

The Myth of the Sophisticated Investor - cwan
http://www.thebigmoney.com/articles/judgments/2010/04/27/myth-sophisticated-investor

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yummyfajitas
The author of this post shows the difference between sophisticated investors
and himself:

 _Consider synthetic CDOs like Abacus. Banks would need to lend out $50
billion of mortgages to regular people in order to create a $1 billion CDO
like Abacus, according to Michael Lewis in The Big Short._

A sophisticated investor realizes that banks didn't need to lend out ANY
mortgages to create a synthetic CDO. A sophisticated investor realizes that a
synthetic CDO is the long side of a bet against the markets. A sophisticated
investor will also form their own opinion about the bet, based on information
about the assets underlying the bet (which were available to every investor),
and will not really care that "omfg, the other side of this bet is a no-name
mid-range hedge fund!"

~~~
philk
I'm not sure, however, that there's a huge use to society in allowing many
bets like this given at the very least it's a huge sink for quality human
capital.

I understand that there is value from the insurance/hedging side, but as we've
seen recently risks may be concealed rather than allayed.

~~~
yummyfajitas
John Paulson and a few other smart people told the world "hey, we are in a
bubble". They put their money where their mouth is and shorted the market.
They and helped prevent us from funneling further labor and resources into
housing we don't need.

Do you really think the world would have been a better place if Paulson built
twitter 2.0 rather than pushing CDO prices down?

~~~
philk
Yes, but the bubble itself was created by investors building and selling
complex financial instruments in the first place. Wouldn't it be better if
investment bankers had been building legitimate businesses rather than working
out new ways to repackage and sell subprime mortgages?

~~~
yummyfajitas
The bubble was created by simple instruments: home mortgages.

It would have been better if women weren't forcing their husbands to buy
houses they couldn't afford, government wasn't encouraging lenders to make bad
loans, and realtors weren't adding fuel to the fire. I don't see a way to
prevent all of that, since all of those things are still happening.

The only reason the bubble burst was because of investment banks and other
speculators eventually figuring out the problem and putting a stop to it.

~~~
philk
No it wasn't. It was caused by lenders being able to lend money that wasn't
theirs, facilitated by complex financial instruments.

If you're a bank and you're lending your own money you've got an incentive to
make sure the loans can be repaid.

If you're a bank and you can instead take the loans you've made, parcel the
debt up in a complicated financial instrument, sell it off to others and take
an essentially risk free commission then you've got an incentive to loan money
to anyone who can hold a pen and sign a document. This means you're going to
lend a lot more money and this is what caused the bubble.

It's not because women were forcing their husbands to borrow, it's because
financial wrangling shifted the risks from the lenders to third parties
further down the line.

~~~
yummyfajitas
The problem with your theory is that many banks kept the riskiest tranches of
loans for themselves while selling the safer tranches to others. They would
only have done this if they believed the underlying mortgages were still good.

Regardless, none of this would have been possible if housing consumers didn't
become housing speculators. Realtors ran commercials encouraging women to
browbeat their husband into buying houses they couldn't afford
(<http://www.youtube.com/watch?v=Ubsd-tWYmZw>). Bush and Barney Frank
encouraged commercial banks to lower lending standards. Speculators followed
the crowd and suffered for their folly. The bubble would have existed without
speculators, though it probably would not have been as large.

~~~
demallien
_The problem with your theory is that many banks kept the riskiest tranches of
loans for themselves while selling the safer tranches to others. They would
only have done this if they believed the underlying mortgages were still
good._

Actually, that doesn't necessarily create any problems for Phil's point of
view. That tranche of highly risky loans had to be kept by the banks - it was
because this high risk stuff had been taken out of the pool that the rest of
the pool looked so appealing to investors. However, the calculations to
determine what percentage of loans needs to be in the high-risk tranche was
very difficult to evaluate, especially if you were the investor seeking to buy
the "safe" tranches, and not the bank that had originally sold the loan.

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rmorrison
The way "sophisticated investor" is used bothers me.

In most places where it's currently used, I want "sophisticated investor" to
mean people who are fully responsible for their money. If they invest it and
quintuple it, cool for them (and they can keep it). If they invest it and lose
it, sucks for them (and we don't bail them out).

Using this definition, if "sophisticated investors" lose their life savings to
Bernie Madoff, sucks for them. They would still have a civil claim against him
in court for lying, but they shouldn't get a government bailout.

I also want to be able to sign some government-support-waiver, and be able to
invest my money however I want. Even if my net worth isn't $2 million and my
salary is less than $500k/year.

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sanj
I've always assumed that "Sophisticated" Investors are those that have more
money to invest/lose.

