Wednesday, November 02, 2011

Ed Lazear's Dominos vs. Popcorn Analogy

Ed Lazear wrote a thoughtful Wall Street Journal editorial on Monday contrasting the conventional dominos view of the US 2008 financial panics and the current European debt crisis with one which he calls 'popcorn.'

Lazear, the previous President's chairman of the CEA, suggested that both crises were more like the various, individual kernels of popcorn exploding independently in hot oil, than a case of dominos toppling one after another.

As a strategist and researcher, I put great value on correct conceptual models, and Lazear, in my opinion, has done some good work here pointing out the fundamental mistake of assuming these financial panics are always domino-like.

Lazear went to some lengths to detail how various banks had binged on mortgage-backed securities long before Lehman's demise. That several shotgun mergers/acquisitions, e.g., BofA/Merrill, Chase/WaMu and Chase/Bear Stearns, occurred before Lehman's filing.

Similarly, in Europe, Lazear notes that the general, common problem are continental governments having lived and promised significantly beyond their means for decades. It simply happens that the unpayable debts are now coming due, with no country really capable of funding the others, or sufficiently strong on its own to avoid problems, either.

Thus, Lazear doesn't see Greece as a triggering event, but, rather, simply the first kernel in the popper to pop. If it had not, Spain, Italy, Portugal and Ireland would still be themselves, and one of them would have been first.

That's not to say there aren't knock-on, domino effects once a major entity, whether company or country, goes down. But the initial shock isn't one of dominos, so much as many bad decisions at multiple entities which happen to come a cropper at nearly the same time.

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