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I find your arguments plausible, but many finance companies were bailed out in a big way by the government recently. I think it's possible that some of these c

I find your arguments plausible, but many finance companies were bailed out in a big way by the government recently. I think it's possible that some of these companies were playing games that gave them a high probability of a decent gain and a small probability of a catastrophic loss. It seems unlikely that playing this sort of game contributes to more accurate pricing.

fleitz 16y ago
Well actually some of the guys who did VERY well did so by buying CDSs (credit default swaps) against CDOs (collateralized debt obligations) it's very likely that the bubble was curtailed before it got even further out of control as some very smart individuals were able to short the housing market via a CDS against a CDO. This pricing differential was essential to Goldman getting out of CDOs and into CDSs against CDOs after they figured out what John Paulson and others were up to. The price increase in CDSs against CDOs in retail mortgages alerted Goldman to the fact that people were very interested in a CDS against what they thought was a very solid asset (CDO consisting of residential mortgages). This is also why AIG got bailed out, GS had enough CDSs with AIG that if AIG went so would GS. I definitely agree with you that in the long run bailouts create an atmosphere of moral hazard and irrational exuberance. The problem also largely stems from political economics, as a representative you want to remain elected, therefore if you can kick the economic collapse can down the road a few years or spread its impact over many years you can stay in office. Therefore the rational economic choice for politicians is to favor bailouts. Very few people will not vote for you because 5 years later their taxes are 10% higher, but most will not vote for you if they lose their job. By the same token most people would rather take a 10% pay cut for 10 years than have no income for 1.

fleitz 16y ago

Well actually some of the guys who did VERY well did so by buying CDSs (credit default swaps) against CDOs (collateralized debt obligations) it's very likely that the bubble was curtailed before it got even further out of control as some very smart individuals were able to short the housing market via a CDS against a CDO. This pricing differential was essential to Goldman getting out of CDOs and into CDSs against CDOs after they figured out what John Paulson and others were up to. The price increase in CDSs against CDOs in retail mortgages alerted Goldman to the fact that people were very interested in a CDS against what they thought was a very solid asset (CDO consisting of residential mortgages). This is also why AIG got bailed out, GS had enough CDSs with AIG that if AIG went so would GS. I definitely agree with you that in the long run bailouts create an atmosphere of moral hazard and irrational exuberance. The problem also largely stems from political economics, as a representative you want to remain elected, therefore if you can kick the economic collapse can down the road a few years or spread its impact over many years you can stay in office. Therefore the rational economic choice for politicians is to favor bailouts. Very few people will not vote for you because 5 years later their taxes are 10% higher, but most will not vote for you if they lose their job. By the same token most people would rather take a 10% pay cut for 10 years than have no income for 1.