Here’s the thing:
This market isn’t over-valued. That’s not why this market is going down. Equities are going down because hedge funds and investment banks are having to sell anything liquid to raise liquidity to bail out the debt markets.
The root of all evil in this situation are the CDO’s and CDO-squareds. They’re mark-to-model, and as a result of the debt crisis, no one wants to sell those dogs at a 50 to 70% haircut — they want to carry them on their books and sell them later, when the panic is over.
So they’re selling commodities and equities, because those are mark-to-market, and they won’t take a 50 to 70% haircut on those positions — only a 5 to 10% in this down market. They use the cash raised from selling equities/commodities to meet the margin calls on their debt/CDO positions, so that they’re not forced to sell off the CDO’s or asset-backed mortgage debt.
Well obviously they should change the model they mark to then . . . : P
Derivatives have never destablized the markets as much as people have claimed they have the power to (yet) but these modern derivatives are very hard to control or regulate. The SEC attorneys take forever to figure them out enough to act. The SEC and CFTC uses investigators that are “street smart” but are not usually mathemeticians and are frankly not even in the same league academically as the fellows creating the derivatives, so it takes the regulators forever to figure out where a violation occurs and usually requires a whistle blower of some kind to explain the issue. I guess I’m saying that if the model is significantly flawed, the property related derivatives could be another layer of things that could destablilize the market further, rather than explanation of why it’s a good time to buy . . .
I’m the kind of guy that calls out that the market is falling more often than it happens . . . but . . .
Excellent summary Dave.