Economics 06/04/2009
Posted by rosshunter on June 3, 2009
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Ezra Klein – My Colleagues Like Gambling Metaphors
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An entrepreneur owes the racehorse.
An “investor” bets on the outcome of the race.
A seller of derivatives offers a side bet to someone else as to the chances that the investor will win his bet.
A seller of CDO’s offers a side bet as to whether the derivative seller will honor his bet if he loses.Question: who is the real person making money in all this?
Answer: the track, they don’t care whether the horse wins or loses, they gets their commission either way. The only way they can lose is if they accepts unbalanced bets. Pari-mutual odds are designed so that this can’t happen.
In my analogy the track owner’s and bookies’ roles used to be taken by brokers and investment bankers, but they got greedy and started to take bets themselves instead of just collecting transaction fees (of which there are now many).
Even with subprime mortgages they wouldn’t have been in much trouble since they packaged up the loans and sold them to others, thus reducing the risk. It was the CDO’s and other financially purposeless transactions that brought the system down.
If you want to point the final finger at blame, then ask who was demanding that banks and other financial firms keep generating ever higher returns? The answer is us. As mutual fund holders and investors in IRA’s and the like we kept demanding 8-15% return per year. Any fund that didn’t meet this level quickly found its investors going elsewhere. The result was everyone got trapped in a cycle of increasing risk.
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Posted from Diigo. The rest of my favorite links are here.
