Playing with Reality.

During the year that has passed I have been trading increasingly in financial markets. What a crazy fool! You must have nerves of steel. Look at all those people on Wall Street, and London, and Tokyo getting kicked out of their jobs! Billions of dollars flying around as if they represent confetti. How do you make sense of it all? These are some of the reactions that I have heard.

A long time ago, one of my gurus told me only try to control the things over which you have control; the rest you have to leave to fate. Another guru told me to make sure that I must ask the right questions, not search always to have the right answer. So, in reaction to a lot of the turbulence in financial markets--and there is a lot going on all the time, it's just that people focus on the large negative or positive movements--there is little you can do but to control your own position, and asking questions is good. Another foreign trader, who is a regular strategic advisor, emphasizes the need for discipline over sentiment. When you put these notions together somethings become clearer. First, you cannot go chasing all the rainbows in the sky, and you do not need to fear that the world will end just because you see dark clouds in the distance. What that means for me is that I focus on a few things and know that the rest has some effect but probably not that much in the short term. Second, you can really only control your losses; and if you do that your gains will take care of themselves. Third, if you do not understand what is going on and have no reason to be involved, then stay out. But keep asking questions.

I don't believe that governments should bail out private sector institutions that are in the business of taking risks, when those risks turn out badly; that is not what tax money should be used for.

That said, I have listened to and read a lot of commentary over the past days about the new "Darwinism" that appears to be moving on Wall Street--only the strongest financial firms will survive.

I have heard in the same breath people plead to let markets work because they send the right signals, but as soon as trouble is on the horizon, then come calls for government help. Most people hear those seemingly opposed arguments as meaning leave the markets alone when things are going well and the operators are making bundles of money, but come to its aid when it looks like parts of it will fold. Often there is the warning that if the financial sector or parts of it are left to fail then the whole economic house of cards will come crashing down. That's a frightening possibility, but it's also not a given. The problem is that one never knows beforehand if failure of a certain large financial institution will be the element that breaks the whole system's back. Luckily, in the age of computers, it's possible to see quickly many of the interlinkages between financial firms and have a good idea of whether it really could be the key. In part, that was an important difference between Bear Stearns and Lehman Brothers; Bear was critically interlinked. That was also likely a risk facing Merrill Lynch, ahead of its "shotgun marriage" with Bank of America. There is also the sense that some institutions are too big to fail: you can understand that for Fannie Mae and Freddie Mac being bailed out, and that may be what determines the fate of AIG (American International Group Inc., the biggest U.S. insurer by assets), a firm that touches almost every part of American life and for whom the ramifications of a bankruptcy may not be calculated fast enough ahead of a collapse. As I write, I hear that the US Federal Reserve will offer AIG a US$85 billion bridging loan and take an 80 percent stake in the company, and there are the word "AIG failure would threaten the stability of world financial markets" (see Bloomberg report). True? False?

Never in my life have I had in my hands or in all of my financial assets at one time one million dollars, yet financial markets allow me to play with sums like that on a daily basis. My limited experience has taught me a few things. First, when it's your own money on the line what you are prepared to risk for an expected reward really changes. I have my own money at stake, even though it is leveraging larger sums; it's only my money that can be lost. By contrast, I cannot really believe that the disciplined approach of risk-to-reward ratios really matters when it's not your own dollar on the table.

But training the nervous system to accept losing money is hard, whether it's your own or others. Most trading platforms try to help in that training by letting you have a demo account. This is usually considerably larger than the real money that most individuals can trade--say US$50,000 compared to a mere US$1,000--and if they do well with the demo, they may build up a notion that big money can be made easily. But if you remember that you are playing with Monopoly money in the demo you can freely trade away and lose with abandon, as you try out strategies; you can even reset the balance if you lose it all. So, you see clearly, it's not like the real world.

I wonder how many of the financial experts who have been managing million and billion dollar asset portfolios gt suckered into making big money easily had no notion of whose money they were really playing with and what would happen if it were lost. However many of them did consider that issue, the number is now greatly outstripped by those who now know what it's like to lose it all. True, there are always packages that mean that amongst the newly unemployed will be those who will get a handsome compensation. Many will have to be creative very quickly to keep their own income streaming in, because their lifestyles were probably built on a belief that their jobs would still be around for a good few more years. So, hail to those from Lehman Brothers who have quickly turned to eBay to try to sell memorabilia etc. (see report); as my wife quipped learning how to make "Lehman-aid".

The last few days have marked a major shift in the financial sector landscape, and when people talk about needing to rewrite the text books it's not hyperbole, because things are happening that were not supposed to happen, and decisions are having to be made for which there are no precedents. That's one of the reasons why those banks and other institutions who have cash have been hanging onto it for dear life; but like with juggling, it you don't let go of the object that needs to move everything comes to a halt.

Finally, financial transformation aside, we have seen something else clearly. When it comes time to collapse there are hard nosed people at the bargaining table. Want a deal? At that price? Sorry, I'm going home. Tomorrow, if I come back I'm sure the price will be better. Also, financial marketeers make money by anticipating movements correctly. Recently, it has been very hard to anticipate things correctly.

Discipline says in that case stay away. I am getting better at Sudoku for the next few days and palying with my demo account.

In all this, I know that people in an island like Barbados are trying to figure out what this may mean for them, being physically and functionally very distant from the turmoil of the world's financial markets, and whose annual income is dwarfed by the figures being used to save one financial institution. That assessment involves a lot of speculation and many possible negatives could be overtaken by other positives. So far, we have seen very little regional or international contagion from the upheaval in financial markets; commodity price gyrations have a more direct and identifiable impact on such economies. We have limited access to foreign exchange, so crude oil prices rising rapidly to around US$145 several weeks ago was more damaging, and the move back to below US$95 this week will be more beneficial. Likewise, the fact that the world economy is likely to grow more slowly is probably going to be on more importance and probably result in lower tourist visits or tourist spending.

Thinking of financial sector aspects specifically, our relative lack of sophistication may be a saving grace: banks in the region have not been directly affected by the sub-prime crisis, because they have not held any of these assets and because their lending operations have been based on the growth of deposits rather than on borrowing from foreign banks. Also, since the 1990s and Jamaica's financial sector difficulties, the regional banking system has gone through a period of consolidation and strengthening, reflected in the increase in capital and a sharp reduction in non-performing loans (see an interesting address from the Governor of the Central Bank of Trinidad and Tobago, given in June this year). That does not mean that we should not care, but it's hard to care when you cannot see how you are affected. As the US budget deficit looks set to rise further from the various rescues, we may be heading for another range of problems, but that's not yet clear on the horizon.

It's rare for us to not see the sun shining. The winds really knock us over are the real ones that tear through the region at this time of hurricane season. The US financial system is sneezing, but we will not necessarily get a bad cold.