6 ms·

Some of this article is well written however the attacks on innovations such as ABS an CDOs is tacky, yes they haven't done well, but that's the nature of innov

by ig1 16y ago

Some of this article is well written however the attacks on innovations such as ABS an CDOs is tacky, yes they haven't done well, but that's the nature of innovation. You're always going to have some innovations that do well and other that do badly, the only way you'll find out is through execution. They were both designed to solve practical problems in liquidity and price discovery. Picking through individual failures and saying the whole system is bad on that basis is like saying startups are worthless because WebVan failed.

chopsueyar 16y ago
Hell of a place to choose to run 'experiments'. Try that shit in an emerging market, first.
- ig1 16y ago
  Each market is different. Even between developed markets, what might work in London might not work in New York or Tokyo. Sure you can block all innovation, but you need to accept you'll block out the good as well as the bad. And that comes at the cost of economic growth.
  - jfoutz 16y ago
    It's a wildly unpopular idea here, but i think a progressive tax really encourages innovation. A zillion small scale trades with little to no tax consequences encourage people really explore the space. Effective strategies grow till efficiency is overcome by tax friction. "To big to fail" is limited by the structure of the system, rather than regulation.
palewery 16y ago
I wonder if it would be called innovation if we called these 'Products' what they really are. CDO='insurance on loans', Synthetic CDOS = 'making bets on other people's loans' When Las Vegas casinos come up with new ways to gamble is it called innovation?
- yummyfajitas 16y ago
  Synthetic CDOs are actually more clever than that. They solve the problem of me wanting mortgage bonds, and you wanting insurance on loans. We both want to take opposite positions (me long, you short). Without a synthetic CDO, we are unable to trade - I'll be trying to buy home loans from WaMu and you'll be talking to the AIG sales desk.
  - loewenskind 16y ago
    The problem with synthetic CDOs is that they're over the counter. You can have more people betting against loans than actual loans and since they weren't controlled the one who was supposed to pay out [1] might not be able to. Speaking to the gambling point, I believe it was Deutsche bank who went to the government to make sure synthetic CDOs wouldn't be classified as gambling before starting to sell them. [1] I can't say "issuer" because these were sold around.
- ig1 16y ago
  > When Las Vegas casinos come up with new ways to gamble is it called innovation? Yes. In my personal opinion the difference between gambling and investment isn't in terminology. It's about expect return. If your expected return is negative than it's gambling, if your expected return is positive it's investment.
  - arethuza 16y ago
    I really don't think gamblers think that way - I know people who play poker fairly seriously (which is clearly gambling) and they play to win and generally they do pretty well - certainly well above break-even.
    - tkahn6 16y ago
      I think serious poker is in a different category than slots or roulette. You can call it gambling but there's a reason there exist top poker players who win with consistency. If it were really random chance, you wouldn't see players that make a living playing poker.
chunkbot 16y ago
Unfortunately, the individual failures were bad enough to bring down the whole system.
- ig1 16y ago
  tbh. If it wasn't CMOs it would have been something else. The fundamental problem here is systematic risk, a bank should be able to fail without bring down other banks, unfortunately the system wasn't able to cope with the failure of a large number of banks who were all exposed to the same risk. If a bunch of the big US car companies failed we may well have seen the same thing, because a lot of the US banks are heavily exposed to that sector. It just so happened it was mortgages that happened to be the tipping point this time. Imagine your a bank and you have a bunch of other banks you deal with, you assign them all individually a "credit risk score" so you know how much extra to charge them to protect you against the risk of them failing before they have a chance to pay you what they owe you (much the same way as credit scores work for people). But you have no-way of understanding the correlation between the risks, if all the banks your dealing with are actually exposed to the same underlying risk (i.e the CMO market) then the risk your exposed to is actually far higher than the sum of the individual risks. But obviously the banks you're dealing with can't tell you what their underlying risks are because that's propriety information, so all you have to go on is the risk rating given by ratings agencies. This is a fundamentally hard problem to solve. No-one really has a good solution. It's much easier to say "let's ban CMOs" than to admit we don't really know how to solve the problem.
  - iwr 16y ago
    It would have been far cheaper just to rescue the FDIC and preserve the money held in savings/checking accounts.
    - ig1 16y ago
      Savings accounts are only a tiny part of the equation, the impact on businesses of a wide spread collapse of investment banks would be much larger. Other countries which offered guarantees on savings accounts still bailed out banks due to the wider economic issues.
notahacker 16y ago
As I interpreted it, the attack was more on the economic rent extracted by the originators of the "zero sum" ABS and CDOs rather than the concepts themselves; the core thesis being that there would be a lot less profit to be extracted from originating opaque financial products if demand for them wasn't artificially inflated by buyers and sellers being insulated from the downside risk of their decisions. It's more akin to saying you end up with too many startups getting too much funding in a climate where investors don't do adequate due diligence. You won't find startups "innovating" in as brazenly cynical a manner as alleged in the Goldman Sachs example the author recounts either...startups don't profit from people shorting the stock they issue.
jbooth 16y ago
I think the point is that they actually don't solve any practical problems in liquidity or price discovery. Does anyone on earth care about the price of lumber within even a 24 hour window? Why should we care about a sub second window? We don't. Wall Street refers to the high frequency game as "taking the dumb money". I call it "ripping off the value investors who actually serve a role in the economy". Finance serves an important function in the economy, routing money to where it's needed. Are they doing a better job of that now than they were in 1985? Not really. So why are they extracting 10X the money in bonuses and profits?
- Symmetry 16y ago
  I'm not sure about subsecond windows, but 24 hour windows certainly matter. Say you're planning on making a big order of lumber for your mill and you're ordering from a market with zero speculation so the prices jump up and down with the supplier's inventory. It makes a lot of sense then to wait a few days (during which your machines and workers are idle) to get the best price possible. I'm not going to say that high frequency trading serves a useful purpose, but to me that looks like a zero-sum struggle between Wall Street firms for profits that Wall Street deserves for doing its thing on a minute to minute or hour to hour level.
  - jbooth 16y ago
    Ok, fine, downgrade 24 hours to 1 hour. Nobody cares about those prices within 1 hour. We've had markets that operate within 1 hour for over a century. What did all the "innovation" actually produce? I know Wall St is making more money but are they providing more value?
    - yummyfajitas 16y ago
      High speed trading is only relevant to the competition between market makers and other short term speculators. It has no effect on long term speculators/hedgers/etc. If you want to trade right now, you will pay a few cents/share for the privilege (this is the spread). If my company was fastest, we sit at the top of the order queue, and we will receive those few cents/share. If GS was faster, they get the pennies. Either way, you trade right now. And if I decide to cut in line by offering a better price, you trade right now for less.

by ig1 16y ago

chopsueyar 16y ago

Hell of a place to choose to run 'experiments'. Try that shit in an emerging market, first.

ig1 16y ago
Each market is different. Even between developed markets, what might work in London might not work in New York or Tokyo. Sure you can block all innovation, but you need to accept you'll block out the good as well as the bad. And that comes at the cost of economic growth.
- jfoutz 16y ago
  It's a wildly unpopular idea here, but i think a progressive tax really encourages innovation. A zillion small scale trades with little to no tax consequences encourage people really explore the space. Effective strategies grow till efficiency is overcome by tax friction. "To big to fail" is limited by the structure of the system, rather than regulation.

palewery 16y ago

I wonder if it would be called innovation if we called these 'Products' what they really are. CDO='insurance on loans', Synthetic CDOS = 'making bets on other people's loans' When Las Vegas casinos come up with new ways to gamble is it called innovation?

yummyfajitas 16y ago
Synthetic CDOs are actually more clever than that. They solve the problem of me wanting mortgage bonds, and you wanting insurance on loans. We both want to take opposite positions (me long, you short). Without a synthetic CDO, we are unable to trade - I'll be trying to buy home loans from WaMu and you'll be talking to the AIG sales desk.
- loewenskind 16y ago
  The problem with synthetic CDOs is that they're over the counter. You can have more people betting against loans than actual loans and since they weren't controlled the one who was supposed to pay out [1] might not be able to. Speaking to the gambling point, I believe it was Deutsche bank who went to the government to make sure synthetic CDOs wouldn't be classified as gambling before starting to sell them. [1] I can't say "issuer" because these were sold around.
ig1 16y ago
> When Las Vegas casinos come up with new ways to gamble is it called innovation? Yes. In my personal opinion the difference between gambling and investment isn't in terminology. It's about expect return. If your expected return is negative than it's gambling, if your expected return is positive it's investment.
- arethuza 16y ago
  I really don't think gamblers think that way - I know people who play poker fairly seriously (which is clearly gambling) and they play to win and generally they do pretty well - certainly well above break-even.
  - tkahn6 16y ago
    I think serious poker is in a different category than slots or roulette. You can call it gambling but there's a reason there exist top poker players who win with consistency. If it were really random chance, you wouldn't see players that make a living playing poker.

chunkbot 16y ago

Unfortunately, the individual failures were bad enough to bring down the whole system.

ig1 16y ago
tbh. If it wasn't CMOs it would have been something else. The fundamental problem here is systematic risk, a bank should be able to fail without bring down other banks, unfortunately the system wasn't able to cope with the failure of a large number of banks who were all exposed to the same risk. If a bunch of the big US car companies failed we may well have seen the same thing, because a lot of the US banks are heavily exposed to that sector. It just so happened it was mortgages that happened to be the tipping point this time. Imagine your a bank and you have a bunch of other banks you deal with, you assign them all individually a "credit risk score" so you know how much extra to charge them to protect you against the risk of them failing before they have a chance to pay you what they owe you (much the same way as credit scores work for people). But you have no-way of understanding the correlation between the risks, if all the banks your dealing with are actually exposed to the same underlying risk (i.e the CMO market) then the risk your exposed to is actually far higher than the sum of the individual risks. But obviously the banks you're dealing with can't tell you what their underlying risks are because that's propriety information, so all you have to go on is the risk rating given by ratings agencies. This is a fundamentally hard problem to solve. No-one really has a good solution. It's much easier to say "let's ban CMOs" than to admit we don't really know how to solve the problem.
- iwr 16y ago
  It would have been far cheaper just to rescue the FDIC and preserve the money held in savings/checking accounts.
  - ig1 16y ago
    Savings accounts are only a tiny part of the equation, the impact on businesses of a wide spread collapse of investment banks would be much larger. Other countries which offered guarantees on savings accounts still bailed out banks due to the wider economic issues.

notahacker 16y ago

As I interpreted it, the attack was more on the economic rent extracted by the originators of the "zero sum" ABS and CDOs rather than the concepts themselves; the core thesis being that there would be a lot less profit to be extracted from originating opaque financial products if demand for them wasn't artificially inflated by buyers and sellers being insulated from the downside risk of their decisions. It's more akin to saying you end up with too many startups getting too much funding in a climate where investors don't do adequate due diligence. You won't find startups "innovating" in as brazenly cynical a manner as alleged in the Goldman Sachs example the author recounts either...startups don't profit from people shorting the stock they issue.

jbooth 16y ago

I think the point is that they actually don't solve any practical problems in liquidity or price discovery. Does anyone on earth care about the price of lumber within even a 24 hour window? Why should we care about a sub second window? We don't. Wall Street refers to the high frequency game as "taking the dumb money". I call it "ripping off the value investors who actually serve a role in the economy". Finance serves an important function in the economy, routing money to where it's needed. Are they doing a better job of that now than they were in 1985? Not really. So why are they extracting 10X the money in bonuses and profits?

Symmetry 16y ago
I'm not sure about subsecond windows, but 24 hour windows certainly matter. Say you're planning on making a big order of lumber for your mill and you're ordering from a market with zero speculation so the prices jump up and down with the supplier's inventory. It makes a lot of sense then to wait a few days (during which your machines and workers are idle) to get the best price possible. I'm not going to say that high frequency trading serves a useful purpose, but to me that looks like a zero-sum struggle between Wall Street firms for profits that Wall Street deserves for doing its thing on a minute to minute or hour to hour level.
- jbooth 16y ago
  Ok, fine, downgrade 24 hours to 1 hour. Nobody cares about those prices within 1 hour. We've had markets that operate within 1 hour for over a century. What did all the "innovation" actually produce? I know Wall St is making more money but are they providing more value?
  - yummyfajitas 16y ago
    High speed trading is only relevant to the competition between market makers and other short term speculators. It has no effect on long term speculators/hedgers/etc. If you want to trade right now, you will pay a few cents/share for the privilege (this is the spread). If my company was fastest, we sit at the top of the order queue, and we will receive those few cents/share. If GS was faster, they get the pennies. Either way, you trade right now. And if I decide to cut in line by offering a better price, you trade right now for less.