On "market neutral" and other misnomers

“John Shad, a free market fundamentalist, was Regan’s choice to run the SEC [1981]. Shad’s idea was to turn the commission into a public-detective agency, ferreting out cases of individual cheating.

Meanwhile, he provided official benediction for a tidal wave of new securities – the offloaded fragments of public and private debt, stock options, and assorted other financial instruments dubbed “derivatives,” a term that neatly captured the aura of higher mathematics and pseudo-science enveloping the street.

Designed as prophylactics against risk, in the end they proved riskier than traditional forms of unprotected financial intercourse. Indeed, the Street’s new lingo was positively Orwellian: “risk arbitrage” was supposed to lower risk, but turned out to be a very high-risk business; “portfolio insurance” was designed to ward off disaster but actually helped trigger it; “hedge funds” didn’t so much hedge bets as inflate them.”

– “Every Man a Speculator: Wall Street in American Life,” Steve Fraser, 2005

I came across this passage last week, and I think it nicely sums up the sort of chaos we see in the markets today. Not to make light of what is happening, or could happen, to our collective investments, but I'd just like to point out that the S&P 500 is down just 6.5% from its recent record highs to Thursday's close.

None of this is to say that the market couldn't still fall 15% from here, in what could shape up to be a summer that rhymes with a repeat of 1998's summertime collapse during the "Asian Contagion."

However, it's worth remembering that for all the talk of the armageddon occurring "RIGHT NOW," we plebes invested in plain-vanilla S&P 500 index funds are still up 2.5% for the year through Thursday's close. The irony of "market neutral" hedge funds reporting significant declines in this environment is rich.

The way many "hedge" funds behave, it's enough to make you wonder whether the real "market neutral" position is simply owning anything ... without leverage.

Along these lines: Cramer's recent freak-out on CNBC is a must watch for anyone even remotely interested in the markets. Having watched this clip several times over the past few days, I'd sum up Cramer's performance as the personification of a market going through withdrawal from an addiction to easy money.

Although I've certainly written about brewing issues in the housing market in the past, I think the cause of today's problems was the Fed lowering rates in 2001-2002, so I'm very skeptical that the right thing for the economy at this very minute is to simply dose up the addict with more of the stuff that brought him to the hospital in the first place.

Is there an equivalent of methadone for the financial markets? I guess we'll soon see... - Ed