It’s been four years since Lehman fell and everything went into the shitter. Here’s a sharp take from a former Goldman VP who’s working at the think tank Demos:
Unfortunately, the disease lingers on even as the symptoms are treated. Thirty five years of deregulated free-for-all trading has changed the way we all think about the system. There was a time, before the Reagan administration commenced the dismantlement of the New Deal (including financial regulation), when investment was primarily about the fundamental value of shares of stock and corporate and municipal bonds. Investors acquired with a view to hold their investments long enough to realize this fundamental value. But the investing public is now enthralled by the mythic trader, able to spin gold from straw using only his sharp wits. Investment is largely accomplished through pooled vehicles like pension funds and mutual funds. These funds, more and more, resemble hedge funds, and the fund managers are compensated accordingly. The quest is a search for “alpha” returns that exceed the markets. Investment in a sound company or a plain vanilla municipal bond seems so very boring when the opportunity to grab a fraction of the limitless wealth of the Wall Street trader is on offer. The problem is that alpha is unachievable, except by happenstance, as study after study demonstrates.
Make no mistake, Wall Street likes this investor infatuation with alpha. Every confidence man knows that the perfect mark is someone who is intent on getting an advantage over the common “Joe.” The pooled funds are increasingly investing in the market, not in projects or companies. They act as if the markets somehow work fairly and predictably so that they can execute some tailored strategy devised by their fund managers that secures healthy returns with minimal risk. After decades of indoctrination, they have yet to shake the ideas espoused by Ayn Rand and the Efficient Markets Hypothesis perpetrated on the world by the University of Chicago.
The latest in the banking world is that JP Morgan Chase is under investigation for weak money laundering controls.
arguingwithsignposts
tl;dr: Wall Street is a cas1no, and the bankers are the house.
Dennis SGMM
It seems to me that the big boys don’t really invest in the old sense any more. They use hardware and software to front-run the markets and their actual ownership of stocks can often be measured in microseconds.
Kirbster
This is why Romney’s domestic policy proposals scare me more than his obvious ineptitude in foreign policy. There is already too much money in the system chasing too few good investments. Wall street is happy to fill the void with ever more exotic derivative products. Imagine the bubble when all the regulations come off and even more money is dumped into the system via tax cuts for the wealthy and the privatization of Social Security. When it all blows up this time, there will be no TARP to put a floor under the disaster, and the autumn of 2008 will seem like good times.
jayackroyd
Alpha is the intercept in the equation Value=a+b(individual securities). Beta (b) is the value associated with a particular investment. Alpha is the value attributed to the “marketplace.” The expected value of alpha is zero, if you believe in the efficient market hypothesis. You can’t make money trading on the alpha.
Baud
It’s been a long time since I’ve been to Salon to read an article, and their website is truly dreadful.
As I see at, investment is like a bell curve. Long term, a very few will do better than the market, a very few will do worse, and most investors will be right around the market average. But, as you said, people can’t stand to be average, so they are susceptible to grifters and manipulators who promise to put them into the top tier, in exchange for a modest consulting fee of course.
Dennis SGMM
@Kirbster:
Wall Street wants all of that juicy Social Security money the way that Hedley Lamarr wanted Rock Ridge. It knows that a straight bailout a la TARP is now dead out. If, on the other hand, the retirement income of millions of Americans is at stake…
Howard Beale IV
In Prosecutors, Debt Collectors Find a Partner
Applejinx
Man.
Just kill the trader beast.
Kill it economically- doesn’t have to get personal.
Talk about a worthless bunch of toxic garbage that does nobody any good. By the nature of ‘alpha’, ‘lottery’ type things, lots of the TRADERS themselves don’t freaking win. But everything has to be about protecting the ability of the one guy to win the lottery, because all those guys believe that they, too, will inevitably be that one guy…
MattF
I suppose this makes me an old-style investor. My take on the current scene is that people just like to gamble– which is fine with me, I’m no Puritan. But when you confuse ‘risk’ with ‘thrill’ you’ve got a problem. Yes, there’s a difference– I tell people that ‘personal finance’ is the opposite of sex; if it’s exciting you’re doing it badly.
Wag
I see much of the problem with Wall Street being the discouragement of long term investments. Bin response, I would propose that Capital Gains taxation be tied via a sliding scale directly to the length of time an investment is held.
Less than a day means a 95% capital gains rate
More than 5 years means 0% rate
Feel free to fill in a sliding scale between the two extremes.
Davis X. Machina
They’re basically daring us to impose DiFazio’s transaction tax.
Petorado
Just as the investment world has skewed toward unreasonable expectations on returns, the businesses that are being invested in have skewed from being customer-focused to being more concerned about the investment community. Publicly owned firms seem more interested in providing less value to customers in order to shift that value to their stocks. Las Vegas capitalism is triumphant over the Adam Smith variety.
Nathan
Meh, I think Wall St. is enthralled by their own bullsh!t and pushing forward this myth… much more so than the public seeking it out. I think traders are the only ones who worship traders and can write such reverent phrases. The rest of us cover our wallets.
Villago Delenda Est
@Applejinx:
This also explains the stupidity of white working class people objecting to taxing the rich; they are CONVINCED they, too, will benefit from those tax cuts.
Eventually.
Chris
@Nathan:
This.
Last I looked, “banks” and “big business” didn’t rank too highly on Gallup’s polls of who Americans trust. They’re popular with themselves, with some of their high society peers (media, politics, etc), and with a mostly-Gooper demographic of petty bourgeois who wish they could be like them someday. That’s it.
(Those voices are louder and more overrepresented than they otherwise might be, because the media mostly hails the former as the Pillars Of Our Nation while presenting the latter as the only voice representing the Man On The Street).
Ben Franklin
I remember the controversy in the 80’s when banks were allowed to sell securities to their customers, as opposed to FDIC insured CD’s and other savings accounts. This was the beginning. The revision of Glass-Steagall came later, but I don’t really understand how Brad DeLong and Tyler Cowen poo-pooed that this caused the CRASH!. Are their any Econs here who can explain how GS was not the fatal blow?
Greg
@Ben Franklin:
Mortgage-backed securities didn’t exist at the time the Glass-Steagall Act was written and made law, and arguably didn’t really apply to or regulate what went wrong during the crash. At least, that was what was said during its repeal in 1999, that it was obsolete and didn’t really apply to many newer financial instruments.
So I think the people saying the GS repeal didn’t cause the crash are narrowly correct, but in a wider sense, the attitude that led to repealing what regulations we did have rather than trying to regulate these new things was obviously wrong-headed and contributory to the meltdown. In that sense, the GS repeal is symbolic of the wider refusal to do anything to reign in the financial system.
Ben Franklin
Thanks, Greg. But I still think the repeal of GS was the coup de gras, rather than simply a contributor to the overall problem.
MikeJ
@Greg:
No, they’re absolutely correct. Legislation isn’t about people’s feelings or attitudes towards things. it’s about which things are legal and which things aren’t.
And yes, the anti-regulation attitude led to the lack of regulation that caused the problems. However I often feel that those on the left demanding a return of Glass-Steagall understand it about as well as those on the right demanding a return to the gold standard. Even though a return of Glass-Steagall may be a good idea on its own, it’s not a magic bullet. You need to convince people that the downside is bad enough that capping the upside is acceptable. The problem with limiting upside potential to limit downside potential is that people on Wall street get rich individually and go broke as corporations.
raven
Wesley Clark ain’t that all that hot when that screeching fucking bitch Liz is on the same show.
Ben Franklin
@MikeJ:
Hmmm. I’m wondering why the dotcom bubble immediately surfaced, followed by credit swaps as the refrain. Coinky-dinky?
Greg
@MikeJ:
I agree with you, but there is a huge difference between “bring back Glass-Steagall”, which is silly and cargo-cult legislating, and “bring back securities regulation LIKE Glass-Stegall” or “motivated to try to produce the same kinds of results as Glass-Stegall”, which are perfectly reasonable things to say and the right thing to do.
Glass-Stegall was a piece of legislation that comes from a particular attitude towards the banking and financial sectors, and we need more of that attitude, just not that particular legislation.
Judas Escargot, Acerbic Prophet of the Mighty Potato God
@Dennis SGMM:
Pretty much this.
And a small per transaction tax (or ‘fee’, who cares what you call it) would go a long way towards curbing the practice.
You want to do a million trades per second? Fine. You’ll be paying a few thousand dollars in taxes per second, also, too.
Villago Delenda Est
@Ben Franklin:
The dotcom bubble was moving right along, thank you, before the GS repeal. It was a classic bubble, in the South Seas/Mississippi Company/Tulip Craze sense…something new, not quite understood, pure enthusiasm spurring its expansion, until at a certain point, people decided to cash out, and POOF there it goes.
The mortgage-backed securities craze is of a different nature, and involved outright fraud at its base to work. The legal protections of title were ignored through MERS deliberately, to avoid all those nasty fees charged in county offices all across the country that give real estate its legal basis..and just as importantly, the deliberate process to move a mortgage from one entity to another. It is, by design, slow and methodical to insure that it is sound. That is anathema to three card monty artists. MERS gave them the tools they needed to run the scam on a massive scale. Suddenly, the money was not in getting the interest of the mortgages, the money was in the churn…because before MERS, it was not possible to churn.
Davis X. Machina
@MikeJ: Barry Ritholtz:
Ben Franklin
@Villago Delenda Est:
It is, by design, slow and methodical to insure that it is sound.
I just remain skeptical that such things would have occurred as easily with an intact GS. I don’t see how you can separate a tiger from his stripes.
Ben Franklin
A comparison to the Titanic’s insufficient lifeboats….
http://www.washingtonpost.com/repeal-of-glass-steagall-not-a-cause-but-a-multiplier/2012/08/02/gJQAuvvRXX_story.html
Ruckus
@Ben Franklin:
Because it seems you are conflicting the law with the desire of what the law does.
GS stopped the things it was written to stop, the excesses of the twenties, the causes of the depression. It would have had no legal effect on the causes of this recession.
OTOH I think you are saying that if GS had been in place people may have taken less risk. But they were/are taking risk with OPM, think mittens/bain, think micro second trading, which could not even exist in the twenties and therefore was never even thought about. The law had/has not kept up with technology and avarice.
FlipYrWhig
@Ben Franklin: Indulge me in my need to be a pedant here: “coup de grace” means “the final blow.” “Coup de gras” would mean something like “the fat blow,” which I picture as someone getting bonked with a can of Crisco.
AHH onna Droid
@Ben Franklin: It’s grace, but, like, whatever.
The tech bubble wasn’t just IT sector irrational exuberance. We also deregulated the electric power sector in a way that facilitated a massive fraud. When web 1.0 burst, it opened up the utilities fraud too, a la Madoff. Both fraud s were capable of being mitigated or prevented by better regulations and enforcement.
The fact that we won’t do that has the net effect of money not being invested in our economy. It travels to markets with greater TRANSPARENCY. Thats code for not ripping you off Joe Kennedy style. The other place money is going is into T-bills, so apparently investors trust the US gov as a concern in terms of how it polices money sent to its various subsidiaries, the states, than any private, publicly traded firm in this country.
Ben Franklin
@Ruckus:
the causes of the depression. I think gambling was the cause of both the depression and the meltdown, no? Isn’t that what GS addressed? I’m no economist, but that’s my impression.
Ben Franklin
@FlipYrWhig:
Indulge me in my need
Hokay.
? Martin
@Dennis SGMM:
The introduction of derivatives really did change things. I don’t disagree on the ‘seeking alpha’ argument above, but there are really a TON of different things that have contributed to change.
Specifically on derivatives (since I trade derivatives for fun and profit) – derivatives abhor stability. They work best when there is chaos – and if you’re good at it, you don’t care what kind of chaos. 5% up/5% down – you don’t care, so long at it’s at least 5%. And the leverage can be MASSIVE. I’ve gotten 10,000% returns in weeks, and when you see that kind of return, it’s hard to stick with the slow and steady path that in your lifetime may never hit 10,000%.
And the timing of that chaos is critical. With a highly connected social world, you get things like Jim Cramer who will lay down a derivatives trade, go on his radio show and spread a rumor about the underlying security, watch the rumor spread, watch the security go up or down, and within a day he’s doubled his money and is out of the trade before the rumor gets quashed and the security go back to where it was trading. Derivatives are unique in creating this behavior.
The high speed trading started 20 years ago with currency trading and it leads to similar behavior.
The fundamental problem is that the rate at which trades could be executed used to be no faster or slower than the rate at which information could flow. It was harder to get an advantage in that situation unless you were on the exchange floor. Today, trades can be executed MUCH faster than information can flow – so before anyone knows whether the information is good or not, someone has already profited off of that information. That’s a big problem and for the kinds of investments that rely on that timing, we need to add appropriate throttles to those trades. We can add transaction fees to the high speed stuff. We can require that derivative trades not be naked trades – that you have to own the underlying security when you execute the trade – because then if you’re betting in the derivative on the security dropping – you’re going to lose equally on the security because you own it. You can still make money here, but it’s less, and the risk is much higher because if your attempt to manipulate the stock comes up short – you lose on both sides, instead of just one.
Ben Franklin
Wiki;
During the Crash of 1929 preceding the Great Depression, margin requirements were only 10%.[18] Brokerage firms, in other words, would lend $9 for every $1 an investor had deposited. When the market fell, brokers called in these loans, which could not be paid back.[19]
GS put a firewall between Banks and Brokerages. Is this what I misunderstand? Credit default swaps did not involve brokers colluding with Bankers?
Then this….:http://www.opendemocracy.net/openeconomy/michael-bullen/return-to-financial-health-is-simple-glass-steagall-plus-transparency
” in my view, key components to the credit and banking crises in the US and UK were the repeal of the Glass Steagall Act by President Clinton in 1999 and the enactment of the Financial Services and Markets Act in 2000, leading to the introduction of “light touch” regulation in the UK. The new regulatory regime in the US allowed Lehman Brothers to rack up leverage of 30.7 times (probably heavily window-dressed) in its last annual financial statements; and enabled commercial banks to take high risk trading positions in mortgage bond portfolios that would not have been permitted prior to the repeal of Glass Steagall and leading to the failure and near-failure of numerous banks.
The trend for US commercial banks to take investment banking positions onto their balance sheets was followed in Continental Europe, particularly in Germany and Switzerland and with entirely predictable results.
The much-vaunted “light touch” system in the UK enabled banks such as HBOS and Bradford and Bingley to increase their balance sheets substantially by borrowing funds on international money markets where previously they had been restricted to relying upon their traditional deposit bases. When the international money markets dried up after the collapse of Lehman, HBOS and Bradford and Bingley, among others, went to the wall. The “light touch” regime also allowed UK banks to compete for new mortgage business by offering 125% mortgages, where 95% had previously been the normal ceiling, and allowed mortgages on greater multiples of income than under the previous regime. Countries that did not follow the trend towards reduced regulation and where banks were still regulated under more traditional regimes, such as Australia and Canada, did not encounter housing bubbles or banking industry collapses.
The second measure must be to maintain levels of market transparency and to make improvements where possible. In particular, it is vitally important that sovereign debt should be openly traded. The problems of political profligacy and dishonesty in Greece were first brought to light, not by Greek politicians, not by the EU, not by political or economic journalists, but by traders in international government bond markets who sold Greek debt, and bought protection on other positions, in response to persistent rumours of irregularities in Greek national finances. Local politicians protested vehemently that the Greek economy was being attacked by speculators (always a favoured response for troubled politicians) and Greek Prime Minister Papandreou went on a world tour to drum up support for his “anti-speculator” position. Subsequently it was revealed that there was little evidence of speculation and that much of the trading was by holders of Greek bonds unwinding or hedging their exposures.
It is clear to me that we need more openness in financial markets, not less, and that any measure that holds politicians to account for their actions must be a good thing, whether that measure involves openness of government bond trading or, for example, investigations into alleged secret deals with American investment banks designed to hide massive and unreported indebtedness. Greece is not on the verge of national bankruptcy because investors in Greek bonds sold or hedged their exposures, Greece is in that position because a political culture of lies and deception developed over a period of a number of years. The international government bond market helped to expose that culture.
As an aside, current calls within the EU from Messrs Papandreou and Barroso, among others, for Eurozone bonds to be backed by all nations that are members of the euro can only lead to reduced transparency of national accounting and indebtedness and must be rejected if the Eurozone economy is not to be further compromised by the type of political deceptions that led to the current crisis..
Ruckus
@Ben Franklin:
You are conflicting the gambling with the casino.
Casinos have rules and laws regulating them. OK they are supposed to, that’s mainly the problem. GS was written for one type of game in basically one casino. The casinos came up with new games that no one had thought of before as well as new ways to gamble.
Gambling is just taking risk. We all do that everyday, driving, walking across the street, sunburn, lottery. But there are protections for all of these, airbags/seatbelts, signals, SPF50, very low risk/high reward ratio. There were/are little to no protections in the “new” financial casinos and many more people willing to risk other peoples money for skewed risk/reward ratios. Another big part of the problem is the OPM belongs not just to a sucker or two, all/most of it belongs to many of us and we didn’t know we were taking a risk. That’s a very high risk/no reward ratio. Only an fucking idiot would get involved in that if they were allowed to know the risk/reward.
Ruckus
Could someone take me out of mod?
I used a word that includes a bad bad bad word. A word that is so bad that it can’t be spelled out or surely flames will erupt from our eyes and our brains will dissolve. Our children run screaming into traffic and will die instantly. This word is so horrible that WP has taken it upon itself to protect us from it, not only in it’s native form but in any possible derivative.
Ben Franklin
@Ruckus:
I know. You create this long comment complete with links, and that happens. I try to copy my post before publishing, so that I can determine the problema.
Sly
@Ben Franklin:
I think it’s more accurate to say that Gramm-Leech-Bliley exacerbated the crisis, but didn’t directly cause it.
The truth is that there are many causes for the collapse and they extend all the way back to at least to the 1986 Tax Reform Act, which made subprime lending a viable large-scale lending practice, especially in a very low interest rate economy like the one we had early last decade that made cash-out refinancing so popular. Hell, even 9/11 was one cause, because it was in response to 9/11 that the Fed lowered interest rates to near-zero.
What GLB did was create a kind of “supermarket of suckers” for the mortgage banking industry to con.
Ben Franklin
@Sly:
I appreciate the tutorial from everyone, but questions persist. Yes, EVERYTHING is interconnected, including the willingness of suckers who want to believe they can have something for nothing, buying homes they really couldn’t afford. But what I’m looking for is a linchpin, (other than greed-the ever present).
Credit default swaps did not involve brokers colluding with Bankers?
If GS was a firewall between bankers and brokerages, why was that defunct as a functionary in 1999? It seems it was repealed exactly because it did that very thing.
Matthew Reid Krell
@Ben Franklin:
I, too, would like to be pelted with fat.
Chris T.
@Ben Franklin:
Because “banks and brokerages” were no longer the two entities through which finance happens.
More specifically, Glass-Steagall established a firewall between “commercial banks” (places where you and I might keep our money and have our mortgages and so on) and “investment banks” (the Goldman Sachs and Lehman Brothers-es). The fundamental idea here is (was): the investment banks may play fast and loose with certain rules, but so what, if they screw up they go under and ordinary folks go about their ordinary lives with no visible change because we still have our jobs and houses and bank accounts.
By the late 1990s, though, banks did not hold mortgages anymore. The linkage of “regular lives” to “regular” (commercial) banks was already gone. Now, you can say “well, but we still had/have our regular bank accounts at the regular banks” and that’s true, but numerically speaking, it’s almost irrelevant. Most “household wealth” is (or was) mostly stored in the form of housing. Moreover, one of the key drivers of instabilities is “leverage”, and most ordinary people only encounter (and use) leverage in buying homes. So the linchpin you’re looking for is actually “people’s homes”. What was (and is) needed is to make sure people don’t gamble away their homes again, via zero-down (or worse) mortgages and stuff like MERS.
Ben Franklin
@Chris T.:
, if they screw up they go under and ordinary folks go about their ordinary lives with no visible change because we still have our jobs and houses and bank accounts
Seems likely they knew this was the mechanism for assuring a bailout from the Feds.
Thanks for the primer.
gene108
@Ben Franklin:
Lehman Brothers, Bear Sterns and AIG never got into commercial banking.
Lehman Brothers and Bear Sterns were always investment banks.
AIG sold insurance, which became very complicated instruments such as collateralize debt obligations that got way out of control, but were originally a good idea.
After Enron, MCI-Worldcom, etc. scandals that shook the financial world in the early 00’s, the financial world used the power of the free market to have counter parties insure corporate bonds that were issued, because investors didn’t trust corporations financial statements.
The problem is the CDO market got much larger than was needed to actually insure the amount of corporate bonds issued, which became another part of the problem in the 00’s financial mess, where the derivatives markets got much larger than the underlying markets the instruments were based on.
Glass-Steagal, by separating commercial and investment banking and insurance, would not have stopped investment banks and insurance companies that never got into commercial banking from taking on huge amounts of debt or getting into the out of control derivatives market.
ericblair
@Ben Franklin:
Development of the mortgage backed security plus increased use of leverage plus poor risk controls plus lack of oversight plus a whole bunch of accumulated cash chasing a few high return investments plus maybe a few other things. I don’t think there’s a single element, other than the idea that the financial tail should be wagging the economic dog.
Glass-Steagal seems to be similar to the Public Option, in that it’s sort of a magic cure-all for the left to fix all our financial problems.
Sly
@Ben Franklin:
I don’t think there really is a linchpin. Here’s a condensed history of mortgage banking as I understand it. See if you can spot one:
In 1980, Congress passed the Depository Institutions Deregulation and Monetary Control Act (DIDMCA), followed by the Alternative Mortgage Transaction Parity Act (AMTPA) in 1982. Both of these laws in effect created the subprime mortgage industry by allowing for variable rate mortgages, balloon payments, and preempting state interest rate caps.
The Tax Reform Act of 1986 prohibited interest deductions on consumer loans but allowed them to continue on mortgages. This effectively made mortgage debt cheaper for most consumers than other forms of debt, especially under conditions where interest rates are low. (For slightly different reasons, the 1986 TRA contributed to the S&L Crisis.)
Fast forward to the late 90s, when interest rates start to fall. Home owners now have an incentive to engage in cash-out refinancing (basically you refinance your mortgage at a lower rate and pocket the difference). Fed policy after 9/11 lowers rates further, creating instant demand for refinancing. The housing market begins to become an attractive sector for speculative investment instead of a long term and relatively low risk investment vehicle.
Mortgage banks start feeding on this demand by lowering mortgage requirements to attract borrowers, but relying more on the features of subprime loans as a hedge against the risk of non-payment. They start securitizing these loans and selling them to institutional investors at an increasing rate, using the “profit” to turn out more loans. Everyone is now a speculative investor, whether they know it or not.
By the mid 2000s, investment banks look at the “profit” being generated by the mortgage banks and figure they should just cut out the middle-man and either buy or form their own mortgage banking divisions. Lehman buys BNC Mortgage. Merrill buys First Franklin. Bear buys EEC Capital. Morgan Stanley buys Saxon Capital. Etc. They securitize these mortgages in house and then sell them to… other investment banks. They start trading default swaps, which they had using since the mid-90s on other kinds of loans, to hedge against risk. The growth of the swap market rises with the growth in the mortgage security market. Investors turn to derivatives to further hedge against the risk created by their overindulgence in swaps.
Then the music stops. People can’t afford the balloon payments or the variable rate. They start to default on their mortgages. Home prices fall. The securities lose value. The swaps are called in, and there isn’t enough money to fulfill the obligations. Then derivatives go bust. Everyone owes massive amounts of money to everyone else, and they all start looking for the safe chair, only to find that there aren’t even any goddamned chairs anymore. Even the most conservative investors, like FNMA, who were simply chasing after the speculators, go under.
As a linchpin, I don’t think Glass-Steagall repeal cuts it. It’s really hard to argue that its repeal actually permitted any trading that led to the crisis, as much of it was legal prior to repeal but the economic conditions weren’t favorable. Plus the shadow banking system rose from the gaps in regulatory law that Glass-Steagall didn’t account for. I think you can argue that the repeal led to the interconnectedness of that shadow banking system with traditional banks (which made the crisis systemic) and helped to foster the illusion that everything was just hunky-dory, but a lot of the regulatory changes that fostered that occurred well before Gramm-Leech-Bliley.
If there’s a linchpin, the closest thing I can think of is Lewis Ranieri.
Sly
@Sly:
And keep in mind that I didn’t bother to go into the role that the ratings agencies played in this catastrophe.
Ben Franklin
@Sly:
I guess we’re all linchpins, now
terry chay
For the next Open Thread: “Vote Obama Style” http://www.youtube.com/watch?v=w3gapBh_yqk
PJ
@gene108: Both Lehman and Bear Stearns had residential mortgage origination subsidiaries. These consumer mortgages were packaged and divided into tranches by another subsidiary, and then sold as securities packages by the parent bank, which is where the real money was and what was driving the whole industry.
Maude
@Sly:
If the Commodities Mod Act hadn’t been made, CDSs would have been insurance with regulation and capital requirements.
AIG went down because they had no idea what they were doing and when they had to pay out on their CDSs, that was all she wrote.
The basic problem was the amount of should have been outright fraud in the CDOs. they were gigantic fraud schemes. The ratings agencies didn’t know what was in the CDOs, gave them high ratings and after the crash, denied responsibly.
GS should be put back in place.
Dodd Frank is having trouble getting put into place, regulations written and going into effect. The money guys and mainly Republicans don’t want any regulation.
FinanceProf
jayackroyd Says:
Alpha is the intercept in the equation Value=a+b(individual securities). Beta (b) is the value associated with a particular investment. Alpha is the value attributed to the “marketplace.” The expected value of alpha is zero, if you believe in the efficient market hypothesis. You can’t make money trading on the alpha.
Further to jayackroyd’s comment – there is a bit of confusion in the OP where the Efficient Markets Hypothesis is listed as one of the evils from the Chicago school. Instead, as jay notes, under the EMH, there is no alpha. This theory is what the OP refers to in referencing studies that show that professionals can’t beat the market. I am constantly telling my students that there is no systematic way to beat the market no matter how much you learn about finance. 40 years of research show this to be true – which suggests that much of what they do on Wall Street is a pure con in terms of convincing investors that they can earn alpha for you. Instead, it appears that the “alpha” earned by hedge funds is due to extra risk that is not adjusted for in deciding what they would have earned (i.e., the formula referenced by jayackroyd).
The bottom line is that the Efficient Markets Hypothesis is hated on wall street. If you talk with a trader, within the first few sentences out of their mouth, they will tell you that markets are not efficient and there are plenty of opportunities for the clever. Why are they so defensive about efficient markets theory? Because the theory says they are full of it with their complicated models that will produce alpha.
elftx
@terry chay:
Got a kick out of that, heyyyy Romneys shaydeeee
LOL