5 ms·

the derivative exposure could be risk-reducing, fwiw.

by grandalf 17y ago

eru 17y ago
It could. Though the netting out only works when your counter-parties turn up to play their part.
- grandalf 17y ago
  True... However it seems to me that singling out a specific type of transaction (such as derivatives) because it faces this kind of risk (the risk of the instrument * the risk of the counter-party) is a bit silly. Much of what we finance is based on a mental model the future that might not be true. Consider a mortgage. If your house burns down then you still owe the payment. So the financial industry invented "fire insurance" for the counter-party risk of derivatives, called CDOs. But they too are blamed for the crisis. The fact is, any set of financial products/buyers/sellers will converge upon a non-worst-case view of the future, and the price of risk will adjust accordingly. Any line you draw in the sand (such as for capital adequacy requirements) is simply an estimate about how risky the future is... and notably it's still a gamble that the future will occur at or above some point in a probability distribution.
  - eru 17y ago
    I agree. Just for the record: I also love short-sellers.
    - grandalf 17y ago
      So do I. I think one of the biggest problems with the financial industry is limits on short selling.
    - T_S_ 17y ago
      Short sellers got rough treatment during the crisis, much of it undeserved. But we should not lump all short sellers together. Fear mongers do exist, but they only thrive in a low information environment, such as a panic. If banks and other companies provided, or were compelled to provide better ongoing information, they wouldn't be exposed to rumors in the first place. They probably wouldn't see their stocks overinflated either, due to the actions of legitimate short sellers.
      - grandalf 17y ago
        I would argue that the "parasitic" short sellers who are information poor should not be viewed differently than "long sellers" who are information poor... and are generally considered perfectly acceptable. A "panic" is just the price decreasing version of a bubble...
        T_S_ 17y ago
        I agree. Ever notice how the media always treat a stock market rally like a sunny day? Too many sunny days bring a drought, which in this case means no chance to buy value at a good price. Short sellers are like rain. My main complaint is that investors are information-starved and our public policy is to blame. All this outrage about people gaming the system is a distraction. We need to fix the system, starting with the banks.
        grandalf 17y ago
        I'm curious what your proposed solutions would be... mine are: - remove capital adequacy requirements as they (like a paper seatbelt) create a false sense of security. Firms should compete on the basis of soundness as well as other characteristics. - pass a law outlawing bank bailouts. - remove restrictions on non-accredited investors, short-selling, derivatives/options trading. - Increase disclosure requirements for financial institutions. - Create a new financial statement called "Statement of Risk Exposure" which is a list of the firms' assets in terms of risk. If an asset is on a debt owed by another firm, then that firm's risk statement could be copied and inserted inline, recursively.
        eru 17y ago
        Yes. We need more bank failures! We should get to the point where a bank failure gets the same attention as any other bankruptcy. The book "Just get out of the way" (http://www.amazon.com/Just-Get-Out-Way-Government/dp/1930865546 http://www.amazon.com/Just-Get-Out-Way-Government/dp/1930865...) has some interesting ideas on how to apply the lessons of now-developed nations to developing ones: Don't copy the bloated institutions the rich world has now, but get inspired by what made them great in the first place. Often these were simpler policies. (Of course this also applicable to developed economies, again.) The author also advocates ridding banks of any (even implicit) government guarantees, to make customers look out for their money instead of relying on glorified ponzi schemes. (Which banks are in a lot of developing countries.)

the derivative exposure could be risk-reducing, fwiw.

eru 17y ago

It could. Though the netting out only works when your counter-parties turn up to play their part.

grandalf 17y ago
True... However it seems to me that singling out a specific type of transaction (such as derivatives) because it faces this kind of risk (the risk of the instrument * the risk of the counter-party) is a bit silly. Much of what we finance is based on a mental model the future that might not be true. Consider a mortgage. If your house burns down then you still owe the payment. So the financial industry invented "fire insurance" for the counter-party risk of derivatives, called CDOs. But they too are blamed for the crisis. The fact is, any set of financial products/buyers/sellers will converge upon a non-worst-case view of the future, and the price of risk will adjust accordingly. Any line you draw in the sand (such as for capital adequacy requirements) is simply an estimate about how risky the future is... and notably it's still a gamble that the future will occur at or above some point in a probability distribution.
- eru 17y ago
  I agree. Just for the record: I also love short-sellers.
  - grandalf 17y ago
    So do I. I think one of the biggest problems with the financial industry is limits on short selling.
  - T_S_ 17y ago
    Short sellers got rough treatment during the crisis, much of it undeserved. But we should not lump all short sellers together. Fear mongers do exist, but they only thrive in a low information environment, such as a panic. If banks and other companies provided, or were compelled to provide better ongoing information, they wouldn't be exposed to rumors in the first place. They probably wouldn't see their stocks overinflated either, due to the actions of legitimate short sellers.
    - grandalf 17y ago
      I would argue that the "parasitic" short sellers who are information poor should not be viewed differently than "long sellers" who are information poor... and are generally considered perfectly acceptable. A "panic" is just the price decreasing version of a bubble...
      - T_S_ 17y ago
        I agree. Ever notice how the media always treat a stock market rally like a sunny day? Too many sunny days bring a drought, which in this case means no chance to buy value at a good price. Short sellers are like rain. My main complaint is that investors are information-starved and our public policy is to blame. All this outrage about people gaming the system is a distraction. We need to fix the system, starting with the banks.
        grandalf 17y ago
        I'm curious what your proposed solutions would be... mine are: - remove capital adequacy requirements as they (like a paper seatbelt) create a false sense of security. Firms should compete on the basis of soundness as well as other characteristics. - pass a law outlawing bank bailouts. - remove restrictions on non-accredited investors, short-selling, derivatives/options trading. - Increase disclosure requirements for financial institutions. - Create a new financial statement called "Statement of Risk Exposure" which is a list of the firms' assets in terms of risk. If an asset is on a debt owed by another firm, then that firm's risk statement could be copied and inserted inline, recursively.
        eru 17y ago
        Yes. We need more bank failures! We should get to the point where a bank failure gets the same attention as any other bankruptcy. The book "Just get out of the way" (http://www.amazon.com/Just-Get-Out-Way-Government/dp/1930865546 http://www.amazon.com/Just-Get-Out-Way-Government/dp/1930865...) has some interesting ideas on how to apply the lessons of now-developed nations to developing ones: Don't copy the bloated institutions the rich world has now, but get inspired by what made them great in the first place. Often these were simpler policies. (Of course this also applicable to developed economies, again.) The author also advocates ridding banks of any (even implicit) government guarantees, to make customers look out for their money instead of relying on glorified ponzi schemes. (Which banks are in a lot of developing countries.)