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Tuesday, June 29, 2010

Ignoring the Lyrics of the Gambler: the love for the Boom and Bust cycle

You've got to know when to hold 'em, know when to hold'em.
Know when to walk away and know when to run

The lyrics above are from the Kenny Roger's karaoke classic, The Gambler. Perfect for tone deaf karaoke singers and words that are ignored by free market economies who appear unable to break a boom and bust cyle.

This realization has occurred to many hedge fund managers, but I became interested in this from learning about Steve Eisman in the Michael Lewis's The Big Short. Like Lewis, I really enjoyed Eisman because he was a hedge fund manager who won't ask you how big your boat is and knows what credit card debt is (reference: the skit "Advice from a Hedge Fund Manager"). Eisman is also known as the guy who predicted the subprime mortgage melt down early enough to bet against it. Less known was that he was as genuinely angry as your average social worker at how subprime lenders were exploiting lower income Americans.

Eisman's next target is the for profit education system which he believes is poised to implode and has also been accused of exploiting lower income Americans. As Eisman or enraged former social workers like myself would say, for profit education institutes exist to skim off the top of education loans by saddling students with debt for a degree that will not help them in the job market. For profit education institutes would indignantly say that they help marginalized individuals get an education in order to help break the cycle of poverty.

The fact that for profit education institutes are very profitable and academically and socially perform at the levels of less expensive 2 year community colleges (and they are 4 year institutions) doesn't help their case. Their profitability has spurned investment which has caused these institutions to become the fastest growing sector in the education system and inhaler of federal loans.

In some ways this has a lot of the characteristics of the subprime business. Easy access to money from the government has fueled growth that has relaxed lending/admissions standards. Regulatory agencies are swooping in and hedge funds are starting to bet that these companies stock will fall in the form of short selling. There will be a bust which will result a lack of payment of loans which have been packaged into securities somewhere which will defaults that are buried in investor portfolios. Since it is unknown where those portfolios are buried, banks will start to mistrust each other which may reduce lending. The only thing difference is that MBA students haven't started to major in education like they majored in real estate during the subprime boom. It also won't be on the same scale as the subprime mortgage business which had reached one trillion dollars. Therefore, we won't have to learn what number is bigger than a trillion but there will be another outlet for indignant rage.

I question if there is any way to ever prevent these boom and bust cycles or are they a permanent part of our beloved free enterprise market that 70% of Americans support according to the Economist (read in a British accent)? Stopping the boom cycle is actually more straight forward as a monetary intervention in the form of the federal reserve board raising the interest rate for banks lending to each other would have a big impact. It's one step by a government body to slow the torrent of easy credit to a brisk stream. The frustrating aspect is that would result in even the liberal New York Times accusing the government of being socialism. I believe in a lot of things that aren't likely to happen (Cleveland Indians winning a World Series, for example) but I don't believe in that happening.

The more popular side of the equation would be to stop the bust cycle. Some of the levers being discussed in the subprime crash were limiting short selling. However, short sellers like Eisman, are increasingly being viewed as serving a useful private sector watch dog. Additional regulation is another option but that usually happens after the fact. Health care has also been considered a candidate for a bubble and the boom and bust cycle given it's rapid increase and overvalued services. The for profit sector is a minority player in this industry so if there is no bust, that could be considered a part of the equation.

Otherwise, Kenny Roger's lyrics will continue to apply to western economies' addiction to the boom and bust cycle.

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