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One interesting question the author obliquely brings up is this: Should all the financial regulation exist? My general sense is ... "not for things more compl

by pnathan 11y ago

One interesting question the author obliquely brings up is this: Should all the financial regulation exist? My general sense is ... "not for things more complicated than savings accounts, checking accounts, and basic mortgages". I really don't see the harm in prediction markets, even if they are putting together strange derivatives.

nosuchthing 11y ago
2007 called, they want their "mortgaged backed[1] security-derivatives[2]" back. [1] (mortgaged backed) = lenders were rubber stamping home loans to people who given their current income would not be able to pay back the loan. [2] "security derivatives" were created on those mortgages as financial instruments that could be traded like stocks, effectively like allowing a 3rd party to take out insurance on your car and get paid when you get in a crash... a full on BET against the bad mortgages - paying out if the mortgages went into default [3] https://en.wikipedia.org/wiki/Credit_rating_agencies_and_the_subprime_crisis https://en.wikipedia.org/wiki/Credit_rating_agencies_and_the... — credit rating agencies, trusted to research, validate and rate the mortgages were for some reason giving the obviously bad and likely to default mortgages ratings on AAA, thus allowing for a greater insurance pay out on the security-derivative bets, creating an incentive for investors to make shit tons of money from defaults on these loans not to mention the repossession of the properties by banks. TLDR; Unregulated 'prediction markets' seemingly colluded to create loans that could not be payed back, than created insurance on those bad loans - falsely evaluated as safe, inflating the pay out, and effectively fabricated a profitable bet against the entire global economy.
- maxerickson 11y ago
  The credit ratings agencies exist because of highly regulated markets. They are most relevant for things like pension funds that are legally required to buy investments above given ratings. It's quite likely that a completely unregulated market would not have that particular set of incentives.
  - s73v3r 11y ago
    I don't see how you can say that at all. One of the goals of making complex shit is to make it harder for people to tell what's going on. While there wouldn't be the incentive to hide from regulators, there absolutely still would be the incentive to hide from customers.
    - maxerickson 11y ago
      The basic thesis is that without regulators customers will be more careful. Another way to put it is that I sort bad regulation below no regulation: good regulation, no regulation, bad regulation. Just because the impression that someone out there is protecting people will cause them to be less wary. Some people will still buy snake oil, but a whole nother group of people will come to use the term as a pejorative.
  - davidgerard 11y ago
    > It's quite likely that a completely unregulated market would not have that particular set of incentives. Given the actual history of how these regulations came about, and what things were like before and after, this statement is inane.
    - maxerickson 11y ago
      Thanks. I take it you don't think it is possible for bad regulation to mislead people? Because that's a piece of what happened in the mortgage crisis, the ratings agencies were given a license to charge fees for putting stamps on bonds, and those bonds were sold into regulated investments like insurance and pensions, investments that people trusted to be in secure assets, in large part because they were regulated. Take away the regulation and a bunch of that money is stuffed in mattresses, which while perhaps unfortunate, is obviously a better outcome than disappearing into a financial black hole.
      - nosuchthing 11y ago
        Widespread trust seems better than widespread mistrust. Trust needs to be restored in regulators, rather than abolishing them and being left with so much uncertainty and a playing field ripe for malice.
tptacek 11y ago
A lot of the law around derivatives regulation seems to have the explicit purpose of building a wall between "gambling" and "risk management" (trading, hedging, &c). A regulatory problem with OTC derivatives in the '90s was that they were determined to be gambling devices, not real financial products. The law is obviously imperfect. But the goal --- don't let us pretend we're financing we're just running games --- seems pretty straightforward. So to my mind, debating the regs that brought down this exchange takes you in one (or more) of three directions: 1. You can believe we shouldn't regulate gambling at all, because people will find ways to gamble, and many people can gamble responsibly. As Levine points out, we might even benefit from the information generated by the gaming activity. 2. You can believe "main street" investors should have access to private company equity and not just large institutional investors. 3. You can believe we should not have "safety and soundness" as a goal for regulating retail financial transactions, and that the SEC/CFTC/&c should not serve a role for the financial system that is similar to the FDA's role for drugs (lots of people also think that the FDA does more harm than good). That is to say: companies should not have to spend large amounts of money to ensure "truth in labeling" for financial products. I tend to think you probably have to believe all of these things to think what Sand Hill Exchange was doing should have been lawful. For instance: if you think there's value in generating retail exposure to startup equity, there are obviously saner ways to provide it than relaxing regs on derivatives betting exchanges.
lorddoig 11y ago
> Should all the financial regulation exist? Almost certainly not. The regulatory burden of operating in the finance industry is overwhelming - innovation is not so much stifled as killed. The big boys thrive because the little guy doesn't stand a chance from the get-go. The whole industry is estimated to be worth ~17% of global GDP and that money, which is almost equivalent to the output of Europe (or every country in the world except the top ~17 richest nations), goes to a list of companies so small you could probably write their names on a single page. It's a joke.
- tptacek 11y ago
  It's far from obvious that the industry would be more diverse and less consolidated if regulations were relaxed. The overwhelming majority of that gigantic flow of money is not main-street retail activity; it's financial engineering serving the operational needs of giant corporations, none of whom are interested in e.g. working with a YC startup for their commercial paper needs.
  - lorddoig 11y ago
    I profoundly disagree. You may very well be right about the majority of that money servicing large corporations, but bear in mind that we're talking about a pot of money the size of Jupiter here. Payment processing alone is worth somewhere in the region of 1trillion USD annually. And that's just for moving money i.e. shuffling rows around databases. Bitcoin, while definitely imperfect, offers the hope of innovating this whole industry into oblivion and replacing it with something entirely autonomous. The insurance industry is worth another ~5trillion USD annually. The name of the game here, of course, is predictive analysis and I'd bet that my Netflix recommendations are more accurate than any assessment any insurance company has ever made of me. I think you'd have diversification up the wazoo in extremely short order. Edit: accuracy
    - tptacek 11y ago
      Payment processing alone is worth somewhere in the region of 6trillion USD annually This seems unlikely. Is this a top-line number? Why aren't existing VISA/MC processors the largest companies in the economy? The number you just gave is orders of magnitude higher than Apple's profits. A couple minutes Google searching suggests that being a card issuer puts you in a relatively low-margin business with absolutely enormous network effects.
s73v3r 11y ago
If the only ones who were ever affected by things in those markets were the ones directly investing in them, you'd be right. As is, however, no man is an island, and problems in those markets tend to bleed out and people who have no connections to them end up facing the consequences.
- maxerickson 11y ago
  There is a fair chance that people would be less inclined to create the interdependencies if there were no regulation. I don't mean that as an argument against regulation, but as an example, there are lots of stock market rules that make it simpler for individuals to make investments (required reporting of information, standards about how it is reported, etc). Without those rules, the risk would be higher and the investment would likely be lower, and the lower investment is exactly less connection to that market.
  - s73v3r 11y ago
    "There is a fair chance that people would be less inclined to create the interdependencies if there were no regulation." I don't buy that for a second.
    - maxerickson 11y ago
      Do you think Without those rules, the risk would be higher and the investment would likely be lower, and the lower investment is exactly less connection to that market. is nonsense, or maybe just disagree with parts or it? I think if I don't own stocks and bonds it is quite clear that I am not as sensitive to those markets.
  - davidgerard 11y ago
    Every regulation ever has come about for a reason of observed behaviour. So given your testable claim, I'd expect you to be able to provide before-and-after examples of regulations, wherein you show that even a significant percentage (of all regulations) make things worse.
emodendroket 11y ago
Yeah, of course not. Incidentally, I just woke up from a coma that I went into around 2006.
davidgerard 11y ago
The problem is when "prediction market" becomes "assassination market". With bitcoins.

by pnathan 11y ago

nosuchthing 11y ago

2007 called, they want their "mortgaged backed[1] security-derivatives[2]" back. [1] (mortgaged backed) = lenders were rubber stamping home loans to people who given their current income would not be able to pay back the loan. [2] "security derivatives" were created on those mortgages as financial instruments that could be traded like stocks, effectively like allowing a 3rd party to take out insurance on your car and get paid when you get in a crash... a full on BET against the bad mortgages - paying out if the mortgages went into default [3] https://en.wikipedia.org/wiki/Credit_rating_agencies_and_the_subprime_crisis https://en.wikipedia.org/wiki/Credit_rating_agencies_and_the... — credit rating agencies, trusted to research, validate and rate the mortgages were for some reason giving the obviously bad and likely to default mortgages ratings on AAA, thus allowing for a greater insurance pay out on the security-derivative bets, creating an incentive for investors to make shit tons of money from defaults on these loans not to mention the repossession of the properties by banks. TLDR; Unregulated 'prediction markets' seemingly colluded to create loans that could not be payed back, than created insurance on those bad loans - falsely evaluated as safe, inflating the pay out, and effectively fabricated a profitable bet against the entire global economy.

maxerickson 11y ago
The credit ratings agencies exist because of highly regulated markets. They are most relevant for things like pension funds that are legally required to buy investments above given ratings. It's quite likely that a completely unregulated market would not have that particular set of incentives.
- s73v3r 11y ago
  I don't see how you can say that at all. One of the goals of making complex shit is to make it harder for people to tell what's going on. While there wouldn't be the incentive to hide from regulators, there absolutely still would be the incentive to hide from customers.
  - maxerickson 11y ago
    The basic thesis is that without regulators customers will be more careful. Another way to put it is that I sort bad regulation below no regulation: good regulation, no regulation, bad regulation. Just because the impression that someone out there is protecting people will cause them to be less wary. Some people will still buy snake oil, but a whole nother group of people will come to use the term as a pejorative.
- davidgerard 11y ago
  > It's quite likely that a completely unregulated market would not have that particular set of incentives. Given the actual history of how these regulations came about, and what things were like before and after, this statement is inane.
  - maxerickson 11y ago
    Thanks. I take it you don't think it is possible for bad regulation to mislead people? Because that's a piece of what happened in the mortgage crisis, the ratings agencies were given a license to charge fees for putting stamps on bonds, and those bonds were sold into regulated investments like insurance and pensions, investments that people trusted to be in secure assets, in large part because they were regulated. Take away the regulation and a bunch of that money is stuffed in mattresses, which while perhaps unfortunate, is obviously a better outcome than disappearing into a financial black hole.
    - nosuchthing 11y ago
      Widespread trust seems better than widespread mistrust. Trust needs to be restored in regulators, rather than abolishing them and being left with so much uncertainty and a playing field ripe for malice.

tptacek 11y ago

A lot of the law around derivatives regulation seems to have the explicit purpose of building a wall between "gambling" and "risk management" (trading, hedging, &c). A regulatory problem with OTC derivatives in the '90s was that they were determined to be gambling devices, not real financial products. The law is obviously imperfect. But the goal --- don't let us pretend we're financing we're just running games --- seems pretty straightforward. So to my mind, debating the regs that brought down this exchange takes you in one (or more) of three directions: 1. You can believe we shouldn't regulate gambling at all, because people will find ways to gamble, and many people can gamble responsibly. As Levine points out, we might even benefit from the information generated by the gaming activity. 2. You can believe "main street" investors should have access to private company equity and not just large institutional investors. 3. You can believe we should not have "safety and soundness" as a goal for regulating retail financial transactions, and that the SEC/CFTC/&c should not serve a role for the financial system that is similar to the FDA's role for drugs (lots of people also think that the FDA does more harm than good). That is to say: companies should not have to spend large amounts of money to ensure "truth in labeling" for financial products. I tend to think you probably have to believe all of these things to think what Sand Hill Exchange was doing should have been lawful. For instance: if you think there's value in generating retail exposure to startup equity, there are obviously saner ways to provide it than relaxing regs on derivatives betting exchanges.

lorddoig 11y ago

> Should all the financial regulation exist? Almost certainly not. The regulatory burden of operating in the finance industry is overwhelming - innovation is not so much stifled as killed. The big boys thrive because the little guy doesn't stand a chance from the get-go. The whole industry is estimated to be worth ~17% of global GDP and that money, which is almost equivalent to the output of Europe (or every country in the world except the top ~17 richest nations), goes to a list of companies so small you could probably write their names on a single page. It's a joke.

tptacek 11y ago
It's far from obvious that the industry would be more diverse and less consolidated if regulations were relaxed. The overwhelming majority of that gigantic flow of money is not main-street retail activity; it's financial engineering serving the operational needs of giant corporations, none of whom are interested in e.g. working with a YC startup for their commercial paper needs.
- lorddoig 11y ago
  I profoundly disagree. You may very well be right about the majority of that money servicing large corporations, but bear in mind that we're talking about a pot of money the size of Jupiter here. Payment processing alone is worth somewhere in the region of 1trillion USD annually. And that's just for moving money i.e. shuffling rows around databases. Bitcoin, while definitely imperfect, offers the hope of innovating this whole industry into oblivion and replacing it with something entirely autonomous. The insurance industry is worth another ~5trillion USD annually. The name of the game here, of course, is predictive analysis and I'd bet that my Netflix recommendations are more accurate than any assessment any insurance company has ever made of me. I think you'd have diversification up the wazoo in extremely short order. Edit: accuracy
  - tptacek 11y ago
    Payment processing alone is worth somewhere in the region of 6trillion USD annually This seems unlikely. Is this a top-line number? Why aren't existing VISA/MC processors the largest companies in the economy? The number you just gave is orders of magnitude higher than Apple's profits. A couple minutes Google searching suggests that being a card issuer puts you in a relatively low-margin business with absolutely enormous network effects.

s73v3r 11y ago

If the only ones who were ever affected by things in those markets were the ones directly investing in them, you'd be right. As is, however, no man is an island, and problems in those markets tend to bleed out and people who have no connections to them end up facing the consequences.

maxerickson 11y ago
There is a fair chance that people would be less inclined to create the interdependencies if there were no regulation. I don't mean that as an argument against regulation, but as an example, there are lots of stock market rules that make it simpler for individuals to make investments (required reporting of information, standards about how it is reported, etc). Without those rules, the risk would be higher and the investment would likely be lower, and the lower investment is exactly less connection to that market.
- s73v3r 11y ago
  "There is a fair chance that people would be less inclined to create the interdependencies if there were no regulation." I don't buy that for a second.
  - maxerickson 11y ago
    Do you think Without those rules, the risk would be higher and the investment would likely be lower, and the lower investment is exactly less connection to that market. is nonsense, or maybe just disagree with parts or it? I think if I don't own stocks and bonds it is quite clear that I am not as sensitive to those markets.
- davidgerard 11y ago
  Every regulation ever has come about for a reason of observed behaviour. So given your testable claim, I'd expect you to be able to provide before-and-after examples of regulations, wherein you show that even a significant percentage (of all regulations) make things worse.

emodendroket 11y ago

Yeah, of course not. Incidentally, I just woke up from a coma that I went into around 2006.

davidgerard 11y ago

The problem is when "prediction market" becomes "assassination market". With bitcoins.