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Banks to sell first post-crisis managed synthetic CDO

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Re: Banks to sell first post-crisis managed synthetic CDO

#91

Post by darawk »

wpietri wrote: post #29
darawk wrote: post #26

Earlier quoted context omitted.

I've read the book. And all his other books. They're fun, but they're not a great source for serious understanding. The book and movie does briefly explain all this, but it paints a picture that the instruments themselves were inherently toxic, which was not the case. What was toxic were the assumptions that went into modeling their risk characteristics. The assets (like all assets) themselves were fine. The problem…

In that assets are only created for people to purchase with informed understanding, I don't think "they were great but nobody understood them" is a possible thing. The clearest example here is shares in a Ponzi scheme. Those are definitely assets, and they are definitely not fine. They are made to not be understood. The same is more subtly true of the previous wave of essentially fraudulent mortgage-backed securities…

> In that assets are only created for people to purchase with informed understanding, I don't think "they were great but nobody understood them" is a possible thing.

It isn't the case that nobody understands them. We understand them just fine now. This is how civilization learns. For a long time we didn't know how to price options - now we're quite good at it.

> The clearest example here is shares in a Ponzi scheme. Those are definitely assets, and they are definitely not fine. They are made to not be understood. The same is more subtly true of the previous wave of essentially fraudulent mortgage-backed securities. But I think the same is also true of any hard-to-understand instrument engineered to look like a good deal at first glance.

Ponzi schemes are designed to defraud unsophisticated investors. These assets serve a useful purpose and work just fine as long as their risks are properly understood, which they now are.

> You also ignore systemic risk. For many years before the 2008 collapse, cognoscenti knew that a lot of risk had gone somewhere, we just didn't know where. But we sure found out! Saying that "all assets are fine" is sort of like saying "all chemicals are fine". It's technically true, in that dioxin and DDT don't intend to be harmful. But if the evidence shows that people can't use them responsibly, then a ban in a totally reasonable outcome.

The evidence does not show that for these assets. You could make a similar case about basically any dangerous but useful technology. When dynamite was first invented i'm sure a lot of people died messing with it. That doesn't mean we should ban it, it means we need to figure out how to handle it and use it safely. We now understand these assets pretty well. I'll bet you basically whatever amount of money you want that the next crisis will not come from these assets.

Re: Banks to sell first post-crisis managed synthetic CDO

#92

Post by darawk »

jfengel wrote: post #42
darawk wrote: post #26

Earlier quoted context omitted.

I've read the book. And all his other books. They're fun, but they're not a great source for serious understanding. The book and movie does briefly explain all this, but it paints a picture that the instruments themselves were inherently toxic, which was not the case. What was toxic were the assumptions that went into modeling their risk characteristics. The assets (like all assets) themselves were fine. The problem…

Blaming the problem on "people" is also missing a large part of the problem. The breadth of the crisis meant that it affected a lot of people who had never heard of CDOs, and never should have. People lost their jobs in totally unrelated fields. Companies couldn't grow because credit dried up while the mess was sorted out. People couldn't sell their houses because the entire market crashed. And so on. Of the people w…

> Blaming the problem on "people" is also missing a large part of the problem. The breadth of the crisis meant that it affected a lot of people who had never heard of CDOs, and never should have. People lost their jobs in totally unrelated fields. Companies couldn't grow because credit dried up while the mess was sorted out. People couldn't sell their houses because the entire market crashed. And so on.

Sure, but i'm not sure what this has to do with my point. Should we ban internet stocks because the market was irrational in 2000?

> There were systemic effects, where a whole lot of people were making apparently sensible local decisions and nobody understood the entire interaction -- but that's not really a good justification for shrugging shoulders and say, "Well, I guess it's everybody's fault, then".

Ok, but how does that cash out in any kind of coherent policy recommendation?

Re: Banks to sell first post-crisis managed synthetic CDO

#93

Post by wpietri »

darawk wrote: post #91
wpietri wrote: post #29

Earlier quoted context omitted.

In that assets are only created for people to purchase with informed understanding, I don't think "they were great but nobody understood them" is a possible thing. The clearest example here is shares in a Ponzi scheme. Those are definitely assets, and they are definitely not fine. They are made to not be understood. The same is more subtly true of the previous wave of essentially fraudulent mortgage-backed securities…

> In that assets are only created for people to purchase with informed understanding, I don't think "they were great but nobody understood them" is a possible thing. It isn't the case that nobody understands them. We understand them just fine now. This is how civilization learns. For a long time we didn't know how to price options - now we're quite good at it. > The clearest example here is shares in a Ponzi scheme.…

I'm not persuaded. There's no such thing as "understand just fine now". Ponzi schemes have been understood since the 1920s, but people keep falling for them. More sophisticated investors can get taken by more sophisticated tricks. Having worked for financial traders, I know just how pleased people can be to have pulled one over on people they see as adversaries.

I agree it's possible that these assets could be fine now, either because people have truly learned a lesson, or just because of the "once bitten, twice shy" reaction that takes a few decades to wear off. But the principle by which you declare them fine, namely that all assets are fine, is definitely wrong.

Re: Banks to sell first post-crisis managed synthetic CDO

#94

Post by darawk »

wpietri wrote: post #93
darawk wrote: post #91

Earlier quoted context omitted.

> In that assets are only created for people to purchase with informed understanding, I don't think "they were great but nobody understood them" is a possible thing. It isn't the case that nobody understands them. We understand them just fine now. This is how civilization learns. For a long time we didn't know how to price options - now we're quite good at it. > The clearest example here is shares in a Ponzi scheme.…

I'm not persuaded. There's no such thing as "understand just fine now". Ponzi schemes have been understood since the 1920s, but people keep falling for them. More sophisticated investors can get taken by more sophisticated tricks. Having worked for financial traders, I know just how pleased people can be to have pulled one over on people they see as adversaries. I agree it's possible that these assets could be fine n…

> I'm not persuaded. There's no such thing as "understand just fine now". Ponzi schemes have been understood since the 1920s, but people keep falling for them. More sophisticated investors can get taken by more sophisticated tricks. Having worked for financial traders, I know just how pleased people can be to have pulled one over on people they see as adversaries.

You could make this argument about literally anything. You're not really saying anything specific to CDOs here, so I can't really give you a more specific response.

> I agree it's possible that these assets could be fine now, either because people have truly learned a lesson, or just because of the "once bitten, twice shy" reaction that takes a few decades to wear off. But the principle by which you declare them fine, namely that all assets are fine, is definitely wrong.

All assets are fine if you understand their risks. Sometimes we deem certain people or groups insufficiently responsible to handle the risks of certain assets. Non-accredited investors are not allowed to invest in private companies. The United States bans "contracts for difference", etc..

I think the problems with CDOs are extremely well understood at this point by everyone in that market. It has been one of the most studied issues of the last decade in quantitative economics. That isn't to say that it's impossible that there's some lurking risk we don't yet get. There absolutely could be. But the probability is much lower than basically any other complex asset class, precisely because this is the one that blew up last time.

If you want to go hunting for latent risk, CDOs are literally the last place you should look. Our economy is chock full of astoundingly complex financial instruments. If you are worried about CDOs because they blew up last time, you are really really missing the point.

If we used your system for banning assets, we'd have banned the stock market in 1929. We'd have banned tech stocks in 2001. Argentina would have basically banned all money by now.

My point is: just pointing at the fact that something blew up once is an insufficient argument that it is not worth the risk. The pattern of "new thing blows up in our face" is quite common across things that turn out to be incredibly valuable and useful. The question at hand is whether we understand it sufficiently well now to use it safely. And the answer is pretty unequivocally yes. We know what we did wrong with CDOs and we know how to correct for it.

Re: Banks to sell first post-crisis managed synthetic CDO

#95

Post by kangnkodos »

BoiledCabbage wrote: post #90
kangnkodos wrote: post #88

Earlier quoted context omitted.

One of the key problems back in 2008 was that AIG was issuing something equivalent to insurance to everyone. Different investment banks were helping their customers to make big bets, and if things went south, they had "insurance" from AIG. In hindsight, AIG wasn't charging enough for this "insurance", and didn't have sufficient reserves to cover their losses if real estate prices across the whole country went down at…

That's again missing for forest for the trees. The whole point is that those questions above cannot be answered ahead of time. The synthetic securities are so complex and intertwined that the risk cannot be safely calculated w.r.t. the amount of money being invested in them until after the fact. Nobody can say if anyone is charging enough for insurance because nobody can quantify the risk accurately. Noone can say if…

I much more agree with you than disagree with you! Almost everything you're saying is true. You make very good points!

I agree that pricing and setting reserves for this insurance is extremely difficult. I disagree that it is impossible. I agree that there are very few people capable of doing this. I disagree that there is no one. I agree that there may currently be no one at the regulatory agencies capable of doing this correctly. I disagree that they cannot hire someone from the industry who is capable of doing this.

BECAUSE it is so difficult and complex to price this insurance and to have sufficient reserves, it's important to not throw up our hands and say that it's impossible. Instead it's important to bring the issue into the open. If regulators are not currently up to the task again this time around, then THAT should be the headline of the articles... "REGULATORS CURRENTLY UNABLE TO PRICE SYNTHETIC INSURANCE AND SET RESERVE LEVELS WHICH COULD LEAD TO THE NEXT FINANCIAL CRISIS"

Re: Banks to sell first post-crisis managed synthetic CDO

#96

Post by wpietri »

darawk wrote: post #94
wpietri wrote: post #93

Earlier quoted context omitted.

I'm not persuaded. There's no such thing as "understand just fine now". Ponzi schemes have been understood since the 1920s, but people keep falling for them. More sophisticated investors can get taken by more sophisticated tricks. Having worked for financial traders, I know just how pleased people can be to have pulled one over on people they see as adversaries. I agree it's possible that these assets could be fine n…

> I'm not persuaded. There's no such thing as "understand just fine now". Ponzi schemes have been understood since the 1920s, but people keep falling for them. More sophisticated investors can get taken by more sophisticated tricks. Having worked for financial traders, I know just how pleased people can be to have pulled one over on people they see as adversaries. You could make this argument about literally anything…

You seem to be arguing with quite a lot of things I didn't say. E.g., I don't have a "system for banning assets".

I do agree that, "All assets are fine if you understand their risks," is moving in the direction of a reasonable principle. So you're making progress. Once you start to grapple with intentional information asymmetries, willful misleading of buyers, and engineering for complexity as a way of hiding risk, you might really get somewhere. I doubt you'll get far enough to prevent the next crash or anything, but definitely somewhere.

Re: Banks to sell first post-crisis managed synthetic CDO

#97

Post by BoiledCabbage »

kangnkodos wrote: post #95
BoiledCabbage wrote: post #90

Earlier quoted context omitted.

That's again missing for forest for the trees. The whole point is that those questions above cannot be answered ahead of time. The synthetic securities are so complex and intertwined that the risk cannot be safely calculated w.r.t. the amount of money being invested in them until after the fact. Nobody can say if anyone is charging enough for insurance because nobody can quantify the risk accurately. Noone can say if…

I much more agree with you than disagree with you! Almost everything you're saying is true. You make very good points! I agree that pricing and setting reserves for this insurance is extremely difficult. I disagree that it is impossible. I agree that there are very few people capable of doing this. I disagree that there is no one. I agree that there may currently be no one at the regulatory agencies capable of doing…

> I disagree that they cannot hire someone from the industry who is capable of doing this.

If the industry could've calculated the risk correctly, they wouldn't have blown up the economy last decade.

Not to mention if only 4 or 5 people can accurately do it, there is no reason that other's will be able to accurately judge who the correct 4 or 5 are. 50 people will say they can do it, 5 are right 45 are wrong, who decides which 5 to believe? People outside of the 50 who knew they weren't even capable of doing the valuation themselves? They're deemed ok to judge?

This is analogous to trying to solve a people problem with technology.

How much risk should society take on so that people have one more avenue to make profit? Everything is risk reward tradeoff, and the risk to the financial sector and borader society isn't worth the reward of having the freedom of profit in those areas.

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