The Panic of '08: What made investors run for the exits?

I think it's pretty clear that it's the unregulated ~$60 trillion CDS monster running loose.

If seemingly healthy companies and banks can blow up tomorrow you can't borrow to anyone, not even over night.

Until there's transparency money will keep flowing into treasury bonds and other investments that are equivalent to sticking money into a giant matress.

The years of federal encouragement (almost madates) to extend credit where it should not have been extended and the subsequent worthless paper certainly had a role in the market failure, but I think the rapid and continual drop is a direct result of federal interference in the free market.

If the institutions facing bankruptcy had been forced to revalue their assets, the hemmorraging would have been contained and the markets could have begun to recover.

As it is now, investors still have no idea of the actual values of companies and no hope of any immediate enlightenment.

There is more information in Soylent's comment than the entire article.

The flocking traders bear a large amount of criticism for the crisis it seems

The trouble with all these financial models is twofold:

1) the assumption such markets're run and used by 'rational' people when in fact the majority of people take their leads from pace-setters and trend-makers supposedly in possession of 'specialised' knowledge (variously defined as 'expert', 'intuitive' or 'downright insane', depending on how their luck plays out); and

2) the unwillingness to factor in the truth that such markets are perpetually ripe for rampant corruption, whether it be of the 'gray area' kind, 'insider dealing', or flagrant manipulation of the market for political or/and personal advantage.

Greed needs you to dupe others.
The best lies starts within yourself.
And when lost are very hard to restore.

The word wasn't 'let there be light'
It was 'let there be trust'

And that's what's missing here.
Rightfully so.

I agree with some of the above posts (and the herd mentality mentioned in the article), but there is another factor here that I've never heard mentioned before.

Basically, open capitalism (ie, unregulated) assumes that all humans will always act in Enlightened Self-Interest. This isn't always true, but it often is. That's what people point to when they say "unfetter capitalism has to work!" But they don't account for the fact that there are two types of Enlightened Self-Interest: Long-term Self-Interest, and Short-Term Self-Interest. Example of why this matters factor:

You have two companies. These companies are the only two research companies on the stock market (for simplicities sake). Both are research firms. Both have equal starting value, and equal research over time potential. In short, one year of research at Firm A has exactly the same worth as one year of research at Firm B (due to costs of scientists, etc). Both are run by enlightened people, who are, as capitalism dictates, acting in Enlightened Self-Interest. There is only one difference: Firm A acts in Long-Term Self-Interest, while Firm B acts in Short-Term Self-Interest.

Both companies see that (rightly or wrongly) the market is very concerned about both CO2 emissions and possible energy shortages in the long term; people are worried about 75 years in the future, not about today. Both companies decide to exploit this worry for their gain.

Firm A begins researching Fusion Power technology, estimating that it will take them about 30 years before it can be commercialized and sold. Firm B begins working on Clean Coal technology, estimating that it will take them about 5 years to commercialize.

Both companies go public in order to raise the funds that they'll need to complete their respective projects. Both succeed in raising more than enough capital over time (money per year, with the explicit condition that if the research stops, the money stops flowing) for their project. They start researching...

*plays Jeopardy music*

Fast forward 5 years. Both companies have been researching away. Both companies have 5 years of research under their belts, and are *still* equal in value (remember, 1 year of research = 1 year of research for the purposes of this thought experiment, regardless of what the research is). As their worth has increased, their stock price has increased in lock-step, as is logical, since their worth is equal.

Firm A has 25 more years before it can commercialize its product. Firm B can to it right now. Firm B does so. Firm B starts to make money. Because it is making money, Firm B starts offering a small dividend, putting all its (meger) profits into its dividend. People see this, and start dropping Firm A's shares in order to invest in Firm B (remember, there are only two research companies in the market for simplicity). Firm B's share price starts to go waaaaaaaaaaaay up, while Firm A's stock price goes waaaaaay down.

But here's the kicker: both companies are STILL equal in real value! They both STILL have 5 years of research assets, and both of those assets are worth the same amount of money! But in stock value, Firm B is worth more than its real value, while Firm A is worth less.

So what happens? Well, eventually someone notices that Firm A's total stockprice is worth a good deal LESS than its total assets. Someone who acts in Short-Term Self-Interest buys up Firm A, and then auctions off its assets piecemeal. All the office chairs get sold to one company. All the paperclips get sold to someone else. The individual patents (obtained through research) are sold off individually to other companies.

So Firm A, acting properly (in Long-Term Self-Interest), is destroyed, while Firm B, acting in Short-Term Self-Interest, flourishes.

Now that our little thought experiment is done, I want you to ask yourself a few questions:

First, which company would YOU have wanted to survive? The one doing Coal Power research, or the one doing Fusion Power research? (There is no significant Fusion research being done in the private market right now. This example illustrates why.)

Second, have you ever seen a company like Firm A bought up and destroyed? I have. It's nasty and it hurts the economy.

Third, have you ever... EVER seen a human act in Enlightened Long-Term Self-Interest? I never have. People don't think more than a few years ahead of themselves. FFS governments have to offer TAX REBATES just to get people to save for their retirements! That's messed up. People are so focused on the here&now that they won't even save for the future without a government poking them with a stick.

Fourthly, this *points all the way up* is the reason why no private corporation engages in real long-term research. If it is more than five... maybe ten years in the future, they won't research it. This is why government funded research is (unfortunately) necessary. Otherwise we'd get lots and lots of new colours of iPod, but nothing REAL. (This is also the reason why anti-biotic research has dropped off to nearly nothing. The new anti-biotics are more than 10 years off, so none of the pharmaceutical companies are willing to research them.)

Fifth, from this example it should be pretty clear why a company is willing to bankrupt itself in the long-term in order to make short-term profits. Why a company is willing to destroy the environment in order to make short-term profits. Why a company is willing to cheat its customers, ruining its brandname *cough*EA, Microsoft, Sony*cough* in order to make short term profits. They don't think ahead. They can't. It happens all the freaking time, and it pisses us all off when it happens, but the reason behind those actions is obvious, isn't it?

gopher65,

You ask, "have you ever... EVER seen a human act in Enlightened Long-Term Self-Interest? I never have."

Of course I have. And how!

You've essentially declared, "All my personal friends, relatives, and dependents pose a real and present threat to my life and my happiness, and I pose an equal risk to theirs." That's unfortunate. I truly intend no sarcasm when I say, "You need new friends."

I act in my long-term self-interest continually. My partner does the same, else he wouldn't be my partner. So do the vast majority of my friends. We *all* reject short-range, non-principled, pragmatic, feel-good, reaction-to-the-moment kinds of "non-thinking" (or improper thinking). I strive very hard to make certain that those who have any purchase whatsoever on my life and time behave in a trustworthy, reliable, honest, principled, reality-oriented, and long-term-thinking manner, if not all of the time, then at least nearly all of the time. I have quite a large circle of friends and acquaintances, by the way, who fit the bill. Many (though not all, by any stretch) share a philosophy called Objectivism.

I suggest if you're unhappy with your current life -- and from the sounds of it, you ought to be -- you should avail yourself of some better way of thinking. It's your choice; you're not predetermined to be a short-range thinker by your genes. After all, your ideas shape your world view (including this comment of yours), whether you hold those ideas consciously or not. IMO, time for you to identify your pragmatism for what it is and replace it with sound, logical, and well-reasoned principles, which in turn will help you to acquire and keep long-range values, including more reliable friends and colleagues.

On this last point, I highly recommend a recent article by philosopher Tara Smith, PhD, entitled "The Menace of Pragmatism", available at http://www.theobj...ard.com/ (also available on news stands at Barnes and Noble). Pragmatism has become a major force in modern American culture, and your article is a case study.

Correction: "...your article is a case study" should read "...your comment is a case study."

I thought the extremes of the tech stock bubble put an end to the idea of "rational markets."
In fact, the Dutch tulip bulb frenzy should have done that back in the early 1600s. Just read "Extraordinary Popular Delusions & the Madness of Crowds" by Charles Mackay to learn just how "rational" markets can be.

I have been wondering whether we would have a stock drop of this magnitude towards the end of the first decade of this century for the last 12 years.

It did happen and I have no idea whether the problems will last for 4 years as my earlier predictions indicated or more of less time.

The problem is that people are unpredictable but crowds are not. And this stock market drop has nothing to do with oil shortages or any of the other major events that are making people nervous on and off over the last few years.

And this little hiccup would be nothing besides what could have happened and may still happen.

Just think what actual assets underpin the $$$$$.

nothing. Once upon a time currency was tied to GOLD now it is tied to nothing.

The only value that a currency has is confidence. If investors and speculators lose confidence in a currency it can drop in value so fast it will make your head spin.

Imagine 400% inflation and what that would do to an economy.

Jenk:

First off, I'm not American;).

Second, I'm a Naturalist, not a Pragmatist.

Thirdly, have you ever lied? To anyone? Ever? (No honey, that dress doesn't make you look fat.) Lying is the epitome of short-term self-interest. You are exchanging trust and credibility in the long-term for short-term comfort. It's not a good idea, but people not only lie, they are PROUD of the fact that they lie. They DEFEND their lying, saying, "some lying is good! Some lying is necessary, or relationships fall apart!" That's simply not true. People only claim that to comfort themselves.

As for some people occasionally acting in long-term self-interest, it happens, but it is too rare to base an entire planet's economic policy on it. And no one acts in long-term interest all the time. If we did, we would never procrastinate. Short-term gain, long-term pain.

Personally, I make a great effort to think long-term. But I find myself fighting my instincts at every turn. I always desire short-term benefits at the expense of long-term detrimental effects (eat that cake now, feel crappy later). I can (and do) fight it, but it takes a lot of effort. Most people can't be bothered. Most people are weak. Most people buy high and sell low. (And other such obvious mistakes that people wouldn't make, if only they knew how to think.)

However, I take your point that it can be said that any (real) relationship is based on trust, and any form of (earned) trust is a form of long-term self-interest.

The root cause of this crisis is the Federal Reserve which artificially manipulates interest rates causing these boom/bust cycles. If the free market was allowed to do its job and these incompetent banks allowed to go bankrupt the market could be restored to its true value.

A combination of Government manipulation
and citizen Stupidity!

Roy Stewart,
Phoenix AZ

ps. 'Write in' "Palin for President"!
for, despite 'Move-On' mania; AK's Governor
Palin IS REAL!

When someone finds himself fighting his "instincts" at every turn, this is often a classic sign of someone whose subconscious premises and conscious convictions are in conflict. It is no surprise when such people claim that it is "human nature" to lie, think short-term, fudge, or "try to get away with things". That is because they experience their own contradictions as inexplicable. They act according to their subconscious premises (which they rarely recognize, though they ought to), and then they regret what they've done according to their conscious convictions. A perfect example would be religious mystics who hold themselves to completely unnatural standards of morality then despise themselves for their own, natural wants and needs, such as the need for sexual gratification.

Here's my solution: Find a philosophy that identifies and explains your *actual* metaphysical nature qua human being, not qua mystical being or some other ridiculous Platonic ideal. Next, this philosophy should identify the nature of your mind and then provide a logical framework for relating to it consistently and managing it so that it functions coherently and reliably in the real world. Finally, it should put forward an ethic which is *actually* achievable and which purpose is to achieve happiness and long-term well-being on this earth.

But that's not enough. A happy life requires a tenacious will to live -- which means to hold onto (or re-establish) a subconscious desire to flourish as a human being, this being a natural state for most children but one that is often destroyed by adulthood -- which in turn means to focus on, think about, and act according to a set of objective, human-life-affirming convictions -- all of which means, in sum, to bring one's subconscious desire to live and to be happy thoroughly in line with one's conscious convictions, and vice versa.

Sadly, you will find it very difficult to achieve this happy state if you have already allowed dishonesty to become your standard modus operandi. I, for one, have *not* made dishonesty my M.O., and I can assure you that I experience no such tortured and harrowing "instincts" to lie, cheat, and do whatever else to destroy my life on a daily basis as has been described in this thread. No thanks. When I look in the mirror, it is very, very important to me that the guy staring back at me is someone I like.

reference Soylent $60Trillion 'Derivatives'.
Within the last two years, I had read a figure of $265Trillion Derivatives held 'Globally' by Banks!
1. Derivatives sank Barings, and I think that was only $20Billion!
2. Derivatives sank 'SK', a leader in it's field,
with ongoing business and uninterrupted 'cash flow'!
3. FTDs (naked shorting) with SECs blessing, has sank/tanked many companies; taking Pension monies with them!
Roy Stewart,
Phoenix AZ
just another 'DC Serf'!

"Underpinning the faith of these economic wizards is the doctrine of equilibrium -- that the market is a neat, self-balancing machine driven by hard-and-fast "fundamentals." ... But many researchers say the equilibrium theory falls badly short of explaining the Wall Street Crash of '29, just as it cannot account for the selloff of '08, or indeed any stock boom-and-bust."

And yet, other researchers and experts show how it was the self balancing of the market that caused these corrections. These crashes are not the result of irrational, emotional people not acting in self-interest but rather the reaction to complex undertakings between rational people.

The credit markets lubricate the engine which is the economy. The engine is about to break according to many political leaders.

Globalization has created a more integrated and co-dependant economy. It has taken time to make it co-dependant and efficient. If it is truely stuffed, then what is the process to undo?

Another reason for the flight from stocks is that the anticipation of an Obama victory is weighing on the minds of investors. Obama has said that he will increase the taxes on long term capital gains. Also it is anticipated that Obama and the democrats will pass a bill authorizing unionization based solely on sign-up cards versus secret elections. Thus, you will see Wal-Mart, etc. all become unionized with higher costs and lower profits, ergo lower stock prices. Many other anti-business policies are anticipated which will reduce profits and stock prices. Whether any of this will come to pass is up for discussion but the perception is that an Obama presidency will be bad for business and stocks.

This isn't an article about economics, it's about psychology.

If the free market was allowed to do its job and these incompetent banks allowed to go bankrupt the market could be restored to its true value.

If this becomes any worse than a mild recession it will be because there's some $60 trillion of completely unregulated Credit Default Swaps which have the potential to cause cascades of failing companies and completely freeze the credit system.

It's my belief that the oil cartels and the speculators are chiefly responsible for "triggering" this crisis.
Oil selling for $146 barrel when the cost of producing it is about $4 per barrel in the middle east is an example or what happens when monopolies and cartels distort the capitalist system. It isn't a free market when the energy production is controlled by governments like russia, and cartels like OPEC.
Of course the polititians in The USA and Europe pandering the the Greens and refusing to implement any kind of coherent energy policy over several decades contributed.
The end result of the high energy costs was such a large increase in costs for fuel, heating, food, transportation, etc. that people no longer had the money to pay the over extended mortgages that they had.
This is not to defend the people who bought houses larger than they could afford or the bankers who gave them loans which they knew were risky.
My biggest concern is that no one seems to acknowledge that low cost energy was the driver of all our economies, and that when the cost of energy went up 6 times in only a few years our economies couldn't handle it.
I'm concerned that polititiona are babbling about renewables and energy independence in 10 years, one of which is impractible, and the other impossible.

It's my belief that the oil cartels and the speculators are chiefly responsible for "triggering" this crisis.
Oil selling for $146 barrel when the cost of producing it is about $4 per barrel in the middle east is an example or what happens when monopolies and cartels distort the capitalist system. It isn't a free market when the energy production is controlled by governments like russia, and cartels like OPEC.
Of course the polititians in The USA and Europe pandering the the Greens and refusing to implement any kind of coherent energy policy over several decades contributed.
The end result of the high energy costs was such a large increase in costs for fuel, heating, food, transportation, etc. that people no longer had the money to pay the over extended mortgages that they had.
This is not to defend the people who bought houses larger than they could afford or the bankers who gave them loans which they knew were risky.
My biggest concern is that no one seems to acknowledge that low cost energy was the driver of all our economies, and that when the cost of energy went up 6 times in only a few years our economies couldn't handle it.
I'm concerned that polititiona are babbling about renewables and energy independence in 10 years, one of which is impractible, and the other impossible.

There is an incredibly easy way to deal with this.

Require the purchaser to take delivery. When these speculators and investors realize the extravagant cost of maintaining warehousing large enough to support accepting delivery, they'll stop artificially running up the price of product that they cannot afford to store.

Another reason for the flight from stocks is that the anticipation of an Obama victory is weighing on the minds of investors. Obama has said that he will increase the taxes on long term capital gains. Also it is anticipated that Obama and the democrats will pass a bill authorizing unionization based solely on sign-up cards versus secret elections. Thus, you will see Wal-Mart, etc. all become unionized with higher costs and lower profits, ergo lower stock prices. Many other anti-business policies are anticipated which will reduce profits and stock prices. Whether any of this will come to pass is up for discussion but the perception is that an Obama presidency will be bad for business and stocks.

This will in turn be horrible for the average citizen as the ERISA law from the 70's setup 401k and 403b accounts as suitable retirement funds. This, being a cost effective alternative to pensioning, allowed businesses to create greater profit by moving from defined benefit to defined contribution.

All of these funds are tied to the stock market which, when it tanks, destroys the retirement funds of everyone without a pension from a state or federal agency in the US.

Another related problem, which is the focus of Richard Kyosaki's "Rich Dad" series, is the fact that fewer people have been born than will be retiring in the next decade. Meaning the retirement system is also top heavy due to the baby boomer generation. If you think this crash is bad, just wait 10 years to see it come to full fruition.

We wont have to wait 10 years....

What made investors run for the exits?

The market is run by thieves! And people are finally realizing that fact. Even global talk is about the complete loss of any faith in the fractional reserve banking system when these billionaires just walk off with our wealth.

We may be witnessing the end of the stock market!!!! Wait til the investors find out there's not enough gold and silver to back everyones certificates of deposite. Then the central bankers will be revealled as the ultra thieves they are. The gold and silver bubble may soon pop as well. Fractional banking can not work as long as the thieves are holding the keys to the vaults, because the day when the doors are finally opened for full public inspection we will find those vaults are completely empty.

People are not over-reacting infact, there's a strange lack of public outrage when we should be demanding that these ceo's who orchestrated this be brought to justice.

Millions of people have put lifetimes of investment into these bankers hands only to find out that they've pilfered those investments.

Our Governments solution is only perpetual debt when it should be prosecution.

But the public is not likely to forget. My grandmother told me about the great depression and she also warned me about the similarity of gambling to the stock market....there are very few winners.

Most Sadly, this reflects upon the world view of capitolism. Rich guys who went to harvard or Yale who only leaned how to lie about what is really in the vaults so he can steal your wealth before you realize the vault is empty.

Be real honest! Do you realy want to invest your savings into this system again? Is the panick realy Il-logical