Some of this article is well written however the attacks on innovations such as ABS an CDOs is tacky, yes they haven't done well, but that's the nature of innovation. You're always going to have some innovations that do well and other that do badly, the only way you'll find out is through execution. They were both designed to solve practical problems in liquidity and price discovery.
Picking through individual failures and saying the whole system is bad on that basis is like saying startups are worthless because WebVan failed.
As I interpreted it, the attack was more on the economic rent extracted by the originators of the "zero sum" ABS and CDOs rather than the concepts themselves; the core thesis being that there would be a lot less profit to be extracted from originating opaque financial products if demand for them wasn't artificially inflated by buyers and sellers being insulated from the downside risk of their decisions.
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.
I think the point is that they actually don't solve any practical problems in liquidity or price discovery.
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?
Wall Street refers to the high frequency game as "taking the dumb money".
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.
Well, you know a lot more about HFT than I do, I just know that I've heard several people refer to their trading practices as taking the dumb money, including a one-guy algo shop that sounded similar to how you've described your work.
At the end of the day though, I'm still stuck on my 1985 story -- compensation, profits, bonuses, etc have skyrocketed since then. But what good have all the newfangled instruments done for the rest of the economy? Doesn't seem like much. So is it just rent-seeking?
EDIT: RE: hiding the big trades in noise. What's wrong with that? Why should they have to develop a special HFT algorithm in order to simply move shares around without getting their lunch eaten? This is exactly the kind of value extraction I'm talking about. HFT shops have now created a huge expense for these retail shops that didn't exist before.. are the financial markets functioning better as a result? No, they're just sucking more money out as transaction costs.
Comp/bonuses went up for some. It went to zero for many others. In 1985, banks had armies of line workers processing trades, managed by officers making decent money. The average comp at a bank might be the average of 1 officer and 100-500 low level line workers. It would be better than other office jobs, but not great.
In 2010, the officer specs out business requirements after talking to traders and regulators, sends the high level work to IT and the CRUD apps to Bangalore. 475 of the 500 line workers have been replaced by a data center in Nutley, NJ, 5 remain in the US handling cash wires and other time-zone sensitive work, and 20 work via email out of an office park in Pune.
For obvious reasons, the average comp of 1 officer + 3 IT guys + 5 US line workers is going to be far higher than the average comp of 500 grunts + 1 officer.
Additionally, for many reasons (IT being one of the biggest ones), it's also vastly easier today to strike out on your own than ever before. In 1985, if you wanted to quit and start a hedge fund, it was tough. Today, a hedge fund can be operated by 3-4 guys + servers. Banks are forced to pay their traders enough money to prevent them from quitting and doing exactly this.
(Remind you of another high comp industry, with established players giving out big comp packages to retain talent?)
Edit (in response to your edit): RE: hiding the big trades in noise. What's wrong with that? Why should they have to develop a special HFT algorithm in order to simply move shares around without getting their lunch eaten? This is exactly the kind of value extraction I'm talking about. HFT shops have now created a huge expense for these retail shops that didn't exist before..
When you make a large trade, there will be a price impact. This is unavoidable - if you are selling millions of shares, supply went up, and price must drop.
In 1985, institutional investors (not retail investors) tried to make sure that other people (their counterparties) suffered the price impact. They would sell shares at full price, retail investors (i.e., my Mom) would buy from them, and then shares would go down once the market figured out supply dramatically increased.
In 2010, some HFT shops will sell to my Mom at a favorable price, and then buy from the institutional investor after prices go down. This benefits the HFT shop and retail investors at the expense of the institutional investor. I'm not saying this is good or bad, I'm saying it benefits "dumb money" (little guys who can't afford to rent an algorithm) at the expense of "smart money" (Goldman, Vanguard, Calpers Pension Fund).
[edit2: just a disclaimer - specific numbers/cities should not be taken as precise. The data center might be in Jersey City or Brooklyn, Pune might be Cebu or even Baltimore, and there might have been 250 or 1000 line workers rather than 500.]
This is an awesome convo BTW, thanks for providing all the detail about the industry.
Regarding our high comp industry vs theirs.. we've reinvented the world at least twice since 1985, and like I said, I haven't seen a reinvention of finance in any positive way. If they're that much more efficient now (and I agree that they are along the lines you're saying), where are the savings for the rest of the economy? I'm all about the TD Ameritrades of the world where I can do an $8 trade, that's providing value and they deserve every penny they earn. But it seems like most of the hedge funds are just playing games to extract money from less sophisticated investors.
Regarding your average comp comparison -- that's fine, I'm all about profiting from efficienbut what about the aggregate comp? Is that higher, too?
Regarding our high comp industry vs theirs.. we've reinvented the world at least twice since 1985, and like I said, I haven't seen a reinvention of finance in any positive way.
In almost every financial service that existed in 1985, margins have been cut to the bone (the main exceptions being M&A and IPO services). The commission on stock trades is now $0-8, it used to be $150, as you note.
When businesses need futures/options (mainly for hedging purposes), they often just buy them on the open market rather than contacting a GS/MS/JPM rep and paying through the nose for the privilege.
Regarding hedge funds/private equity, Warren Buffet and others have commented that there are very few hidden gems left, particularly gems detectable by financial/technical analysis. I.e., good businesses are getting more investment.
Regarding your average comp comparison -- that's fine, I'm all about profiting from efficienbut what about the aggregate comp? Is that higher, too?
It's a good question. Top traders get more, but they also tend to earn more. Good IT is certainly vastly cheaper than armies of line workers, and HFT is cheaper than human market makers. More financial services are provided today - my understanding is that credit cards were hardly pervasive in 1985, and no one would cell you a phone on quasi-credit like they do today.
I have absolutely no idea and I'd be very skeptical of anyone who claims to know.
Corporations can now protect themselves from all sorts of risks which weren't possible before using swaps and future instruments.
Innovations in debt financing drove the huge economic growth of the last two decades. Mobile phone technology would never have taken off if cellphone companies couldn't have used debt financing to build huge cell tower infrastructures.
CMOs for all the problems they caused, did allow for a huge increase in home ownership. For every default there are dozens of paid-up home owners who could never have afforded to buy a house otherwise.
Electronic Government bond auctions have driven down the cost of government borrowing, leading to lower taxes.
Forex costs have dropped massively. Look at your laptop. It's likely that during the manufacture dozens of countries were involved and likely hundreds of currency transactions. You paid less for your laptop because of a decade of innovation in the FX markets.
I'm not sure about subsecond windows, but 24 hour windows certainly matter. Say you're planning on making a big order of lumber for your mill and you're ordering from a market with zero speculation so the prices jump up and down with the supplier's inventory. It makes a lot of sense then to wait a few days (during which your machines and workers are idle) to get the best price possible. I'm not going to say that high frequency trading serves a useful purpose, but to me that looks like a zero-sum struggle between Wall Street firms for profits that Wall Street deserves for doing its thing on a minute to minute or hour to hour level.
Ok, fine, downgrade 24 hours to 1 hour. Nobody cares about those prices within 1 hour. We've had markets that operate within 1 hour for over a century.
What did all the "innovation" actually produce? I know Wall St is making more money but are they providing more value?
High speed trading is only relevant to the competition between market makers and other short term speculators. It has no effect on long term speculators/hedgers/etc.
If you want to trade right now, you will pay a few cents/share for the privilege (this is the spread). If my company was fastest, we sit at the top of the order queue, and we will receive those few cents/share. If GS was faster, they get the pennies. Either way, you trade right now. And if I decide to cut in line by offering a better price, you trade right now for less.
I wonder if it would be called innovation if we called these 'Products' what they really are. CDO='insurance on loans', Synthetic CDOS = 'making bets on other people's loans' When Las Vegas casinos come up with new ways to gamble is it called innovation?
Synthetic CDOs are actually more clever than that.
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.
The problem with synthetic CDOs is that they're over the counter. You can have more people betting against loans than actual loans and since they weren't controlled the one who was supposed to pay out [1] might not be able to.
Speaking to the gambling point, I believe it was Deutsche bank who went to the government to make sure synthetic CDOs wouldn't be classified as gambling before starting to sell them.
[1] I can't say "issuer" because these were sold around.
> When Las Vegas casinos come up with new ways to gamble is it called innovation?
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.
Gambling is when the economic activity is zero-sum -- there is a loser exactly equal to the winner. Investment puts money to work so the effect is their is more real wealth in the world. For example, a farmer buys an irrigation system with a small business loan -- now there is more food in the world. A homeowner uses a home equity loan to insulate his house -- now there is more energy in the world.
Contrast this with a casino developing super-slots with a $1 million payout. The casino might increase their take, but their is no increase of real wealth in the world.
Well, if I go out and buy some stock in a publicly traded company post IPO the company won't see any of my money it will simply go to someone who purchase it from its current owner.
If there was no secondary market, the company would receive far less money at the IPO.
Liquidity is very valuable. Compare the more and less liquid shares in Chipotle - the only difference between CMG and CMG.B is that CMG.B has more voting rights, but less liquidity.
Sorry - I was really thinking about the definition of "gambling" and "investing" above. So perhaps using that terminology the original investors at an IPO are willing to do so expecting liquidity based on the willingness of others to gamble on the stock.
You're confining gambling only to casino games or games with vigs (http://en.wikipedia.org/wiki/Vigorish). Under your definition, when I play cards with my friends for money, I'm not gambling because my expected return is zero. Actually, judging by my known skills in any particular game vs. my partner's skills, what I'd be doing would be varying nightly.
What you're saying seems to be a useful distinction, though, but I'd say it's the difference between "risk entertainment" or something else and investment, rather than gambling and investment, because it's all gambling.
I really don't think gamblers think that way - I know people who play poker fairly seriously (which is clearly gambling) and they play to win and generally they do pretty well - certainly well above break-even.
Think about it this way: if you buy a slot machine to put in your store/bar/etc, are you gambling or investing ? - it's clearly a game of chance, and you might lose money on it, however because the odds are set in your favour in the long term you'll make money. Hence it's an investment rather than gambling.
You do actually get angel investors who invest in poker players with solid track records.
I think serious poker is in a different category than slots or roulette.
You can call it gambling but there's a reason there exist top poker players who win with consistency. If it were really random chance, you wouldn't see players that make a living playing poker.
It's a wildly unpopular idea here, but i think a progressive tax really encourages innovation.
A zillion small scale trades with little to no tax consequences encourage people really explore the space. Effective strategies grow till efficiency is overcome by tax friction. "To big to fail" is limited by the structure of the system, rather than regulation.
tbh. If it wasn't CMOs it would have been something else.
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 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.
Note that some of the systemic risk was caused by regulation.
The US govt gave fannie and freddie stock special treatment when held by banks as part of their assets. As a result, banks overloaded on Fannie and Freddie. When Fannie and Freddie went down, that took a lot of banks into technical insolvency. (It didn't help that Fannie and Freddie lied about the loans in their portfolios, which threw off everyone's risk analysis of the market as a whole.)
Bond insurance was encouraged by regulators because it let banks and pension funds hold bonds as "safe" assets. (When you're pushing mortgages, you need to make them appear safe so more folks will buy them.)
The SEC gave a ratings monopoly to three ratings institutions. When they got it wrong....
Almost All of the systemic risk was caused by regulation. Too big to fail messed up with "the role of market discipline in financial markets" (3rd pillar of Basel II). Firms were even picking their own regulators (through loopholes) so they got the most lax ones. And so on.
I actually think that---since we cannot regulate for every contingency---then it's much better to avoid having too big to fail firms.
> then it's much better to avoid having too big to fail firms.
If a company that is, say 10x the size of Goldman Sachs, is "too big to fail" and therefore too big to allow to exist, what does that tell us about the US govt?
Company investment and banking accounts aren't protected by FDIC, so that alone could wipe out a lot of companies.
Credit would go from "hard" to "near-impossible". Investment banks finance all sorts of things you would never think about. For example the kitchen equipment in your local fast food chain (The pizza chain Dominos ended up buying the leasing arm of an investment bank which financed it's kitchens to ensure it's own stability).
Larger companies rely on their investment banks for all sorts of things, from FX to protecting against counter-party risk (i.e. providing insurance against your main customers or suppliers going bankrupt).
Comments
Some of this article is well written however the attacks on innovations such as ABS an CDOs is tacky, yes they haven't done well, but that's the nature of innovation. You're always going to have some innovations that do well and other that do badly, the only way you'll find out is through execution. They were both designed to solve practical problems in liquidity and price discovery.
Picking through individual failures and saying the whole system is bad on that basis is like saying startups are worthless because WebVan failed.
As I interpreted it, the attack was more on the economic rent extracted by the originators of the "zero sum" ABS and CDOs rather than the concepts themselves; the core thesis being that there would be a lot less profit to be extracted from originating opaque financial products if demand for them wasn't artificially inflated by buyers and sellers being insulated from the downside risk of their decisions.
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.
I think the point is that they actually don't solve any practical problems in liquidity or price discovery.
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?
Wall Street refers to the high frequency game as "taking the dumb money".
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...
Well, you know a lot more about HFT than I do, I just know that I've heard several people refer to their trading practices as taking the dumb money, including a one-guy algo shop that sounded similar to how you've described your work.
At the end of the day though, I'm still stuck on my 1985 story -- compensation, profits, bonuses, etc have skyrocketed since then. But what good have all the newfangled instruments done for the rest of the economy? Doesn't seem like much. So is it just rent-seeking?
EDIT: RE: hiding the big trades in noise. What's wrong with that? Why should they have to develop a special HFT algorithm in order to simply move shares around without getting their lunch eaten? This is exactly the kind of value extraction I'm talking about. HFT shops have now created a huge expense for these retail shops that didn't exist before.. are the financial markets functioning better as a result? No, they're just sucking more money out as transaction costs.
Comp/bonuses went up for some. It went to zero for many others. In 1985, banks had armies of line workers processing trades, managed by officers making decent money. The average comp at a bank might be the average of 1 officer and 100-500 low level line workers. It would be better than other office jobs, but not great.
In 2010, the officer specs out business requirements after talking to traders and regulators, sends the high level work to IT and the CRUD apps to Bangalore. 475 of the 500 line workers have been replaced by a data center in Nutley, NJ, 5 remain in the US handling cash wires and other time-zone sensitive work, and 20 work via email out of an office park in Pune.
For obvious reasons, the average comp of 1 officer + 3 IT guys + 5 US line workers is going to be far higher than the average comp of 500 grunts + 1 officer.
Additionally, for many reasons (IT being one of the biggest ones), it's also vastly easier today to strike out on your own than ever before. In 1985, if you wanted to quit and start a hedge fund, it was tough. Today, a hedge fund can be operated by 3-4 guys + servers. Banks are forced to pay their traders enough money to prevent them from quitting and doing exactly this.
(Remind you of another high comp industry, with established players giving out big comp packages to retain talent?)
Edit (in response to your edit): RE: hiding the big trades in noise. What's wrong with that? Why should they have to develop a special HFT algorithm in order to simply move shares around without getting their lunch eaten? This is exactly the kind of value extraction I'm talking about. HFT shops have now created a huge expense for these retail shops that didn't exist before..
When you make a large trade, there will be a price impact. This is unavoidable - if you are selling millions of shares, supply went up, and price must drop.
In 1985, institutional investors (not retail investors) tried to make sure that other people (their counterparties) suffered the price impact. They would sell shares at full price, retail investors (i.e., my Mom) would buy from them, and then shares would go down once the market figured out supply dramatically increased.
In 2010, some HFT shops will sell to my Mom at a favorable price, and then buy from the institutional investor after prices go down. This benefits the HFT shop and retail investors at the expense of the institutional investor. I'm not saying this is good or bad, I'm saying it benefits "dumb money" (little guys who can't afford to rent an algorithm) at the expense of "smart money" (Goldman, Vanguard, Calpers Pension Fund).
[edit2: just a disclaimer - specific numbers/cities should not be taken as precise. The data center might be in Jersey City or Brooklyn, Pune might be Cebu or even Baltimore, and there might have been 250 or 1000 line workers rather than 500.]
This is an awesome convo BTW, thanks for providing all the detail about the industry.
Regarding our high comp industry vs theirs.. we've reinvented the world at least twice since 1985, and like I said, I haven't seen a reinvention of finance in any positive way. If they're that much more efficient now (and I agree that they are along the lines you're saying), where are the savings for the rest of the economy? I'm all about the TD Ameritrades of the world where I can do an $8 trade, that's providing value and they deserve every penny they earn. But it seems like most of the hedge funds are just playing games to extract money from less sophisticated investors.
Regarding your average comp comparison -- that's fine, I'm all about profiting from efficienbut what about the aggregate comp? Is that higher, too?
Regarding our high comp industry vs theirs.. we've reinvented the world at least twice since 1985, and like I said, I haven't seen a reinvention of finance in any positive way.
In almost every financial service that existed in 1985, margins have been cut to the bone (the main exceptions being M&A and IPO services). The commission on stock trades is now $0-8, it used to be $150, as you note.
When businesses need futures/options (mainly for hedging purposes), they often just buy them on the open market rather than contacting a GS/MS/JPM rep and paying through the nose for the privilege.
Regarding hedge funds/private equity, Warren Buffet and others have commented that there are very few hidden gems left, particularly gems detectable by financial/technical analysis. I.e., good businesses are getting more investment.
Regarding your average comp comparison -- that's fine, I'm all about profiting from efficienbut what about the aggregate comp? Is that higher, too?
It's a good question. Top traders get more, but they also tend to earn more. Good IT is certainly vastly cheaper than armies of line workers, and HFT is cheaper than human market makers. More financial services are provided today - my understanding is that credit cards were hardly pervasive in 1985, and no one would cell you a phone on quasi-credit like they do today.
I have absolutely no idea and I'd be very skeptical of anyone who claims to know.
Corporations can now protect themselves from all sorts of risks which weren't possible before using swaps and future instruments.
Innovations in debt financing drove the huge economic growth of the last two decades. Mobile phone technology would never have taken off if cellphone companies couldn't have used debt financing to build huge cell tower infrastructures.
CMOs for all the problems they caused, did allow for a huge increase in home ownership. For every default there are dozens of paid-up home owners who could never have afforded to buy a house otherwise.
Electronic Government bond auctions have driven down the cost of government borrowing, leading to lower taxes.
Forex costs have dropped massively. Look at your laptop. It's likely that during the manufacture dozens of countries were involved and likely hundreds of currency transactions. You paid less for your laptop because of a decade of innovation in the FX markets.
I'm not sure about subsecond windows, but 24 hour windows certainly matter. Say you're planning on making a big order of lumber for your mill and you're ordering from a market with zero speculation so the prices jump up and down with the supplier's inventory. It makes a lot of sense then to wait a few days (during which your machines and workers are idle) to get the best price possible. I'm not going to say that high frequency trading serves a useful purpose, but to me that looks like a zero-sum struggle between Wall Street firms for profits that Wall Street deserves for doing its thing on a minute to minute or hour to hour level.
Ok, fine, downgrade 24 hours to 1 hour. Nobody cares about those prices within 1 hour. We've had markets that operate within 1 hour for over a century.
What did all the "innovation" actually produce? I know Wall St is making more money but are they providing more value?
High speed trading is only relevant to the competition between market makers and other short term speculators. It has no effect on long term speculators/hedgers/etc.
If you want to trade right now, you will pay a few cents/share for the privilege (this is the spread). If my company was fastest, we sit at the top of the order queue, and we will receive those few cents/share. If GS was faster, they get the pennies. Either way, you trade right now. And if I decide to cut in line by offering a better price, you trade right now for less.
I wonder if it would be called innovation if we called these 'Products' what they really are. CDO='insurance on loans', Synthetic CDOS = 'making bets on other people's loans' When Las Vegas casinos come up with new ways to gamble is it called innovation?
Synthetic CDOs are actually more clever than that.
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.
The problem with synthetic CDOs is that they're over the counter. You can have more people betting against loans than actual loans and since they weren't controlled the one who was supposed to pay out [1] might not be able to.
Speaking to the gambling point, I believe it was Deutsche bank who went to the government to make sure synthetic CDOs wouldn't be classified as gambling before starting to sell them.
[1] I can't say "issuer" because these were sold around.
> When Las Vegas casinos come up with new ways to gamble is it called innovation?
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.
Gambling is when the economic activity is zero-sum -- there is a loser exactly equal to the winner. Investment puts money to work so the effect is their is more real wealth in the world. For example, a farmer buys an irrigation system with a small business loan -- now there is more food in the world. A homeowner uses a home equity loan to insulate his house -- now there is more energy in the world.
Contrast this with a casino developing super-slots with a $1 million payout. The casino might increase their take, but their is no increase of real wealth in the world.
Well, if I go out and buy some stock in a publicly traded company post IPO the company won't see any of my money it will simply go to someone who purchase it from its current owner.
If there was no secondary market, the company would receive far less money at the IPO.
Liquidity is very valuable. Compare the more and less liquid shares in Chipotle - the only difference between CMG and CMG.B is that CMG.B has more voting rights, but less liquidity.
http://www.google.com/finance?chdnp=1&chdd=1&chds=1&...
Sorry - I was really thinking about the definition of "gambling" and "investing" above. So perhaps using that terminology the original investors at an IPO are willing to do so expecting liquidity based on the willingness of others to gamble on the stock.
Or something like that :-).
I agree, if you "invest" for a few months or days you are just gambling.
Check out this post on where to put your money now -- this is not a scam therefore it is not easy, or risk free:
http://scottlocklin.wordpress.com/2010/11/20/investments-for...
You're confining gambling only to casino games or games with vigs (http://en.wikipedia.org/wiki/Vigorish). Under your definition, when I play cards with my friends for money, I'm not gambling because my expected return is zero. Actually, judging by my known skills in any particular game vs. my partner's skills, what I'd be doing would be varying nightly.
What you're saying seems to be a useful distinction, though, but I'd say it's the difference between "risk entertainment" or something else and investment, rather than gambling and investment, because it's all gambling.
I really don't think gamblers think that way - I know people who play poker fairly seriously (which is clearly gambling) and they play to win and generally they do pretty well - certainly well above break-even.
All gamblers play to win.
Think about it this way: if you buy a slot machine to put in your store/bar/etc, are you gambling or investing ? - it's clearly a game of chance, and you might lose money on it, however because the odds are set in your favour in the long term you'll make money. Hence it's an investment rather than gambling.
You do actually get angel investors who invest in poker players with solid track records.
I think serious poker is in a different category than slots or roulette.
You can call it gambling but there's a reason there exist top poker players who win with consistency. If it were really random chance, you wouldn't see players that make a living playing poker.
Hell of a place to choose to run 'experiments'.
Try that shit in an emerging market, first.
Each market is different. Even between developed markets, what might work in London might not work in New York or Tokyo.
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.
It's a wildly unpopular idea here, but i think a progressive tax really encourages innovation.
A zillion small scale trades with little to no tax consequences encourage people really explore the space. Effective strategies grow till efficiency is overcome by tax friction. "To big to fail" is limited by the structure of the system, rather than regulation.
Unfortunately, the individual failures were bad enough to bring down the whole system.
tbh. If it wasn't CMOs it would have been something else.
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 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.
Note that some of the systemic risk was caused by regulation.
The US govt gave fannie and freddie stock special treatment when held by banks as part of their assets. As a result, banks overloaded on Fannie and Freddie. When Fannie and Freddie went down, that took a lot of banks into technical insolvency. (It didn't help that Fannie and Freddie lied about the loans in their portfolios, which threw off everyone's risk analysis of the market as a whole.)
Bond insurance was encouraged by regulators because it let banks and pension funds hold bonds as "safe" assets. (When you're pushing mortgages, you need to make them appear safe so more folks will buy them.)
The SEC gave a ratings monopoly to three ratings institutions. When they got it wrong....
Regulation is systemic risk.
Almost All of the systemic risk was caused by regulation. Too big to fail messed up with "the role of market discipline in financial markets" (3rd pillar of Basel II). Firms were even picking their own regulators (through loopholes) so they got the most lax ones. And so on.
I actually think that---since we cannot regulate for every contingency---then it's much better to avoid having too big to fail firms.
> then it's much better to avoid having too big to fail firms.
If a company that is, say 10x the size of Goldman Sachs, is "too big to fail" and therefore too big to allow to exist, what does that tell us about the US govt?
It would have been far cheaper just to rescue the FDIC and preserve the money held in savings/checking accounts.
Savings accounts are only a tiny part of the equation, the impact on businesses of a wide spread collapse of investment banks would be much larger.
Other countries which offered guarantees on savings accounts still bailed out banks due to the wider economic issues.
What is a scenario where business would be disrupted in this manner? After all, even with the bailouts, credit is as hard to obtain.
Company investment and banking accounts aren't protected by FDIC, so that alone could wipe out a lot of companies.
Credit would go from "hard" to "near-impossible". Investment banks finance all sorts of things you would never think about. For example the kitchen equipment in your local fast food chain (The pizza chain Dominos ended up buying the leasing arm of an investment bank which financed it's kitchens to ensure it's own stability).
Larger companies rely on their investment banks for all sorts of things, from FX to protecting against counter-party risk (i.e. providing insurance against your main customers or suppliers going bankrupt).