The Global Market And the Subprime Crisis

At Aleablog (aleablog.com), a blogger by the name of JCK links to a report published by the Bank of England that attempts to "map" the current state of the world's financial system.

The bank's Financial Stability Report, published last month, contains many interesting figures; one of the most intriguing is a diagram showing that the subprime assets that have created so much turmoil in the world's markets comprise a tiny sliver of the financial pie.

Felix Salmon of Market Movers (portfolio.com/views/blogs/market-movers) puts it succinctly: "The entire market in subprime debt is just 1.4% of the size of global equity markets. Or, to put it another way, a 1.4% downward fluctuation in stocks erases the same amount of value as if all subprime-backed bonds were collectively marked to $0."

The report states that there "are reasons to be cautious when considering a quantitative 'map' of the financial system. Statistics are drawn from many different sources. This raises the potential for overlapping or missing data."

Even if the map contains some inaccuracies, Gillian Tett of the Financial Times warns that "financial history suggests that it is often small events, or assets classes, that spark 'tipping points' in finance." Let's hope that these relatively tiny fluctuations don't fit that bill.

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'LOCKING IN' ENERGY PRICES

A reader of Marginal Revolution (marginalrevolution.com) asks the moderator, Tyler Cowen, whether his utility company is trying to scam him.

"I've recently received 'lock-in' offers from my gas and electricity company," he writes. "They're offering me the 'opportunity' to commit to the current price of gas and electricity for two years, instead of paying the fluctuating month-to-month rates. … Are the energy companies signaling that they think energy prices are too high and will go down? Or do you think there could be something else behind the strategy?"

Mr. Cowen responds that fluctuating prices are better for the consumer than for the producer. The buyer has a higher expected surplus if he has "a price of 50 half of the time and a price of 200 the other half of the time," Mr. Cowen writes. But if the price is 125 all the time, the seller has a higher expected surplus. "That is one reason why the utility may prefer a lock-in," he writes.

But there are other reasons: "There is also a 'only the stupidest consumers will respond' effect. It costs the utility very little to make an offer favorable to themselves but unfavorable to the consumers. It's worth doing even if only a few people accept. Given that utilities are regulated monopolies, you should expect conflict of interest to be high and thus decline most of their offers."