4 ms·

You can't "know better" when the risk is deliberately obfuscated in millions of pages of paper.

cm2187 8y ago
I don't think that the investors who got burned by CDOs in 2008 didn't understand the mechanism of transmission of losses in these structured transactions. They simply grossly underestimated the underlying risk they were exposed to (the assumption that the real estate market in the US was diversified and that it wouldn't all go down at the same time). Plus the quality of the underwritting had gone down the drain, but I am not convinced it was documented as such. But even if it was all documented, we are not talking about millions of pages of paper. A typical documentation for one of these structures is 200-500 pages, of which a lot is mostly irrelevant. An investor taking a significant position in one of these structures ought to read the relevant parts. But even highly paid professionals can be lazy too.
navigatesol 8y ago
So why are people/institutions buying things they do not understand? If you ask me, they are the greedy party.
- hannasanarion 8y ago
  Or you can be both. Part of the impetus for the 2007 crash was that investment companies like AIG were making complicated and obscure financial instruments that hid lots of risk, while also being the agency everybody looked to to grade the risk of financial instruments. They rated their own mortgage debt products as low-risk based on fraudulent analysis.
shitgoose 8y ago
can you, please, clarify, what those "millions of pages of paper" are?
- module0000 8y ago
  Presumably he means a noise-laden prospectus detailing the financial instruments in use for a particular fund. If you have a money manager, are you paying him/her to read that paper, and it's not millions of pages. They look something like this...think of it as a set of rules for what the manager does with your money: 1) We invest you stocks/bonds rated <N> and above 2) We exit positions under <XYZ> circumstances 3) We enter positions under <ABC> circumstances 4) Past performance by following rules 1-3 is N% No one failed to read these in the past, instead they focused on the potential profit, which blinded them to the potential downside. This is an investing 101 lesson, that continues to be taught to money managers each time their profit chasing occludes their risk management. If you, a regular working class citizen, were burned by this(perhaps in your 401k), then it's worth reading the prospectus your fund manager sent you. When you see the list of funds included in your fund, you should have received a prospectus for each of those as well. Look for which funds make up the majority of your funds holdings, and read those prospectuses. If you find(and are uncomfortable with) one of those funds being a triple-leveraged ETF backed by 30-year mortgages, then you should talk to your fund manager about that.
whatok 8y ago
These things are not sold to retail investors. If you're an institutional investor and don't know what you're investing in, that's on you.
- mattmanser 8y ago
  No it's not, it's on the taxpayers because they get bailed out.
- short_sells_poo 8y ago
  The darker side of the problem is that staff and decision makers at institutions have no skin in the game so to speak. They are not the owners, and are highly unlikely to see the long term downside of their decisions. They hope that by the time the music stops playing, they won't be around to have to deal with the consequences. Some token measures like deferred bonuses or long vesting stock options have been done, but ultimately this just pushed out the horizon a bit. So you have to take care no to be part of a cockup in 5 years instead of 1 year.
  - whatok 8y ago
    I don't disagree that incentive structures drive poor long-term decisions but that's separate from "omg complex 100000 page prospectus". Misaligned perspectives exist whether there's a prospectus or not.
    - short_sells_poo 8y ago
      You are right of course, I was just trying to provide an explanation as to why institutional clients aren't more diligent. They are often not particularly skilled either, as those who can see through the game are on the other side of the trade. Working at a pension fund is not a sexy or exciting proposition by any measure, so talent tends to go elsewhere. It's the same situation as bright researchers going to finance where they get paid multiples of what they'd earn in their own field. Once you sign your soul to the devil, it is very difficult to get out. I'm speaking from experience.
- 8y ago

I don't think that the investors who got burned by CDOs in 2008 didn't understand the mechanism of transmission of losses in these structured transactions. They simply grossly underestimated the underlying risk they were exposed to (the assumption that the real estate market in the US was diversified and that it wouldn't all go down at the same time). Plus the quality of the underwritting had gone down the drain, but I am not convinced it was documented as such. But even if it was all documented, we are not talking about millions of pages of paper. A typical documentation for one of these structures is 200-500 pages, of which a lot is mostly irrelevant. An investor taking a significant position in one of these structures ought to read the relevant parts. But even highly paid professionals can be lazy too.

navigatesol 8y ago

So why are people/institutions buying things they do not understand? If you ask me, they are the greedy party.

hannasanarion 8y ago
Or you can be both. Part of the impetus for the 2007 crash was that investment companies like AIG were making complicated and obscure financial instruments that hid lots of risk, while also being the agency everybody looked to to grade the risk of financial instruments. They rated their own mortgage debt products as low-risk based on fraudulent analysis.

shitgoose 8y ago

can you, please, clarify, what those "millions of pages of paper" are?

module0000 8y ago
Presumably he means a noise-laden prospectus detailing the financial instruments in use for a particular fund. If you have a money manager, are you paying him/her to read that paper, and it's not millions of pages. They look something like this...think of it as a set of rules for what the manager does with your money: 1) We invest you stocks/bonds rated <N> and above 2) We exit positions under <XYZ> circumstances 3) We enter positions under <ABC> circumstances 4) Past performance by following rules 1-3 is N% No one failed to read these in the past, instead they focused on the potential profit, which blinded them to the potential downside. This is an investing 101 lesson, that continues to be taught to money managers each time their profit chasing occludes their risk management. If you, a regular working class citizen, were burned by this(perhaps in your 401k), then it's worth reading the prospectus your fund manager sent you. When you see the list of funds included in your fund, you should have received a prospectus for each of those as well. Look for which funds make up the majority of your funds holdings, and read those prospectuses. If you find(and are uncomfortable with) one of those funds being a triple-leveraged ETF backed by 30-year mortgages, then you should talk to your fund manager about that.

whatok 8y ago

These things are not sold to retail investors. If you're an institutional investor and don't know what you're investing in, that's on you.

mattmanser 8y ago
No it's not, it's on the taxpayers because they get bailed out.
short_sells_poo 8y ago
The darker side of the problem is that staff and decision makers at institutions have no skin in the game so to speak. They are not the owners, and are highly unlikely to see the long term downside of their decisions. They hope that by the time the music stops playing, they won't be around to have to deal with the consequences. Some token measures like deferred bonuses or long vesting stock options have been done, but ultimately this just pushed out the horizon a bit. So you have to take care no to be part of a cockup in 5 years instead of 1 year.
- whatok 8y ago
  I don't disagree that incentive structures drive poor long-term decisions but that's separate from "omg complex 100000 page prospectus". Misaligned perspectives exist whether there's a prospectus or not.
  - short_sells_poo 8y ago
    You are right of course, I was just trying to provide an explanation as to why institutional clients aren't more diligent. They are often not particularly skilled either, as those who can see through the game are on the other side of the trade. Working at a pension fund is not a sexy or exciting proposition by any measure, so talent tends to go elsewhere. It's the same situation as bright researchers going to finance where they get paid multiples of what they'd earn in their own field. Once you sign your soul to the devil, it is very difficult to get out. I'm speaking from experience.
8y ago