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I love Matt Levine's articles. He's good at simply explaining the arcana of Wall Street. But when I read this article, I can only say one thing: Why? Why is W

I love Matt Levine's articles. He's good at simply explaining the arcana of Wall Street. But when I read this article, I can only say one thing: Why? Why is Wall Street spending all this time and energy in creating all these different securities? I suspect that any excess "profits" or "returns" to be had from them accrue 90% to the bankers and 10% to the muppets funding them. So why do the muppets keep playing this game?

x3n0ph3n3 11y ago
Because muppets don't believe they are muppets.
- a3n 11y ago
  If you look around the table, and you can't find the muppet, ...
meric 11y ago
The muppets are fund managers who use other people's money to buy Wall Street securities. People have fund managers because of the law.
- kennethh 11y ago
  Muppets are usually pension funds, where the people doing the investing want to do it as easy as possible and with high rewards so they get the bonus for doing nothing.
mathattack 11y ago
People need to invest their money somewhere. In this case, the sucker would actually have been DB's investors if the worst case ever did happen. (They would have gone under like many other banks - the bailout saved them.) In this case the investors they sold protection to (hedge funds) got better prices than they ordinarily would have, because of the risk hidden in the conduit.
zzleeper 11y ago
To expand on the other replies, and based on experience: 1) The way you get to sell products to investors is by promising some sort of alpha: "My fund is less risky, my derivative pays more for the same risk, etc." 2) But magic does not happen in the financial markets (and when it does is through the old stories.. diversification, transferring the risk to those of broader shoulders, etc.) 3) So what you do is HIDE THE RISK. There are many ways to do that, and they usually involve COMPLEXITY. Complexity and opacity are your friends, as they confuse investors who don't realize there is a hidden risk somewhere there, or a scenario you haven't told them (but put on page 350) where if A B and C happen, then he will lose a lot of money. I'm not joking here.. sometimes complexity is good as it allows you to e.g. reduce mismatches in your risks (your income is in USD and expenses in EUR, your debts are long term and assets short term, etc.). However, the ultimate purpose of most complex products is that they allow you to sell stuff that appears better than it really is. And IT WORKS. Everytime. Against millionaires and against folks buying silly combos of insurances plus deposits (forgot their names).
- PhantomGremlin 11y ago
  > So what you do is HIDE THE RISK I've been rereading my copy of Taleb's Antifragile. He keeps hammering similar points over and over: complexity, risk, opacity, susceptibility to Black Swans, etc. I think I'd be depressed if I worked on Wall Street and the better part of my compensation resulted from peddling all these confusing products. Still, as you point out, sometimes complexity is good. I do understand that.
- mynegation 11y ago
  These combos are called "structured products"
- wpietri 11y ago
  And I would almost be ok with this if the complexity-generators understood all their complexity and were using it as a great trick to steal money from idiots. What really scares me is that a) even the complexity-generators can easily miss potential issues, and b) when you throw all this complexity together, nobody has any clue what's going on. And then we wrap it up all with a bow by allowing finance people to alternately claim that a) they are so smart they deserve to personally make millions to billions, and b) they couldn't possibly be held accountable for systemic fuckups, because nobody could possibly have known. I'll accept one or the other, but the combination is incredibly dangerous.
ddeck 11y ago
>Why is Wall Street spending all this time and energy in creating all these different securities? The primary purpose of these trades is to offload super senior risk from DB's balance sheet. Super senior risk is the risk that DB retained when it (very profitably) sold various other tranches on a group of assets (typically CDS on a bunch of corporate and sovereign credits). This type of risk is very difficult to sell as the return is very low and most entities they might buy unfunded protection from are likely to not be able to pay in the event that the swap pays out. Offloading that risk through a swap to a conduit like this allows DB to release (expensive) capital/reserves that would otherwise need to hold.
lmm 11y ago
It's a regulatory arbitrage. Everyone knows that the risk on those super-senior tranches is basically zero (it would take something like 60% of the world's investment-grade companies going bankrupt for them to actually pay off), but the regulations say that Deutsche would have to hold assets to cover it. So they find some investors who declare that they'll cover it instead, in exchange for a few percentage points, and everybody wins: the investors get (a small amount of) free money, Deutsche can hold fewer assets and use its balance sheet for more profitable things. Even the regulators probably don't mind so much - the regulations are overly simplistic (dare I say populist?) in circumstances like this, and everyone knows that.
- FeepingCreature 11y ago
  My programmer instinct here is - if the regulations have a problem, let profit fail to be made. Fail early, fail hard, then go fix it. Don't go off operating in an undefined state.
  - lmm 11y ago
    I think anyone who has programmed for a medium- or large-sized organization will be familiar with the experience of getting a stupid technical directive from above (e.g. "this part must be XML") and treating it as an obstruction to be worked around (while technically abiding by the letter of it). It's not an undefined state, it's just a case where the rule is unhelpful.
deleted 11y ago
[deleted]
pjc50 11y ago
The "muppets" are multi-billionaire asset holders. That money has to go somewhere and they want a return on it, or at least the promise of a return. Quite a lot of financial strangeness can be answered with "where else are you going to put your money?" Western treasury bonds are the safe option, but they're close to negative yields. Spending $1.01 at auction to buy a bond which nominally costs 95c and pays back $1 in five years doesn't look great. So there is a huge demand for "riskless" positive-yielding investments. That's why London (and elsewhere) property continues to shoot upwards in value way beyond the ability of the inhabitants to afford it. That's why Switzerland has negative interest rates. And so on.

x3n0ph3n3 11y ago

Because muppets don't believe they are muppets.

a3n 11y ago
If you look around the table, and you can't find the muppet, ...

meric 11y ago

The muppets are fund managers who use other people's money to buy Wall Street securities. People have fund managers because of the law.

kennethh 11y ago
Muppets are usually pension funds, where the people doing the investing want to do it as easy as possible and with high rewards so they get the bonus for doing nothing.

mathattack 11y ago

People need to invest their money somewhere. In this case, the sucker would actually have been DB's investors if the worst case ever did happen. (They would have gone under like many other banks - the bailout saved them.) In this case the investors they sold protection to (hedge funds) got better prices than they ordinarily would have, because of the risk hidden in the conduit.

zzleeper 11y ago

To expand on the other replies, and based on experience: 1) The way you get to sell products to investors is by promising some sort of alpha: "My fund is less risky, my derivative pays more for the same risk, etc." 2) But magic does not happen in the financial markets (and when it does is through the old stories.. diversification, transferring the risk to those of broader shoulders, etc.) 3) So what you do is HIDE THE RISK. There are many ways to do that, and they usually involve COMPLEXITY. Complexity and opacity are your friends, as they confuse investors who don't realize there is a hidden risk somewhere there, or a scenario you haven't told them (but put on page 350) where if A B and C happen, then he will lose a lot of money. I'm not joking here.. sometimes complexity is good as it allows you to e.g. reduce mismatches in your risks (your income is in USD and expenses in EUR, your debts are long term and assets short term, etc.). However, the ultimate purpose of most complex products is that they allow you to sell stuff that appears better than it really is. And IT WORKS. Everytime. Against millionaires and against folks buying silly combos of insurances plus deposits (forgot their names).

PhantomGremlin 11y ago
> So what you do is HIDE THE RISK I've been rereading my copy of Taleb's Antifragile. He keeps hammering similar points over and over: complexity, risk, opacity, susceptibility to Black Swans, etc. I think I'd be depressed if I worked on Wall Street and the better part of my compensation resulted from peddling all these confusing products. Still, as you point out, sometimes complexity is good. I do understand that.
mynegation 11y ago
These combos are called "structured products"
wpietri 11y ago
And I would almost be ok with this if the complexity-generators understood all their complexity and were using it as a great trick to steal money from idiots. What really scares me is that a) even the complexity-generators can easily miss potential issues, and b) when you throw all this complexity together, nobody has any clue what's going on. And then we wrap it up all with a bow by allowing finance people to alternately claim that a) they are so smart they deserve to personally make millions to billions, and b) they couldn't possibly be held accountable for systemic fuckups, because nobody could possibly have known. I'll accept one or the other, but the combination is incredibly dangerous.

ddeck 11y ago

>Why is Wall Street spending all this time and energy in creating all these different securities? The primary purpose of these trades is to offload super senior risk from DB's balance sheet. Super senior risk is the risk that DB retained when it (very profitably) sold various other tranches on a group of assets (typically CDS on a bunch of corporate and sovereign credits). This type of risk is very difficult to sell as the return is very low and most entities they might buy unfunded protection from are likely to not be able to pay in the event that the swap pays out. Offloading that risk through a swap to a conduit like this allows DB to release (expensive) capital/reserves that would otherwise need to hold.

lmm 11y ago

It's a regulatory arbitrage. Everyone knows that the risk on those super-senior tranches is basically zero (it would take something like 60% of the world's investment-grade companies going bankrupt for them to actually pay off), but the regulations say that Deutsche would have to hold assets to cover it. So they find some investors who declare that they'll cover it instead, in exchange for a few percentage points, and everybody wins: the investors get (a small amount of) free money, Deutsche can hold fewer assets and use its balance sheet for more profitable things. Even the regulators probably don't mind so much - the regulations are overly simplistic (dare I say populist?) in circumstances like this, and everyone knows that.

FeepingCreature 11y ago
My programmer instinct here is - if the regulations have a problem, let profit fail to be made. Fail early, fail hard, then go fix it. Don't go off operating in an undefined state.
- lmm 11y ago
  I think anyone who has programmed for a medium- or large-sized organization will be familiar with the experience of getting a stupid technical directive from above (e.g. "this part must be XML") and treating it as an obstruction to be worked around (while technically abiding by the letter of it). It's not an undefined state, it's just a case where the rule is unhelpful.

deleted 11y ago

[deleted]

pjc50 11y ago

The "muppets" are multi-billionaire asset holders. That money has to go somewhere and they want a return on it, or at least the promise of a return. Quite a lot of financial strangeness can be answered with "where else are you going to put your money?" Western treasury bonds are the safe option, but they're close to negative yields. Spending $1.01 at auction to buy a bond which nominally costs 95c and pays back $1 in five years doesn't look great. So there is a huge demand for "riskless" positive-yielding investments. That's why London (and elsewhere) property continues to shoot upwards in value way beyond the ability of the inhabitants to afford it. That's why Switzerland has negative interest rates. And so on.