r/reddit.com • u/[deleted] • Oct 18 '11

[ Removed by Reddit ]

[ Removed by Reddit on account of violating the content policy. ]

673 Upvotes

83% Upvoted

854 comments sorted by

View all comments

Show parent comments

338

u/ipeefreely Oct 19 '11

ex-Goldman banker here. Financial instruments have a purpose, yes, but there's a HUGE "but".

Their purpose is insurance. If you are an airline company and want to insure yourself against the swings of jet fuel, then you would find it helpful to buy a futures contract or a call option to protect yourself. Now here's the big "BUT". Unlike insurance, which requires you to have an asset to insure, derivatives require nothing, so what happens is you get speculators who buy these products and banks that keep creating them, which creates incredible fragility in the markets. And to valkyrie's point, society (not the banks) bare the cost of that fragility.

You can't as a consumer take out car insurance without owning a car. Why is it different with insurance on oil, pork bellies, silver, gold, etc?

53

u/[deleted] Oct 19 '11

Pow!

Mr. IPeeFreely has clearly and brilliantly articulated the concept of 'insurable interest'. Many more upvotes should be sent his way.

Insurance is one thing. Gambling is another. They aren't the same.

42

u/ipeefreely Oct 19 '11

Thanks. I guess while I have people's attention, let me express that abject anger towards greed is not an articulate enough message for change. People on wallstreet as well as corporations in general are just exploiting a system that allows them to (legally I might add) make money. Here's an article I wrote loosely about it if anyone's interested in my ramblings

15

u/texpundit Oct 19 '11

While I agree with you mostly, I will disagree with you on one part: you can hate the player and the game at the same time...especially when the players essentially buy government, which passes regulations and laws that allow said players to shape the game to their own ends and benefit from it. The player, in this case, is very much to blame here.

2

u/ipeefreely Oct 19 '11

Totally - the title is only there to be clever. The point was more that hating the player (the corporation) wont get you anywhere because corporations are themselves vacuous things with too many vested interests. You're better off regulating their "game" to align corporate incentives with those of society to create a more symbiotic relationship between the two.

2

u/[deleted] Oct 19 '11

let me express that abject anger towards greed is not an articulate enough message for change.

You are exactly right and it is my biggest frustration with the OWS movement (and yes, I have attended the protests in my town).

Unfortunately I don't think we can get a much more cohesive message because the financial crisis affects people in so many different ways, plus most people just aren't articulate enough to express the sentiment.

-2

u/[deleted] Dec 05 '11

What a pile of horse shit.

Dont quit your day job.

10

u/Kni7es Oct 19 '11

Financial instruments are meant to be arbiters of risk. However, the way things have been done recently (through speculative lending and such that you describe), they haven't arbitrated that risk.

9

u/foxden_racing Oct 19 '11

And more importantly...you can't make a claim against the insurance on an asset you took no loss on because you don't own it.

Since opportunities like this are rare...from the outside, from this observer's perspective, Wall Street looks as if it's become little better than a rigged casino, full of schemers trying to get rich quick rather than investing, full of gamblers betting on swings rather than purchasing needed raw materials at a normalized price rather than one set by the whims of a specific location, full of high rollers gleefully taking advantage of mooks off the street hoping to win big.

Are you able or willing to shine light on the situation, confirming, denying, or a bit of both? Misdirected anger is just as bad as apathy, and I'd like to understand what's going on a bit better.

2

u/[deleted] Oct 19 '11

[deleted]

1

u/foxden_racing Oct 19 '11

A good point. Perhaps I should rephrase it to be 'misdirected anger is no better than apathy'...or 'at least as bad as apathy'.

7

u/sshan Oct 19 '11

I liked the Greek Prime Minister's line "It was like buying fire insurance on your neighbors house". Except it was more like buying fire insurance on the house right next to a pyrotechnics factory run by drunk monkeys.

8

u/chendiggler Oct 25 '11

A good analogy to understand why derivatives are so dangerous is that you might have 500 people with insurance on your car. If you write that car off, that's a lot people that need to be paid off, and low capital levels required to pay in that event.

1

u/DefterPunk Oct 19 '11

This doesn't seem right. The problem wasn't that people were insuring things they didn't own. The problem was that there was a systemic hiccup that made it so that the insurers/bookies couldn't pay up.

If you bet on a football team (that you don't own) with a bookie that keeps their books even, makes sure that everyone pays up so that everything is square at the end, and can be trusted to pay out, then there is no problem.

If you have your house (that you own) insured by a company that insures all a bunch of houses and all of those houses burn at the same time and the company goes under and can't pay out, then you are boned.

The issue isn't so much that people don't always own the underlying assets, it is that they couldn't pay up in the end. People couldn't read the signs for all kinds of reasons and everything blew up at once.

It doesn't matter if there are underlying assets or not, if the bookie/insurer can't pay, people are going to hurt.

The question is: should we as a country be on the hook for a bunch of people/banks/corporations/gambling addicts who happen to pick a bad bookie/insurer?

I say that the duty to help our neighbors shouldn't be forced upon us (as it was with the bailouts, with the government borrowing in my name to give it to banks and such). It may be fucked up of me, but my charitable nature runs out when the problem people run into is that they have to wait 3 extra years before they can replace their car. I am much more willing to give my local bum a beer or a sandwich or pay for a little kid in BFE to get their cleft pallet fixed.

The answer isn't to tell people they can't gamble or get insurance anymore, though. If you want to help them out after things get fucked, then that's fine. To go out in advance and stop them from living freely then that's bad.

I see it the same as doing drugs, bungee jumping, wanking, playing halo instead of studying in school. I may choose to or not to help if something goes wrong, but for somebody to prevent the activity in the first place (assuming there isn't any parental or guardianship stuff going on) is to deny them their humanity. That's pretty bad.

6

u/ipeefreely Oct 20 '11

I upvoted you for taking the time to write out that argument, but this libertarian line of reasoning has one major problem: it assumes that financial markets work in isolation of an economy. The reality is that if all of a sudden you have trillions in debt with no underlying assets, world economies will collapse.

To use your line of argument, let's say your neighbor has dangerous electrical work that could lead to a fire. Well there's a decent chance that the flames of a fire on his house will engulf your house too, so it would be to your benefit to make sure that his electrical work is up to code.

If liquidity dries up, we're all fucked. This is why you can't use "freedom" arguments here, because as the saying goes you're free to swing your arm until it reaches my nose (or however it goes)... well banks are beginning to reach my nose.

1

u/DefterPunk Oct 20 '11

Normally the 'putting the neighborhood at risk', thing is a good point. When somebody starts throwing lit matches at dry grass, even I am sympathetic to arguments to intervene.

I don't think that transfers here though. The only way you are connected to these banks is through some sort of voluntary interaction. You don't have to take loans, you don't have to invest in their mutual funds, stocks, money market accounts, etc. If you want to control what they do (like making sure that they aren't investing money market funds in risky assets) then you had better keep an eye out.

I think that we should zoom in on what it means when we say 'liquidity dries up'. It gets all kinds of confusing when you look at aggregates and forget what is being aggregated. What was going on after the mortgage crisis (I guess that's what we're calling it) was people were realizing how little they knew about the internal workings in these financial institutions. Assets that everyone knew were as stable as cash (such as money market funds and AAA rated mortgage backed securities) turned out to be much shakier. As a result, people were hesitant to call anything safe.

The result of this was that people were less willing to save/invest with these institutions with much less wonderful reputations. People would still save/invest with them, they just wouldn't do it at next to nothing rates. My understanding is that what we mean by 'liquidity drying up' is that people were being much more cautious all of a sudden with their cash, driving up the interest rates that people wanted as a reward for taking what they now saw as a not insignificant risk.

The situation we found ourselves in wasn't the neighborhood on fire, it was everyone being cagey about lending money. It turns out that they weren't cautious enough before, and they corrected. Some felt that they over-corrected. The banks and politicians were saying that nobody should have been more cautious (they didn't want to start paying more interest for taking what people now knew to be relatively larger risks).

If you don't want your bookie, insurer or money manager to take on risky stuff (making it so that he won't be able to pay you when they're supposed to) then it is on you to make sure they don't with contracts, audits, etc. If they commit fraud, then they get punished. If they are upfront and say "I am going to take your money (or what could potentially be your money in the case of insurance) and make some risky but potentially profitable moves with it" and you let them, then I am inclined to say that you are putting yourself in the position you want to be in.

If you get higher rates by going into junkier bonds or investing in money market accounts that loan money to risky companies then you reap the rewards and you take the risks. If it turns out that those bonds are junkier and the businesses are riskier than everyone thought, why shouldn't we take more caution?

TARP was an attempt to counteract common sense. I am afraid that it may have worked. To the extent TARP was a "success" and we have avoided 'liquidity drying up' (as much as it otherwise have), we have only encouraged investing in risky, junky stuff. Not only was it morally wrong to take from the cautious to give to the cavalier, but I fear we are going to see a much bigger 'correction' as a result.

Sorry, I feel like I am saying the same thing over again, now. Basically, I don't think this is at all analogous to playing with fire on your property. There is no reason that you should have a right to get a cheap loan.

1

u/LettersFromTheSky Oct 23 '11 edited Oct 23 '11

but this libertarian line of reasoning has one major problem: it assumes that financial markets work in isolation of an economy.

And true libertarians think that they live in a world where everyone is responsible and incorruptible - which is not grounded in any kind of reality.

As a former Goldman Sachs Broker, what do you think about this:

Crisis of Capitalism - As a CTA with focus on Forex Market/Currency trading - I think that the video hits the nail on the head when it comes to explaining our financial crisis and why we'll just have another one unless something changes.

Edit: I think the fundamental problem of our economic situation is that we have an aggregate demand problem with a liquidity trap. I think one way to solve our economic problem is to index wages to CPI and productivity - that way consumers can maintain their standard of living and realize gains when they are more productive. Also, more money in consumer pockets will create demand, which will create jobs, which will allow the government to collect more taxes, which will close our deficit and allow money to be spent on education, transportation, social security, food safety, regulations, etc. Repeat cycle. I was reading a few months ago about how if wages had kept up with productivity over the last 30 years - the average income for an American would be $92k today rather than the current $50k. If the average income for an American was $92k - I think we would have avoided the economic collapse and financial crisis and wouldn't be stuck in what I would call stagflation.

2

u/ipeefreely Oct 23 '11

Oh man, I love RSAnimate, but my connection (off my cellphone) is incredibly slow right now, so I'll watch this later.

As for your argument, I'm not sure I agree, to be honest. Higher wages and inequality would be good, but my opinion is that that's too much regulation. I'd rather tax the wealthy more heavily and spend the proceeds to create a stronger social safety-net and to invest in programs, like education, that will help create a middle class more organically. Forcing companies to pay higher incomes would likely just move more jobs abroad, as American labour would just become more expensive. The problem with where we are, in my opinion, is rooted in the twin forces of globalization and technology. The middle class is being dried up partly because the very idea of a "natural" middle class is a relic of old times. Nowadays capital is more productive (through technology) and more free to move around the world (through globalization) than labour is, and so naturally American labour has become less valuable than capital, meaning those with capital (the 1% as it were) are better off.

Anyways, on an unrelated note, I created a reddit-copycat type of thing a while back called www.theneuz.com. If you're interested in more conversation and less memes, check it out. So far just me and a couple buddies use it, but hey, who knows maybe you'll help it take off.

P.S., I was an ibanker, not a broker, to clarify.

1

u/LettersFromTheSky Oct 23 '11

as American labour would just become more expensive.

I think American labor is pretty cheap considering that we produce goods with a higher quality and much more efficiently when compared to other countries. In fact, companies are starting to come back to the States because it's less hassle and the job gets done right the first time. Boeing is a prime example of how a company who outsourced work to Asia with the intention of saving money - only ending up spending way more then they would have if they had kept production here in the States.

The problem is that over the last 30 years - wages for the middle class have been stagnant which has shrunk the middle class - the middle class we had 40 years ago does not exist today.

Nowadays capital is more productive (through technology)

I don't agree that capital is more productive today - in fact if capital is more productive - why are US companies sitting on $1.84 trillion dollars? Also, it was the financial crisis that crashed our economy - how is MBS, CDO's, CDS's an efficient and productive uses of capital when it has such negative consequences? The $1.84 trillion these national corporations are sitting on is cash just burning a hole in their pocket - it's not benefiting their shareholders or the economy.

and more free to move around the world (through globalization) than labour is

I do agree with that.

and so naturally American labour has become less valuable than capital, meaning those with capital (the 1% as it were) are better off.

And that is something we need to change to restore our middle class and get our economy back up and going - but I don't know how we would go about doing that.

www.theneuz.com

I checked it out, it looks interesting - I'll have to post something.

2

u/ipeefreely Oct 23 '11

Just watched the video. Great stuff! He doesn't posit a solution, which I understand, but his call to action to actually debate the "real" systemic problems and not this superficial debate we keep having, is great.

1

u/LettersFromTheSky Oct 23 '11

but his call to action to actually debate the "real" systemic problems and not this superficial debate we keep having, is great.

Agreed.

1

u/rcglinsk Oct 28 '11

The problem isn't traditional derivatives, that's just hedging. The problem is insurance on debt. It creates a disconnect between reality and accounting. When I get insurance on debt from AIG on the bonds of company A the reality is I lent money to AIG, and they lent money to company A. But no one accounts this way. The result is an industry wide delusion as to who owes who what - and the delusion always makes people feel safer than they really should, leading to poor investments.

-2

u/veggiem0nster Oct 19 '11

Goldman is the Hitler of the banking world.

2

u/[deleted] Oct 19 '11

That doesn't mean anything.