Monday, 17 November 2008

The Consequences of Efficiency (in practice)

Back in September I wrote about the flip side of “efficiency” in capital markets, singling out sec lending as a culprit.

Last month, A.I.G. asked for additional $38 billion in financing on top of the $85 billion it has already received, raising questions, according to the New York Times, “about how a company claiming to be solvent in September could have developed such a big hole by October.”

Here is a crucial part of the answer:
While about $7 billion of its quarterly losses … were connected with the insurance coverage ... a bigger share of the losses, about $18 billion, were incurred because the assets in A.I.G.’s investment portfolio had fallen in value. Of that total amount, losses of a little less than $12 billion were on investments made under A.I.G.’s securities lending program.
To understand what is taking place in the financial markets, on top of the theory, one must also know the nitty-gritty of the ways money is made. Only then theory could be deployed to connect the dots. Theorizing alone would not do.