watch?v=jqxENMKaeCU ). "Scientists tell us that we have 10 years to change the way we live…" claims this hauntingly beautiful and thoroughly misleading documentary.

This beautiful Earth is shown endangered by trade and commerce and threatened most by one black flowing demon, the oil that feeds global agriculture, transportation, factories and homes. Our world is fragile, claims the narrator, and fated to fail catastrophically as the world economy hurtles off a Peak Oil cliff while still pouring CO2 into the atmosphere's heat-trapping blanket.

It is hard not to be moved by these 2 gigabytes of free eco-Ministry (made possible in part by the excess fiber laid down in the late dot.com years, and Google fortunes created by these cheap fiber networks). Over 6.6 million people have watched Home online, absorbing claims like: "Increasingly insatiable desires and profligacy. We know that the end of cheap oil is immanent, but we refuse to believe it." Maybe this meme beamed out to computer and high-def TV screens across the world calls wealthy investors and government officials to pour more millions into green energy promotions, just as the grand speech to investors in "The Way We Live Now" paints the dawn of a new age of railroads, calling men to action: to buy more stock and make great family fortunes with the railroad's rising sun.

Consider too that soon the entire U.S. strategic petroleum reserve will be unnecessary (or more unnecessary). As major oil fields in U.S. lands and waters come onstream, and algae-based fuels ramp up into large scale production, the U.S. won't need these reserves any more than we needed rubber trees to tap during WWII. If President Obama wants to boost his popularity and Democratic chances for the next election, he could begin to release oil from the Strategic Reserve as he announces major biofuel and U.S oil production increases.

So, how can investors and speculators spot anomalies in booming industries that might be signs of major price-distorting fraud?