Last week one of the TV pundits, one of those instant experts on Greece, opined that those in government were "market morons." He went on to explain that the Europeans would bungle the Greek situation and contagion would follow.
This viewpoint -- pretty widespread among the investment and trading community -- was misguided, overconfident, and ill-informed. Most importantly, it led to the wrong conclusion, providing an investment opportunity for everyone else.
With a little study, you can learn to outwit the punditry.
A Simple Model of Government Decisions
How do democratic leaders make their decisions? This is a very complex topic. Any model involves ruthless simplification. Let me start by emphasizing that decision makers in a democracy do not include pleasing the market as a major motivation. Markets do not vote. A small minority of voters have significant stock holdings. The market is important since it shows the reaction of sophisticated and wealthy voters, and changes may lead to other economic effects. It is not the be-all and end-all for decision makers, nor should it be.
What do they consider?
- Voter opinions. In a representative government, the leader should pay attention to the opinions of those represented.
- The general interest. Representatives are supposed to analyze problems and figure out what is right. Sometimes the conclusion will conflict with popular opinion.
- The balance. When the first two points are in conflict, the decision maker must weigh the factors and resolve the Burkean dilemma, which I described at length while analyzling another issue in 2008.
Briefly put, the decision maker tries to figure out and to do the right thing, sometimes facing electoral consequences.
The Relevance in the Greek Situation
There was a lot of fear mongering concerning Greece. Many sources kept calling this a potential "Lehman event" when that was actually an unlikely outcome, as I explained at the outset. This was going to be another Lehman, the start of European contagion, the tipping of dominoes, and a scary implication for the well-chosen acronym PIIGS.
The most offensive of these sources suggested that US investors in money market funds were at risk since the funds had very short-term paper with European banks that had credit default swap holdings related to Greece.
Those scaring people about their cash holdings, pandering for page views, should be ashamed!
Now that these bozos have gotten the entire story wrong, they have moved on to explaining why this is "kicking the can down the road" and it will all end badly.
The Greek situation is a complex story which has not ended, and it does involve delaying a debt restructuring. This is exactly what we should have expected. The decision makers are striving to find a solution that does not trigger CDS payoffs. They are not market morons. They delayed decisions until they had a plan that would not generate systemic risk.
The market rallied today based upon a Bloomberg story that the proposed plans would not be a "credit event." Readers should also consider this article from the FT, showing how the CDS decision is really made. This source is authoritative, much better than the favorite conspiracy website of many market followers. There is also a nice explanation about why Greece is different from AIG. The key point is that AIG was AAA rated and did not need to post collateral. The world has changed. Everyone has daily margin calls.
The point that investors should remember is that the decision makers are all focused on avoiding systemic risk. They are specifically addressing your biggest fear!
Current Investment Implications
Without apology the mistaken pundits are moving on to a new problem. The world always has an inexhaustible supply of problems.
The new one is pretty easy. Many investors think that the debt ceiling will not be raised, leading to a default on US government obligations. Michael Farr got to do a guest post on CNBC.com, where he moves smoothly from one fear to another.
I'll stand by my forecast that there will be an eleventh-hour resolution. Most responsible market professionals agree with this, even including Tea Party founder Rick Santelli who has frequently noted that the bond market does not reflect the default potential.
I guess we should give a hat tip to Farr, since it takes a lot to outflank Santelli.
If you have a long-term time frame for your investments, you are supposed to seek times when misguided worries dominate the market. I have a method for assessing risk -- one that uses market data instead of anecdotes. You should have one as well.
