Allow me to quote Robert Gilpin from his book Global Political Economy "...greed is the only human trait found to be insatiable." Well, Wall Street or Tadawol boil down to the same thing in my opinion: Greed. Today's crash is mainly because of sub-prime mortgage loans and derivatives, and the Saudi Arabian crash was because of over-enthusiastic middle class investors and the greed of the Ultra-High Net Worth Individuals (UHNWI), that bloated stock values to exploit the very young, and very immature Saudi Market.
Here is how Tadawul looked in 2006 around the fourth quarter of the fiscal year.
Ed, from whom I borrowed the above chart, has a better explanation in his Daily Dose of Optimism. I am just shedding light on the similarities of markets, even if they are in the Middle East, which is considered a young market. (I foresee a post on Shari'a bonds coming at one point!) as Arabs, especially us Lebanese, have been traders for centuries. Anyway....
A good friend of mine, of whom I graduated almost at the same time from university in Beirut, invested $10K in the KSA stock market, and he almost cashed in, as it rose up 35%, only to see it then crash by 50%, and he ended in a loss. Since he was my classmate, you can imagine that he wasn't a big time investor, and he was maybe looking to make some fast cash so he could get married to his college sweetheart (whom he eventually broke up with - talk about crashes!) . So was the case of hundreds of others in Riyadh. The trick about KSA is that betting is illegal, and it seems that for ordinary Saudis, it has become the new pass time, more like obsession.
My friend didn't sell but figured the market will bounce back, yet, this was just a market correction, and stocks had deflated back to their normal price.
Fast forward to 2008, and I think N. Taleb would like me when I call all these financial reporters stupid, when they misuse his term "Black Swan". I hate it when people throw around buzz words that they don't know what they mean. What is happening today is NOT a black swan: Although the markets are crashing and there are alot of similarities to 1998 , when LTCM went down, it's not the same, and it's much worse. A black swan is when something unforseen, and unpredictable happens. What started the fall of LTCM is when the Russian government defaulted on it's bonds, triggering a liquidity issue. The sub-prime mortgage isn't unexpected, it's based on bad decisions and spiralling calculations by the banks, which was seen coming since a few months. NOT a black swan.
Here is how the Dow index looks like today:
This is due to a culminating problem, the sub-prime mortgage. In a nutshell, when markets were healthy, and banks felt happy, they became too easy with their lending, notably when giving out mortgage loans. So, here is how it goes: the bank valuates a house at lets say, $500k, and they give out a loan for 600k$. The housing market prices at the time were soaring, so, in case the home owner couldn't pay out his mortgage, then the bank would sell the house which was now valued more than 600k - that is if markets kept going up- thus the bank ends up making a profit AND getting there money back.
There is a catch.
When homeowners started taking bigger loans, which of course incurred bigger interests, they figured after a while, that not only was it too high of an interest for them, but they also didn't need that bigger house anyway! (Greed again) So, they did the obvious, and sold the house. One by one, people started selling houses, and the house prices dropped. So, the house that cost 500k, now cost 450k. The banks, instead of making a premium,ended up with a loss. The house sold at a sub-prime price. In some other post, once things clear up more and more, I may try to explain to myself how this packaging and re-packaging of these losses by the I-banks, got them to the second chart above.
The parallelism between the market today, and the Saudi market in 2006 ,the ordinary man who thought that he could get a good deal and improve his life: house, marriage, etc., because money was abundant and so easy to get, sent us all tumbling down. Blame the banks, because well , they are the one doing the lending, and well, if the pie looks big, everyone wants a bigger piece.
That is called greed......and they'll just do it again.
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