sub-prime mortgages

     Now that the major investment banks of the United States are essentially a curious part of our history, the availability of capital, especially for risky projects is going to be hard to find for an extended period. 

     The seats were still warm on the Board of Governors chairs at the FED as they arose to announce their last interest rate cut this month when the DOW plummeted over 200 points.  The past two cuts were met with at least momentarily rising markets but now the expectation is that the FED will need to be much more aggressive in 2008, perhaps one large interest rate cut or two moderate ones to stem the tide of the economic slow down which seems to be appearing (but has not actually arrived in any benchmark statistics yet)..

     Explaining the big drop, commentators pointed out the huge role expectations have in markets.  If you expect more and bigger cuts, these incremental quarter and half percent moves are just delays in the inevitable and investing will have to wait until the big one comes (and lowers the cost of investing even more).  This is the same pattern that is well documented in inflationary times.  If you expect prices to rise, you buy now and that drives up the cost of goods.  If you expect prices to fall, you delay purchases and collectively, that results in a price decline to move building inventory.

Economists often make the distinction between risk and uncertainty. When they do, most people think they are splitting hairs just for their own personal amusement. This kind of thing gives rise to my favorite definition of economics: "Common sense made difficult".

However, what we are seeing on display in the equity markets is a classic example of the distinction. Risk is normally defined as the likelihood of a negative outcome upon which a probability can be assigned. Uncertainty on the other hand exists when outcomes are out there to which no probability can be reasonably assigned.