Ron Amundson’s Political Blog

The blogosphere has been awash with folks crying in their beer… Egads, investors will never invest again, banks wont lend, the end of economic civilization as we know it is near… Well short of the last one, which imho is needed, the another two are pretty blatantly in error.

Investors want to make money… and along with that, guess what, the more potential gain, the greater the risk. Less than 2% of all patents make enough money to generate the costs of filing, far fewer even cover their development costs, and even less end up making a profit. Even less than that make a substantial return….  despite, the high risk, new tech is often the domain of IPO’s which attract substantial investment. However, even then, the chance of 100% loss of investment is very real. Just ask any holders of stock options from the dotcom era who failed…

Will changes in risk management in the investment world, especially as concerns government involvement, change the game… Yep, it probably will. However to state investors will not step up to the plate is significatly in error. If there is money to be made, or even a chance, by far investors will step in, albeit it is likely a different demographic will be in the game as contrasted with history.

Sec 363 of the bankruptcy code as concerns secure creditors has shifted things around for years… Secured creditor status does not grant safety, nor mulligans. It can be safer, but not always. This is not new, nor rocket science, and case law and history most certainly have justified twiddling with priorities. Either way, a fool is often parted with their money. Someone was either A too greedy, or B asleep at the wheel when investing in GM and Chrysler bonds. They had to know what was on the horizon, I certainly did, even going back as far as 2003, albeit I didnt know when things would unravel. As time passed, it appeared things would take a header sooner and sooner. Thus, to step in and buy bonds as many investors did late in the game was a calculated risk… and it didnt turn out too well. The beer has been spilled… and yes, some folks retirement was lost, and that is sad, especially if they were at the whims of an inept fund manager. If anything, the one change that needs to be made, is not to Sec 363, but to provide more diversity and options for folks retirement funds to prevent that lockin, plus additional education.

As far as contracts and loans go…. a bank makes money on loans and on bank fees. If, and I do hope it comes to pass, further restrictions come into play on fees, then banks have to return to their core, and that is the loan business. Interest rates are determined by market and by risk. Getting a loan when one has an equal or greater amount of cash in a bank’s CD’s is easy, and provides very low interest rates. In more than a few cases, large customers pretty much dictate what the rate will be, as the bank is backed into a corner. Otoh, getting an unsecured loan, unless one has a high income, a low debt to income ratio, and very stable employment is likely to result in a much higher interest rate, because the risk is higher. Certainly, those with low credit scores, low income, and high debt to income ratio can be charged the highest rates, as the risks of default are exceedingly high. The bank knows this, the investors know this, its not rocket science. And if default happens on an unsecured loan…. well, the bank gets a few cents on the dollar for selling it off for someone else to collect on, or if the customer declares chapter 7 bankruptcy, they get zero. On the other hand, if default doesn’t happen, the bank makes a small fortune. Its pretty simple, and its basic risk management 101, even going so far that a number of high interest loans are predicted to default, but that the aggregate will return huge gains.

The problem is, when the risk management model is upended… if one was being too greedy, or purposely chose to ignore specific factors, the default losses will exceed the gains, and before too long, they should cease to exist. Of course, there is the aspect of the culpability of the third party ratings agencies… if they are in error, the bank could still theoretically do everything right, and still loose their shirt, alas there is also an element of caveat emptor. Just because a bond rating or credit score is exemplary, its really only a tiny portion of the real risk at hand. Certainly a loan to an employee of a firm in bankruptcy with a 800 credit score is more risky than a loan to a person with a 700 working at a long term company showing positive trends and on a hiring spree.

Thus, when a bank or other firm gets hit with defaults, its their problem, they took on the risk, now they have to pay the piper. If anyone was foolish enough to have more than the FDIC limits tied up in such…. well, I would hope they are getting greater returns than the masses, as the risk is substantial. Granted, there are reasonable concerns for commercial entities.

And that’s what it comes down too… what is a reasonable risk, and how much return do I want. I have no right to cry in others beer, when I took a risk, and it fell apart, barring in mind, I took said risk with knowledge or a perception of what I was up against. Banks must loan money and investors must invest to exist, failing to do so, will ensure they will fail… thus changes in government policy, changes in risk models etc will not result in lack of loans, or investments. It will hopefully result in greater upfront awareness and understanding, and from a reactionary pov, fewer loans and investments in the short term, but they will come back… perhaps with more strings, or less favorable returns, but they will be back.

And lastly, the end of economic civilization as we know it, must come to an end. Liar loans must end, risky investments sold as no risk investments must end, and the whole ecoclimate needs to change. That is a good thing, and will poise us for future growth in a huge way based upon a real economy, with real and sold underlying fundamentals, not selective models based upon ignoring very real key factors, or bogus bookeeping.