Thanks to all of my readers who commented on the original piece. You were a real help to me. Okay, what are the differences between fresh produce and financial assets?
- Time horizon — fresh produce is perishable, whereas most risky assets are long-dated, or in the case of equities, have indefinite lives.
- Ease of creation — New securities can be created easily, but farming takes time and effort.
- Excess Supply vs. Excess Demand — With a bumper crop, there is excess supply, and the supply is typically high quality. Now to induce buyers to buy more than they usually do, the price must be low. With financial assets, demand drives the process. Collateralized Debt Obligations were profitable to create, and that led to a bid for risky debt instruments. The same was true for many structured products. The demand for yield, disregarding safety, created a lot of risky debt and derivatives.
- Low Supply vs. Low Demand — With a bad crop, there is inadequate supply, and the supply is typically low quality. Prices are high because of scarcity. With financial assets, low demand makes the process freeze. What few deals are getting done are probably good ones. Same for commercial and residential mortgage lending. Only the best deals are getting done.
Fresh produce is what it is, a perishable commodity, where quantity and quality are positively correlated, and pricing is negatively correlated. Financial assets don’t perish rapidly, quantity and quality are negatively correlated, and pricing is often positively correlated to the quantity of assets issued, since the demand for assets varies more than the supply. Whereas, with fresh produce, the supply varies more than the demand.
That’s my take after your excellent comments. Any more improvements that can be made?