Critical thinking/Holier than thou
Critical thinking blog by Dr Boy
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Sub-prime thinking
--Dr Boy 14:09, 9 August 2007 (GMT)
You don't have to be financially literate to know the reasons for the recent bump in the economy. The fall (which has wiped billions of dollars from the global economy) was triggered by defaults in sub-prime mortgages in the US. Low interest rates and the large market that created for mortgages made many NBFIs throw risk analysis techniques out the window in the search for a bigger share of the new market growth. This crash is the reason you never hand the company direction to a marketing manger.
Surprisingly many of these loans were made to parties with low credit ratings (i.e. little ability to pay back the loan) making these loans high risk, some borrowers having no income, no job and no collateral (see NINJA loan, i.e. No Income, No Job, no Assets).
The economics explained in thought exercises
Here's a thought exercise for you at home who may not be familiar with the basics of financial management (though spotting the mistake is rather rudimentary in this case).
Would you lend upwards of $300,000 to someone who had NO ABILITY to repay you?
If you answered no then you're smarter than many of corporate financial managers in the US over the past three or four years.
If you answered yes I have some exiting new financial products to sell to you.
There is some logic to this madness however. The idea is that these loans are for mortgages where the property being purchased is used as collateral, and any defaults would end in repossession and the financier would make his money back by selling the house on in the real estate market. On paper this is a good idea, in reality this logic is full of holes. In making this loan you're taking a large bet on house prices going up. No big deal you may think, house prices always go up.... kinda.
Not really, house prices go up most of the time in response to demand but also in response to inflation, where your money is worth less than before and hence to make the house the same value on the market you have to trade more dollars for it. This makes a lot of house price growth deceptive. It's price grows the same way the price of a bottle of coke has grown in the past twenty years - some demand, a lot of inflation. Houses are like any commodity, their price will depend on demand. If everyone tries to sell, the price goes down. This is especially a problem in the housing market for reasons too broad to go into here, but I'll go into moar detail if you ask nicely. When house prices drop in an inflated economy bad shit happens
Picking when to bail
There's an old addage in the investment game, which is a very good rule of thumb.
If laymen are telling you to buy, sell
There are many adaptations of this saying but they all have the same meaning. If people are selling books on how to make money on something, or you see people on one of our half arsed excuses for news services telling people about how they've made millions and "you can too!", then you can't make money at it. The reason is simple. The strategy involves purchasing an asset, in this case a house, with the expectation of returns on that asset (selling it on at a higher price). The problem is that there are a limited number of houses, and if everyone starts buying the price goes up. This means that the people selling make money. The people who then buy only make money if they then sell the asset. But if everyone then starts to sell the price goes down, meaning the buyers lose money, and the only people who made money are the people that bought well before the prices started going up.
Failure of those who should know better
Many of the hedge funds and mortgage brokers who have collapsed in the US in the past few weeks should definitely have known better. These people would be well aware of the dynamics of boom in high risk mortgages. More people buying houses that couldn't buy before, and who are likely to default. Short term rally in the price from all the buying activity followed by a drop in prices as the previous buyers default. When they default the lender repossesses and many of the homes end up back on the market and our buyers turn to sellers and drop the prices. This is how our lenders make losses, and our hedge fund that invested in them collapse.
Retrospect?
Retrospect's a bitch hey? oh wait, I already ranted about this exact problem in 2004/2005 here. The truth is that many people were pointing out that the housing boom was getting a bit silly, just not many people listen when they're promised money. When there's potential for profit critical thinking goes out the window.
Dr. Boy
Triumph of Hope over Reason mkII
--Dr Boy 10:51, 26 July 2007 (GMT)
My ignorance of particular systems of lotteries means my previous entry on lotteries was a bit myopic in focusing on Tuesday for my statistical sample. Monday has a smaller lottery than Wednesday and hence it would be only natural that there would be fewer winners coming in on a Tuesday than a Thursday. There was only one on the Tuesday, who spent his $10 on more lottery tickets, but Wednesday had a few more winners.
In fact I think there was perhaps ten or more winners that came in today (Thursday). Nobody won more than $26 dollars, most winning about $10 to $15. But yet again we see a triumph of hope over reason. As with the previous day ALL BUT ONE of the lottery winners spent ALL of their winnings on MORE LOTTERY TICKETS. Does anyone see a horrible cycle continuing in perpetuity? I propose we rename gambling to the Stupidity Tax, as gaming revenues in this state are highly taxed and these revenues are derived exclusively from human stupidity.
Secondly it is worth noting that most winners would only have won back about what they spent on tickets in the first place.
Why is it that when a fairly risky real estate investment scheme collapses and the public loses millions of dollars ASIC is called in to try and throw people in goal, but when a lottery scheme does worse (stupefying risk) they simply shrug and say "somepeople win". But nearly everyone loses and most "winners" don't even cover the cost of their tickets. People know this and still buy tickets. But if they know they're not going to win, why buy?
Bullshit maths:
Say you buy three tickets a week for Monday, Thursday and Saturday. This is a pretty common scenario.
The tickets cost $7.15, $7.55 and $7.45 (from memory) for a standard "game". This means you spend $22.15 a week on the lottery, coming to $1,151.80 per year.
Option A: Bank account
I have access to a bank savings account which has zero transactions costs and a 6.9%pa interest rate compounded quarterly (this is no joke, this is my real savings account with the NAB, you can get one too) which I'll use for the analysis. The only catch to thi account is that your funds are illiquid, only accessible by transferring to your regular savings account by phone or internet banking and then being used through that account.
Say that instead of spending the money on lottery tickets, you put $88.60 into your bank account once a month. In three months (and three payments) your $265.80 will be compounded to $270.39. Not much, but it's a start. After three more payments and another compounding your account balance will be $545.43. By the third quarter your balance is $815.82 and by the end of the year your balance becomes $1,100.27. Your profit from interest is an boring $37.07. Doesn't sound too sexy, BUT you DO get to keep your $1063.20 capital investment.
Option B: Lottery
Say you spent this same money amount of money ($88.60) on lottery tickets.
Based on my somewhat anecdotal observations made so far (I don't have the stats to run the actual probable returns, sorry) I would say that one ticket in every 200 wins between $5 to $15 dollars. In one year you buy three tickets a week and hence buy 156 tickets. By my estimate you would probably not have won anything, but lets be a little generous and say you're one of the zero people I've ever met that have won more than $50. Let's say you won $500! Awesome! I love money! $$$
At the end of the year you've beaten the odds and won money, but you've lost your entire capital investment of $1063.20. You've been extraordinarily lucky and have come out minimising your losses to $563.20. Seriously, that very lucky for you, you're a winner.
The Bank account may be slow to pay out but remember you're not spending money to do it. I'm not even going to recommend you save the money, spend it on beer! or strippers! Anything is better than the handing it to someone else for nothing.
In the words of the surprise spruiker "these people can't get enough! their money is simply walking out the door!.." etc. etc.
Dr. Boy
Triumph of Hope over Reason
--Dr Boy 10:24, 25 July 2007 (GMT)
Last week I began working a rather arduous part time job in the hopes of securing enough cash to be able to go on a corp traineeship where I would no doubt teach Indian call centre workers how to sound like they hit their wives and drink uncontrollably, all the while wishing I could've got the one traineeship which had a real job attached for which I was qualified.
In any case I was astounded by the sheer amount of cash that people were virtually forcing into our cash register for lottery tickets. I was previously unaware that lotteries comprised such a large sum of revenue in our ubiquitous Adelaide economy, thinking that the bulk of gambling was taking place on the glittering and stammering pokies. Indeed they are the most visible, but it seems the undetected scam is pulling more dollars than one may think.
After brief training on the functions of the lottery ticket dispensing cash register I started working it and was dumbfounded by the sheer number of patrons who were throwing money away. Previously I had been working our regular cash registers as my place of employment is both a grocer, cafe/eatery and a newsagency and had not realised how many of our customers were there to hand money over for a statistically worthless piece of paper. Once behind the lotteries register I realised that perhaps every fourth or fifth customer was buying a lottery ticket in a large, high-turnover shop.
The amounts they spent on a single ticket sometimes were as low as $4.30 but the mode average would be $7.55 (the price of an "easy-pick" in that night's lottery draw with many customers buying three of four of these tickets). Many bought "maxi-pick" tickets with a slightly higher (but statistically irrelevent) probability of winning for $26. There were two patrons I remember in particular who spent $125 and $170 each (approximately). Most patrons would spend between $10 and $25.
I don't think I really need to go over the math for this one, lottery tickets are not worthwhile purchases. The sheer amount of cash we were handed on that day, I felt was worthy of a blog entry.
For all the gamblers who walked in and paid us so much money, there was one winner.
He won ten dollars.
Dr. Boy
