This house is burning down

There is a lot going on in the world right NOW. Forget about the election. The federal government, the Department of the Treasury to be exact, is stepping in to seize control of Fannie Mae and Freddie Mac and save the failing companies using Uncle Sam's checkbook. This has serious implications for the bond market. This debt is held in large concentrations on the balance sheets of large institutions around the world. Additionally it has been trading at huge spreads to treasuries lately. Now, a FNM or FRE bond resembles a treasury and spreads are going tighter, especially in the most senior debt in the capital structure. So far it looks like the common shareholders are going to take a bath.

This ties in to the book I am reading right now, Nassim Taleb's "Fooled by Randomness" in which Black Swans are discussed. Black swans are essentially life's unpredictable events. Taleb argues we are conditioned to think that life has causation and predictability. Everyone learns in college about statistical probabilities and the normal distribution. The mere fact that the distribution is termed "normal" alludes to the assumption most people make about the predictability of life. Taleb argues that life's not "normal" and the distribution of life's events are actually more leptokurtic with high impact "fat tail" random events that can't be predicted.

So is this a black swan event? The treasury isn't known to step in and inject government money into a private company. But this was predicted by a lot of the smart money on the Street. We are going to see some huge spread tightening that would definitely be a fat tail event on a frequency distribution chart. What I deduce from this is that you can't reduce this situation to mathematics. How could you? People have tried with differing degrees of success to reduce trading markets to mathematical probabilities. That seems impossible in this situation given that Washington policy makers are directly involved and I can't imagine any mathematical success has been achieved in predicting Washington policy making.

Taleb is sort of onto something. There are hundreds of strategies out there that are only susceptible to losses in the proverbial hundred year storm. However, it's turning out that these storms are coming around quite often. Early 90's housing crash, late 90's Russian Ruble crisis and LTCM blowup, dot com crash, and now the credit crunch/housing crisis. Each one has required "unprecedented" government intervention, most recently FNM and FRE as well as the rescue of Bear Stearns. While market policy setters in Washington preach free markets and limited intervention, they usually seem to feel empowered in their time in office to intervene.

So it turns out that this government intervention and injection of capital into FNM and FRE that the market had been calling for for some time were pushed into action by some recent discoveries into FNM and FRE's accounting practices. Basically these government sponsored entities (GSEs) are like huge banks. Like any bank, they need to have sufficient capital (ie money) to back themselves up. Well, the Treasury hired Morgan Stanley to look over the two firm's assets and found that while legal, the accounting practices used, in accounting lingo, would be what is known as "qualified," ie not up to snuff. Thus, their ailing balance sheets are worse than we thought!

Well I hope you could sit through that and I apologize if you are totally lost. In other news, I had never eaten at Hooter's as of two weeks ago and I have since eaten there twice. Maybe because I live so close to one. Or maybe it's a random black swan type of occurrence. I went to a girl's bday dinner a week or so ago and this weekend my dad is visiting, basically on a vacation from my mom, and he wanted to go because he's never been there. Something about that place bugs me. I really wish the waitresses wouldn't write their names on the napkins. That's so dumb and corny. It was funny to see a kid there with his dad and older brother for his 13th birthday. It's like a puberty party. After that I played night golf with my dad, sister, and brother in law.

Tonight I am 100% alone. I have 3 roommates, all girls, one of which is my sister. I think they are all with their BFs. I am Hans Solo. However, I have a lot of stuff to entertain me. I've got the first season of Flight of the Conchords going, I have a book to read (Fooled by randomness), and a blog. And a thriving multilingual AIM convo...shout out!