The Nature of Volatility is Not Gain or Loss, but Volatility
Crisis Policy Forum, Quipu Economic Forum ::
13 October 2008 :: by J.E. Robertson
Open.Salon.com :: The Dow Jones Industrial Average (DJIA/Dow) today had its single biggest day of gains in history, climbing 936 points. It could be a good sign, that on Friday the market “established a bottom”, but it’s important to remember: the nature of volatility is not that it is ripe for gain or ripe for loss, but that it is volatility, and one’s will and judgment are not always as relevant as one would like.
The Dow had its largest numerical point-gain, but also its 4th largest percentage gain, at over 11%. The S&P 500 and the NASDAQ also increased by more than 11%, ostensibly as a reaction to news that governments around the world had made a concerted effort to buy shares in troubled banks, possibly to help even healthy banks gain access to capital, by letting governments take a share, in exchange for some say in how they are run, and the right to sell at a later date.
The program would be “voluntary”, meaning no one is proposing a mass nationalization of banking assets, so there is no need to worry —if you’re in the financial industry— that the fundamental principles of a financial marketplace will be relegated to history by a wave of government decrees. But there is more than easy capital at play: there is the atmosphere of volatility, which favors certain investment mindsets.
In a time of unprecedented declines, there must be, logically, a few good bargains to be had, and nobody wants to lose out on those bargains. So the same rationale of fear and uncertainty that pushed people to sell and “get out” of the plummeting market last week —in turn driving the steep declines ever further— now may have motivated a return to buying, out of concern that great opportunities could be lost.
Morgan Stanley is reported to have gained 85% on its share value today alone. This may have to do with the deep uncertainty concerning the company’s future, its steep declines in recent weeks, and news last week that a deal to shore up its financial reserves may have fallen through. Today, it looked like the firm was in better condition, and the buy was a bargain-basement deal.
Morgan Stanley may be more stable than it was last week, during the worst losses in the Dow’s history (2,400 points, or 22% in one week), but the astonishing sudden increase in stock value is due to volatility, not to a lightning fast economic recovery or restoration of order to the banking system.
The DJIA is sometimes erroneously referred to as “the stock market”, as if there were no NYSE or any other exchanges or indices, and its daily point-total is counted as one of the most reliable measures of the performance of the New York Stock Exchange. But it is just one facet of what is now a global marketplace, and it has become one of the many tools for gauging what is happening in what is now a global banking crisis.
It is, in some ways, more important to acknowledge that this is a banking crisis, than to use terms like “economic” or “financial”, because banking underpins a lot of economic activity, but a banking crisis can be contained if banking reforms or interventions are well-planned and well-executed. And because the word “financial” often gives the impression of having to do with stock brokers, the art of the deal and “high finance” investment banking, but this crisis has come to permeate the banking sector broadly.
On Monday, Neel Kashkari, assistant Treasury Secretary and interim head of the $700 billion bailout program - outlined some of the steps the government will take in the weeks and months ahead. The program includes buying soured mortgage assets from banks and buying stock in a number of financial institutions. (Full story)
Meanwhile, House Democrats are meeting Monday to put together a second economic stimulus package that could be worth $150 billion, although House Republicans are reportedly skeptical, CNN reports.
World leaders met over the weekend to come up with solutions. After an emergency meeting Sunday, 15 European nations agreed to help their troubled banks by adding capital and guaranteeing inter-bank lending. (Full story)
To put the problem of gain versus loss in the environment of a banking meltdown into perspective, the bleeding was not limited to “one or two bad actors” as karmic retribution for their ill-advised or unethical deeds, but spread like contagion to all corners of the global banking system, which had become overly dependent on the easy flow of new capital, through credit and investment insurance, some of which was flimsy or even non-existent (like the esoteric “credit default swaps”).
Now, we are looking headlong into a global government-backed buyout of “toxic assets”, financial instruments or even banking entities whose value relies heavily on unsustainable debt. That means there will be a wholesale revolution in the functioning of financial markets, and the goal will be to decrease volatility.
So, for now, the market is ripe for volatility, fraught with uncertainty, and prone to huge, historic swings, on the downside and on the upside. It will be necessary, from whatever point of view one takes, to remember that gains and losses on the stock market are both spurs and symptoms: they can represent underlying ills or dynamism, but also make things happen, like spur the collapse of otherwise viable firms or “lubricate” credit sources, for businesses, for investment and for consumers.
That, ultimately, is the goal, and it will be the coordinated respose to the crisis, not the volatile activity of the markets, that decides if credit becomes available more broadly.