Why is finance so complex? (2011)(interfluidity.com)
interfluidity.com
Why is finance so complex? (2011)
http://www.interfluidity.com/v2/2669.html
147 comments
*If you life in a first world country and come from at least a lower-middle class background
You are talking about money. Not modern wall-street finance.
> huge amount of human progress is owed to modern-day financial institutions.
Like synthetic credit default swaps?
> Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten.
Complexity that can't be coped with is rotten! The Linux kernel is quite complex but each part of it is well understood and there are a lot mechanisms in software to reduce complexity.
> But the vast majority of financial innovations are deeply ingrained in the good life that you get to enjoy every day.
Tell that to Greece people that got into the Euro because of clever CDS from Goldman Sachs or the masses of people that are stuck in debt from their education or credit cards.
> Sometimes we make products that we don't always completely understand until later.
That does not stop you from selling them and acting like you do. However recent financial crises have shown that banks offering these products for the most part understand them... the persons buying them don't.
> Funds the massive philanthropy expenditures that help those in need everyday
That shouldn't be needed in the first place if there wouldn't be such a huge inequality. Philanthropy is not a good idea for a good-working society. There are laws and a justice system that is more fair than a few far too rich persons with a selectively good cause.
> Finance is an art, not a science.
And it should be a tool not an art. A means to an end.
You are talking about money. Not modern wall-street finance.
> huge amount of human progress is owed to modern-day financial institutions.
Like synthetic credit default swaps?
> Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten.
Complexity that can't be coped with is rotten! The Linux kernel is quite complex but each part of it is well understood and there are a lot mechanisms in software to reduce complexity.
> But the vast majority of financial innovations are deeply ingrained in the good life that you get to enjoy every day.
Tell that to Greece people that got into the Euro because of clever CDS from Goldman Sachs or the masses of people that are stuck in debt from their education or credit cards.
> Sometimes we make products that we don't always completely understand until later.
That does not stop you from selling them and acting like you do. However recent financial crises have shown that banks offering these products for the most part understand them... the persons buying them don't.
> Funds the massive philanthropy expenditures that help those in need everyday
That shouldn't be needed in the first place if there wouldn't be such a huge inequality. Philanthropy is not a good idea for a good-working society. There are laws and a justice system that is more fair than a few far too rich persons with a selectively good cause.
> Finance is an art, not a science.
And it should be a tool not an art. A means to an end.
> Like synthetic credit default swaps?
If you're against CDS, you should explain why.
Like any financial product, CDS is not perfect, but it's also intellectually dishonest to argue that it doesn't offer any benefit to society. For example, CDS is used widely by the insurers that the parent noted help individuals protect themselves and their property.
> Complexity that can't be coped with is rotten! The Linux kernel is quite complex but each part of it is well understood and there are a lot mechanisms in software to reduce complexity.
You apparently assume that the financial markets are too complex to be managed but poll people on a busy street in any major city and many will probably tell you they feel computer software is unmanageably complex too. Should we call software rotten because some people who used it have suffered some loss as a result?
> Tell that to Greece people that got into the Euro because of clever CDS from Goldman Sachs or the masses of people that are stuck in debt from their education or credit cards.
It takes two to tango. It would be unfair to pretend that some of the near countless individuals and companies active in providing financial services have not acted immorally or even illegally, but it's intellectually dishonest to pretend that every person who has taken on more debt than he or she can manage is a victim who was coerced into making financially imprudent decisions.
This applies to countries too.
> However recent financial crises have shown that banks offering these products for the most part understand them... the persons buying them don't.
Save for Lehman, which was allowed to fail, the large banks were bailed out. If they were as savvy as you seem to think, why did they need bailouts?
If you're against CDS, you should explain why.
Like any financial product, CDS is not perfect, but it's also intellectually dishonest to argue that it doesn't offer any benefit to society. For example, CDS is used widely by the insurers that the parent noted help individuals protect themselves and their property.
> Complexity that can't be coped with is rotten! The Linux kernel is quite complex but each part of it is well understood and there are a lot mechanisms in software to reduce complexity.
You apparently assume that the financial markets are too complex to be managed but poll people on a busy street in any major city and many will probably tell you they feel computer software is unmanageably complex too. Should we call software rotten because some people who used it have suffered some loss as a result?
> Tell that to Greece people that got into the Euro because of clever CDS from Goldman Sachs or the masses of people that are stuck in debt from their education or credit cards.
It takes two to tango. It would be unfair to pretend that some of the near countless individuals and companies active in providing financial services have not acted immorally or even illegally, but it's intellectually dishonest to pretend that every person who has taken on more debt than he or she can manage is a victim who was coerced into making financially imprudent decisions.
This applies to countries too.
> However recent financial crises have shown that banks offering these products for the most part understand them... the persons buying them don't.
Save for Lehman, which was allowed to fail, the large banks were bailed out. If they were as savvy as you seem to think, why did they need bailouts?
CDS are not bad but the capital reserve requirements are way to low. If selling a CDS required a 1/3 capital reserve then they would be priced at reasonable levels and actually be wotprth something. Instead upper mid level employees used CDS to make a classic bet, in the worst case the company fails so it does not really matter how much it fails therefore my average expected downside is limited and the upside is unlimited, therefore lets go insane.
>The Linux kernel is quite complex but each part of it is well understood and there are a lot mechanisms in software to reduce complexity.
Well understood by experts, as is the appropriate section of the financial system. You chose to learn about the kernel, someone else chose to learn about asset backed securities. The guy who learned about Bach probably considers both to be very complex.
Well understood by experts, as is the appropriate section of the financial system. You chose to learn about the kernel, someone else chose to learn about asset backed securities. The guy who learned about Bach probably considers both to be very complex.
I have to say that the complexity of finance is more like the artificial complexity of Java EE, a regular developer can get a grasp of the Linux kernel by reading "Operating System Concepts", finance is more like a AbstractSingletonProxyFactoryBean.
*If you life in a first world country and come from at least a lower-middle class background
> I'd say this used to be true, but now ZIRP (Zero Interest Rate Policy) hurts any class of savers first world et al
> I'd say this used to be true, but now ZIRP (Zero Interest Rate Policy) hurts any class of savers first world et al
"Complexity that can't be coped with is rotten!"
I respectfully disagree.
https://en.m.wikisource.org/wiki/I,_Pencil
I respectfully disagree.
https://en.m.wikisource.org/wiki/I,_Pencil
Isn't that an example of complexity that is being successfully coped with, thanks to the abstractions provided by the various industries and institutions that provide raw materials, processing, shipping, etc?
The fact that every man in the street doesn't understand the mechanisms of these product doesn't mean they can't be copped with. In fact the most benign parts of banking are most likely completely obscure to most people (payment systems).
I don't think the 2008 crisis was caused by complexity. Most actors on these structured credit markets understood well the products. It was rather caused by over leverage and complacency toward credit risk.
And it will happen again. Hopefully the banking system is much stronger now, and the legal mechanisms are in place to limit the cost of a failing bank to tax payers. But the excess of liquidity as a result of money printing has starved investors for yield, and I believe that they are investing in places where they would rather not, like in 2005. Then it was subprime and commercial real estate. Now most likely emerging markets.
I don't think the 2008 crisis was caused by complexity. Most actors on these structured credit markets understood well the products. It was rather caused by over leverage and complacency toward credit risk.
And it will happen again. Hopefully the banking system is much stronger now, and the legal mechanisms are in place to limit the cost of a failing bank to tax payers. But the excess of liquidity as a result of money printing has starved investors for yield, and I believe that they are investing in places where they would rather not, like in 2005. Then it was subprime and commercial real estate. Now most likely emerging markets.
For people wondering about complexity of financial products, and if individual banks and traders did or did not precisely understand the implications of what they were doing, i wholeheartedly recommend everyone read Dit kan niet waar zijn (This cannot be true) by Joris Luyendijk. He spent about a year doing “anthropology” in the London financial sector, and it's a fascinating, horrifying read. I'm not sure if that book has been translated into English yet, but otherwise his column at the Guardian makes for equally good reading [1].
1. http://www.theguardian.com/commentisfree/joris-luyendijk-ban...
1. http://www.theguardian.com/commentisfree/joris-luyendijk-ban...
I guess I'm not clear as to what "can't be coped with" means precisely.
I've been reading it as "Grokked," as in 'understood.'
Cause it aint "coped," as in "they could handle it."
Copped would be more like they got some of something on the sly, possibly through sleight of hand ( copped a feel. )
In this case, accidental understanding of a system?
I bet you don't own an iPhone (because the explanations were solely for that specific category of people)!
</sarcasm>
</sarcasm>
> Like synthetic credit default swaps?
You mean a synthetic CDO? CDS don't need to be synthetic.
>Tell that to Greece people that got into the Euro because of clever CDS from Goldman Sachs The people of Greece (and their political leaders) wanted to get into the Euro. They spun their own fiction.
>Tell that to Greece people that got into the Euro because of clever CDS from Goldman Sachs The people of Greece (and their political leaders) wanted to get into the Euro. They spun their own fiction.
The fallacy here is assuming that because it does all of those positive things, it must therefore holistically be optimal.
Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten.
Why would such an assumption be naive?
It doesn't seem naive to me at all. I was reading a 1994 paper that I posted recently called "A Uniform Name Service for Spring's UNIX Environment" which made me think how simplified a modern Unix could be if it adopted the name service primacy described therein from its onset.
It is just as naive to assume that all complexity is intrinsic and not incidental or the result of inadequate abstractions.
Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten.
Why would such an assumption be naive?
It doesn't seem naive to me at all. I was reading a 1994 paper that I posted recently called "A Uniform Name Service for Spring's UNIX Environment" which made me think how simplified a modern Unix could be if it adopted the name service primacy described therein from its onset.
It is just as naive to assume that all complexity is intrinsic and not incidental or the result of inadequate abstractions.
Yes. For instance, before invention of vector notation, many laws of physics were extremely complex. Before Copernicus system, describing the movements of planets was very complex too.
While not hundred percent sure, it is highly possible that finance complexity will magically disappear once we get a proper model for money transactions. I certainly hope so, because a better model means more means to solve economic issues.
Right now economists are like the physicians in the time of Molière, they understand nothing and have only two cures: bloodletting and lavement (change interest rate and remove taxes)
While not hundred percent sure, it is highly possible that finance complexity will magically disappear once we get a proper model for money transactions. I certainly hope so, because a better model means more means to solve economic issues.
Right now economists are like the physicians in the time of Molière, they understand nothing and have only two cures: bloodletting and lavement (change interest rate and remove taxes)
It was still very complex after Copernicus.
His system still used circular orbits and epicycles. The only real difference was that he put the sun in the middle instead of the Earth. In fact, it required more epicycles / gave more imprecise results.
The real improvement came when circles were replaced with ellipses by Kepler.
That wasn't entirely accurate, either, but replacing the ideal circles with the law of Gravitation (Newton) fixed that.
Economists have many more than just two cures -- which is why some of them keep harping on regulations and overly protective labour laws in Greece (and the rest of the Mediterranean swamp), their very expensive pension system, and the huge size of their public sector. Krugman doesn't, which is why I have absolutely no respect for him.
His system still used circular orbits and epicycles. The only real difference was that he put the sun in the middle instead of the Earth. In fact, it required more epicycles / gave more imprecise results.
The real improvement came when circles were replaced with ellipses by Kepler.
That wasn't entirely accurate, either, but replacing the ideal circles with the law of Gravitation (Newton) fixed that.
Economists have many more than just two cures -- which is why some of them keep harping on regulations and overly protective labour laws in Greece (and the rest of the Mediterranean swamp), their very expensive pension system, and the huge size of their public sector. Krugman doesn't, which is why I have absolutely no respect for him.
Ok, maybe it was Kepler, but the argument still holds: something that we believe is extremely complex could very much become much simpler and obvious in the future. This would require changing the place of the "center". Maybe it mean that money is not what we believe it is, or that banks should not be big companies but some fluid, or that wealth is not really transmitted during a transaction, or whatever. Finance is dangerously complex and may not have to be like that. Every timesomeone explains stock options to me I understand for ten minutes and then forget is definition. This means the model didn't stick, for me at least. (Good mathematical models are very sticky, told once about it one well never forget) So it's a mess and it's worth trying something else.
That sounds like an extremely rational view of modern economics, I love it.
Can someone smarter than me tackle this argument?
Can someone smarter than me tackle this argument?
This is why we should have more software architects and systems engineers working in politics. They know how to deal with problems at multiple levels of abstraction, and they know how to keep complexity down.
> Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten.
The reality is, the derivatives market is larger than the actual market. More capital is invested in calls guessing if Google is going up than is actually invested in Google. This is a sign something is rotten.
This article from 2008 has a lot of interesting data from after the subprime crash ( http://monthlyreview.org/2008/12/01/financial-implosion-and-... ). It then has an analysis of that data. Whether or not you agree with the analysis, the data it points to is interesting.
The reality is, the derivatives market is larger than the actual market. More capital is invested in calls guessing if Google is going up than is actually invested in Google. This is a sign something is rotten.
This article from 2008 has a lot of interesting data from after the subprime crash ( http://monthlyreview.org/2008/12/01/financial-implosion-and-... ). It then has an analysis of that data. Whether or not you agree with the analysis, the data it points to is interesting.
The nominal value of the notes in the derivatives market is extremely large. However, we can't equate $500B notional of e.g. CDS written against Apple debt with $500B of Google stock. The CDS represents (1) to the seller, an small initial premium and a large, extremely low-probability liability requiring some collateral, and (2) a stream of future payments from or to the buyer, depending on the cost of insuring the debt. Up until a credit event, the only money exchanged is the premium, and perhaps some collateral, both of which are (for highly rated debt) orders of magnitude smaller than the notional value of the contract.
> and a large, extremely low-probability liability requiring some collateral
Having read up on the topic, the problem appears to be that this probability cannot be accurately determined, due to useless models being used (e.g. Normal distribution to model complex phenomena).
So the probability is often not so low as the financial experts think. Besides that, it does happen that the liability becomes due, as in the 2007/2008 GFC. People were shocked because their models indicated that such an event should practically never happen (due to it being of such low probability).
When the liability is due, the whole system collapses (as it did in 2007/2008) because the collateral that is held is often not worth what it's is marked up to be.
So the whole system is fragile and prone to systematic collapse. Sounds pretty rotten to me.
Having read up on the topic, the problem appears to be that this probability cannot be accurately determined, due to useless models being used (e.g. Normal distribution to model complex phenomena).
So the probability is often not so low as the financial experts think. Besides that, it does happen that the liability becomes due, as in the 2007/2008 GFC. People were shocked because their models indicated that such an event should practically never happen (due to it being of such low probability).
When the liability is due, the whole system collapses (as it did in 2007/2008) because the collateral that is held is often not worth what it's is marked up to be.
So the whole system is fragile and prone to systematic collapse. Sounds pretty rotten to me.
Well it gets more complex when you add mark to market into the mix. Plenty of the financial products that "blew up" in 2007/2008 were actually very profitable for those able to hold on to them.
Out of curiosity, where does the capital sit when it is "invested in derivatives"?
With whoever sold the derivative.
The size of the global derivatives market is 1.5 quadrillion dollars. Global GDP is not even $90 trillion.
90,000,000,000,000 GWP
1,500,000,000,000,000 global derivatives
> The size of the global derivatives market is 1.5 quadrillion dollars
No. No it is not. No 1,000,000,000 times. NOTIONAL DOES NOT EQUAL MARKET VALUE.
It's also completely meaningless as most trades offset. Trades are rarely torn up, you just do a new one to offset your risk. E.g GS vs JPM: they probably have 100bn of notional with each other. Actual risk? very little as the vast majority of trades just offset.
Current outstanding derivative notional is more like a measure of all notional that's historically traded.
Anyhow that aside, notional is STILL a meaningless number. It tells you nothing about the risk or market value of the trade.
No. No it is not. No 1,000,000,000 times. NOTIONAL DOES NOT EQUAL MARKET VALUE.
It's also completely meaningless as most trades offset. Trades are rarely torn up, you just do a new one to offset your risk. E.g GS vs JPM: they probably have 100bn of notional with each other. Actual risk? very little as the vast majority of trades just offset.
Current outstanding derivative notional is more like a measure of all notional that's historically traded.
Anyhow that aside, notional is STILL a meaningless number. It tells you nothing about the risk or market value of the trade.
Yeah. It's a little bit amusing when people equate "I don't understand anything whatsoever about finance and have no desire to understand it" with "it is extremely complex". There is nothing complex about notional value of a derivative vs its market value. 2008 happened not because finance is complex, but because financial bets always incur a degree of risk and that risk sometimes materializes. Anyone who ever extended a loan to anyone else takes a risk that the loan will not be paid back. Sometimes, it isn't paid back
[deleted]
>* Allows you to get a mortgage
Simply the base artifact of modern finance. Why do I need a mortgage? (hint: to supply interest payments to banks AKA the institutors of the world of modern finance)
>* Allows you to protect yourself with health/car/life/home/title/etc insurance
See above.
>* Pays for your highways/stadiums/schools and other public works
"Pays". A meaningless word.
>* Protects your deposits
Only through magic. If deposits are lost, they are merely re-created as modern finance is an arbitrary mathematical construct.
>* Pays for your retirement
"Pays for your retirement"
>* Funds the college fund that paid for your school
"Funds the fund" that "paid". Again, meaningless except insofar as your school depends on magic numbers being circulated.
>* ... Or the student loans that allowed you to attend school
Ah, yes, the loans; again, the foundational unit of modern finance, without which the "world of finance" would be radically different.
>* Supports the global supply chain that brings you your iPhone, stocks the grocery store/your favorite restaurants with food, and puts the clothes on your back.
Supports in name, but is curiously not actually involved in any physical aspect of realizing any of those things.
>* Funds the growth of corporations large and small, giving you the job that allows you to buy an iPhone
"Funds" ... "giving [me] the job"
>* Funds the massive philanthropy expenditures that help those in need everyday
"Funds", because the actual work is done by real people.
>* Pays the pensions of the elderly
I guess the system isn't complete evil.
Simply the base artifact of modern finance. Why do I need a mortgage? (hint: to supply interest payments to banks AKA the institutors of the world of modern finance)
>* Allows you to protect yourself with health/car/life/home/title/etc insurance
See above.
>* Pays for your highways/stadiums/schools and other public works
"Pays". A meaningless word.
>* Protects your deposits
Only through magic. If deposits are lost, they are merely re-created as modern finance is an arbitrary mathematical construct.
>* Pays for your retirement
"Pays for your retirement"
>* Funds the college fund that paid for your school
"Funds the fund" that "paid". Again, meaningless except insofar as your school depends on magic numbers being circulated.
>* ... Or the student loans that allowed you to attend school
Ah, yes, the loans; again, the foundational unit of modern finance, without which the "world of finance" would be radically different.
>* Supports the global supply chain that brings you your iPhone, stocks the grocery store/your favorite restaurants with food, and puts the clothes on your back.
Supports in name, but is curiously not actually involved in any physical aspect of realizing any of those things.
>* Funds the growth of corporations large and small, giving you the job that allows you to buy an iPhone
"Funds" ... "giving [me] the job"
>* Funds the massive philanthropy expenditures that help those in need everyday
"Funds", because the actual work is done by real people.
>* Pays the pensions of the elderly
I guess the system isn't complete evil.
You need a mortgage because you don't have $400,000 in cash sitting around.
You need insurance because you don't have the personal finances to adequately cover the risk of "life"
You need insurance because you don't have the personal finances to adequately cover the risk of "life"
If we live in a democracy, and money is backed by the state, why do we have to pay interest to profit-making banks and insurance companies?
Giving out mortgages is not difficult. You just have to be a bank. Not only that but 2007 showed that profit-making banks are even worse than a reasonable person, or precocious five year old, would be at deciding who should be given a mortgage.
Mortgages are a necessary part of society. Profit-making banks are not.
The only reason you spend your life slaving away paying extra interest to the shareholders of banks, is because banks have manoeuvred themselves into a privileged position. Inequality is not an accident of the system, it is the point of the system.
Giving out mortgages is not difficult. You just have to be a bank. Not only that but 2007 showed that profit-making banks are even worse than a reasonable person, or precocious five year old, would be at deciding who should be given a mortgage.
Mortgages are a necessary part of society. Profit-making banks are not.
The only reason you spend your life slaving away paying extra interest to the shareholders of banks, is because banks have manoeuvred themselves into a privileged position. Inequality is not an accident of the system, it is the point of the system.
Even if the banks weren't trying to make a profit, you'd still have to pay interest as loan-making is inherently risky enough that at some point, somebody has to cover the costs of those who default.
I prefer the suggestion of Positive Money ( http://positivemoney.org ), which is that bank accounts are split by savings and investments. Savings would just keep your money safe (no interest), investments would have a potential return but also carry the risk of a loss. It'd be up to you how you wanted to split your money between savings and investments.
The bank that is the closest to this model (that I know of) is Mondo (due to be launching soon). Along with it's other innovations, it plans to allow you to invest money via Funding Circle for a potential return:
http://www.thememo.com/2015/06/25/meet-mondo-the-app-thats-g...
This is a smart idea on a couple of levels, it mitigates against the risk of bank runs and it provides a better return than many high street banks offer (the current average return rate from Funding Circle is 6.6%):
https://www.fundingcircle.com/statistics
The bank that is the closest to this model (that I know of) is Mondo (due to be launching soon). Along with it's other innovations, it plans to allow you to invest money via Funding Circle for a potential return:
http://www.thememo.com/2015/06/25/meet-mondo-the-app-thats-g...
This is a smart idea on a couple of levels, it mitigates against the risk of bank runs and it provides a better return than many high street banks offer (the current average return rate from Funding Circle is 6.6%):
https://www.fundingcircle.com/statistics
Absolutely. But if retail banking were run predominantly by non-profits, we'd pay a lot less of it.
Mortgages are secured loans, so an individual default is no problem. The primary risk is of mass default (a housing crash).
If you agree with the pseudo-MMT view of the world, then the mortgage is created out of thin air in the first place, so if everybody defaults all that happens is that the money supply increases permanently instead of temporarily.
Mortgages are secured loans, so an individual default is no problem. The primary risk is of mass default (a housing crash).
If you agree with the pseudo-MMT view of the world, then the mortgage is created out of thin air in the first place, so if everybody defaults all that happens is that the money supply increases permanently instead of temporarily.
Defaults exist because it is a loan-backed currency.
Defaults have nothing to do with "loan-backed currency", as if that statement means anything.
You could have a default on a loan if you were paying for your house with NukaCola bottle-caps, or engraved-crab-shells.
You could have a default on a loan if you were paying for your house with NukaCola bottle-caps, or engraved-crab-shells.
If your legal tender currency is created primarily through loans, then it is loan-backed.
As you noted, the concept of a "loan" entails the possibility of default.
If most currency is created through loans and loans must be repaid in that currency, the system-wide probability of defaults is significant. The likelihood of defaults increases as loans require payors to also include tribute payments (interest), for which no currency was ever created (necessitating that the payor obtain the requisite currency from someone else before the default day occurs).
As you noted, the concept of a "loan" entails the possibility of default.
If most currency is created through loans and loans must be repaid in that currency, the system-wide probability of defaults is significant. The likelihood of defaults increases as loans require payors to also include tribute payments (interest), for which no currency was ever created (necessitating that the payor obtain the requisite currency from someone else before the default day occurs).
So you want to collect enough taxes to have the government provide zero interest mortgages. Does that mean everyone gets a mortgage, regardless of creditworthiness? You want me to pay for other people's mortgages, when they won't even give me one?
That's essentially how buy to let works. As a renter I am paying for someone else's mortgage. If I could get a zero interest (or even normal interest) mortgage guaranteed by the government I wouldn't have to rent and I could retain that value that I have generated for myself. As it stands I work my ass off and make someone else rich in exchange for keeping my chin just above the water line. Housing is a necessity and its profitization is unethical. It amplifies wealth disparities and destroys value in society.
How would banks collect profit then?
I didn't rule out being charged a nominal fee for the service. They could also focus on non-essentials? Banks have many products other than mortgages.
The parent never mentioned zero interest, why not have a interest just because the loan is granted by the government? Just call it a tax instead of interest.
Except Fannie May and Freddie Mac were a significant part of the reason that bad mortgage lending was made - because politicians wanted more people to be home owners. Profit making banks should be the reason that lending decisions are strict.
It wasn't just banks making poor decisions in 2007 about who should have a mortgage.
It wasn't just banks making poor decisions in 2007 about who should have a mortgage.
"Giving out mortgages is not difficult."
That is true only if you are not concerned about being repaid at a reasonable rate of interest. Lenders need to assess credit and interest rate risk.
That is true only if you are not concerned about being repaid at a reasonable rate of interest. Lenders need to assess credit and interest rate risk.
Bingo. Cut out the middle man, or at least make the middle man not-for-profit. Prices would drop and nothing of value would be lost.
> You need a mortgage because you don't have $400,000 in cash sitting around.
And a large part of why housing costs $400,000 in the first place is due to the availability of mortgages. Mortgages gave themselves a reason to exist.
And a large part of why housing costs $400,000 in the first place is due to the availability of mortgages. Mortgages gave themselves a reason to exist.
Not really. Land, Materials, and a team of carpenters/electricians/roofers/hvac/painters for 3-6 months ends up at around 400k. It's not really that crazy. If you paid them all programmer salaries, you'd never get a house for under 1mm.
The problem is that you have to take into account that those values are biased because mortgages exist. The value of a home is exactly what a person is willing and able to pay for it.
If mortgages never existed then people would value housing much less because it's no longer $x monthly, it's the whole thing up front.
You're right that a portion comes from material cost but the cost inflates to fit the budget of the expected buyer. Without mortgages the typical suburban house would be built so that a middle-class person could afford it.
From this you can argue that mortgages are a good thing because they allow a person with less wealth to get more/better houses by leveraging future income, but the trade-off is that buyer takes on more risk, there are no low cost homes in good neighborhoods which could be reasonably bought outright, and people are more dependent on their credit rating.
If mortgages never existed then people would value housing much less because it's no longer $x monthly, it's the whole thing up front.
You're right that a portion comes from material cost but the cost inflates to fit the budget of the expected buyer. Without mortgages the typical suburban house would be built so that a middle-class person could afford it.
From this you can argue that mortgages are a good thing because they allow a person with less wealth to get more/better houses by leveraging future income, but the trade-off is that buyer takes on more risk, there are no low cost homes in good neighborhoods which could be reasonably bought outright, and people are more dependent on their credit rating.
Exactly. That is why the UK has had to keep "emergency" low interest rates for the last 7 years or so. If they were to rise, people wouldn't be able to afford their houses and the prices would drop. The banks assets would loose value and we would have another crisis.
You can definitely build a whole house from scratch for less than 400k. You can build it for less than $100k - http://www.zillow.com/oh/home-values/
No, most of the value in a home comes from the land underneath it. The point being made above is that the availability of credit leads to asset inflation, as more people are able to compete for the same scarce things (desirable living locations).
Mind you, credit does have a purpose - if your income and your house's value appreciate faster than the interest rate being charged to you, then you were able to gather the resources for it.
No, most of the value in a home comes from the land underneath it. The point being made above is that the availability of credit leads to asset inflation, as more people are able to compete for the same scarce things (desirable living locations).
Mind you, credit does have a purpose - if your income and your house's value appreciate faster than the interest rate being charged to you, then you were able to gather the resources for it.
Haha. You should become a developer. You would be rich in weeks.
I have a house in the UK which has a rebuild cost of £27k. The house is valued at approx £120k, but it's the cost of the land that makes up the rest.
That's ridiculous. Here in Poland, ever since our beloved government started funding a percentage of new developer-sold apartment mortgages to young couples, the prices magically rose about 15-20%. Are you saying that the roofers and painters suddenly started demanding more money?
But debt (and banking in general) just increases your available funds from x to, say, ax+b. How the funds are then spent - wastefully or wisely - and how the markets are regulated and react, are another questions. I mean, at least in theory, mortgages could be seen as equivalent to consumers simply having a little more money.
A monolithic concrete dome that is energy-efficient, fire-proof, tornado-proof and earthquake-proof costs around $30k. But it's not your money so you don't care that the banks are subsidizing incredibly complex, unreliable, weak, stucco-wall houses that due to their unnecessary complexity, naturally end up costing several times more than a better, simpler house.
> A monolithic concrete dome that is energy-efficient, fire-proof, tornado-proof and earthquake-proof costs around $30k.
For a space smaller than a typical studio apartment. The Monolithic Dome Institute[1] quotes domes at $125/sf (including walls) for a "regular" finish. Your $30,000 dome would have a footprint of 250 sf. My house would cost at least $287,500 to replace with a dome; in contrast, it would cost about $150,000 to replace it with another wood-framed house. Concrete block costs would depend heavily on how complex the floor plan is, but would still be cheaper than a monolithic dome.
[1] http://www.monolithic.org/forms/the-residential-evaluator
For a space smaller than a typical studio apartment. The Monolithic Dome Institute[1] quotes domes at $125/sf (including walls) for a "regular" finish. Your $30,000 dome would have a footprint of 250 sf. My house would cost at least $287,500 to replace with a dome; in contrast, it would cost about $150,000 to replace it with another wood-framed house. Concrete block costs would depend heavily on how complex the floor plan is, but would still be cheaper than a monolithic dome.
[1] http://www.monolithic.org/forms/the-residential-evaluator
No, it's because a house is 400,000 times more valuable than a can of coke.
That's only true for a marginal can of coke. If you have nothing else to drink and are about to die a lone can of coke becomes much more valuable than the house.
Diamond/water paradox
Diamond/water paradox
Until you drink the coke and a blizzard comes.
Also, there's no paradox.
Also, high diamond costs are due to marketing.
Also, there's no paradox.
Also, high diamond costs are due to marketing.
The banks really succeeded in convincing you that that's the price of a house, but that only says something about you, not about the real price of a house.
A 500 sq ft monolithic dome house costs around $30k. It fulfills all the roles of a normal house, but better, safer, and cheaper.
Now tell me how I'm wrong because "furniture doesn't fit in curved walls" and how that justifies the $370k discretionary increase in how much you want to help banks prey on homeowners and earn more interest.
A 500 sq ft monolithic dome house costs around $30k. It fulfills all the roles of a normal house, but better, safer, and cheaper.
Now tell me how I'm wrong because "furniture doesn't fit in curved walls" and how that justifies the $370k discretionary increase in how much you want to help banks prey on homeowners and earn more interest.
> Now tell me how I'm wrong because "furniture doesn't fit in curved walls"
Well, yeah, if you are going to have a house that small -- 500 sq. ft. -- optimal shape is a pretty big concern.
> and how that justifies the $370k discretionary increase
Well, much of the increase is going to be land price. Even a 500 sq. ft. dome home anywhere more typical home prices for reasonably moderately sized homes are around $400,000 is going to be a lot more than $30k just of the land it sits on.
Well, yeah, if you are going to have a house that small -- 500 sq. ft. -- optimal shape is a pretty big concern.
> and how that justifies the $370k discretionary increase
Well, much of the increase is going to be land price. Even a 500 sq. ft. dome home anywhere more typical home prices for reasonably moderately sized homes are around $400,000 is going to be a lot more than $30k just of the land it sits on.
Eh, I lived in a 400sq foot dome for four years. Always with a room-mate, sometimes with two. It was great. The bit of space between the couch and the wall just becomes some oddly-shaped storage space. Sometimes people would carve their own dome-fitting bookshelves in the wood shop.
There were fourteen of these domes, run as a cooperative, on three acres of land. The loans on building them were paid off in full by the early eighties, and I believe there was about a decade where no one paid rent. But eventually it was decided that a nest egg should be built up for upkeep and so on; by the time I was there, it was running about a third of market rent, and these days (due to some additional pressure to modernize) the rents are up to about 2/3 market.
Cooperative ownership is fantastic, and a great cure for the ails of capitalism. But they tend to not get a lot of investment for exactly the same reason: capital isn't interested in investing in non-capitalist spaces.
But it's certainly possible to band together with some friends to get an initial down-payment+loan. Then you incorporate the cooperative, and essentially 'sell' the house to the new cooperative, so that the 'rent' you pay to your new co-op pays off the bank loans. Once the loans are paid off, the cooperative becomes an autonomous creature, self-sustaining as long as there are people happy to live with other people and decide how the place will be run, rather than dealing with a landlord...
There were fourteen of these domes, run as a cooperative, on three acres of land. The loans on building them were paid off in full by the early eighties, and I believe there was about a decade where no one paid rent. But eventually it was decided that a nest egg should be built up for upkeep and so on; by the time I was there, it was running about a third of market rent, and these days (due to some additional pressure to modernize) the rents are up to about 2/3 market.
Cooperative ownership is fantastic, and a great cure for the ails of capitalism. But they tend to not get a lot of investment for exactly the same reason: capital isn't interested in investing in non-capitalist spaces.
But it's certainly possible to band together with some friends to get an initial down-payment+loan. Then you incorporate the cooperative, and essentially 'sell' the house to the new cooperative, so that the 'rent' you pay to your new co-op pays off the bank loans. Once the loans are paid off, the cooperative becomes an autonomous creature, self-sustaining as long as there are people happy to live with other people and decide how the place will be run, rather than dealing with a landlord...
> Cooperative ownership is fantastic, and a great cure
> for the ails of capitalism.
I agree capital tends to avoid housing co-ops because they smell funny and act differently and the laws around them are a mess. As a result, it's harder to assess the risk for a co-op than other businesses and more complicated to borrow, contract, etc.
It's totally possible to do at smaller scale; I've known of some micro co-ops of just one or two houses that have been quite successful. The smaller scale minimizes certain kinds of headaches..
People who can afford 400k mortgages expect to earn, over their lifetime, more than 400k. They just haven't earned it /yet/. The willingness of people to pay them over 400k for a lifetime of labor is what makes houses worth that much, not the willingness of banks to lend them that money today.
Actually, when I hire people I don't recommend them mortgaging their life, regardless of what I might think about affording or not to pay for their services either now or in an immediate future. In a surrounding changing world, instead of gaining leverage to better cope with its changing nature, people instead take mortgages! And guess what - they don't do it in their most clear minds. They always do this life-changing decision dreaming. That is what makes things overpriced and unaffordable without a mortgage.
> Why do I need a mortgage?
If you want to see what life is like without access to modern financial tools, got visit an Indian Reserve in Canada. Housing is cheap there.
Lack of access to modern financial instruments--municipal bonds in particular--is a major block in the way of First Nation's prosperity. Last year a new kind of "aboriginal bond" was floated for the first time to get around this, and hopefully more will come.
So you have an example of what life looks like in your dream world. It isn't pretty. And like everyone else who is pro-finance here, I'm not saying there aren't issues with what we've got. We can fix them. What we can't fix is the massive poverty that comes without access to financial tools, however morally repugnant those tools seem to naive outsiders.
If you want to see what life is like without access to modern financial tools, got visit an Indian Reserve in Canada. Housing is cheap there.
Lack of access to modern financial instruments--municipal bonds in particular--is a major block in the way of First Nation's prosperity. Last year a new kind of "aboriginal bond" was floated for the first time to get around this, and hopefully more will come.
So you have an example of what life looks like in your dream world. It isn't pretty. And like everyone else who is pro-finance here, I'm not saying there aren't issues with what we've got. We can fix them. What we can't fix is the massive poverty that comes without access to financial tools, however morally repugnant those tools seem to naive outsiders.
> If you want to see what life is like without access to modern financial tools, got visit an Indian Reserve in Canada. Housing is cheap there.
So the wealth which flows in resource-abundant places is due to banking, and subsequently the lack of wealth in some desolated lands is due to the lack of credit availability, and both have nothing to do with the natural conditions of those regions?
So the wealth which flows in resource-abundant places is due to banking, and subsequently the lack of wealth in some desolated lands is due to the lack of credit availability, and both have nothing to do with the natural conditions of those regions?
Allows you to get a mortgage which is a function of available credit which is near limitless and so becomes a function of your expected lifetime earnings. Times two now they lend at "household" income.
Education prices are also a function of available credit that tops out at expected total salary less food/rent expenses.
It's enslaving you. Unless you ride it and enslave others.
Your list reads like a wide-eyed econ grad. This is not the real world.
Also note the "we" in the statement. Vested interest.
Education prices are also a function of available credit that tops out at expected total salary less food/rent expenses.
It's enslaving you. Unless you ride it and enslave others.
Your list reads like a wide-eyed econ grad. This is not the real world.
Also note the "we" in the statement. Vested interest.
Well, there could be some counterarguments.
> Allows you to get a mortgage
Wonder if that was always so? Didn't people manage somehow to have a house without something which name suggests it will be paid for the whole life?
> Allows you to protect yourself with health/car/life/home/title/etc insurance
A casino, right? On average you lose, but for a price you buy a hedge against unforeseen? At least unforeseen for you?
> Pays for your highways/stadiums/schools and other public works
I thought my taxes pay for that :) . Do you mean "finances" as "machinery which helps moving money"? I think there are several definitions there.
> Protects your deposits
That's great and helpful
> Pays for your retirement
Nah, that's those same deposits. I largely pay myself for retirement, by saving the whole life. There is also an element of "societal insurance", when I pay a little extra to help myself in case I suddenly become disabled. Or dead. Or, well, not so little; that depends.
> Funds the college fund that paid for your school
Again, it's either another example of "moving money", or an oddity - as people managed to get educated even without banks.
> ... Or the student loans that allowed you to attend school
Same thing.
> Supports the global supply chain that brings you your iPhone, stocks the grocery store/your favorite restaurants with food, and puts the clothes on your back.
Yes, that's another important role - bringing together lenders and borrowers, for a fee. One ought to assume the fee in the computerized XXI century should be small?
> Funds the growth of corporations large and small, giving you the job that allows you to buy an iPhone
Same thing. Banks don't "fund" - they "serve". Money aren't theirs, but theirs', banks', depositors.
> Funds the massive philanthropy expenditures that help those in need everyday
Talked about that already.
> Pays the pensions of the elderly
We already talked about that.
So, to boil down - banks provide money-related services, like "guarding" deposits (you pay for the privilege) or "investing" deposit money (you ought to share risks and benefits). Other than that...
> Allows you to get a mortgage
Wonder if that was always so? Didn't people manage somehow to have a house without something which name suggests it will be paid for the whole life?
> Allows you to protect yourself with health/car/life/home/title/etc insurance
A casino, right? On average you lose, but for a price you buy a hedge against unforeseen? At least unforeseen for you?
> Pays for your highways/stadiums/schools and other public works
I thought my taxes pay for that :) . Do you mean "finances" as "machinery which helps moving money"? I think there are several definitions there.
> Protects your deposits
That's great and helpful
> Pays for your retirement
Nah, that's those same deposits. I largely pay myself for retirement, by saving the whole life. There is also an element of "societal insurance", when I pay a little extra to help myself in case I suddenly become disabled. Or dead. Or, well, not so little; that depends.
> Funds the college fund that paid for your school
Again, it's either another example of "moving money", or an oddity - as people managed to get educated even without banks.
> ... Or the student loans that allowed you to attend school
Same thing.
> Supports the global supply chain that brings you your iPhone, stocks the grocery store/your favorite restaurants with food, and puts the clothes on your back.
Yes, that's another important role - bringing together lenders and borrowers, for a fee. One ought to assume the fee in the computerized XXI century should be small?
> Funds the growth of corporations large and small, giving you the job that allows you to buy an iPhone
Same thing. Banks don't "fund" - they "serve". Money aren't theirs, but theirs', banks', depositors.
> Funds the massive philanthropy expenditures that help those in need everyday
Talked about that already.
> Pays the pensions of the elderly
We already talked about that.
So, to boil down - banks provide money-related services, like "guarding" deposits (you pay for the privilege) or "investing" deposit money (you ought to share risks and benefits). Other than that...
You seem to be confusing finance with retail banking.
>Didn't people manage somehow to have a house without something which name suggests it will be paid for the whole life?
Well, for a while people were indentured farmers, then you got people renting tenements and apartments in cities, with some land-grant family farms/homsteads being passed down through inheritance. Mass suburban home ownership is mostly a post-WWII phenomenon, and mostly funded through credit. Though for a time, most people got their mortgages from community credit unions (or similar), those were still financial institutions, just in decentralized cooperative form. Big banks ended up being able to provide better rates through sheer scale.
>A casino, right? On average you lose, but for a price you buy a hedge against unforeseen?
My mother had a brain hemorrhage last week, we paid about $1000 for $500k+ of medical care. The insurance industry works only because insurance companies can invest their giant pool of money and see large enough gains to both cover all their costs and make it worth their while. Insurance premiums aren't sitting around as cash.
Your point?
>that's those same deposits
Nope, it's the interest on those deposits, the core service of the financial services industry. Retirement is entirely predicated on compound interest.
> Same thing. Banks don't "fund" - they "serve". Money aren't theirs, but theirs', banks', depositors.
It's hard to imagine how you could possibly be more wrong. We're not talking about business checking accounts here, we're talking about banks investing in businesses. Banks absolutely do fund businesses, and own (shares in) those businesses in return.
An investment bank owns a business and, in turn, its checking accounts in retail banks.
I don't think you understand banks' roles in philanthropy and education - successful nonprofit institutions like universities draw their operating budgets from interest on their endowments. Were it not possible to park $x billion in account and draw $y million a year in interest for literally forever, many such institutions could not exist.
>Didn't people manage somehow to have a house without something which name suggests it will be paid for the whole life?
Well, for a while people were indentured farmers, then you got people renting tenements and apartments in cities, with some land-grant family farms/homsteads being passed down through inheritance. Mass suburban home ownership is mostly a post-WWII phenomenon, and mostly funded through credit. Though for a time, most people got their mortgages from community credit unions (or similar), those were still financial institutions, just in decentralized cooperative form. Big banks ended up being able to provide better rates through sheer scale.
>A casino, right? On average you lose, but for a price you buy a hedge against unforeseen?
My mother had a brain hemorrhage last week, we paid about $1000 for $500k+ of medical care. The insurance industry works only because insurance companies can invest their giant pool of money and see large enough gains to both cover all their costs and make it worth their while. Insurance premiums aren't sitting around as cash.
Your point?
>that's those same deposits
Nope, it's the interest on those deposits, the core service of the financial services industry. Retirement is entirely predicated on compound interest.
> Same thing. Banks don't "fund" - they "serve". Money aren't theirs, but theirs', banks', depositors.
It's hard to imagine how you could possibly be more wrong. We're not talking about business checking accounts here, we're talking about banks investing in businesses. Banks absolutely do fund businesses, and own (shares in) those businesses in return.
An investment bank owns a business and, in turn, its checking accounts in retail banks.
I don't think you understand banks' roles in philanthropy and education - successful nonprofit institutions like universities draw their operating budgets from interest on their endowments. Were it not possible to park $x billion in account and draw $y million a year in interest for literally forever, many such institutions could not exist.
> I don't think you understand banks' roles in philanthropy and education - successful nonprofit institutions like universities draw their operating budgets from interest on their endowments. Were it not possible to park $x billion in account and draw $y million a year in interest for literally forever, many such institutions could not exist.
They used to own land (and peasants!) themselves or they were funded by someone who did (Church/King/Prince). The former was preferred due to the larger independence and stability it gave them.
Copenhagen University used to own lots of land, for example. So did (do) Oxford and Cambridge.
They used to own land (and peasants!) themselves or they were funded by someone who did (Church/King/Prince). The former was preferred due to the larger independence and stability it gave them.
Copenhagen University used to own lots of land, for example. So did (do) Oxford and Cambridge.
I thank you - and all other who replied - deeply, but I'm not sure I understand you - or agree with you.
I do assume there are two kinds of banks. One is "retail", or financial services, as I understand it. Gets its money as fees. Another is investment - this one takes risks and reaps rewards, but it's a different kind of organization - somewhat similar to a group of people, who pooled their money and work on a kind of gambling, often reaping rewards, but also taking risks.
Talking about this second group, it's entirely different - for many people who are not members of that group of investors (risk-takers) it's outside of what they deal with. So I'm mostly talking about first group.
For example, my point regarding insurance is that I'm dealing with professionals having different amount of information than I do, and benefiting from that. Theoretically market should bring insurance premiums to some average profit margin. Also theoretically I should be able to earn on average more than I spend on average on insurance, so examples with big expenses are supposed to be exceptions, and on average I'd have more money paying for cases myself. In that sense, insurance premiums are spent (supposed to be, mostly) on cases where insurance events happen.
Next, "those same deposits" - I think the word "principal" is meaningful :) as there won't be interest without principal. So I still think we talk about deposits - together with added relatively modern service of investing, getting some averaged interest and paying some fees to the service which does the investing. Yes, that's the core service. Of retail banks... may be we actually agreeing here?
Next, of course banks invest, that's how they pay that interest. The principal money still aren't theirs - so banks don't "fund" - as in "fund with their own money" - since retail banks by definition don't deal with their own money; instead banks pass those money as credits - or, yes, even to buy shares. The fact that, say, universities takes their budgets from interest shows that service works - but it's not the banks, who "pay" - don't assign the source to them - it's principal, combined with the service (for which banks don't pay, but receive fees), which generates interest. Bank is a sort of an engine which you feed with fuel to get desired outcome (bad analogy, I know), but I think fuel here is more principal (sic), more fundamental than the service.
I do assume there are two kinds of banks. One is "retail", or financial services, as I understand it. Gets its money as fees. Another is investment - this one takes risks and reaps rewards, but it's a different kind of organization - somewhat similar to a group of people, who pooled their money and work on a kind of gambling, often reaping rewards, but also taking risks.
Talking about this second group, it's entirely different - for many people who are not members of that group of investors (risk-takers) it's outside of what they deal with. So I'm mostly talking about first group.
For example, my point regarding insurance is that I'm dealing with professionals having different amount of information than I do, and benefiting from that. Theoretically market should bring insurance premiums to some average profit margin. Also theoretically I should be able to earn on average more than I spend on average on insurance, so examples with big expenses are supposed to be exceptions, and on average I'd have more money paying for cases myself. In that sense, insurance premiums are spent (supposed to be, mostly) on cases where insurance events happen.
Next, "those same deposits" - I think the word "principal" is meaningful :) as there won't be interest without principal. So I still think we talk about deposits - together with added relatively modern service of investing, getting some averaged interest and paying some fees to the service which does the investing. Yes, that's the core service. Of retail banks... may be we actually agreeing here?
Next, of course banks invest, that's how they pay that interest. The principal money still aren't theirs - so banks don't "fund" - as in "fund with their own money" - since retail banks by definition don't deal with their own money; instead banks pass those money as credits - or, yes, even to buy shares. The fact that, say, universities takes their budgets from interest shows that service works - but it's not the banks, who "pay" - don't assign the source to them - it's principal, combined with the service (for which banks don't pay, but receive fees), which generates interest. Bank is a sort of an engine which you feed with fuel to get desired outcome (bad analogy, I know), but I think fuel here is more principal (sic), more fundamental than the service.
> I thought my taxes pay for that :) . Do you mean "finances" as "machinery which helps moving money"? I think there are several definitions there.
You are correct in that the money used to build highways etc. does start as your tax dollars. However, I would imagine that it is then held (and allowed to appreciate) in the form of a reasonably liquid portfolio of cash, bonds, and equities. I suppose you could technically reduce finance to "moving money around", but that is such a gross simplification that it would be like saying programmers just type for a living.
> Nah, that's those same deposits. I largely pay myself for retirement, by saving the whole life.
If your entire retirement savings are in simple savings accounts (i.e. in a bank instead of a brokerage account), I am afraid you are losing out on quite a substantial return that could allow you to either retire earlier or enjoy a higher annual income during retirement (or both).
> > Funds the college fund that paid for your school > Again, it's either another example of "moving money", or an oddity - as people managed to get educated even without banks.
The statement that college funds, loan programs, and scholarship endowments (all powered by "finance") pay for the education of practically every student in the country is true, unless you save for college in a piggy bank.
> you ought to share risks and benefits
If you want to share the risks and benefits, there's an easy way to do that: get a brokerage account. If you have deposited your money, the basic assumption is that you are willing to accept a lower rate of return in exchange for a (practically) risk-free place to store your money.
depends on how much you want to rely on the FDIC
You are correct in that the money used to build highways etc. does start as your tax dollars. However, I would imagine that it is then held (and allowed to appreciate) in the form of a reasonably liquid portfolio of cash, bonds, and equities. I suppose you could technically reduce finance to "moving money around", but that is such a gross simplification that it would be like saying programmers just type for a living.
> Nah, that's those same deposits. I largely pay myself for retirement, by saving the whole life.
If your entire retirement savings are in simple savings accounts (i.e. in a bank instead of a brokerage account), I am afraid you are losing out on quite a substantial return that could allow you to either retire earlier or enjoy a higher annual income during retirement (or both).
> > Funds the college fund that paid for your school > Again, it's either another example of "moving money", or an oddity - as people managed to get educated even without banks.
The statement that college funds, loan programs, and scholarship endowments (all powered by "finance") pay for the education of practically every student in the country is true, unless you save for college in a piggy bank.
> you ought to share risks and benefits
If you want to share the risks and benefits, there's an easy way to do that: get a brokerage account. If you have deposited your money, the basic assumption is that you are willing to accept a lower rate of return in exchange for a (practically) risk-free place to store your money.
depends on how much you want to rely on the FDIC
> "You are correct in that the money used to build highways etc. does start as your tax dollars."
Taxes are not the only way that governments get money. Sales of government bonds are likely to generate a large portion of capital behind infrastructure projects.
Taxes are not the only way that governments get money. Sales of government bonds are likely to generate a large portion of capital behind infrastructure projects.
> > Pays for your highways/stadiums/schools and other public works
> I thought my taxes pay for that :) . Do you mean "finances" as "machinery which helps moving money"? I think there are several definitions there.
If your local municipality can go to Big Investment Bank Inc to arrange a bond issue, they can time-shift their tax receipts in order to build that new school/library/highway overpass now rather than 10 years from now.
If your local municipality can go to Big Investment Bank Inc to arrange a bond issue, they can time-shift their tax receipts in order to build that new school/library/highway overpass now rather than 10 years from now.
Most states provide a state backed deposit guarantee. It's not guaranteed by the banks.
Plus regarding "funding" education etc they do no such thing, this is funded by the state. The post you reply to is littered with incorrect statements. Well done for calling some out.
Plus regarding "funding" education etc they do no such thing, this is funded by the state. The post you reply to is littered with incorrect statements. Well done for calling some out.
All of these were done 25, 50, or 100 years ago. The basis for the mortgage industry as we know it was developed during the new deal.
I need some serious convincing that the effects securitization of everything has been a net win.
The markets for most of this stuff are made or directly supported by the Federal government.
I need some serious convincing that the effects securitization of everything has been a net win.
The markets for most of this stuff are made or directly supported by the Federal government.
I think it's fine:
http://www.tradingeconomics.com/embed/?s=unitedstamonsupm0&d...
Look at that innovation! How is your life doing recently? I feel like mine is four times better. Oh no wait land is way more expensive and I'm working to pay my landlord every month. Should I go to my bank and make a huge bet on record low rates or wait for them to print some more whilst wages are static?
http://www.tradingeconomics.com/embed/?s=unitedstamonsupm0&d...
Look at that innovation! How is your life doing recently? I feel like mine is four times better. Oh no wait land is way more expensive and I'm working to pay my landlord every month. Should I go to my bank and make a huge bet on record low rates or wait for them to print some more whilst wages are static?
So tax land rents, not labor.
I agree. Land value tax. It would cut the banks down to size in no time as it would cut down land speculation which makes up the bulk of bank lending.
I'd simply be interested in seeing more of working people's spending money available to increase the economy. I am not sure that this must be at the expense of banks.
One natural experiment in the effects of speculation is home prices in Texas ( which taxes land rents more than most states ) vs. Florida ( which taxes them less ).
It would also help address some examples of misallocation of land. Since the tax base is now largely market driven, it's all but impossible to game.
One natural experiment in the effects of speculation is home prices in Texas ( which taxes land rents more than most states ) vs. Florida ( which taxes them less ).
It would also help address some examples of misallocation of land. Since the tax base is now largely market driven, it's all but impossible to game.
Well, it's a very small sample, but Florida was one of the hardest hit by the housing bubble a few years ago, while Texas had relatively stable housing prices. California also was heavily impacted by the housing bubble and it has Prop 13.
Careful, money supply is not at all the same thing as inflation, see:
http://inflationdata.com/Inflation/Inflation/Money_Supply_an...
Because we are in a big "liquidity trap": http://krugman.blogs.nytimes.com/2013/04/11/monetary-policy-...
The fed printed money can only be loaned, not just given away. This limits its direct impact on inflation. On the other hand, it certainly would cause inflation if it made it out of the banks. But banks will only loan if they think they can make money: only if there is economic growth to take advantage of, otherwise it just sits.
At this point we should not limit growth based on lack of liquidity, so it's probably not a bad thing that the fed is pumping money into the banks.
I read that some in the fed suggest that interest rates should be raised. The expectation of future higher rates might encourage people to borrow and spend now: https://www.stlouisfed.org/publications/regional-economist/a...
http://inflationdata.com/Inflation/Inflation/Money_Supply_an...
Because we are in a big "liquidity trap": http://krugman.blogs.nytimes.com/2013/04/11/monetary-policy-...
The fed printed money can only be loaned, not just given away. This limits its direct impact on inflation. On the other hand, it certainly would cause inflation if it made it out of the banks. But banks will only loan if they think they can make money: only if there is economic growth to take advantage of, otherwise it just sits.
At this point we should not limit growth based on lack of liquidity, so it's probably not a bad thing that the fed is pumping money into the banks.
I read that some in the fed suggest that interest rates should be raised. The expectation of future higher rates might encourage people to borrow and spend now: https://www.stlouisfed.org/publications/regional-economist/a...
securitization is just the process of transferring risk from those who think they can't hold it to those who think they are very good at holding it. It is a tool, and it is a very good tool. A shovel is a tool and if I take a shovel and kill someone with it, that doesn't make the tool itsel bad
I didn't say it was bad, just not particularly useful in proportion to the other effects.
>Financial innovation make our lives more predictable and less sensitive to chance.
lol.
lol.
Go live in a world where theres no securitization of debt, no interest on debt, no mitigation of risk, no insurance against risk, hell even no banks.
No banks means no jobs, bad housing, no tools, no pc's, no security, no stores - but that dosnt matter, cause you dont have any money either, bad food, no mass production++
Most people commenting in this tread has no concept about what finance is and does, so it must be inherently evil.
Well, the world is more complex than that. Without finance your standard of living would probably be below one tenth of what it is now -unless you already live on the street of course. But then you wouldn't care because you'd probably be a alcholic or druggie. You won't get hold of any drugs or boose either so your fucked as well.
Tldr; The world runs on debt & oil. Get used to it, it isn't going to change anytime soon.
No banks means no jobs, bad housing, no tools, no pc's, no security, no stores - but that dosnt matter, cause you dont have any money either, bad food, no mass production++
Most people commenting in this tread has no concept about what finance is and does, so it must be inherently evil.
Well, the world is more complex than that. Without finance your standard of living would probably be below one tenth of what it is now -unless you already live on the street of course. But then you wouldn't care because you'd probably be a alcholic or druggie. You won't get hold of any drugs or boose either so your fucked as well.
Tldr; The world runs on debt & oil. Get used to it, it isn't going to change anytime soon.
The key word here is innovation. Lot of the stuff you described (except perhaps debt securitization) is old and tested. To an outsider like me, it looks like a lot of financial innovation today (the kind that Wall Street does by hiring Physics and Math Phds)is primarily aimed at making a few rich people even richer at the expense of everybody else and provide zero or negative value to society. Why should we encourage that behaviour? Then there is the good kind of innovation like Micro-financing that is done in places like Bangladesh, and that you know, actually is designed to help the common man. Even crowd-funding (is that financial innovation?) could be considered good (although caution and regulatory oversight should be built in). This is kind of innovation seems to be the exception rather than the rule though.
I say financial innovation should treated by govt. with greater caution and suspicion especially when the effects of such innovation has consequences on the wider economy or when it involve other people's money.(Who's bright idea was it anyway, to allow banks and funds to gamble with people's pensions and deposits?)
If you can provide a counter-example to this, that would be much welcome.
edit: And no, I don't think a world without debt securitization would be such a bad thing.
I say financial innovation should treated by govt. with greater caution and suspicion especially when the effects of such innovation has consequences on the wider economy or when it involve other people's money.(Who's bright idea was it anyway, to allow banks and funds to gamble with people's pensions and deposits?)
If you can provide a counter-example to this, that would be much welcome.
edit: And no, I don't think a world without debt securitization would be such a bad thing.
Banking allows us to get mortgages.
"Finance" gives us 2% down payment mortgages which are than packaged and sold to Japanese pension funds with currency and interest rate hedges mixed in... which then go on to screw everyone involved since NO ONE reads or understands the terms of the investment vehicle besides the financial engineers who wrote & sold them.
The same holds true for all the points you listed.
Fortunately, Capitalism has a fail safe. All this financial nonsense would have been fixed if the banks were allowed to fail in 2008. The US federal government is largely to blame for the continued parasitical rent seeking of the high finance class.
"Finance" gives us 2% down payment mortgages which are than packaged and sold to Japanese pension funds with currency and interest rate hedges mixed in... which then go on to screw everyone involved since NO ONE reads or understands the terms of the investment vehicle besides the financial engineers who wrote & sold them.
The same holds true for all the points you listed.
Fortunately, Capitalism has a fail safe. All this financial nonsense would have been fixed if the banks were allowed to fail in 2008. The US federal government is largely to blame for the continued parasitical rent seeking of the high finance class.
Currently the financial system generates profit while destroying value. It's out of control and only serves the interest of those who already have considerable amounts of capital.
Financial innovation make our lives more predictable...
Not necessarily. It may also make our lives a game of chance or a house of cards. You didn't say what kind of innovation.
Not necessarily. It may also make our lives a game of chance or a house of cards. You didn't say what kind of innovation.
All these things were available 50 years ago.
Exactly. The adjective "innovative" has an inherent timeframe associated with it. I don't think we can consider mortgages "innovative" in 2015.
> Financial innovation...
This vague phrase is very misleading. It is certainly not true that all "Financial Innovation" makes our lives more predictable and less sensitive to chance. Please see 2008 for reference.
Sure, there are some benefits to basic finance and lending, but "basic finance and lending" are not really "Financial Innovation" at this point either. I think we would all benefit if you defined your terms better.
This vague phrase is very misleading. It is certainly not true that all "Financial Innovation" makes our lives more predictable and less sensitive to chance. Please see 2008 for reference.
Sure, there are some benefits to basic finance and lending, but "basic finance and lending" are not really "Financial Innovation" at this point either. I think we would all benefit if you defined your terms better.
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Finance is complex because:
1. If a transaction is complex, it's easy to sucker people into buying. Why would anyone buy a structured product?
2. If a transaction is complex, both sides can claim an immediate profit based on their idea of how it should be valued.
3. A lot of complexity in finance is driven by the fact that big banks can borrow at 0% while true inflation is higher. Via various derivatives, this government interest rate subsidy is packaged and sold. For example, I can't borrow at 0% to buy stock, but if I buy a call option, the bank can borrow at 0% to finance their hedge.
4. Because different people have different interest rates (banks borrow at 0%, large corporations borrow at 5%), banks can price a derivative at 3%, and both sides can LEGITIMATELY claim an immediate profit on the trade. (Bank borrows at 0% and lends at 3% to finance the derivative hedge. The corporation is borrowing at 3% instead of the 5% they normally would pay.)
1. If a transaction is complex, it's easy to sucker people into buying. Why would anyone buy a structured product?
2. If a transaction is complex, both sides can claim an immediate profit based on their idea of how it should be valued.
3. A lot of complexity in finance is driven by the fact that big banks can borrow at 0% while true inflation is higher. Via various derivatives, this government interest rate subsidy is packaged and sold. For example, I can't borrow at 0% to buy stock, but if I buy a call option, the bank can borrow at 0% to finance their hedge.
4. Because different people have different interest rates (banks borrow at 0%, large corporations borrow at 5%), banks can price a derivative at 3%, and both sides can LEGITIMATELY claim an immediate profit on the trade. (Bank borrows at 0% and lends at 3% to finance the derivative hedge. The corporation is borrowing at 3% instead of the 5% they normally would pay.)
Banks don't necessarily borrow at 0%. Granted, they are able to borrow at a much lower rate than you or me (closer to the Federal Funds Rate managed by the U.S. Federal Reserve), but they still pay interest on their loans.
Of course, real interest rates have gotten close to zero, but in general real interest rates of 0% are nonsensical in stable, developed economies. Economically speaking, if rates were 0%, it would in the long run make sense to bulldoze the rocky mountains to save money on gas, because there is no marginal cost to consider.
Of course, real interest rates have gotten close to zero, but in general real interest rates of 0% are nonsensical in stable, developed economies. Economically speaking, if rates were 0%, it would in the long run make sense to bulldoze the rocky mountains to save money on gas, because there is no marginal cost to consider.
"if rates were 0%, it would in the long run make sense to bulldoze the rocky mountains to save money on gas, because there is no marginal cost to consider"
Wait, run that by me again more slowly.
In general, it does make sense to make large infrastructure investments in order to increase long term productivity, especially when interest rates are low, but in general, it's always the case. Hell, bits of the Rockies WERE bulldozed (And dynamited) to save money on railroad or freeway construction that would pay off on a fifty to a hundred year timescale. What does zero percent interest have to do with that? Presumably there are even some positive interest rate values for which the eventual gas savings outweigh the cost of hiring the guys with the bulldozers, if those are the only costs you care about.
If there's a quadrillion dollars worth of hydrocarbons on Titan, and it'll cost me a trillion dollars and fifty years to bring them to earth, it makes economic sense for me to do it, even if interest rates are 5%. I don't think it's the interest rate that makes these projects make sense or not make sense.
What's the magic that happens at zero that causes otherwise nonsensical projects to make economic sense?
Wait, run that by me again more slowly.
In general, it does make sense to make large infrastructure investments in order to increase long term productivity, especially when interest rates are low, but in general, it's always the case. Hell, bits of the Rockies WERE bulldozed (And dynamited) to save money on railroad or freeway construction that would pay off on a fifty to a hundred year timescale. What does zero percent interest have to do with that? Presumably there are even some positive interest rate values for which the eventual gas savings outweigh the cost of hiring the guys with the bulldozers, if those are the only costs you care about.
If there's a quadrillion dollars worth of hydrocarbons on Titan, and it'll cost me a trillion dollars and fifty years to bring them to earth, it makes economic sense for me to do it, even if interest rates are 5%. I don't think it's the interest rate that makes these projects make sense or not make sense.
What's the magic that happens at zero that causes otherwise nonsensical projects to make economic sense?
Exactly. I think he's assuming he'll never have to pay back the principle.
(In response to above as well as parent)
> What's the magic that happens at zero that causes otherwise nonsensical projects to make economic sense?
The bulldozing-mountains example is purposefully over-the-top (I believe I first heard it in an article by Bernanke[0]). The point that I am trying to illustrate is that at a 0% interest rate, the traditional marginal cost/marginal utility analysis breaks down, since as long as the marginal utility of the last investment dollar spent outweighs the marginal cost of spending that dollar (the interest rate), traditional economic thinking would have you spend that dollar.
> Exactly. I think he's assuming he'll never have to pay back the principle.
The rocky-mountain example does assume this, but it doesn't make a 0% interest rate any more ludicrous. Imagine that you could take out a loan for $x at 0%. Simply because of the fact that time gives assets the opportunity to grow, the future value of that loan when it is to be repaid is greater than the value when you received the loan [1]. Of course, the 0% rate would remove some traditional investment options (savings account, Treasury bonds, etc.), I think it is reasonable to assume that investments will still be able to appreciate to some degree.
However, this appreciation would be constrained in reality by inflation if the real interest rate is 0%. If, on the other hand, the nominal interest rate is 0%, then the loan effectively counteracts the headwind of inflation, and any return, no matter how small, winds up in your pocket.
[0 (7th paragraph)] http://www.brookings.edu/blogs/ben-bernanke/posts/2015/03/31... [1] https://en.wikipedia.org/wiki/Time_value_of_money
> What's the magic that happens at zero that causes otherwise nonsensical projects to make economic sense?
The bulldozing-mountains example is purposefully over-the-top (I believe I first heard it in an article by Bernanke[0]). The point that I am trying to illustrate is that at a 0% interest rate, the traditional marginal cost/marginal utility analysis breaks down, since as long as the marginal utility of the last investment dollar spent outweighs the marginal cost of spending that dollar (the interest rate), traditional economic thinking would have you spend that dollar.
> Exactly. I think he's assuming he'll never have to pay back the principle.
The rocky-mountain example does assume this, but it doesn't make a 0% interest rate any more ludicrous. Imagine that you could take out a loan for $x at 0%. Simply because of the fact that time gives assets the opportunity to grow, the future value of that loan when it is to be repaid is greater than the value when you received the loan [1]. Of course, the 0% rate would remove some traditional investment options (savings account, Treasury bonds, etc.), I think it is reasonable to assume that investments will still be able to appreciate to some degree.
However, this appreciation would be constrained in reality by inflation if the real interest rate is 0%. If, on the other hand, the nominal interest rate is 0%, then the loan effectively counteracts the headwind of inflation, and any return, no matter how small, winds up in your pocket.
[0 (7th paragraph)] http://www.brookings.edu/blogs/ben-bernanke/posts/2015/03/31... [1] https://en.wikipedia.org/wiki/Time_value_of_money
I guess that assumes infinite access to credit? Otherwise there would be an opportunity cost associated with bulldozing the rocky mountains in favor of some other activity with higher marginal utility, right?
Time gives the money a chance to grow if there is anywhere that offers a safe return. Lending at a negative interest rate is paying someone to keep your money safe. Borrowing at a real negative interest rate may not make sense if you aren't sure you can do that.
Actually, it was a bad example.
Suppose you spend $1M to produce something worth $100k. You lost $900k.
But suppose you borrowed at 0% while inflation was (to use round numbers) 10%. After about 50 years of borrowing at 0%, your $100k is now worth more than $1M. (I'm too lazy to use logs to figure out the exact breakeven point right now.) You made a profit.
With 0% interest rates, your investment that destroyed $900k of value was (eventually) profitable. If you can avoid mark-to-market accounting, you can just borrow, wait for inflation, and eventually sell for a profit.
When interest rates are less than inflation, a capital-destroying investment can seem profitable.
Suppose you spend $1M to produce something worth $100k. You lost $900k.
But suppose you borrowed at 0% while inflation was (to use round numbers) 10%. After about 50 years of borrowing at 0%, your $100k is now worth more than $1M. (I'm too lazy to use logs to figure out the exact breakeven point right now.) You made a profit.
With 0% interest rates, your investment that destroyed $900k of value was (eventually) profitable. If you can avoid mark-to-market accounting, you can just borrow, wait for inflation, and eventually sell for a profit.
When interest rates are less than inflation, a capital-destroying investment can seem profitable.
So in this scenario, you either got an indefinite-term loan with a 0 interest payment, or you took a big risk by betting that the cost of borrowing would not increase until you could pay down the loan.
Its possible to borrow money, blow through the cash on some unproductive investment and then be unable to repay the principle on the agreed-upon schedule.
FWIW, I'm relatively quick, pick up languages (both CS and natural), frameworks, algorithms, etc. without much trouble.
But I've tried again and again to understand how our basic Federal Reserve System functions - Gov't debt, banks, reserve margins, mortgage loans, etc. etc.
I've NEVER gotten a basic "THIS IS HOW IT WORKS in 21 DAYS", Stack Exchange-type-answer. Lots of opinions...
This itself leads me to believe that Finance is corrupt.
I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
T. Jefferson
But I've tried again and again to understand how our basic Federal Reserve System functions - Gov't debt, banks, reserve margins, mortgage loans, etc. etc.
I've NEVER gotten a basic "THIS IS HOW IT WORKS in 21 DAYS", Stack Exchange-type-answer. Lots of opinions...
This itself leads me to believe that Finance is corrupt.
I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
T. Jefferson
Lmao, can't understand it so it's corrupt.
Sounds like all the people that think the same about IT. It's "magic".
Buy and read some books, it's laid out pretty clearly. If you're not sure what to read, email some of the professors in finance at the University you went to.
Sounds like all the people that think the same about IT. It's "magic".
Buy and read some books, it's laid out pretty clearly. If you're not sure what to read, email some of the professors in finance at the University you went to.
If you think you understand the truly complex parts of finance, I would encourage you to re-evaluate. The world economy is still in turmoil and slow recovery because a huge amount of the experts didn't even properly understand the "innovative finance" they were using in 2008.
I don't understand it, and I have seen countless interviews and articles from respected economists who say there are financial products they don't totally understand either.
To "understand" something in finance is not quite the same as other disciplines. You can understand all the pieces and all the rules of something, but not truly "understand" it entirely. Economics involves a lot of sociology/psychology and difficult-to-predict human behavior. It is likely that no one is completely aware of all of these factors when it comes to any given financial instrument.
So, I don't think you should be laughing at someone and telling them to read books as if this is algebra or something.
I don't understand it, and I have seen countless interviews and articles from respected economists who say there are financial products they don't totally understand either.
To "understand" something in finance is not quite the same as other disciplines. You can understand all the pieces and all the rules of something, but not truly "understand" it entirely. Economics involves a lot of sociology/psychology and difficult-to-predict human behavior. It is likely that no one is completely aware of all of these factors when it comes to any given financial instrument.
So, I don't think you should be laughing at someone and telling them to read books as if this is algebra or something.
I understand the parts I've worked in. No one likely has a clear understanding of 100% of finance (this actually crosses finance, accounting and economics, as well as statistics, programming and many other disciplines).
I have degrees in Finance and Economics, I'm a software engineer and my first job was as an Auditor for Andersen, so yeah, I've got a bit of a back ground in the "complex parts" of finance.
All it is for the most part is a fucking shell game FYI with different entities jumping through different nonsensical made up loopholes in tax law, financial regulations and anything else they can do to game the system.
Lots of people understood the "innovative finance" in 2008 and prior. For every stupid bet, there's someone on the other side. In fact, the reason we saw almost no finance people go to prison while the government gave billions, shows they know it far better than you give them credit.
You're right, reading a book about it is beyond most people. You have to actually pay attention as well.
I have degrees in Finance and Economics, I'm a software engineer and my first job was as an Auditor for Andersen, so yeah, I've got a bit of a back ground in the "complex parts" of finance.
All it is for the most part is a fucking shell game FYI with different entities jumping through different nonsensical made up loopholes in tax law, financial regulations and anything else they can do to game the system.
Lots of people understood the "innovative finance" in 2008 and prior. For every stupid bet, there's someone on the other side. In fact, the reason we saw almost no finance people go to prison while the government gave billions, shows they know it far better than you give them credit.
You're right, reading a book about it is beyond most people. You have to actually pay attention as well.
I'm curious what makes you so sure you really understand it? It seems to me that when wealth is being concentrated more and more into the hands of the wealthiest all over the world, there is something deeply wrong with the financial industry and its textbooks.
Lol, degrees in finance and econ. Years of working in the industry as well. Why do you think people in finance aren't the ones being eaten up by increasing productivity and stagnant wages?
I got out of the field because I thought IT would be more rewarding. If I had it to do over again, I'd be one of those finance assholes ripping everyone off and laughing all the way to the bank.
I got out of the field because I thought IT would be more rewarding. If I had it to do over again, I'd be one of those finance assholes ripping everyone off and laughing all the way to the bank.
Stop quoting lies. http://www.monticello.org/site/jefferson/private-banks-quota...
It may be inaccurate, but it is hardly "lies." It is clear from the other verifiable quotations on your link that Thomas Jefferson would probably agree with the misquote anyway.
Article appears to answer the question why does finance exist, not why is it so complex.
I think the answer for why is it so complex is that it is a human domain that rewards complexity.
First, humans that turn their full brain power on something inevitably make complicated structures. If you think about it, this becomes clear that it's true, even if there's absolutely nothing there. For instance, it's almost worth picking up a practitioner's book on numerology or astrology, a really "good" book that goes deep into the details and history, not just a superficial "intro" jobber, to witness the incredible complexity humans bring into a field that 90%+ of the readers of this comment will agree there is virtually no reason for it to possess, because there's no "there" there.
How much more complexity and richness we can bring to an already complex field!
And as others are pointing out already, finance also rewards complexity, both because people can hide things in the complexity and because people can fool themselves into thinking they understand the complex things, and because the interaction of all these complex things is even more complex.
You want another domain that works much like that? Consider any ol' pile of code that a software company runs on. It's bad enough that all software companies of any size are trying to solve a non-trivial problem, but throw a few hundred random developers at it and before you know it the "simple billing system" has 100-line buggy sorting functions sitting next to the double-booking accounting algorithms and all the other endless monstrosities we sometimes swap stories about on HN or various reddits. And then one day a trivial quirk in that sorting algorithm accidentally erases all the data in your customer database when it accidentally decided everybody had failed to pay their balances for over a thousand years or something. Computing is complicated even before humans start humaning the place up, but then it gets even worse.
I think the answer for why is it so complex is that it is a human domain that rewards complexity.
First, humans that turn their full brain power on something inevitably make complicated structures. If you think about it, this becomes clear that it's true, even if there's absolutely nothing there. For instance, it's almost worth picking up a practitioner's book on numerology or astrology, a really "good" book that goes deep into the details and history, not just a superficial "intro" jobber, to witness the incredible complexity humans bring into a field that 90%+ of the readers of this comment will agree there is virtually no reason for it to possess, because there's no "there" there.
How much more complexity and richness we can bring to an already complex field!
And as others are pointing out already, finance also rewards complexity, both because people can hide things in the complexity and because people can fool themselves into thinking they understand the complex things, and because the interaction of all these complex things is even more complex.
You want another domain that works much like that? Consider any ol' pile of code that a software company runs on. It's bad enough that all software companies of any size are trying to solve a non-trivial problem, but throw a few hundred random developers at it and before you know it the "simple billing system" has 100-line buggy sorting functions sitting next to the double-booking accounting algorithms and all the other endless monstrosities we sometimes swap stories about on HN or various reddits. And then one day a trivial quirk in that sorting algorithm accidentally erases all the data in your customer database when it accidentally decided everybody had failed to pay their balances for over a thousand years or something. Computing is complicated even before humans start humaning the place up, but then it gets even worse.
>The core purpose of status quo finance is to coax people into accepting risks that they would not, if fully informed, consent to bear.
That is a pretty loaded statement. That would be like saying the core purpose of the software industry is to destroy jobs and in turn collect part of the salary that those jobs previously paid. It might technically be true, but it is twisting things to make them sound intentionally evil.
That is a pretty loaded statement. That would be like saying the core purpose of the software industry is to destroy jobs and in turn collect part of the salary that those jobs previously paid. It might technically be true, but it is twisting things to make them sound intentionally evil.
But it's actually true. I've personally had the experience (as a freelancer) of watching people that I had just recently met be laid off because of what I was being generously paid to do. I did not like it.
I could at least comfort myself by the fact that what I was doing was actually useful (and creating efficiencies that destroyed jobs), whereas concealing risk is actively deceitful and destructive.
I could at least comfort myself by the fact that what I was doing was actually useful (and creating efficiencies that destroyed jobs), whereas concealing risk is actively deceitful and destructive.
According to the article though, this deceitfulness is actually good, not destructive. It puts us into a more productive Nash equilibrium than we'd be if we each individually assessed the risk of our single investment and said "na, too risky".
Efficiency is therefore deliberately harmful, except when in the form of a paycheck, QED.
Well done, good luck.
Well done, good luck.
Financiers are buyers and sellers of risk. They do so at prices that are generally advantageous to them. They are able to do so because they make a profession out of it: they have a lot of capital to work with, and they spend a lot of time thinking about it.
To call finance intentionally opaque is a perhaps true, but it shouldn't be vilified much more than other goods and services, the providers which all maintain some level of "opacity" towards their customers. In a sense, it's a fundamental part of any capitalistic transaction. A farmer sells an apple for more than it costs for her to make it, but you're willing to pay her for it because you aren't that good at growing apples. To her, it might be worth what it cost her to grow it, but to you, it is clearly worth what you are willing to pay for it, because you have the added benefit (or requirement) of being able to eat it and survive. So it is worth more to you, less to her, and she profits.
One could see similarities in insurance (much closer to finance than apple-growing, if not finance itself). An insurer charges you (or maybe an aggregated group of "yous") more than it costs to provide a certain protection (or hedge against a certain risk). You are willing to pay the premium because clearly the risk protection matters more than getting some "theoretically optimal" price.
With increased availability in technology and information, certain kinds of finance are becoming easy to do "on your own" - the most salient example is perhaps index investing. Many people are realizing that financiers cannot add value and they need less of a middleman.
I thought I'd share my contrasting thoughts, but I very much enjoyed the read.
To call finance intentionally opaque is a perhaps true, but it shouldn't be vilified much more than other goods and services, the providers which all maintain some level of "opacity" towards their customers. In a sense, it's a fundamental part of any capitalistic transaction. A farmer sells an apple for more than it costs for her to make it, but you're willing to pay her for it because you aren't that good at growing apples. To her, it might be worth what it cost her to grow it, but to you, it is clearly worth what you are willing to pay for it, because you have the added benefit (or requirement) of being able to eat it and survive. So it is worth more to you, less to her, and she profits.
One could see similarities in insurance (much closer to finance than apple-growing, if not finance itself). An insurer charges you (or maybe an aggregated group of "yous") more than it costs to provide a certain protection (or hedge against a certain risk). You are willing to pay the premium because clearly the risk protection matters more than getting some "theoretically optimal" price.
With increased availability in technology and information, certain kinds of finance are becoming easy to do "on your own" - the most salient example is perhaps index investing. Many people are realizing that financiers cannot add value and they need less of a middleman.
I thought I'd share my contrasting thoughts, but I very much enjoyed the read.
Animal spirits are game theory
Human behavior is a large part of the complexity because we try to use things like game theory to predict how someone will act based on a confined set of conditions which totally ignore the very long game which has been playing from long in the past and will continue long in the future. There are too many factors to account for which can make an actor appear irrational given the posited conditions, however the truth is there can never be a rational actor until we map every input and interaction in someones life. This is why the idea of a rational actor is horseshit.
Nick Szabo did a recent post that covers this:
A small-game fallacy occurs when game theorists, economists, or others trying to apply game-theoretic or microeconomic techniques to real-world problems, posit a simple, and thus cognizable, interaction, under a very limited and precise set of rules, whereas real-world analogous situations take place within longer-term and vastly more complicated games with many more players: "the games of life".
http://unenumerated.blogspot.com.au/2015/05/small-game-falla...
Human behavior is a large part of the complexity because we try to use things like game theory to predict how someone will act based on a confined set of conditions which totally ignore the very long game which has been playing from long in the past and will continue long in the future. There are too many factors to account for which can make an actor appear irrational given the posited conditions, however the truth is there can never be a rational actor until we map every input and interaction in someones life. This is why the idea of a rational actor is horseshit.
Nick Szabo did a recent post that covers this:
A small-game fallacy occurs when game theorists, economists, or others trying to apply game-theoretic or microeconomic techniques to real-world problems, posit a simple, and thus cognizable, interaction, under a very limited and precise set of rules, whereas real-world analogous situations take place within longer-term and vastly more complicated games with many more players: "the games of life".
http://unenumerated.blogspot.com.au/2015/05/small-game-falla...
Finance is not complex. It really isn't. if you know the right people you can find out all the information you need. However:
The very foundations of Finance are built on sand
What do I mean by that? Finance is built on the concept of value, or worth. "How much is this gold worth?", "how much is the client willing to pay for this service?"
The concept of value and worth are subjective. They are in the eye of the beholder:
If you ask a thirsty backpacker stranded in the middle of the Sahara: How much are you willing to pay for a 2 litre bottle of water? The answer, most likely is many monies & possible limbs.
Now trying flogging the same water to city trader in a champagne bar.
I can hear you scoffing, "Oh but that's a silly example, the backpacker was practically dead" Correct, worth is subjective. Its based on your circumstances. There are many other examples, the Turner painting in a jumble sale, the sale of a sports car when the wife becomes pregnant, etc, etc.
Complex derivatives are really not complex. They are normally a "RAID" of different types of contracts. What then happens is the end user is deliberately bamboozled into not asking questions.
The very foundations of Finance are built on sand
What do I mean by that? Finance is built on the concept of value, or worth. "How much is this gold worth?", "how much is the client willing to pay for this service?"
The concept of value and worth are subjective. They are in the eye of the beholder:
If you ask a thirsty backpacker stranded in the middle of the Sahara: How much are you willing to pay for a 2 litre bottle of water? The answer, most likely is many monies & possible limbs.
Now trying flogging the same water to city trader in a champagne bar.
I can hear you scoffing, "Oh but that's a silly example, the backpacker was practically dead" Correct, worth is subjective. Its based on your circumstances. There are many other examples, the Turner painting in a jumble sale, the sale of a sports car when the wife becomes pregnant, etc, etc.
Complex derivatives are really not complex. They are normally a "RAID" of different types of contracts. What then happens is the end user is deliberately bamboozled into not asking questions.
The inherent role of finance is NOT to hide risk. Its role is to connect people who have one type of asset they no longer want with someone who does.
In that way bankers are just like lawyers and accountants. You pay someone to do things you don't have the time to do (or even learn how to do) so you can focus on your job. Its division of labour at the macroeconomic level and everyone benefits from specialisation.
Now, I agree that contemporary finance is bloated with opacity and that banks do benefit from this via corruption (tax code and compliance reform are needed ASAP). But its disingenuous to say that the value of finance is entirely "placebo".
In that way bankers are just like lawyers and accountants. You pay someone to do things you don't have the time to do (or even learn how to do) so you can focus on your job. Its division of labour at the macroeconomic level and everyone benefits from specialisation.
Now, I agree that contemporary finance is bloated with opacity and that banks do benefit from this via corruption (tax code and compliance reform are needed ASAP). But its disingenuous to say that the value of finance is entirely "placebo".
Curiously, placebos work even if the patient knows it is a placebo.
Hence http://placebobutton.com/
More on topic, this article is full of red herrings and poor analogies such as the above. Why on earth would you use game theory's payoff matrices as an analogy to what could perfectly be put into words? The authors thoughts on "financial institutions buffering fear" really don't require invocation of another complex framework unless he somehow wants to derive credibility from this, which would of course be poor form.
More on topic, this article is full of red herrings and poor analogies such as the above. Why on earth would you use game theory's payoff matrices as an analogy to what could perfectly be put into words? The authors thoughts on "financial institutions buffering fear" really don't require invocation of another complex framework unless he somehow wants to derive credibility from this, which would of course be poor form.
Finance is just a set of tools. Just like anything else it really comes down to the moral fiber of the individual wielding that tool.
Fischer Black and Myron Scholes weren't sitting in front of their white board thinking about all the people they could rip off. They were genuinely trying to find a way to price options as a tool to mitigate risk.
I can use a hammer to build a house or sink the hammer into my enemies head. Either way, it's still a hammer.
Fischer Black and Myron Scholes weren't sitting in front of their white board thinking about all the people they could rip off. They were genuinely trying to find a way to price options as a tool to mitigate risk.
I can use a hammer to build a house or sink the hammer into my enemies head. Either way, it's still a hammer.
I disagree with the main thesis here. The author states that complexity is due to opacity. This may be true in some cases but there are a number of complexities in finance that are not opaque. For example, look at all the optionality and contingent payouts in an 'Power Reverse Dual Currency' derivative. It's a really complex thing. However, the term sheets tell you everything about the transaction and the ultimate payout of the derivative (it may be 50 pages long, but it's all there).
To say that all things in finance are complex because they are opaque is pretty wrong. Maybe the author is talking about a different dimension of finance (e.g. the unpredictability of human behavior, I mean sure, that's opaque, but that's not finance).
To say that all things in finance are complex because they are opaque is pretty wrong. Maybe the author is talking about a different dimension of finance (e.g. the unpredictability of human behavior, I mean sure, that's opaque, but that's not finance).
"The core purpose of status quo finance is to coax people into accepting risks that they would not, if fully informed, consent to bear."
This. If you have money, and let it be known that you have money, you will be offered a large number of stupid deals. There is a huge range of financial products out there which underperform the market. Amazingly, people buy them. Wealthy people.
The deals offered poor people, such as payday loans, and crap auto loans, suck even worse. Most Americans were better off when we had regulated savings and loans, tightly regulated banks, and a much narrower range of financial products.
This. If you have money, and let it be known that you have money, you will be offered a large number of stupid deals. There is a huge range of financial products out there which underperform the market. Amazingly, people buy them. Wealthy people.
The deals offered poor people, such as payday loans, and crap auto loans, suck even worse. Most Americans were better off when we had regulated savings and loans, tightly regulated banks, and a much narrower range of financial products.
https://www.youtube.com/watch?v=iFDe5kUUyT0 series is a good watch and will give you an idea why they "made" it complex.
This reminded me of the concept of demurrage in currency [1]. The idea was brought up to solve that exact problem. The messy system of inflationary fiat currencies won, and even though it is probably better and more practical, the demurrage would have had the advantage of making it clear what we're trying to achieve. Inflation seems to be hated by many people which, judging from their other political viewpoints, should be supportive of it...
[1] https://en.wikipedia.org/wiki/Demurrage_%28currency%29
[1] https://en.wikipedia.org/wiki/Demurrage_%28currency%29
Taxes also had a lot to do of the complexity of the system.
I think of it as an arms race between traders and regulators. The more complex the security, the longer it will take regulators to pass rules against its misuse, figure out taxation, etc. In the meantime, the inventor stands to make an enormous amount of money.
Also, there's an inherent information asymmetry favoring the inventor.
Also, there's an inherent information asymmetry favoring the inventor.
Or, some investment decisions resemble Keynesian beauty contests:
https://en.wikipedia.org/wiki/Keynesian_beauty_contest
https://en.wikipedia.org/wiki/Keynesian_beauty_contest
There was a nice result a while back that the efficient market hypothesis is true IFF P=NP.
http://arxiv.org/pdf/1002.2284.pdf
http://arxiv.org/pdf/1002.2284.pdf
The fundamental reason is because we may create financial products. They can be socially very useful, they may endow their creators with vast profits, or both. So the creation of financial products is strongly incentivized both from the buyer- and seller-sides.
However, there are only really two things that we can use to create these products: debt and risk. Thus, when we try to create financial products, we create structures composed entirely of debt and risk, which become very complex. The reason why they become so complex is similar to any other case in which you try to make highly sophisticated structures from only very simple/basic components: there ends up being a great number of details.
However, there are only really two things that we can use to create these products: debt and risk. Thus, when we try to create financial products, we create structures composed entirely of debt and risk, which become very complex. The reason why they become so complex is similar to any other case in which you try to make highly sophisticated structures from only very simple/basic components: there ends up being a great number of details.
Consider that the Brownian model of financial markets was discovered by Bachelier in 1900, five years before Einstein, and the pace of financial innovation in the intervening century, and you have your answer for why finance is complex.
[1]: https://en.wikipedia.org/wiki/Louis_Bachelier
[1]: https://en.wikipedia.org/wiki/Louis_Bachelier
The only good innovation in the intervening century was the ATM..
Derivatives are instruments for transferring risk from those who understand it to those who do not.
Credit (including fractional reserves) definitely makes things a lot more common located.
Finance is complex because it's basically math. And math can get very complex.
Because telling the future is complex
Definitely read "fiance". Maybe I'm just projecting.
"The study of money, above all other fields in economics, is the one in which complexity is used to disguise truth or to evade truth, not to reveal it."
John Kenneth Galbraith, Money: Whence It Came, Where It Went (1975), p. 5
John Kenneth Galbraith, Money: Whence It Came, Where It Went (1975), p. 5
because it attempts to quantify and model the unpredictable and lot of people are paid very well to keep that image going for as long as they can.
* Allows you to get a mortgage
* Allows you to protect yourself with health/car/life/home/title/etc insurance
* Pays for your highways/stadiums/schools and other public works
* Protects your deposits
* Pays for your retirement
* Funds the college fund that paid for your school
* ... Or the student loans that allowed you to attend school
* Supports the global supply chain that brings you your iPhone, stocks the grocery store/your favorite restaurants with food, and puts the clothes on your back.
* Funds the growth of corporations large and small, giving you the job that allows you to buy an iPhone
* Funds the massive philanthropy expenditures that help those in need everyday
* Pays the pensions of the elderly
Financial innovation make our lives more predictable and less sensitive to chance. One could argue a huge amount of human progress is owed to modern-day financial institutions.
Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten. Finance is an art, not a science. Sometimes we make products that we don't always completely understand until later. But the vast majority of financial innovations are deeply ingrained in the good life that you get to enjoy every day.