Friday, May 18, 2012

Unintended Consequences

According to sociologist Robert K. Merton, unintended consequences can be roughly grouped into three types: 
  1. A positive, unexpected benefit (usually referred to as luck, serendipity or a windfall).
  2. A negative, unexpected detriment occurring in addition to the desired effect of the policy 
  3. A perverse effect contrary to what was originally intended (when an intended solution makes a problem worse)
When we talk about the government, which one fits like a glove?  Actually, #2 and #3 fit.  Think about the war on drugs. Restricting access does indeed reduce some consumption but it also creates a black market. It also got young experimenting idiots to smoke sevia.

But since I am a financial guy, let's talk about #3 - the irony of making it worse. You know, the road to hell is paved with good intentions.  Think about low interest rates so people can buy houses. Not only did it create a bubble but it left many of those new house owners in bankrupt and worse off than they were before.

In the stock market, everyone knows (eyeroll) that the small investor was out of it since the last financial blow up. The Fed gooses the market (not the economy) with free money and suddenly everyone is interested in buying Facebook. After all, the fist quarter was one of the best on record.

Those of us in snarky-ville say that the little guy is about to get hosed on Facebook and by extension everything else. Just when you thought it was maybe, kind of safe toe play in the stock market the Fed takes away the punchbowl, analysts prognosticate that Facebook could double before earnings matter and although the stock closed with a teeny tiny gain anyone believing it after the open got snookered.

I have seen this before. IPOs go to the moon and just when my company went public and I was actually allowed to buy into it the end was near. I saw that stock trade at the IPO price as underwriters feverishly supported it. Guess what happened after they stopped?  Kablooey!

You can stop reading here. I am afraid I am about to wax a little political. 

So, thank you Fed for "saving" the economy by allowing banks to base their whole business on arbitrage instead of lending. Thanks for artificially inflating the stock market so it has a long way to fall to get back to true equilibrium. And thanks for keeping saving rates so low so that savers got screwed.

Noble intentions. Unintended consequences.


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