Original Sin

We spend a lot of time on this site writing about the risks in financial markets. About how to understand what creates those risks, how they manifest themselves, how they dissipate, what role individuals and institutions have in their creation and propagation, etc. I would say that this is one of the hallmarks of this site and is what makes it so utterly unique relative to other financial media. In life there is both yin and yang; if every other financial comment you hear is yin, you’ve gotta have some yang to balance it out.

Taking that idea to heart, I realize that I have sometimes wantonly forgotten about the need for balance - for both yin and yang - in ascribing blame for risk.

If I am guilty of anything in writing about risk, it is that I fault the role that institutions play too much while giving a pass to individuals who also participate in the markets. It is an easy reflex: why not blame the Fed for their role in creating an environment where risk taking is incented and rewarded? After all they control the lever of credit creation – that birthplace of risk?

But for every creditor there must be a debtor. It is a two way transaction, impossible to complete without both sides agreeing to do so. And this is a key point in understanding the markets. The Fed, the Bush administration, the GSE’s, the mutual fund industry, foreign central banks; all of them are incredibly important for creating the environment in which the world economy can have such massive imbalances. As purveyors of moral hazard, these institutions are unrivaled.

But individuals, in their everyday saving, investment, and spending decisions, play as essential a role in this environment as those institutions.

Let us not forget then, that though the Fed and its ilk might have set the table, ultimately individuals are the ones that sit and eat.