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The Myth of the Sophisticated Investor

20 points by cwan 17y ago

deleted 17y ago
[deleted]
yummyfajitas 17y ago
The author of this post shows the difference between sophisticated investors and himself: Consider synthetic CDOs like Abacus. Banks would need to lend out $50 billion of mortgages to regular people in order to create a $1 billion CDO like Abacus, according to Michael Lewis in The Big Short. A sophisticated investor realizes that banks didn't need to lend out ANY mortgages to create a synthetic CDO. A sophisticated investor realizes that a synthetic CDO is the long side of a bet against the markets. A sophisticated investor will also form their own opinion about the bet, based on information about the assets underlying the bet (which were available to every investor), and will not really care that "omfg, the other side of this bet is a no-name mid-range hedge fund!"
- philk 17y ago
  I'm not sure, however, that there's a huge use to society in allowing many bets like this given at the very least it's a huge sink for quality human capital. I understand that there is value from the insurance/hedging side, but as we've seen recently risks may be concealed rather than allayed.
  - yummyfajitas 17y ago
    John Paulson and a few other smart people told the world "hey, we are in a bubble". They put their money where their mouth is and shorted the market. They and helped prevent us from funneling further labor and resources into housing we don't need. Do you really think the world would have been a better place if Paulson built twitter 2.0 rather than pushing CDO prices down?
    - philk 17y ago
      Yes, but the bubble itself was created by investors building and selling complex financial instruments in the first place. Wouldn't it be better if investment bankers had been building legitimate businesses rather than working out new ways to repackage and sell subprime mortgages?
      - yummyfajitas 17y ago
        The bubble was created by simple instruments: home mortgages. It would have been better if women weren't forcing their husbands to buy houses they couldn't afford, government wasn't encouraging lenders to make bad loans, and realtors weren't adding fuel to the fire. I don't see a way to prevent all of that, since all of those things are still happening. The only reason the bubble burst was because of investment banks and other speculators eventually figuring out the problem and putting a stop to it.
        philk 17y ago
        No it wasn't. It was caused by lenders being able to lend money that wasn't theirs, facilitated by complex financial instruments. If you're a bank and you're lending your own money you've got an incentive to make sure the loans can be repaid. If you're a bank and you can instead take the loans you've made, parcel the debt up in a complicated financial instrument, sell it off to others and take an essentially risk free commission then you've got an incentive to loan money to anyone who can hold a pen and sign a document. This means you're going to lend a lot more money and this is what caused the bubble. It's not because women were forcing their husbands to borrow, it's because financial wrangling shifted the risks from the lenders to third parties further down the line.
        yummyfajitas 17y ago
        The problem with your theory is that many banks kept the riskiest tranches of loans for themselves while selling the safer tranches to others. They would only have done this if they believed the underlying mortgages were still good. Regardless, none of this would have been possible if housing consumers didn't become housing speculators. Realtors ran commercials encouraging women to browbeat their husband into buying houses they couldn't afford (http://www.youtube.com/watch?v=Ubsd-tWYmZw http://www.youtube.com/watch?v=Ubsd-tWYmZw). Bush and Barney Frank encouraged commercial banks to lower lending standards. Speculators followed the crowd and suffered for their folly. The bubble would have existed without speculators, though it probably would not have been as large.
sanj 17y ago
I've always assumed that "Sophisticated" Investors are those that have more money to invest/lose.
rmorrison 17y ago
The way "sophisticated investor" is used bothers me. In most places where it's currently used, I want "sophisticated investor" to mean people who are fully responsible for their money. If they invest it and quintuple it, cool for them (and they can keep it). If they invest it and lose it, sucks for them (and we don't bail them out). Using this definition, if "sophisticated investors" lose their life savings to Bernie Madoff, sucks for them. They would still have a civil claim against him in court for lying, but they shouldn't get a government bailout. I also want to be able to sign some government-support-waiver, and be able to invest my money however I want. Even if my net worth isn't $2 million and my salary is less than $500k/year.

20 points by cwan 17y ago

deleted 17y ago

[deleted]

The author of this post shows the difference between sophisticated investors and himself: Consider synthetic CDOs like Abacus. Banks would need to lend out $50 billion of mortgages to regular people in order to create a $1 billion CDO like Abacus, according to Michael Lewis in The Big Short. A sophisticated investor realizes that banks didn't need to lend out ANY mortgages to create a synthetic CDO. A sophisticated investor realizes that a synthetic CDO is the long side of a bet against the markets. A sophisticated investor will also form their own opinion about the bet, based on information about the assets underlying the bet (which were available to every investor), and will not really care that "omfg, the other side of this bet is a no-name mid-range hedge fund!"

philk 17y ago
I'm not sure, however, that there's a huge use to society in allowing many bets like this given at the very least it's a huge sink for quality human capital. I understand that there is value from the insurance/hedging side, but as we've seen recently risks may be concealed rather than allayed.
- yummyfajitas 17y ago
  John Paulson and a few other smart people told the world "hey, we are in a bubble". They put their money where their mouth is and shorted the market. They and helped prevent us from funneling further labor and resources into housing we don't need. Do you really think the world would have been a better place if Paulson built twitter 2.0 rather than pushing CDO prices down?
  - philk 17y ago
    Yes, but the bubble itself was created by investors building and selling complex financial instruments in the first place. Wouldn't it be better if investment bankers had been building legitimate businesses rather than working out new ways to repackage and sell subprime mortgages?
    - yummyfajitas 17y ago
      The bubble was created by simple instruments: home mortgages. It would have been better if women weren't forcing their husbands to buy houses they couldn't afford, government wasn't encouraging lenders to make bad loans, and realtors weren't adding fuel to the fire. I don't see a way to prevent all of that, since all of those things are still happening. The only reason the bubble burst was because of investment banks and other speculators eventually figuring out the problem and putting a stop to it.
      - philk 17y ago
        No it wasn't. It was caused by lenders being able to lend money that wasn't theirs, facilitated by complex financial instruments. If you're a bank and you're lending your own money you've got an incentive to make sure the loans can be repaid. If you're a bank and you can instead take the loans you've made, parcel the debt up in a complicated financial instrument, sell it off to others and take an essentially risk free commission then you've got an incentive to loan money to anyone who can hold a pen and sign a document. This means you're going to lend a lot more money and this is what caused the bubble. It's not because women were forcing their husbands to borrow, it's because financial wrangling shifted the risks from the lenders to third parties further down the line.
        yummyfajitas 17y ago
        The problem with your theory is that many banks kept the riskiest tranches of loans for themselves while selling the safer tranches to others. They would only have done this if they believed the underlying mortgages were still good. Regardless, none of this would have been possible if housing consumers didn't become housing speculators. Realtors ran commercials encouraging women to browbeat their husband into buying houses they couldn't afford (http://www.youtube.com/watch?v=Ubsd-tWYmZw http://www.youtube.com/watch?v=Ubsd-tWYmZw). Bush and Barney Frank encouraged commercial banks to lower lending standards. Speculators followed the crowd and suffered for their folly. The bubble would have existed without speculators, though it probably would not have been as large.

sanj 17y ago

I've always assumed that "Sophisticated" Investors are those that have more money to invest/lose.

rmorrison 17y ago

The way "sophisticated investor" is used bothers me. In most places where it's currently used, I want "sophisticated investor" to mean people who are fully responsible for their money. If they invest it and quintuple it, cool for them (and they can keep it). If they invest it and lose it, sucks for them (and we don't bail them out). Using this definition, if "sophisticated investors" lose their life savings to Bernie Madoff, sucks for them. They would still have a civil claim against him in court for lying, but they shouldn't get a government bailout. I also want to be able to sign some government-support-waiver, and be able to invest my money however I want. Even if my net worth isn't $2 million and my salary is less than $500k/year.