Investors like themes, they like to operate and think according to the major themes that dictate new developments. I think one of the biggest themes in this current investment environment and in the next few years will be the dominance of unintended consequences – an environment where the unintended consequences of actions will speak much louder than the intended actions themselves.

We have already seen numerous occasions over the past few years where this has been the case and will continue to see them given current developments. These are just some of the instances where the unintended consequences of our actions already have or will very soon come to dominate the path we end up on:

Greece Bailout

The Greece bailout – a situation where we have yet to witness the unintended consequences, but will for sure in the near future. Greece was able to convince the larger Euro nations and the IMF to provide them with a bailout package to help it through its immediate needs while making lofty promises of improvement intended to pacify those looking for some sort of justification for the bailout. What are the unintended consequences here? The moral hazard that comes with such bailouts is undeniable. When the Euro zone went out of its way to bail out Greece, even though its own constitution disallowed exactly such bailouts, it gave a precedent to all those peripheral countries that are in a similar fiscal situation as Greece. Why would Portugal and Spain now back away from asking the larger European countries for aid? If Greece, then why not us? We have not seen the unintended consequences of the Greece bailout yet, but we will. Portugal has already been downgraded by S&P and Spain is quite likely in the crosshairs as well. If both these countries go cap in hand to the ECB again, there’ll be little that they can do to deny them.

Flash Crash

When high-frequency traders first came about, they were seen as market players that will help improve the liquidity of the market and bring in spreads and transaction costs, and that did happen. The high-frequency trading model became so successful that today about 70% of the volume on the NYSE comes from such firms. But the flash crash of May 6^th showed us the unintended consequences of this change in market structure. When the market confusion and panic set in, most HFT firms backed out of the market to understand what’s going on. But when 70% of the market liquidity suddenly disappears, you are left with a gaping hole that resulted in trades getting executed at inexplicably low prices. The market on May 6^th, contrary to popular belief right after the crash, behaved just as it was supposed to. There was no big malfunction or technical glitch that caused what happened. It was the unintended consequences of the change in our market structure that lead to the flash crash.

Circuit Breakers

This is a case where I believe we were actually spared the unintended consequences. The circuit breakers did not get triggered on May 6^th because the market did not drop enough for the circuit breakers to be activated. But think about this – if the market had indeed dropped the required percentage and trading was halted, what would have happened? The market would have shutdown for the day at a level that would have been 10% below the day’s open. Meaning, investors would not have had the chance to see the huge, sharp rebound following the flash crash that restored some sort of normality. Everyone would have gone home thinking that there is some very solid fundamental reason behind the 10% drop and that they should stay out of the market, which would not have helped the situation when the market opened the next day. As it turned out, the circuit breakers did not get triggered and investors got to see the rebound and realized that what they had seen was only a temporary drop and there was no imminent economic collapse.

Ultimately, you have to ask when all these and other unintended consequences will end? They will only when policymakers realize that their actions are not implemented in the real world in a bubble that affects only the areas for which they were intended.

Disclosure: Long market

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