Originally published at: https://boingboing.net/2019/05/03/this-time-its-different.html
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So synthetic CDOs are basically derivatives of regular CDOs?
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Financial instruments are complicated, and I find this scene from ‘The Big Short’ to be super helpful. I watch this film probably once a year to remind myself on the importance of eating the rich.
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iBankers can try to justify these horrors all they want, but in the end they exist only because of greed and the degenerate gambler’s insatiable need for new action.
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That, plus the fact we keep declaring certain institutions “too big to fail” so they get to externalize their downsides but keep all the profits.
C-suite execs doing hard time in federal penitentiaries, their personal fortunes confiscated, the businesses they managed broken up and sold off piecwise to more responsible owners.
We need something like the above, or we’ll keep having 2008s over and over and over again.
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Designing, making, and selling a real thing that people are actually willing to pay more for that it took to make is hard. Taking bets on other people’s work is easy. The mindset that the point of the market is profit (not to encourage actually making new and better things) inevitable leads to more and more of this.
Wall st. is like professional sports if it was run by Vegas casinos that cared only about the their vig with complete disregard for the effect on the game, except in this game everyone gets hurt whether they choose to play or not
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Profit maximization as a comprehensive societal philosophy makes as much sense as blood maximization as a comprehensive theory of medicine.
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Correct. CDO’s are not derivatives. But they are how institutions like Fanny Mae and Freddie Mac work.
Derivatives are a bit like insurance. They are also where the term “hedge” as in “hedge fund” get their name. Risk has a negative value and there are usually people you can pay to take on the risk.
All is well as long as everything works within an assumed range of conditions. Someone gets a loan. Lenders diversify. And can accept a lower average rate of return in exchange for a less volatile rate of return.
It’s when economic conditions shift outside that range that things get ugly. The insurers can’t cover the losses and the lenders don’t get paid from either the loans or the insurance. The most critical time for the insurance, and it of no use. Anybody left holding cash refuses to lend until they feel safe again.
The solution isn’t necessarily to ban CDOs or derivatives. The first step is to ban bundling or reselling of CDOs and derivatives, which tends to mask the risk and assumptions in the base loans of the original CDO. Second is to put limits on derivative leveraging (the ratio of bets to cash assets). Those two alone will significantly shrink the number of CDO’s and derivatives without freezing up credit availability.
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My new plan is to sell an instrument that hedges the risk of synthetic CDO’s.
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It’s a very real problem when financiers are managing portfolios of assets that require active stewardship and maintenance of those physical assets with no real experience in that line of business or interest in doing so beyond setting up the derivatives for sale.
It’s not like this hasn’t been seen before in our lifetimes. Throw anything in there and certify that it’s a quality asset- put no money into maintenance. I’ll be gone after the financial instrument is sold anywho.
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If regular derivatives are like casino-style gambling, synthetic derivatives are like skeezy OTB joints. You’re basically making bets on other peoples’ bets.
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If I recall correctly, the informal term used to be ‘naked’ as in ‘naked derivatives’.
Selling any financial instrument not backed by actual ownership by the asset(s) in question is pretty much just gambling, and any bank wishing to engage with it should have to open separate companies that were regulated primarily by gambling laws rather than financial regulations.
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some years ago when the Fidelity Magellan fund proposed allowing derivatives in their holdings, I immediately pulled my IRA dollars out of there. The abstraction of a mutual fund was enough for me and I was NOT looking for abstraction of abstraction as an investment.
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We also need to stop giving a pass to the corrupt politicians who enable it.
Biden, Clinton, Klobuchar, Pelosi, and Schumer all voted for the 2008 bailout. Anyone who has a serious problem with what these bankers are doing should never consider voting for these politicians for anything.
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Too bad we didn’t create a robust entity to oversee this sort of thing. Oh wait, we did, the CFPB! Which the repos undermined because they don’t want to get in the way of bankers getting (temporarily) rich.
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I’m guessing the only reason these instruments again exist is because the credit-rating agencies are again not using the correct metrics to assess the risk of these instruments? If they had rated them as “junk” they wouldn’t be nearly so viable. (But, then, the credit-rating agencies wouldnt get the business of being paid to rate them in the first place.)
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Good call. Even without that, these days, I’d recommend a total market fund over a fund like Magellan. Much cheaper expense ratio, better diversification, and better performance.
In addition, a good total market fund is (IMO) less of an abstraction because you know exactly what you’re getting. It seeks to replicate an index of the entire market, and you can look at the precise holdings whenever you want. Not a lot of mystery compared to some other approaches.
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The apparent complexity of these schemes serve to insulate them from common sense. So investors can jump, figuring that other people must’ve figured out all the details.
Fisheries management is conceptually pretty simple. You can “tax” the little fishies only so much before their productivity declines, and if you crash the fishery entirely, hardly anyone will get to fish. I kinda wish similar caps were in place and widely understood for the human version. I know theres a whole lot of wiggle room in the concept of “sustainable”. But we need to start someplace…
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It pisses me off that the financial people can come up with ridiculous bullshit like this and the advice we get from banks is this bullshit:
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It’s been enough of a respite that they figure they can blow this shit up and do the good ole privatize the profits and socialize the bailout costs routine.
The memory of the average American is embarrassingly short.
One perfect example of this is an idiotic meme that I have seen going around recently, created by the braintrust at Turning Point USA. Obviously these people would have some idiotic thing to say if you reminded them that the economy was in a recession in 2009, but I sincerely believe that they (Turning Point) know that most of the people that they are targeting (especially) have a short memory, and use this to their advantage. So to will the crooks on Wall Street.
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