Maybe A Silver Lining

When I stop by for a brief visit with my friends and family, the questions as to what I am currently doing always arise. While I usually attempt to feign interest towards unnecessary drivels like this, I have somewhat developed a disdain for this question in particular. Since almost everyone I know is either apathetic or ignorant of investment banking, this conversation usually ends in frustration on my part as the conversations usually follow the below sequence:

F&F: I haven’t seen you in a while, what are you up to now?

Shane: I am completing a bachelors program at Penn and hopefully after that, I can secure a great job on Wall Street working for a bank.

F&F: You want to be a teller at a bank?

Shane: No, this is not for a teller. This is for a position at the bank headquarters, usually on Wall Street, where the actual profits are being generated for the bank.

F&F: So you want to be a loan officer?

Shane: No, those are examples of job opportunities in commercial banks. I am aiming for an investment bank.

Person: An investor?

Shane: No, not an investor. These banks work with stocks and are more concerned with asset valuations of various companies. They provide services to corporation on numerous activities such as mergers and acquisitions, helping firms raise cash to conduct business, selling corporate securities to the public and advising on financial strategies.

Person: So a stockbroker?

Shane (in frustration): Yes, a stockbroker…that is exactly what I am hoping to do.

 

Now with the current credit crisis and the press that these banks are receiving, my latest conversation departed from the standard convention. It seems there is no more layman confusion (or at least reduced confusion – at least they’re in the ballpark now) as what constitutes an investment bank.

 

F&F: I haven’t seen you in a while, what are you up to now?

Shane: I am completing a bachelors program at Penn and hopefully after that, I can secure a great job on Wall Street working for a bank.

Person: Oh, you want to be like those assholes that ruined our economy.

Shane (in relief): Thank you, you saved me from seven minutes of excruciating and agonizing explanation.

Person: Of what?

Shane: Just be happy we skipped it, I am.

 

Maybe a silver lining indeed.

The Subprime Credit Crisis Explained

In case you needed another explanation of the credit crisis, I stumbled across this hilarious homemade clip and I thought it was only appropriate to share.

See it here

The Rise and Fall of Oil Prices: OPEC’s practical example of Game Theory

Over the summer, the price of oil hit a high of $147 a barrel driving the price of gas at the pump to a near high of $4.00 a gallon in some markets. Prices were rising due to the increased demand for oil over the summer months and the geopolitical conflict occurring in the Middle East. Due to the high price of a barrel, there were numerous calls for increased production of oil along with calls for a reduction in the demand of oil and increased investment in alternate forms of energy.

The high price of oil did correlate with a decrease in the market demand for oil as consumers started to fear the damage of $4.00 a gallon gas price on their income. As market demand for oil fell, the price of oil started to drop at an alarming rate. To counter the falling price of oil, the Organization of Petroleum Exporting Countries, OPEC, decided to cut back on the production of oil. Since OPEC operates as a cartel of twelve countries, all the countries must agree to cut back on their individual production.

For many of the countries in OPEC, the revenue from oil accounts for a substantial portion of their GDP and these countries’ government depend on the oil revenue as a necessary source of income. With the drop in oil prices, these countries experienced a broad constraint on their governmental expenditure. For all the OPEC countries, especially the ones described above, the necessity to increase the revenue from their oil exportation is essential.

If all the OPEC countries were to cut their oil production, the available supply of oil in the global market would decrease causing an upward pressure on the price of oil. Yet each individual OPEC country faces a different equilibrium than that of acting in the best interest of the group. If the said country chooses to cheat and produce at a higher level than the OPEC mandate, it stands to earn greater revenue. Each country lacks power to substantial influence the price with increased supply (market supply would still drop), but the increased supply by the country would contribute to overall revenue and profit. The problem inherent in this logic reasoning is that all the countries actually face the same incentives and are quite aware that other countries face this equilibrium as well. The below results are then possible:

	Individual Cheat	Individual Don’t Cheat
OPEC Cheat	Market – High supply, low price, low profit Individual – High supply, low price, low profit	Market – High supply, low price, low profit Individual – Low supply, low price, lower profits
OPEC Don’t Cheat	Market – Low supply, high price, high profit Individual – High supply, high price, higher profit	Market – Low supply, high price, high profits Individual – Low supply, high price, high profits

 

 

 

 

 

 

 

 

 

Although the fourth quadrant is the efficient equilibrium in that it benefits all OPEC countries if everyone cooperates, the incentives would lead to actions in the first quadrant. So, when OPEC announces its intention to cut supply, the news is widely ignored because it is now assumed that OPEC lacks the power to enforce the countries to produce in the fourth quadrant. So even with OPEC’s announcement, oil prices continued to decline. It seems the only thing today that can increase the price of oil is the increased demand of oil by consumers and a threat (or assumed threat) of increased geopolitical conflicts in OPEC countries that could potential disrupt oil production.