New research counters risky image of popular financial investments

[SkinsHokieFan]

Got this in my email this morning. This was a study done by a Virginia Tech finance professor

http://www.vtnews.vt.edu/story.php?relyear=2010&itemno=161



BLACKSBURG, Va., March 15, 2010 -- They have been called "financial weapons of mass destruction" and blamed for a number of catastrophic losses and bankruptcies. New research by a finance professor at Virginia Tech's Pamplin College of Business, however, counters the popular perception of derivatives as dangerous tools and investments.

In a study to be published in the Journal of Financial and Quantitative Analysis, Yong Chen, an assistant professor of finance, investigates how derivatives are used by hedge funds and focuses on the relationship between derivatives use and hedge funds’ risk-taking behavior.

Despite the widespread use of derivatives by hedge funds, Chen says, little is known about their effects on fund risks and performance. How do derivatives users differ from nonusers with respect to fund risks and performance? Do hedge funds that use derivatives demonstrate a greater propensity for risk shifting? Are derivatives-using funds more likely to fail? “Such questions, and their answers, are very important to investors, lenders, and regulators.”

Examining more than 5,000 hedge funds during 1994-2006, Chen found that 70 percent of them trade derivatives. On average, those that do so showed lower fund risks (as measured by fund return volatility, average market exposure, and market exposure during market downturns or extreme market events). “Overall, the evidence does not suggest that derivatives use by hedge funds leads to more risk-taking.”

His findings would be of broad interest, he says, given the current concern about the risk-taking activities of hedge funds and other quasi-bank institutions among lenders, investors, and regulators, who are seeking to increase government oversight of hedge funds.

“In the past two decades,” Chen says, “derivative markets and the hedge fund industry and have experienced explosive growth and wielded increasing influence on the market and economy.”

Deriving their value from other assets, derivatives are financial instruments that allow investors to speculate on the future price of an asset — commodities or shares, for example — without buying the underlying asset. Developed to allow investors to hedge, or insure against, risks in financial markets, derivatives such as futures, options, and swaps, have become investments in their own right.

Hedge funds, which use aggressive strategies to maximize returns in managing investments of wealthy private investors or institutions, have become major players in derivative markets, Chen says. “The pervasive use of derivatives by hedge funds stands in sharp contrast to mutual funds,” he notes, citing one study that found that only about 20 percent of mutual funds use derivatives.

The high-risk image of derivatives, Chen notes, resulted from a number of spectacular financial failures, all of which involved derivatives trading: the bankruptcy of Orange County, Calif., in 1994; the collapse of British-owned Barings Bank in 1995; the fall of U.S. hedge fund Long-Term Capital Management in 1998; the failure of another U.S. hedge fund, Amaranth, in 2006; and the huge losses of French bank Société Générale in 2008. It was legendary investor Warren Buffet who called derivatives “financial weapons of mass destruction.”

Depending on the purpose — hedging or speculation — the use of derivatives may be associated with lower or higher fund risk, Chen said. “Although it cannot be ruled out that some hedge funds use derivatives to speculate on asset prices,” he says, “the overall evidence is more consistent with risk-management-motivated use of derivatives.”

Chen’s study found that “derivatives users engage less in risk shifting,” the practice in which funds performing poorly in the first half of a given year tend to increase portfolio risk in hopes of catching up in the second half, while funds performing well try to lock in their returns by lowering risk. Derivatives users, he adds, are also less likely to liquidate during market downturns.

IMAGE INFORMATION: Finance assistant professor Yong Chen says that the overall evidence does not suggest that derivatives use by hedge funds leads to more risk-taking.

[DjTj]

“Overall, the evidence does not suggest that derivatives use by hedge funds leads to more risk-taking.”What a totally useless statement.

Of course the vast majority of derivatives are perfectly fine, and when used correctly, they actually decrease risk by allowing investors to hedge. We aren't worried about most derivatives; we're worried about a tiny fraction of the derivatives that are sold, but can take us down because they are lined up like dominoes.

Big crashes happen in that rare circumstance when derivatives are valued incorrectly, and instead of hedging a risk, it is multiplied ... e.g. selling credit default swaps on mortgage-backed-securities that are highly correlated with each other. The underlying assets go down, and then everything goes down...


Depending on the purpose — hedging or speculation — the use of derivatives may be associated with lower or higher fund risk, Chen said. “Although it cannot be ruled out that some hedge funds use derivatives to speculate on asset prices,” he says, “the overall evidence is more consistent with risk-management-motivated use of derivatives.”Even if 99.9% of those in the derivatives markets are using them to decrease risk, that 0.1% can still take us down (and they did).

If this study is advocating for a hands-off approach, then I think that's naive. What's needed in the derivatives market is more transparency, so that if someone starts loading up on a risky position, somebody else in the market might notice, and small corrections can happen before big corrections.

[HOF44]

Aren't the problems with the companies that offered the derivatives more than the ones who used them like the hedge funds. The large institutions offering them didn't understand or didn't appreciate the risk they were taking on. When things tanked and they came due, the Gov. had to step in and bail them out to avoid a cascading failure of financial institutions.

[zoony]

Examining more than 5,000 hedge funds during 1994-2006, Chen found that 70 percent of them trade derivatives. On average, those that do so showed lower fund risks (as measured by fund return volatility, average market exposure, and market exposure during market downturns or extreme market events). “Overall, the evidence does not suggest that derivatives use by hedge funds leads to more risk-taking.”




That date range is absolutely hilarious. I mean really- does he think we're all dumb? :ols:


That said, my main problem with derivatives is my main problem with most of the wall st. lawyers and traders.

They add absolutely no value to the US Economy. None. Zilch. They are leaches, every damn one of them. They've inserted themselves into the financial transactions that exist between American companies that produce goods and services and the financial systems that support them.

They sell it and then they bet on it. Legally. And they're terrible at it. The entire thing comes crashing down and brings the economy with it.


If there was ever a better example of the free market acting in its own interest at the expense of the greater good, I don't think I could name one.

[zoony]

And BTW, hedge funds, by definition, are a scam. That is all :)

[Destino]

That date range is absolutely hilarious. I mean really- does he think we're all dumb? :ols:
Who funded this study? Seriously that date range is suspect as hell.

[Prosperity]

That date range is absolutely hilarious. I mean really- does he think we're all dumb? :ols:


That said, my main problem with derivatives is my main problem with most of the wall st. lawyers and traders.

They add absolutely no value to the US Economy. None. Zilch. They are leaches, every damn one of them. They've inserted themselves into the financial transactions that exist between American companies that produce goods and services and the financial systems that support them.

They sell it and then they bet on it. Legally. And they're terrible at it. The entire thing comes crashing down and brings the economy with it.


If there was ever a better example of the free market acting in its own interest at the expense of the greater good, I don't think I could name one.

don't they theoretically make financing good ideas easier (even if they have none of their own to contribute)

I would say that is valuable, if not respectable.

[zoony]

don't they theoretically make financing good ideas easier (even if they have none of their own to contribute)

a derivative would be a bet that a good idea is going to come to fruition or not.

Selling stock and bonds directly to the investor brings in the capital you're referring to. Ironically, the same brokerage houses that sell a companies stocks and bonds will come right behind those sales and bet whether or not the stock is a POS or not.

But, no conflict of interest here, no regulation needed. Move along, nothing to see here

http://www.johnny-zoom.com/images/southpark_cop.gif

[zoony]

anyone see 60 minutes last night? I highly recommend taking 30 minutes out of your day to catch it (video at link)

http://www.cbsnews.com/stories/2010/03/12/60minutes/main6292458.shtml


.......

[egtuna]

But, no conflict of interest here, no regulation needed.

We need OTC regulation no question about it. Ivestment banks fight regulation under the guise of "protecting the small farmers" who use futures and commodity options to hedge against poor crop yields. However, I don't think they're protecting "small farmers". They're protecting "bookies" like John Merriweather and his band of merry mathmaticians who create and destroy wealth (Long Term Capital Management anyone?).

[Prosperity]

I don't understand how all these supposedly intelligent people who are all bred in our most elite schools, somehow could be so incompetent. (like how could the rating agencies not notice? how could the brokers be so foolish?)...

ugh it's frustrating

Zoony's link actually helps answer some of those questions

[zoony]

I don't understand how all these supposedly intelligent people who are all bred in our most elite schools, somehow could be so incompetent. (like how could the rating agencies not notice? how could the brokers be so foolish?)...



There's the rub. I've said it several times before over the past few years- folks need to take a hard look at this country's MBA and law schools.

Are we teaching our future business leaders how to add value to the US Economy, or how to get their slice of the pie?

It's the latter, by and large.

....

[Corcaigh]

There's the rub. I've said it several times before over the past few years- folks need to take a hard look at this country's MBA and law schools.

Are we teaching our future business leaders how to add value to the US Economy, or how to get their slice of the pie?

It's the latter, by and large.

....

It's one of the few professions where the measure of success for many is how fast you can make enough money to get out :-)

[zoony]

Big crashes happen in that rare circumstance when derivatives are valued incorrectly, and instead of hedging a risk, it is multiplied ... e.g. selling credit default swaps on mortgage-backed-securities that are highly correlated with each other. The underlying assets go down, and then everything goes down...


And the fact that absolutely no assets have to be held to sell a derivative.


I mean, why don't any of the Vegas casinos let any random stranger come to their window and say "I'd like to bet $1,000,000 on the Redskins game"... take a ticket, and walk off- without actually giving the Casino the money to hold?

That's what a derivative is. Pure and simple. Casinos, run by mobsters, are smarter than Harvard MBA's and our country's finest lawers :doh1:

[Corcaigh]

Just a personal anecdote, my post graduate research involved some mathematical modelling and simulation using techniques close to those employed by major firms in the London Financial sector. I did interview with some and was appalled at their activities. They were building models and betting huge sums on what at least most of them would admit to being bull**** concepts, but all that mattered was whether it was possible to make short term profits. They were proud of their ingenuity but had as much integrity as someone selling diet pills in an infomercial.

[DjTj]

That date range is absolutely hilarious. I mean really- does he think we're all dumb? :ols:It definitely weakens his position a lot if he has to preface every conclusion with, "between 1994 and 2006..."


That said, my main problem with derivatives is my main problem with most of the wall st. lawyers and traders.

They add absolutely no value to the US Economy. None. Zilch. They are leaches, every damn one of them. They've inserted themselves into the financial transactions that exist between American companies that produce goods and services and the financial systems that support them.There have always been middle-men. If they didn't provide value, then they wouldn't exist.

And I would argue that the financial sector, in particular, brings a lot of money to the United States from abroad ... the fact that foreign investors and foreign companies run their deals through Wall Street is a huge part of why America remains on top.


They sell it and then they bet on it. Legally. And they're terrible at it. The entire thing comes crashing down and brings the economy with it.I wouldn't say they're terrible at it. Between 1994 and 2006, they were pretty good, and a lot of people made out pretty damn well. And if you want to blame Wall Street for the crash, you also have to credit them with the bubble - most of what the economy gained from 2001-2008 was a creation of Wall Street. Everyone shared in it on the way up, and everyone is sharing in it on the way down.


If there was ever a better example of the free market acting in its own interest at the expense of the greater good, I don't think I could name one.SUV's, perpetual copyrights, HMO's ... Every market acts in its own interest. It is the job of government regulation to align that with the greater good. We seriously failed in that respect over the past few years.


And the fact that absolutely no assets have to be held to sell a derivative.

I mean, why don't any of the Vegas casinos let any random stranger come to their window and say "I'd like to bet $1,000,000 on the Redskins game"... take a ticket, and walk off- without actually giving the Casino the money to hold?]/QUOTE]I think you're getting your buyers and sellers mixed up. The "no assets" rule in a casino would be you putting down $1 million on the Redskins without knowing whether the casino has $2 million in its vaults to pay you back. Nevada regulates this betting by requiring that casinos hold on to a certain amount of cash.

[QUOTE]That's what a derivative is. Pure and simple. Casinos, run by mobsters, are smarter than Harvard MBA's and our country's finest lawers :doh1:Bookies go broke all the time because they are not holding on to enough cash and a major upset happens. The difference is not that casinos are run by smarter people; it's that the government regulates casinos a lot more closely than they regulate banks.

[Prosperity]

There's the rub. I've said it several times before over the past few years- folks need to take a hard look at this country's MBA and law schools.

Are we teaching our future business leaders how to add value to the US Economy, or how to get their slice of the pie?

It's the latter, by and large.

....


I'm going to law school next year, if I'm more of a d-bag 3 years from now I'll think you are right.

For the most part though I don't think it's the grad schools that should teach ethics. The ethical mistakes that cause this mess aren't complicated scenarios... they were pretty obvious sins that everybody is smart enough to figure out. I mean you work for a rating agency it's your job to rate accurately, if you don't understand it don't take the word of the Goldman Sachs who are interested in getting high ratings. If you work for AIG don't take the word of the other two *******s.

Those people were probably vacuous fools before they ever got an MBA or JD

[zoony]

Just a personal anecdote, my post graduate research involved some mathematical modelling and simulation using techniques close to those employed by major firms in the London Financial sector. I did interview with some and was appalled at their activities. They were building models and betting huge sums on what at least most of them would admit to being bull**** concepts, but all that mattered was whether it was possible to make short term profits. They were proud of their ingenuity but had as much integrity as someone selling diet pills in an infomercial.


I know this is a long article, but it's from one of my favorite authors and if you have a second (or 1/2 hour :ols: ) check it out. This is sort of tangential to what you are saying- but along the lines of mathematical modeling and all that other mumbo-jumbo- nobody can freakin' understand it. Not even the people who put it together

http://www.gladwell.com/2007/2007_01_08_a_secrets.html

a few excerpts:


"This is a simple case, ladies and gentlemen," the lead prosecutor for the Department of Justice said in his closing arguments to the jury:

Because it's so simple, I'm probably going to end before my allotted time. It's black-and-white. Truth and lies. The shareholders, ladies and gentlemen, . . . buy a share of stock, and for that they're not entitled to much but they're entitled to the truth. They're entitled for the officers and employees of the company to put their interests ahead of their own. They're entitled to be told what the financial condition of the company is.

They are entitled to honesty, ladies and gentlemen.

But the prosecutor was wrong. Enron wasn't really a puzzle. It was a mystery.



and


Enron's S.P.E.s were, by any measure, evidence of extraordinary recklessness and incompetence. But you can't blame Enron for covering up the existence of its side deals. It didn't; it disclosed them. The argument against the company, then, is more accurately that it didn't tell its investors enough about its S.P.E.s. But what is enough? Enron had some three thousand S.P.E.s, and the paperwork for each one probably ran in excess of a thousand pages. It scarcely would have helped investors if Enron had made all three million pages public. What about an edited version of each deal? Steven Schwarcz, a professor at Duke Law School, recently examined a random sample of twenty S.P.E. disclosure statements from various corporations—that is, summaries of the deals put together for interested parties—and found that on average they ran to forty single-spaced pages. So a summary of Enron's S.P.E.s would have come to a hundred and twenty thousand single-spaced pages. What about a summary of all those summaries? That's what the bankruptcy examiner in the Enron case put together, and it took up a thousand pages. Well, then, what about a summary of the summary of the summaries? That's what the Powers Committee put together. The committee looked only at the "substance of the most significant transactions," and its accounting still ran to two hundred numbingly complicated pages and, as Schwarcz points out, that was "with the benefit of hindsight and with the assistance of some of the finest legal talent in the nation."




"These were very, very sophisticated, complex transactions," says Anthony Catanach, who teaches accounting at the Villanova University School of Business and has written extensively on the Enron case. Referring to Enron's accounting firm, he said, "I'm not even sure any of Arthur Andersen's field staff at Enron would have been able to understand them, even if it was all in front of them. This is senior-management-type stuff. I spent two months looking at the Powers report, just diagramming it. These deals were really convoluted."




Woodward and Bernstein didn't have any special training. They were in their twenties at the time of Watergate. In "All the President's Men," they even joke about their inexperience: Woodward's expertise was mainly in office politics; Bernstein was a college dropout. But it hardly mattered, because coverups, whistle-blowers, secret tapes, and exposés—the principal elements of the puzzle—all require the application of energy and persistence, which are the virtues of youth. Mysteries demand experience and insight. Woodward and Bernstein would never have broken the Enron story.



How can we possibly expect investors to make rational decisions regarding these transactions and business dealings?







.........

[zoony]

There have always been middle-men. If they didn't provide value, then they wouldn't exist.

Wrong. If there was no money to be made, they wouldn't exist.



And I would argue that the financial sector, in particular, brings a lot of money to the United States from abroad ... the fact that foreign investors and foreign companies run their deals through Wall Street is a huge part of why America remains on top.

That has little to do with the credit default swaps and betting going on.




I wouldn't say they're terrible at it. Between 1994 and 2006, they were pretty good, and a lot of people made out pretty damn well.
I'd say they're pretty terrible.



SUV's, perpetual copyrights, HMO's ... Every market acts in its own interest. It is the job of government regulation to align that with the greater good. We seriously failed in that respect over the past few years.

absolutely.



Bookies go broke all the time because they are not holding on to enough cash and a major upset happens. The difference is not that casinos are run by smarter people; it's that the government regulates casinos a lot more closely than they regulate banks.


I think we're kind of saying the same thing. And I'm not saying there are no dumb bookies out there.

I'm just asking- how dumb would you have to be to just take a random bet from a stranger for money you couldn't cover if you lost, with the person you're betting with putting up no money either? Pretty dumb, imo

Free markets ftw! :)

.....

[DjTj]

Wrong. If there was no money to be made, they wouldn't exist.But why would people pay them money, if there is no value? These funds do not exist without outside investors, and those investors definitely think they are getting value from the money that is paid to the fund managers.


That has little to do with the credit default swaps and betting going on.There were many Asian and European investors with money in the U.S. housing market, and we all benefited from that. All of it was tied together, and it was great for America for those years.


I'd say they're pretty terrible.And terribly profitable.


I think we're kind of saying the same thing. And I'm not saying there are no dumb bookies out there.

I'm just asking- how dumb would you have to be to just take a random bet from a stranger for money you couldn't cover if you lost, with the person you're betting with putting up no money either? Pretty dumb, imoWell, that's not exactly what happened. When AIG sold a CDS to Goldman, Goldman paid a fee for it. One side will always be putting up some money for any option.

The difference is really that casinos are required to hold on to a certain amount of cash. Insurance companies are required to hold on to a certain amount of cash. Commercial banks are required to hold on to a certain amount of cash. Investment banks and hedge funds ... not so much.

Chris Dodd is unveiling his bill right now: http://www.marke****ch.com/story/dodd-to-propose-limits-on-banks-risks-2010-03-15?dist=countdown

...if we ever get health care reform out of the headlines, this will be the next big push.

[zoony]

But why would people pay them money, if there is no value? These funds do not exist without outside investors, and those investors definitely think they are getting value from the money that is paid to the fund managers.

This is interesting, from the 4 minute mark

http://www.cbsnews.com/video/watch/?id=6298084n&tag=related;photovideo

Providing this not so much to argue my point, only to say that I'm far from the only one who is thinking this way right now :)

"on Wall St, the business has become very obviously divorced from productivity... they were very good at putting themselves in the middle of transactions... and taking a little piece of it. The world would be much better off had the industry never even have existed."



There were many Asian and European investors with money in the U.S. housing market, and we all benefited from that. All of it was tied together, and it was great for America for those years.

Foreign investment occured before 2000 when this was passed. So, I fail to see a causal relationship

http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000



And terribly profitable.

Thanks to the US Taxpayers covering much of the $1.75 Trillion loss.




Well, that's not exactly what happened. When AIG sold a CDS to Goldman, Goldman paid a fee for it. One side will always be putting up some money for any option.

But couldn't cover, nor were they required to hold any assets to cover. Insurance companies and Banks have to hold to a different set of rules, for good reason.




The difference is really that casinos are required to hold on to a certain amount of cash. Insurance companies are required to hold on to a certain amount of cash. Commercial banks are required to hold on to a certain amount of cash. Investment banks and hedge funds ... not so much.


Yes, I know :)

[DjTj]

I'm going to law school next year, if I'm more of a d-bag 3 years from now I'll think you are right.Law school certainly won't make you that way ... I was more idealistic and probably more liberal coming out of law school than at any point in my life.

The real world is what makes people chase profit and lose sight of the big picture. Life becomes simpler, paychecks have to pay rent, and you eventually you just do your job ... the people really making the decisions are 10 or 20 years out of business school or law school. They have already forgotten everything that they learned in school.

And I don't really think it's about ethics. It is more incompetence than ethics. The people making the bond ratings didn't think they were screwing over the economy. They weren't as diligent as they should have been, but as zoony points out in relation to Enron, it wasn't that easy to figure out what all these deals were about.


"on Wall St, the business has become very obviously divorced from productivity... they were very good at putting themselves in the middle of transactions... and taking a little piece of it. The world would be much better off had the industry never even have existed."That is all hindsight though. Of course we know now that the world would be better off if it hadn't been so easy to collateralize mortgages and then insure against it, but the problem isn't the people doing it or their motivations; it's that we created a system where the rest of the market wasn't able to see what was going on, and where we allowed these risks to be multiplied without any reserve requirement.

Would we be better off if we had never started a nationwide market for collateralized mortgages with Fannie and Freddie after World War II?

Would we be better off if stock options weren't an available form of compensation that drove the dot-com boom?

Not all options are bad, and not all speculation is bad. It just needs regulation.


Foreign investment occured before 2000 when this was passed. So, I fail to see a causal relationshipI'm not saying that there is a causal relationship between this particular crisis and foreign investment. I'm saying that Wall Street is going to cause crises like this every few years, especially when they are poorly regulated. That crisis is going to originate in the United States.

But in exchange for those occasional crises, Wall Street also moves a lot of money from abroad into the United States. We are on the cutting edge of global finance, and there are both benefits and risks from that. I think it's a net positive to have Wall Street in the United States.


Thanks to the US Taxpayers covering much of the $1.75 Trillion loss.Even counting the bailout, I think it was still profitable if you start the clock a little earlier. In hindsight, the the 2001-2008 period was not, but there was certainly profit from the mid-90's and plenty of profit if you want to start further back than that.


Yes, I know :)I suppose we generally agree, but the difference is that I don't think it makes much sense to blame the schools or to blame "Wall Street" in general ... the people that use money to make money will continue to exist, they will continue to have short-term profit motives, and they will continue to create crises from time to time.

Maybe what I'm trying to say is, "Don't hate the player, hate the game." Our focus should be on changing the rules of the game.

[zoony]

I suppose we generally agree, but the difference is that I don't think it makes much sense to blame the schools or to blame "Wall Street" in general ... the people that use money to make money will continue to exist, they will continue to have short-term profit motives, and they will continue to create crises from time to time.

Maybe what I'm trying to say is, "Don't hate the player, hate the game." Our focus should be on changing the rules of the game.



I think Obama said it best when he said "few are to blame, but we're all responsible"

hell, I might have that backwards :ols:

Anyways- I'm not blaming so much as I'm advocating we take a real look at needed regulations- and to say that I wouldn't even stop there. I think the problem is systemic... and the best place to attack that kind of thing is at the very beginning of the vine.

.....

[Predicto]

I think Obama said it best when he said "few are to blame, but we're all responsible"

hell, I might have that backwards :ols:

Anyways- I'm not blaming so much as I'm advocating we take a real look at needed regulations- and to say that I wouldn't even stop there. I think the problem is systemic... and the best place to attack that kind of thing is at the very beginning of the vine.

.....

I wish we could start with the underlying model of internal corporate governance, but that is a pipe dream.

[GibbsFactor]

and the best place to attack that kind of thing is at the very beginning of the vine.

.....


Ohh ohhh ohhhh.... me me me me....


:silly:

[zoony]

I wish we could start with the underlying model of internal corporate governance, but that is a pipe dream.


I've been sniffing that one firsthand lately- and boy does it stink.

[zoony]

Ohh ohhh ohhhh.... me me me me....


:silly:



:ols: I said FIX- not do away with :)

[GibbsFactor]

:ols: I said FIX- not do away with :)

See, you got me all wrong. Start macro and work in. I'm telling ya...

I'm not one that thinks we should let all us sharks free to frenzy. But I am one that thinks we need to take a comprehensive look at our entire finaicial system and re-evaluate it. Is the bottom line really the answer to our puzzle? Clearly not. We wouldn't have this "war on poverty" if our system was top notch.

[zoony]

See, you got me all wrong. Start macro and work in. I'm telling ya...

I'm not one that thinks we should let all us sharks free to frenzy. But I am one that thinks we need to take a comprehensive look at our entire finaicial system and re-evaluate it. Is the bottom line really the answer to our puzzle? Clearly not. We wouldn't have this "war on poverty" if our system was top notch.



True to an extent... BUT... to DJ's point above, it's still the best in the world (and quite frankly nobody else is close)

I am of the opinion that overall we have it right- but there are definitely portions that are not. Commodities futures, derivatives, and corporate governance like Predicto points out is pretty crappy (anyone want to explain why we allow someone to be CEO AND Chairman, for instance?)


Not sure we need a tops down re-evaluation so much as a good bath.
........

[GibbsFactor]

Not sure we need a tops down re-evaluation so much as a good bath.
........

Not to side track this thread any more but I wanted to put one little fact out there....

Highest county median income in 1970? Around 15K. 40 years later? 110K.

Inflation is a tax.

[zoony]

Not to side track this thread any more but I wanted to put one little fact out there....

Highest county median income in 1970? Around 15K. 40 years later? 110K.

Inflation is a tax.


you're not going to get much argument from me that the Fed has been printing too much money. Heck, Alan Greenspan has recently said as much in a very public mea culpa

Where I do get confused about where you're coming from (hey, you put it out there :) )- this is a direct result of the monetarist theory and the Chicago school- which very much is in bed with libertarian theory. How do you reconcile that?

I would be interested in hearing more about the "inflation is a tax" statement though if you have time

(sorry SHF for the hijack :) but I think we're the only two posting in here anyways :silly: )

[Lombardi's_kid_brother]

But why would people pay them money, if there is no value? These funds do not exist without outside investors, and those investors definitely think they are getting value from the money that is paid to the fund managers.

In jumping back between for-profits and not for profits in recent years, I've become absolutely stunned at the number of people who have jobs in the private sector who seem absolutely supurflulous. I'm convinced that 75 percent of consultancy positions are some elaborate confidence game. My company had a consultant in the office for two years. I'm pretty sure I equalled the knowledge he brought to us after attending a particularly informative 5-day conference.

Not sure how this relates to financial markets and zoony's points, but he can probably take it from here.

[Corcaigh]

(sorry SHF for the hijack :) but I think we're the only two posting in here anyways :silly: )

Yeah ... the rest of us are busy, ya know, adding value to the US economy. :)

[zoony]

Yeah ... the rest of us are busy, ya know, adding value to the US economy. :)



ZING!! :ols:

/thread

[boofMcboof]

It definitely weakens his position a lot if he has to preface every conclusion with, "between 1994 and 2006..."

There have always been middle-men. If they didn't provide value, then they wouldn't exist.

The value that you're alluding to is liquidity. Traders and speculators provide the pricing mechanism between producers and buyers.



And I would argue that the financial sector, in particular, brings a lot of money to the United States from abroad ... the fact that foreign investors and foreign companies run their deals through Wall Street is a huge part of why America remains on top.

I believe you're spot on. The world's financial system is hinged to the United States with the dollar as the reserve currency. The world is forced to serve and finance U.S. debt because commodities, like oil are priced in dollars. Dollar hegemony, is the term coined I believe.

[GibbsFactor]

you're not going to get much argument from me that the Fed has been printing too much money. Heck, Alan Greenspan has recently said as much in a very public mea culpa

Where I do get confused about where you're coming from (hey, you put it out there :) )- this is a direct result of the monetarist theory and the Chicago school- which very much is in bed with libertarian theory. How do you reconcile that?

I would be interested in hearing more about the "inflation is a tax" statement though if you have time

(sorry SHF for the hijack :) but I think we're the only two posting in here anyways :silly: )

I think it's still connected. Just taking a micro level with these fancy financial vehicles and then looking at the broader picture leads us to this discussion. The financial system is very complicated, so complicated that these wall street lawyers and brokers rarely understand all the complexities. To then expect the government to properly regulate these vehicles is lunacy. Even if a good regulation protocol is established, some mathematician will eventually figure out a way to get around it or more likely come up with an entirely new vehicle that is not regulated. So then the answer must be to make new financial vehicles illegal. That won't happen.

As for the tax, just take a look at the CPI. As of January 2010 it's 216. That represents a 116% decrease in the value of the dollar since 1982. I beg you to find an investment vehicle that produces any thing near that value. A 116% return over 28 years is rare indeed. So even the richest of the rich are being taxed by our Keynesian activities. Of course in our current monetary system, government intervention is not just advised, it is required. This hurts the lower paid people the most because the prices for everything go up but income levels are much slower to keep up. It's an indirect tax, but a tax none the less.

I'm a fan of "keep it simple, stupid". It's a hard argument to sell, however, since this system has helped make us one of the more economically powerful nations of all time. But when you look at the fall out, the unemployment, the large and devastating bubbles, the unsustainable debt that is piled up and the inflation essentially taxing all of our savings, and the debts middle class must pile up to maintain any level of healthy living, any sane person should sit back and wonder if this is all the optimal way of handling our business. This makes it that much harder to ever rise in class. The lower class can't get credit, the middle class are in debt up to their eyeballs. No wonder we need SS.

I do not believe any one school of thought has it right and I admit I am not highly educated in any economic school of thought. I do think that those that are highly educated in our current economic policies are too concerned with how to manipulate the system and not nearly concerned enough if it is, in fact, the best system. I feel it's a system of greed that ironically cripples one's wealth over time.

[zoony]

I don't disagree with a lot of what you are saying GF- I really don't. It's not hard to be a cynic, especially these days.

However, two things I would point out. While inflation has gone up quite a bit, no doubt- the dollar's purchasing power is at an all time high.

I can remember as a kid- when someone got a new car, EVERYONE on the block came to check it out. My mother agonized for weeks over the purchase of a blender. Now, you can pick up a blender at target for $29. I remember my dad guarding his power tools like they were gold bars. Because they were really, really expensive as a proportion of income.


The other thing- I disagree with you that markets cannot be regulated. I think history is filled with examples of markets that were regulated successfully. Hell, Wall St. didn't do the nosedive until they were given the green light by Congress in 2000. Commodities didn't **** the bed until the traders and speculators got hold of them. California didn't have rolling power outages until the government decided to deregulate. etc. etc

[GibbsFactor]

I believe you're spot on. The world's financial system is hinged to the United States with the dollar as the reserve currency. The world is forced to serve and finance U.S. debt because commodities, like oil are priced in dollars. Dollar hegemony, is the term coined I believe.

If the dollar loses it's reserve status, which the Euro has been gaining on, it's game over for us. All we need to do is lose that pristine credit rating. Many oil bourses are already using the Euro.

[zoony]

If the dollar loses it's reserve status, which the Euro has been gaining on, it's game over for us. All we need to do is lose that pristine credit rating. Many oil bourses are already using the Euro.



The Euro is less confidence inspiring right now than the dollar is, by a great deal

[GibbsFactor]

I don't disagree with a lot of what you are saying GF- I really don't. It's not hard to be a cynic, especially these days.

However, two things I would point out. While inflation has gone up quite a bit, no doubt- the dollar's purchasing power is at an all time high.

I can remember as a kid- when someone got a new car, EVERYONE on the block came to check it out. My mother agonized for weeks over the purchase of a blender. Now, you can pick up a blender at target for $29. I remember my dad guarding his power tools like they were gold bars. Because they were really, really expensive as a proportion of income.

Which is why it's a hard argument to sell. :) However, when you were a kid, the average American didn't have as much debt as they do now. That blender for $29 was probably bought with store credit at 20+%. Not to mention the industrial age has brought down prices of items. (see Moore's law) It is estimated that 43% of Americans spend more then they make in a given year. That's a stressful life while the rich get richer because they are able to take advantage of the manipulations mentioned above. That's why I think it's a fallacy, the same fallacy that keep us in our current economic policy. But hey, people can buy new cars more often so it's a hard argument to sell.


The other thing- I disagree with you that markets cannot be regulated. I think history is filled with examples of markets that were regulated successfully. Hell, Wall St. didn't do the nosedive until they were given the green light by Congress in 2000. Commodities didn't **** the bed until the traders and speculators got hold of them. California didn't have rolling power outages until the government decided to deregulate. etc. etc

I admit to being an ideologue. Unfortunately, my utopia doesn't exist. I agree we need regulations because we just aren't as civil as we think. But that shouldn't be the only answer. Why not come up with a system that inherently requires less regulation but keeps all consumers safe? I think it can be done but we are all too concerned with how we can manipulate this current system and we end up in these times. Some benefited but many more lost their home. The ups and downs are too wild and I don't think it's natural. Again, I'm a fan of keeping it simple, not outsmarting ourselves. Stability in society is my endgame.

[GibbsFactor]

The Euro is less confidence inspiring right now than the dollar is, by a great deal

Yes! I know it's had it's problems. Guess it depends on what happens with Greece. And we should all thank our lucky stars that it is. Cause for a while there in '08 and '09 I was very worried.

[Hubbs]

Holy crap, an economic thread in which I actually largely agree with zoony.

This can only mean one thing...

http://bringontheendtimes.files.wordpress.com/2009/02/end-nigh.jpg

(Well, I agree with most of the substance of what zoony said, at least. The more I learn about our financial system, the more I'm convinced that there's no good reason for a lot of these "products" to exist. All the commentary in which being pants-****tingly dumb is equated with free markets - when in reality, the "casino" in zoony's scenario gets to repackage the bet and sell it to someone else, thereby creating profit while risking absolutely nothing, and that ain't exactly dumb - is just, well, zoony being zoony.)


Where I do get confused about where you're coming from (hey, you put it out there :) )- this is a direct result of the monetarist theory and the Chicago school- which very much is in bed with libertarian theory. How do you reconcile that?

While Alan Greenspan described himself as a libertarian - and he certainly holds many views that qualify - I have to say that this comment befuddles me just a bit. After all, you've established in many a thread that Ron Paul makes decisions for all libertarians. It's a collective hive mind, like the Borg, in which all thoughts are controlled by Mr. Paul. And as I'm sure you know, he's been railing against the existence of the Fed for years. So how could Fed actions to pull the strings on the economy be part of libertarianism?

:silly:

[DCSaints_fan]

As for the tax, just take a look at the CPI. As of January 2010 it's 216. That represents a 116% decrease in the value of the dollar since 1982. I beg you to find an investment vehicle that produces any thing near that value. A 116% return over 28 years is rare indeed. So even the richest of the rich are being taxed by our Keynesian activities

116% over 28 years is not hard. Even something with a 5% interest rate will yield a 392% return in that time period (1.05^28 = 3.9201) . I'm sure you could have got a T-bill at that rate, (or better, wasn't the prime rate > 10% back then?)

[Fergasun]

So can we start a thread on the 2200 page Lehman report where they talked about how Lehman was using their "financial instruments" to hide the fact that they were insolvent, and apparently it went on for 2 months and a bunch of insiders knew... and they actually had some help from our now Treasury Secretary...

[Hubbs]

So can we start a thread on the 2200 page Lehman report where they talked about how Lehman was using their "financial instruments" to hide the fact that they were insolvent, and apparently it went on for 2 months and a bunch of insiders knew... and they actually had some help from our now Treasury Secretary...

I believe it was more than a two-month scam, actually. Something I read yesterday dated it back to 2007.

[zoony]

While Alan Greenspan described himself as a libertarian - and he certainly holds many views that qualify - I have to say that this comment befuddles me just a bit. After all, you've established in many a thread that Ron Paul makes decisions for all libertarians. It's a collective hive mind, like the Borg, in which all thoughts are controlled by Mr. Paul. And as I'm sure you know, he's been railing against the existence of the Fed for years. So how could Fed actions to pull the strings on the economy be part of libertarianism?

:silly:


I often point to Ron Paul because like it or not he's the face of libertarianism. I also will go to libertarian's web sites. Of course, whenever I point out what the two believe, I get blasted for it because I'm "painting with a broad brush."

See, that's one of the things that's so frustrating about libertarianism- and absolutely part of its appeal to many; it's a moving target. Folks can define it however they want. You're not accountable to the views of others as is so often the case in the other two parties.

But I digress, Milton Friedman was the economic advisor to Ronald Reagan, the developer of monetarist economic theory (of which Greenspan & Bernanke are/were disciples), and easily as much if not more tied to the libertarian movement than Keynes is to the Democratic party. I was just curious how libertarians reconcile Friedman's thesis on the Great Depression and the manipulation of interest rates while simultaneously disagreeing with TARP and ranting about inflation.


.......

[zoony]

All the commentary in which being pants-****tingly dumb is equated with free markets - when in reality, the "casino" in zoony's scenario gets to repackage the bet and sell it to someone else, thereby creating profit while risking absolutely nothing, and that ain't exactly dumb - is just, well, zoony being zoony.)



I'm not really following you here- but credit default swaps, almost universally regarded as THE key player in the Great Recession, were a direct result of governmental deregulation of the markets.

The reason Insurance Companies and Banks don't crash that way is the government requires that they hold a certain amount of assets to the debt they generate. Without those regulations, they wouldn't. Why? Because they could never be competitive by placing a voluntary restriction on themselves while their competitors didn't.

So the underlying value of these derivatives crash, there are no assets to cover the loss.


I think that's the example you're referring to. If not let me know

[Hubbs]

I often point to Ron Paul because like it or not he's the face of libertarianism. I also will go to libertarian's web sites. Of course, whenever I point out what the two believe, I get blasted for it because I'm "painting with a broad brush."

See, that's one of the things that's so frustrating about libertarianism- and absolutely part of its appeal to many; it's a moving target. Folks can define it however they want. You're not accountable to the views of others as is so often the case in the other two parties.

But I digress, Milton Friedman was the economic advisor to Ronald Reagan, the developer of monetarist economic theory (of which Greenspan & Bernanke are/were disciples), and easily as much if not more tied to the libertarian movement than Keynes is to the Democratic party. I was just curious how libertarians reconcile Friedman's thesis on the Great Depression and the manipulation of interest rates while simultaneously disagreeing with TARP and ranting about inflation.


.......

Oh, I agree, he is. I'm just remembering a particular thread in which Larry (I believe) stated, in reference to himself, that not all libertarians believe something (I don't even recall the topic anymore). You responded with a Ron Paul quote expressing support for whatever the hell we were talking about. The implication being that if Ron Paul thinks it, well, damnit, Larry, you think it too, whether you like it or not.

I grant you that self-described libertarians likely have a wider swath of potential positions because things like anarchism have been put under the umbrella of libertarianism, and I would disagree with an anarchist about all sorts of things. But I also think you tend to apply the lens of dogmatism more closely in the case of libertarians for some reason. Do all liberals believe in, say, gay marriage? If the answer is yes, does that mean Barack Obama is not a liberal? What about abortions? Late-term? Should parents have to be informed if a minor is getting an abortion? If two self-described liberals disagree on that issue, is one of them not really a liberal? Or should we accept the notion that, given the relatively small number of political labels we commonly use, no label could possibly encompass every position on every issue? You speak of "moving targets" as if the same isn't true about other labels. Is Mitt Romney, the man behind RomneyCare, a conservative? Do you think those who attended CPAC would agree with your answer? Do you think I would?

I largely agree with you about Friedman and the general definition of libertarianism. I believe that many self-described libertarians of 30 years ago would say that the idea of a monetary system independent of political influence was beneficial, and that the Fed simply controls the amount of money moving around in the free markets, thereby tickling everybody's liberty bone. I also believe there were many who would say that the Fed suffers from the same problem that any other effort at some sort of central economic power suffers from - its governors believe that they can control interest rates better than anybody else, and when they're wrong, the consequences affect the entire world. (There's also the issue of a monetary system which specifically aims for never-ending inflation.) I think most modern-day libertarians have adopted this view, and I think they've done it because of the evidence presented to them in the form of the past decade.


I'm not really following you here- but credit default swaps, almost universally regarded as THE key player in the Great Recession, were a direct result of governmental deregulation of the markets.

The reason Insurance Companies and Banks don't crash that way is the government requires that they hold a certain amount of assets to the debt they generate. Without those regulations, they wouldn't. Why? Because they could never be competitive by placing a voluntary restriction on themselves while their competitors didn't.

So the underlying value of these derivatives crash, there are no assets to cover the loss.

Yes, I agree, except for the part about the "direct result of governmental deregulation." As I understand it, the problem is that the market was never regulated. The swaps were mostly created specifically outside of existing regulations, and, yes, my crazy ass agrees that that seems to have been proven to be a Not Good Thing.