chiro said:
twofish, I have a lot of respect for you and your insight and advice you give to other members including me, but I have to ask you how you think you are helping society out when the following is happening (or has happened)
Because I'm doing my job right (or at least trying to). When all hell was breaking loose in 2007, I was thinking to myself, "things could be worse." You had massive chaos and destruction, but there were areas in which things didn't fall apart, and that kept the world financial system from totally imploding.
1) Mortgage-backed securities
Without mortgage-backed securities, it would be impossible for *anyone* to get *any* mortgage loans. The idea behind the MBS is that you package mortgages into bundles that are easy to sell. Now the problem was that people made getting mortgages too easy and a lot of people that got mortgages shouldn't have gotten them, but the solution to that is to tighten regulation at the retail level, and not make it effectively impossible to issue mortgages at all.
Your bank has about 20% of your money in MBS. The reason banks hold MBS rather than straight mortgages is that if you go to an ATM and you want your money, it's hard to sell a mortgage. If you put the money into an MBS, then when the bank runs low on cash, it can immediately sell the MBS it has. Also pension funds and insurance companies put a lot of their money into MBS (the good kind).
Now during the crisis, people suddenly got scared, and one thing that happens when you think that something is worthless is that it becomes worthless. People suddenly looked at every MBS, and thought sell, which was a problem since 20% of a bank's money is in MBS (70% is in straight loans and 10% in cash). Once you burn through the 10% cash, if you have MBS's and loans which no one will buy, then banks start failing.
So what the government did was to buy up MBS, wait until people calmed down, and it's been able to make a small profit selling them back. People are trying to figure out what to do about mortgage-backed securities, but it's not a obvious how to get rid of them, and not obvious that we should even try.
(d) A lot of which do not serve any social purpose at all. As an example the insurance that most people are familiar with like life insurance or car insurance or income insurance serves a social need: A husband dies and his widowed wife still has a roof over her head and can feed her children. Nowadays you can get derivatives that have a contract to claim funds on things that the holder of the contract DOES NOT EVEN OUTRIGHT OWN. How the hell does this benefit anyone and how the hell is it even legal?
Because an airline wants to be able to lock in the price of oil in one year, and so he buys a contract of oil futures. The airline hasn't purchased the oil, but he buys a contract to stabilize the price of oil. Similarly a farmer that wants to lock in the price of wheat will buy futures. He doesn't own any wheat yet (because it hasn't been grown). There's also currency futures and options. Interest rate futures and options.
Also in many countries, derivatives function like mutual funds. Rather than buy a mutual fund with a basket of N stocks, you buy a derivative contract that targets the price of the stock. The US has rather restrictive laws on who can buy derivatives, which is why most of the stuff gets sold in London.
Derivatives are largely unregulated in the United States, because it's illegal to sell more derivatives to retail investors, and people who can buy derivatives (and you need a million+ dollars to be an accredited investor) presumably know what they are doing (although we can question that). The theory is that if you have a million dollars, then you don't need government protection since you can hire your own people to protect you. There are weaknesses in that theory.
The one firm with probably the highest collective IQ in finance got bailed out. But we still use models based on their work. If that doesn't indicate something I don't know what does.
No we don't. No one has used Black-Scholes directly since 1987. The models that are in use a lot of the ideas of Black-Scholes, but they all have corrections for the very serious known problems. Also for risk management, it's questionable how well Black-Scholes works as a framework at all, so people use other things.
It should also be pointed out that what got LTCM in trouble had nothing to do with Black-Scholes. LTCM was also not heavily invested into derivatives.
Also, common sense and humility are more important than IQ.
There used to a be a law that was a kind "antitrust law for financial institutions". It was abolished. Now look at what has happened. It wasn't created for no reason you know.
Glass-Steagall. It was an American law that prevented US banks from being both commercial banks and investment banks. Personally, I don't think that it had much of a real impact because:
1) It's an American law. One reason that it was repealed was that most other countries (chiefly Germany) never had anything like that. Also some countries in which did well (chiefly Canada) repealed Glass-Steagall like restrictions around the same time that the US did. The only two countries that have these banking restrictions are China and Israel.
2) if you look at the banks, the ones that got into big trouble (Lehman and Bear Stearns) were stand-alone investment banks. Same with Washington Mutual. WaMu had no investment bank operations. By contrast, Bank of America and JPMorganChase were is relatively good shape pre-crash.
One good/bad thing about different countries is that different countries have radically different financial systems. In the US, people in the 1930's believed that the cause of the depression were that banks were too big, and so the laws that came into effect made sure that the banks stayed small. Conversely Canada believed that banks were too small, so they set up their laws to favor a few big banks. Personally, I don't think that it matters that much.
3) Accounting standards
(a) They can be deceptive and do not always reflect the true numbers. Look at what Enron did.
Sure. Sometimes to figure out the true situation you almost need a Ph.D to figure out what is going on. Which is why people hire Ph.D.'s.
The truth is that there are players (and they are big ones) that have gotten laws changed, have used business practices that have destroyed large parts of society (even entire countries), have committed outright fraud (call it whatever you want, fraud is fraud), and have for the most part gotten away with it.
True enough. However, if you want to have effective regulation, you have to know the industry. This creates a problem called regulatory capture in which the people that can talk intelligently about an industry are all employed by said industry. I'm not sure really how to fix the problem.
Finance can do a lot of damage, but it can also do a lot of good. Bad finance has destroyed economies, but good finance has created them.
I don't know your exact function twofish or in what capacity it entails, but I think you would be naive to think that these people who are above the law really give two hoots about Joe Q public and its prosperity.
There are people who do, and people who don't. You have a choice as to who you work for, and I've chosen to work with and for people that I think really worry about the consequences of our actions, which is perhaps why we did less badly than other companies when the hammer fell.
One thing that you very quickly figure out when you study finance is that no one is an island. If someone gets into financial trouble, even if they were stupid, it impacts you. Conversely, if the average person makes more money, it's good for you if you work in finance since you have more money to manage.
Personally, I'm terribly, terribly worried about the direction that the US is heading. I don't think that the US is spending enough money on infrastructure, there's too little money going into research, elementary school teachers should make more money and investment bankers should make less. You can fix the problem by taxing investment bankers and giving the money to public schools and graduate students, but Congress isn't listening to me.
But I don't think anything is going to be helped if I quit my job.
