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Why is finance so complex? (2011)

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Re: Why is finance so complex? (2011)

#11

Post by pessimizer »

slg wrote: post #8

>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 e…

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.

Re: Why is finance so complex? (2011)

#12

Post by jerf »

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.

Re: Why is finance so complex? (2011)

#13

Post by jameshart »

britknight wrote: post #6
fsk wrote: post #2

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 govern…

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…

"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?

Re: Why is finance so complex? (2011)

#14

Post by h8trswana8 »

The world of finance makes these aspects of your life function:

* 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.

Re: Why is finance so complex? (2011)

#15

Post by civilian »

jameshart wrote: post #13
britknight wrote: post #6

Earlier quoted context omitted.

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…

"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 WER…

Exactly. I think he's assuming he'll never have to pay back the principle.

Re: Why is finance so complex? (2011)

#16

Post by branchless »

h8trswana8 wrote: post #14

The world of finance makes these aspects of your life function: * 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 gl…

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.

Re: Why is finance so complex? (2011)

#17

Post by Spooky23 »

h8trswana8 wrote: post #14

The world of finance makes these aspects of your life function: * 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 gl…

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.

Re: Why is finance so complex? (2011)

#19

Post by obrero »

h8trswana8 wrote: post #14

The world of finance makes these aspects of your life function: * 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 gl…

> 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.

Re: Why is finance so complex? (2011)

#20

Post by branchless »

Spooky23 wrote: post #17
h8trswana8 wrote: post #14

The world of finance makes these aspects of your life function: * 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 gl…

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 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?

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