

Late But Essential Review - duke_sam
http://www.tbray.org/ongoing/When/201x/2010/08/28/The-Big-Short

======
Estragon

      Finance should be regulated into utility status all over the civilized
      world, and if the community of hard-core financial engineers really
      wants to go on being a collective pathogen, they’ll be forced to
      acknowledge that what they do just isn’t civilized behavior, and do it
      somewhere else. We’ll be way better off without them among us. 
    

As George Soros describes in the historical section of _The New Paradigm for
Financial Markets_ , this was exactly the attitude which evolved from the
wreckage of the Great Depression, but starting as early as the 60s the
financial world steadily chipped away at the constraints which had been
imposed. (Soros himself was one of the pioneers in the dilution of these
constraints.)

~~~
wmf
20-30 years of sanity might be better than none.

------
RockyMcNuts
The events described in the Big Short are a national disgrace.

Wall Street was engaged in a fraudulent conspiracy in which the buyer, the
seller, the guaranty company, and the rating agency would willingly suspend
disbelief so the buyer could get a 'AAA' security that miraculously paid a few
hundred basis points over AAA corporates and count as AAA toward risk-based
capital regulations, everyone got fees, and those 'lucky' subprime borrowers
could suddenly access unlimited amounts of credit without adequate income or
collateral.

Then when this created a giant bubble (along with other factors like
deregulation, lax application of the regulatory powers that existed, a
shockingly long period of lax monetary policy, and human greed) and it all
blew up with catastrophic consequences, the banks got a giant bailout, went
back to business as usual, and (so far) fended off meaningful reform. They
said, who could have known, when the book shows many people did in fact
clearly analyze the situation and foresee catastrophe.

That being said - there are countries that have highly state-controlled
finance sectors. A notable feature is that they don't have vibrant startup and
VC sectors. The only reason capital is available in large sums to start up
companies like Google and Facebook is because of the possibility of rich IPO
exits. Interestingly, some of those countries with regulated and state-owned
banks, where the startup scene is nonexistent and the same 50 companies have
dominated the economy forever, did not escape reckless behavior and large
losses in the banking sector.

This is still America, last I checked, and people should be free to take big
risks and come up with innovative financial structures. But consumer
regulation must prevent toxic consumer products like the certain subprime
products that were misleadingly marketed. Banks, which are systemically
important, enjoy special privileges that make them a lot of money, and receive
implicit and explicit government guarantees, cannot become giant extremely
leveraged hedge funds.

So, you need to make a distinction between a highly regulated utility
financial sector; and a speculative sector which can keep taking the risks and
innovating in ways that create value, without the rest of us being on the hook
to bail them out when things don't work out.

------
nl
_Of all the failures that led to the big meltdown, the most aggravating is the
failure of the bond-rating agencies. These people took good money for pasting
AAA credit ratings on piles of the most implausible shit imaginable, and
what’s irritating isn’t that they did it, it’s that apparently they didn’t
break any laws and thus there’s little prospect of the long prison terms that
anything smelling of natural justice would require._

If anyone is looking for a YC application idea, there's one right there. To be
more explicit:

Ratings agencies currently are paid by investment companies to rate the risk
associated with the products they are bringing to market (ie, the fox is
paying the farmer to tell the chickens how safe the hen house is ).

The financial incentives for ratings agencies are aligned with the sellers,
not the buyers. That creates a huge risk for the buyers, because they can't
(or shouldn't) trust the ratings.

There's an opportunity there to create a company that does ratings but takes
money from the buyers, not the sellers.

(Note that entrenched players will go to huge lengths to tell you how hard
this is, and how smart all the "financial engineers" are. From my very basic
investigations, I'm not at all convinced that it's as hard as they try and
make it seem.)

~~~
anamax
You're forgetting that many institutions can only accept/rely on ratings from
regulator-approved companies.

For example, the SEC has granted a ratings monopoly to three companies.

The idea is that ratings are too important to be left to some unapproved
company. If anyone could issue ratings, folks might be led to make bad
investments....

This is one example of how regulation is systemic risk.

~~~
nl
It might be possible to market directly to consumers in the retail market.

I assume you'd need a licence to give financial advice, but that should be
easier to get than the rating agency license (I assume).

 _This is one example of how regulation is systemic risk._ Well it sounds more
like bad regulation to me.

~~~
anamax
> > This is one example of how regulation is systemic risk.

> Well it sounds more like bad regulation to me.

Every regulation can be bad. However, unlike individual firm policy,
regulation is system-wide, so the risk is necessarily systemic.

------
guelo
Unfortunately the recently passed financial regulation, while containing some
good provisions, doesn't do enough to put the genie back in the bottle.

~~~
werrett
Was the genie ever in the bottle?

That's not a rhetoric question. I generally wonder whether Finance has been
consider to be anything other than self-serving.

~~~
nl
_I generally wonder whether Finance has been consider to be anything other
than self-serving_

No it hasn't. But there have been times (eg, post WW2 to Regan-era) and places
where regulation has shaped the market in such a way that financial players
interests were more aligned with society as a whole.

~~~
anamax
> But there have been times (eg, post WW2 to Regan-era) and places where
> regulation has shaped the market in such a way that financial players
> interests were more aligned with society as a whole.

How about some evidence? Be careful of correlation vs causation. Heck - be
careful about correlation. (Consider fees for stock purchase.)

Note that inflation had some effect. The dollar threshold for "accredited
investor" was constant for a long time, but $200k/year in income and $1M in
"not-residence" investments became more common. As a result, more folks could
be angels.

~~~
nl
_How about some evidence?_

Fair call. I suspect we are talking about different things, though. I'm not
talking about investment performance at all - more about how the financial
sector supports the healthiness of the rest of the economy.

Anyway, some evidence that regulation can align the interests of the financial
sector with the economy as a whole:

For example, Australia has quite strong financial regulation - much, much
stronger than in the US and UK. This includes everything from higher ratios of
capital-to-loans required by the banks, to stricter laws around mortgages.

When the financial crisis hit in 2008, the Australian banks were able to
survive very well, which - combined with a government stimulus program and
continual growth in China - meant that Australia was the only developed nation
that did not fall into recession in 2009.

More evidence?

* Both sides of politics in Australia are supportive of strong financial regulation

* The CIA World Fact book says _The Australian financial system remained resilient throughout the financial crisis and Australian banks have rebounded_ [https://www.cia.gov/library/publications/the-world-factbook/...](https://www.cia.gov/library/publications/the-world-factbook/geos/as.html)

* The World Economic Forum says _The United Kingdom, buoyed by the relative strength of its banking and non-banking financial activities, claimed the Index's top spot from the US, which slipped to third position behind Australia largely due to poorer financial stability scores and a weakened banking sector._ [http://www.weforum.org/en/initiatives/gcp/FinancialDevelopme...](http://www.weforum.org/en/initiatives/gcp/FinancialDevelopmentReport/index.htm)

* _Australia has four of the only around a dozen AA-rated banks in the world, due in part to a tight regulatory regime and domestic banks' limited exposure to poor-quality loans that were the downfall of many banks globally.

Australia has a so-called "four pillars" policy that prevents the four largest
banks from merging. That has shielded the four, Australia & New Zealand
Banking Group Ltd., National Australia Bank, Commonwealth Bank of Australia,
and Westpac Banking Corp., from takeover and allowed them to build up
profitable, dominant market positions without the need to delve into riskier
lending practices.

John Brogden, chief executive of pension and managed funds industry lobby the
Investment & Financial Services Association, said the results are a "testament
to our deep and liquid markets, supported by Australia's superannuation
(pension) and managed funds sectors."

Australia has a A$1 trillion-plus retirement savings industry, aided by the
introduction of mandatory employer contributions to employee pension funds in
the early 1990s._
[http://wiadomosci.onet.pl/2057316,10,global_crisis_nudges_au...](http://wiadomosci.onet.pl/2057316,10,global_crisis_nudges_australia_up_world_financial_sector_ranks,item.html)

~~~
anamax
> For example, Australia has quite strong financial regulation - much, much
> stronger than in the US and UK. This includes everything from higher ratios
> of capital-to-loans required by the banks, to stricter laws around
> mortgages.

You don't understand - the loose standards in the US for mortgages came from
govt, not banks.

> Anyway, some evidence that regulation can align the interests of the
> financial sector with the economy as a whole:

You're assuming that govt is interested in the economy as a whole. I don't
know about Australia, so I'll accept your assertion that the Australian govt
is concerned about the economy as a whole, but the US govt isn't.

And no, the Repubs aren't the worst culprits here. They're largely useless to
moderately clueless, but they're not actively hostile.

~~~
nl
_You don't understand - the loose standards in the US for mortgages came from
govt, not banks._

Yes, I do understand that.

In Australia (and in many other places) "sub-prime loans" were not made by
banks because they are illegal.

There have been occasional attempt by non-bank lenders to bring them in (eg,
"low doc loans") but in every case the loopholes that allowed them were
closed.

 _You're assuming that govt is interested in the economy as a whole. I don't
know about Australia, so I'll accept your assertion that the Australian govt
is concerned about the economy as a whole, but the US govt isn't._

That's quite a bold statement! How about some evidence? ;)

~~~
anamax
>> You're assuming that govt is interested in the economy as a whole. I don't
know about Australia, so I'll accept your assertion that the Australian govt
is concerned about the economy as a whole, but the US govt isn't.

> That's quite a bold statement! How about some evidence? ;)

You quoted one bit "You don't understand - the loose standards in the US for
mortgages came from govt, not banks."

Another is regulatory "encouragement" for banks to hold fannie and freddie
stock; that put them all at risk.

