No Free Lunch [Or: The Stupid Germans Come Home To Roost]

I know that my friends and associates who work at at investment banks make piles of money. I know that they make this money mostly because the value of their skills is colossal. I know that the value of their skills is colossal because people with their skills can make mountains of money with a sprinkling of capital and a deluge of leverage.

Nine years out of 10, anyway.

But in that 10th year they wipe out about 10x-100x their capital. The business model is spared, the conventional wisdom goes, because of bailouts of various kinds.

But bailouts don’t tell the whole story for me. Bailouts aren’t certain so there will only be SO much money willing to bet on a bailout. There’s an idiot at that poker table and I think we’re figuring out who it is.

Here are some quotes about this recent paper:

Krugman:

this is the latest in a series of papers arguing that the U.S. shadow banking system consists in large part of … European banks. This suggests that the creation of the euro had large implications even in US capital markets; and of course it suggests that the financial fallout of the euromess could be very large here as well.

In short, the ECB could be in the process of destroying not just the euro, but the world.

Cowen quotes the abstract under the title “If True We Are Doomed”:

European banks may have played a pivotal role in influencing credit conditions in the United States by providing US dollar intermediation capacity. However, since the eurozone has a roughly balanced current account while the UK is actually a deficit country, their collective net capital flows vis-a-vis the United States do not reflect the influence of their banks in setting overall credit conditions in the US.

Michael Lewis:

When Goldman Sachs helped the New York hedge-fund manager John Paulson design a bond to bet against—a bond that Paulson hoped would fail—the buyer on the other side was a German bank called IKB. IKB, along with another famous fool at the Wall Street poker table called WestLB, is based in Düsseldorf—which is why, when you asked a smart Wall Street bond trader who was buying all this crap during the boom, he might well say, simply, “Stupid Germans in Düsseldorf.”

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