Lebowski Enlightenment #3


Buried down in that otherwise only interesting for the strange takes on economics and history is this gem :

“The final bit is that they look at the exogenous shocks and it terrifies them. It terrifies me, too. People in power, in state treasuries, won’t allow themselves to quantify the levels of shock that are on the way. If 60 per cent of sovereigns become insolvent because of ageing costs, which S&P says is likely, …”

Did you realize that the S&P said* that?  Don’t you think that every single bond trader in the world has that fact tattooed on their soul?  That cycle in the bond market and trading theory was discussed in Taleb’s Fooled By Randomness, I recommend reading it for a background here.  Downside risk is important to those guys, they are aware of every nuance.  That is not a nuance.

So the world’s financial system is leveraged 37-to-1, based on sovereigns, 60% of which will become insolvent.

There must be a good explanation of why I didn’t know that.  Did you know that?

I see on the news stories about the probability of earthquakes in the next 30 years or meteor in the next several hundred.  Does 37-1 on 60 percent default rate in a downturn sound like 30 years to you?

The inevitable crash will cause many big problems.  For example, the financial system pays pensions.  If there is a long economic problem, pensions won’t be paid.  I have not heard the news or government discussing that.

One would expect an inevitable disaster like that would be the subject of much talk and planning.  At least once a week the news would feature a discussion of the plans for dealing with the coming problems and have people from the Fed and Treasury on the program.

But the news tells me that the economy is improving, with statistics to prove it. There must be a good explanation of the difference.  That explanation must be important, why would such a problem be ignored?

*I believe that to be true, but can’t find a reference.  Few countries are generating sufficient taxes for normal operations and interest payments in this era of very low interest.  If interest rates rise to even 5%, some will default.  10% many will default.  In the 1980s depression in the US, the prime rate hit 21% in December 1981, was above 10% from October 1978 through May 1985.

None of this discusses the many cities and some states that are bankrupt, will never repay their bonds.  Everybody knows.

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