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I'll never be sure why he is so hard up for 20 bucks. But for whatever reason, my grandfather frequently asks me to borrow $20 until "his humpback brother straightens up."
While I oddly never found this request odd, I didn't realize my grandfather's form of financing was so widespread. This week, General Motors CEO Rick Wagoner said his company would need additional capital to stay afloat-to the tune of billions more than GM said it needed a mere two weeks ago. For the first time, the executive has claimed that the automaker will actually fail if it can't secure this loan by the end of the month.
Can this much have changed in a mere two weeks? While I previously argued fear is driving the market volatility and it won't stop until the specter is identified, that doesn't mean we can't ID why the market is afraid.
It's important to note the difference between fear and risk. It's often said investors don't like risk, but this isn't really true-they just demand compensation for taking risk. To some extent, risk is quantifiable and subject to analysis. Uncertainty is a fact of life, but knowing your exposure helps you cope with uncertainty and make the best possible decisions.
Fear is irrational or unidentifiable risk, as typically defined. Unfortunately, this financial crisis has given the market plenty of logical reasons to be irrational. For those keeping score, that doesn't make a lick of sense.
The fact is that throughout the crisis, the one thing that may have helped is a shred of honesty. The term "moral hazard" gets thrown around a lot today - the belief that bailing out troubled firms won't discourage them from taking unnecessary risks the next time around. The real moral hazard is reporting what investors want to hear, even if it's not the whole truth.
Did GM really not know how much trouble they were in two weeks ago? Does two weeks make $6 billion of difference? I personally doubt it. GM execs thought they were doing themselves a favor by asking for as little as possible up front. Retrospectively, it was the worst possible option. I have plenty of issues with loaning money to automakers - failing business model comes to mind - but more so, I have a problem going into a tunnel without seeing the light at the end.
It's not just the automakers. Goldman Sachs is expected to announce its first loss since going public, with write-downs of multiple asset categories - several quarters after rival banks did the same. When Citigroup took billion dollar write-downs time and time again, they always said they had set their records straight. These are the last write-downs.
Time and time again, they were wrong. Without the ability to rely on management assertions and financial reports, quantifying and mitigating risk becomes more and more difficult.
Excessive leverage, poor lending standards and credit default swaps may have set the financial sector ablaze, but sugarcoating the bad news has exacerbated the economic woes.
Fear isn't irrational when firms give you plenty of reason to be afraid.
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