Friday, October 10, 2008

Stock drops are the result of rational behavior

Let's assume that X% of stock buys before three weeks ago were margin buys. Now that credit is drying up, one would expect the number of people buying stocks to go down. Which means demand goes down, which means the price goes down.

Now, imagine you're a corporation used to borrowing money to cover spikes in your operating expenses. You do this not because you don't have the money, but because the interest you can earn on that money in the market is higher than the interest it costs you to borrow it. Now that credit is drying up and stock prices are going down, that is no longer the case. In fact, the liquidity crisis is so bad that, even with stocks going down as much as they are, it's still cheaper for you to sell stocks to cover your expenses than it is for you to borrow money, assuming you're able to borrow at all. And if you're not able to borrow at all, then you have no choice but to sell stocks to cover your operating expenses if they're your most liquid asset. More people selling means the price goes down even more.

And now you get into people that depend on their investments for retirement income. In good times, they can live off dividends and the occasional sell-off. Now the dividends are shrinking, and sell-offs net less profit, they have to sell more.

And the price goes down even further.

I'm hoping Paulson's recapitalization plan will help, but the simple fact is that we've all been dependent for too long on easy credit to help us ease the spikeyness of our incomes and outgoes, and no matter what happens in Washington, we're going to have to detox from credit, and that's going to kind of suck.

1 comment:

Anonymous said...

Ok, so now go read the Alaska investigation report on Palin and Troopergate and when you get done, ask yourself, who was really running the state from the Governor's office? Sarah Palin or Todd Palin.

...Among other details that came out in the report. The guy she hired to replace Monegan had to resign 15 days later because of an alleged sexual harassment complaint filed...because she never even bothered to check first before appointing him as Commisioner of Public Safety?

Exactly how did McCain vet this woman? Or was he nominating Sarah & Todd as co-veeps?