Picking through individual failures and saying the whole system is bad on that basis is like saying startups are worthless because WebVan failed.
It's more akin to saying you end up with too many startups getting too much funding in a climate where investors don't do adequate due diligence.
You won't find startups "innovating" in as brazenly cynical a manner as alleged in the Goldman Sachs example the author recounts either...startups don't profit from people shorting the stock they issue.
Does anyone on earth care about the price of lumber within even a 24 hour window? Why should we care about a sub second window? We don't. Wall Street refers to the high frequency game as "taking the dumb money". I call it "ripping off the value investors who actually serve a role in the economy".
Finance serves an important function in the economy, routing money to where it's needed. Are they doing a better job of that now than they were in 1985? Not really. So why are they extracting 10X the money in bonuses and profits?
This is a rather strange thing for them to say, since it's usually the smart money types complaining about HFT.
It used to be that mutual/pension funds and other institutional investors could hide their big trades in noise - the market would adjust slowly, and other people (retail investors, smaller shops, assorted other suckers) would absorb the price impact of the trades. Now they are complaining they can't do this anymore.
http://www.advancedtrading.com/exchanges/showArticle.jhtml?a...
(The authors of this article work for a "rent our 'screw the retail guys' algorithm" outfit.)
Basically, assorted HFT shops catch them in the act, trade ahead of them, and split the profits with the former "suckers" [1].
[1] Crossing the spread means that the passive investors in the market are making a premium.
[1] See also this article: http://www.zerohedge.com/article/pipeline-executives-confirm...
They solve the problem of me wanting mortgage bonds, and you wanting insurance on loans. We both want to take opposite positions (me long, you short). Without a synthetic CDO, we are unable to trade - I'll be trying to buy home loans from WaMu and you'll be talking to the AIG sales desk.
Yes.
In my personal opinion the difference between gambling and investment isn't in terminology. It's about expect return. If your expected return is negative than it's gambling, if your expected return is positive it's investment.
Try that shit in an emerging market, first.
Sure you can block all innovation, but you need to accept you'll block out the good as well as the bad. And that comes at the cost of economic growth.
The fundamental problem here is systematic risk, a bank should be able to fail without bring down other banks, unfortunately the system wasn't able to cope with the failure of a large number of banks who were all exposed to the same risk.
If a bunch of the big US car companies failed we may well have seen the same thing, because a lot of the US banks are heavily exposed to that sector. It just so happened it was mortgages that happened to be the tipping point this time.
Imagine your a bank and you have a bunch of other banks you deal with, you assign them all individually a "credit risk score" so you know how much extra to charge them to protect you against the risk of them failing before they have a chance to pay you what they owe you (much the same way as credit scores work for people).
But you have no-way of understanding the correlation between the risks, if all the banks your dealing with are actually exposed to the same underlying risk (i.e the CMO market) then the risk your exposed to is actually far higher than the sum of the individual risks. But obviously the banks you're dealing with can't tell you what their underlying risks are because that's propriety information, so all you have to go on is the risk rating given by ratings agencies.
This is a fundamentally hard problem to solve. No-one really has a good solution. It's much easier to say "let's ban CMOs" than to admit we don't really know how to solve the problem.
The lesson is: Take risks. You will pocket profits right away and bailouts will cover any downside.
Now, taking a more realistic view, when Lehman collapsed, the stock market went into free-fall. The links between all those financial corporations are so thick that if one of them is allowed to fail, it threatens to bring the whole thing down.
If the governments of the world had not, with uncommon speed and purpose, stepped in and "bailed out the banks", money would, at this point, be more useful as fuel in a stove than as a bartering device.
The idea of letting failing companies fail is valid as long as they don't bring down the whole system. If you let companies grow to such a level of interconnectedness and size that they have the potential to destroy the whole world economy in a matter of months, and then you suddenly realise that they are that big and they are failing, the correct course of action is not to let them fail, but to sort out the short-term problem (i.e. bail them out) and then work on the long-term problem (cut down their size and complexity so they can once again fail without destroying everything).
Until a proper regulatory framework is in place to prevent financial companies from getting so intertwined and large that they can bring down the whole house of cards (for that's what every economy is, a house of cards based upon the common trust that it's all going to work out ok), it is in fact very reasonable to suggest that a good medium-term step is to get those companies to "stop innovating", given that their incentives are such that they will inevitably bring the whole thing down if allowed.
This is a more realistic view than the "let them fail" silliness.
Paul Krugman of the NY Times wrote extensively both during the crisis and since about the correct way to handle this situation:
1. Put the failing bank into "receivership". I.e., a "receiver" (temporary managerment) appointed by the government takes over the company and tries to salvage it.
2. Fire the original management team. I.e., the ones that got them into this mess with their excessive risktaking. Good. They should suffer the consequences of their bad management decisions. That's capitalism.
3. Take on whatever additional debt or equity financing is necessary to turn the company around - without paying any regard to the positions or desires of the current stockholders. The current stockholders' positions' will likely get diluted to nearly worthless. Good. They should suffer the consequences of their bad investing decisions. That's capitalism.
4. After the company is turned around, take it out from under government receivership, hire a new management, and (if needed/appropriate) launch it public again via an IPO.
There's a long, established history for handling failed banks this way (read up on the S&L Crisis), and it's the proper way to keep an institution alive and out of bankruptcy, without rewarding the management and stockholders who brought it to bankruptcy in the first place.
Krugman often pointed out, though, that the Obama administration was too scared to go this route - perhaps because they were worried about the absurd accusations of "socialism" that the Psychotic Right would undoubtably have started screaming about.
So instead, they chose to reward the management and shareholders that caused the problem, by using government money to help prop up the value in their worthless company. Moral hazard indeed! Privatize all the profits, but give all the losses to the public. And socialism is the evil here?!?!?!?
I certainly get the point that, now that things are stable, the governement needs to haul all these failed bank leaders into a room and make them pay back the bonuses earned leading up to the crisis.
Have you really never noticed this before?
The real systemic risk was in throwing good resources after the bad. The "contagion" was other governments being spurred to do the same.
Read more http://www.newyorker.com/reporting/2010/11/29/101129fa_fact_...
- The unintended consequences of the Federal Reserve system of monetary distortion.
For those who have nothing to seek, these services are indeed an environmental scourge. ;)
