
Understanding Debt, Risk and Leverage - nickb
http://betterexplained.com/articles/understanding-debt-risk-and-leverage/
======
jerf
Even as a libertarian, I find the temptation to call for a ban on leveraging
past about 10x very strong. It's just insane. As the article says, at 30x
you're looking at a 3% drop wiping you out and 4% sending you into horrifying
debt. What market, anywhere, ever, can guarantee never to drop 3%? None worth
being in.

And it has to be a guarantee, too, because like gambling in Vegas, once you're
wiped out, you lose and can't play again. (Without a government prop, anyhow.)

Add to that the way leverage calls tend to cascade and crash the entire
system, and it just seems an insane primitive to build a financial system on.

(In practice, my ban would fail anyhow, since I'm sure some financial
legerdemain could figure out how to triple-leverage something if somebody
really wanted it, regardless of how carefully the law was written. Maybe what
I really want is the ability to invest money (including my bank savings
account) and specify a leverage tolerance limit. Anyway, I'm not really trying
to propose a solution, just express some horror at the use of leverage in our
system.)

~~~
sokoloff
It took me less than two seconds to figure out how to use two companies to get
to 100x, or three companies to get to 1000x, etc, etc.

Thinking as a libertarian, the key is to eliminate the government prop for the
losers. People involved get the implied government/judicial prop of bankruptcy
protection if they need it, but otherwise, let them fail, let the failures
cascade as they will, and get on with the healing/repair/rebuilding as soon as
possible.

Sure, I agree that it sucks that someone might have an employment agreement
that suggests they are owed a stream of the future profits of a company in the
form of a private pension, and if that company fails, they won't get that
pension payment.

So what? That's like me betting my buddy a billion dollars on a coin flip and
then the winner trying to collect the bet from a third party (the government
is nothing more than a series of third parties acting collectively). "But I
had an agreement and I was counting on that money to live in retirement?"
True, but not the problem of the taxpayers that you wagered your retirement on
a poorly managed company, whether it's a bank, brokerage, or in the case of
GM, a retiree health care and pension company that happens to build cars with
a portion of its efforts.

~~~
netcan
_Thinking as a libertarian,_

To me there seem to be two practically inseparable parts to thinking as a
libertarian, when applying it to a practical issue. The idea that Government
intervention is amoral & the idea that government intervention is counter-
productive.

The former is really an assertions in an area where it is hard to rationally
reach an kind of a foundation. This applies equally to most ethical
frameworks. I'm not singling out libertarians. The latter often seems to be
motivated by faith associated with the former.

You don't here many socialists admitting that while libertarians are morally
wrong, their economic models produce a lot more wealth. You don't hear much
the other way either.

In fact, those that accept that morally superior & practically effective are
often independent. What I am saying is that I don't think that many without an
ideological attachment to 'laissez faire' economies would be arguing your
position.

The incentives & market signals may not have been perfect. There may have been
some distortion coming from the possibility of state intervention. But there
was & remains a clear incentive to succeed & a clear disincentive to go
bankrupt. The major forces at play leading to a 30/1 leverage are market
forces. But eliminating the chance a bailouts are a small drop in that ocean.
How about eliminating the possibility of bankruptcy or legal liability? Those
are probably bigger

The paper economics is built on lots of assumptions & axioms nailed in with
common sense & on average or defining away problems. Consumers make rational
decisions=> Define utility creatively. On average & in the long term people
are perfectly informed.

Anyway, technical discussions aside, I think it is important for people to
look at what parts of the 'ideologies' they subscribe to are independent of
each other.

Does it follow from agreeing that socialism is a morally superior concept to
capitalism mean that there are no problems inherent in state controlled
institutions? Does believing that a coercive state is a bad thing mean that
everything you want from an economy can be achieved without it?

I think that the anti-welfarists need to accept for example that sometime,
somewhere laissez faire markets may produce a situation where a good chunk of
society is undernourished. And more to the point that it may not always
produce the economically most efficient outcomes.

~~~
sokoloff
For the record, I do "accept that sometime, somewhere laissez faire markets
may produce a situation where a good chunk of society is undernourished." I
think that it's the pro-welfarists and socialists that seem to have a problem
accepting that.

To me, wanting minimal government interference in private choices is purely a
matter of practicality, not one of morality. I'd prefer that the government
not be a nanny to the entire population, constantly at the ready to wipe the
nose and dry the tears of anyone who gets hurt. I do agree that _if_ the
government is going to serve that purpose, then they'll pretty much have to
take away the rewards for good choices, as both a disincentive to take large
risks and equally importantly, because it's going to be damned expensive to
prop up everyone who chose poorly, someone's got to pay for it, and only those
who chose well can afford it.

We're pretty far afield of hacker news at this point, and I suspect we
understand each other views at a gross level and simply disagree on where the
optimal point for a society's government to strive for is located. If it's any
consolation, despite having made good choices, I have no say or sway in the
matter and that people who think more like you are in power and are determined
to wipe the noses that "need" wiped and dry the abundant damp eyes, so you'll
get your way anyhow...

~~~
netcan
Yo're right I did hit far off the point I was making which is: Hard
libertarians read this story as market signals were distorted by government.
We might as well be burning silos of wheat.

Social Democrats are predictably reading this as an example that markets do
not protect themselves against unacceptable results.

But it seems that anyone without an ideological attachment is siding with the
latter. Of course this is dangerous as it probably means a wholesale swing
towards that side which comes with a whole lot of completely unrelated stuff.

~~~
anamax
> Social Democrats are predictably reading this as an example that markets do
> not protect themselves against unacceptable results.

Yes, but Social Democrats haven't figured out that regulation doesn't
eliminate risk. Financial regulation in particular concentrates risk. The
"most effective" reduces the probability of a loss but increases the magnitude
even more, increasing the expected value (which is the product of the
probability of a loss and the loss's cost if it occurs). This can be a bad
thing if the expected value is catastrophic, as we're seeing.

We're much better off with continuous small failures than we are with
occasional large ones.

------
jsmcgd
_My inner geek cringes, since the sides of a lever move in opposite
directions_. His inner geek need not cringe, a crowbar is a kind of lever
where the 'sides' move in the same direction. Voilà!

------
maurycy
Taking leverage makes sense only if the expected value is positive.

If you don't know it, only if marginal utility of potential loss is either
smaller or equal to potential gain.

It is important, though, to not confuse potential loss with volatility. :-)

