what NOT to read (demon of our own design)

[rsliu]

It sounds like his argument is that widespread use of leverage and derivatives might cause extreme market moves in certain conditions. This is not a trivial concern. I've seen quotes basically saying the same thing from Warren Buffet, Alan Greenspan, and the editorial page of The Economist. The truth is that no one really knows whether there is some thread out there that, when unraveled, will cause the entire financial system to collapse (this exact fear is what prompted the LTCM bailout). This guy does seem like a [censored] writer but his concern is legitimate.

[DcifrThs]

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It sounds like his argument is that widespread use of leverage and derivatives might cause extreme market moves in certain conditions. This is not a trivial concern. I've seen quotes basically saying the same thing from Warren Buffet, Alan Greenspan, and the editorial page of The Economist. The truth is that no one really knows whether there is some thread out there that, when unraveled, will cause the entire financial system to collapse (this exact fear is what prompted the LTCM bailout). This guy does seem like a [censored] writer but his concern is legitimate.

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agreed. your point is 100% valid and the concern is definitely legitimate. he could have presented it in a ton of different ways, though.

we are in a complex system that appears diversified but hasn't been tested.

but comparing the improvement of bridges & construction to the financial engineering & economic volatility vs. financial market volatility i think is a poor logical route to take.

i just don't recommend reading this book.

Barron

[eastbay]

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but comparing the improvement of bridges & construction to the financial engineering & economic volatility vs. financial market volatility i think is a poor logical route to take.

i just don't recommend reading this book.

Barron

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Both markets and bridges have functions, and their designs should be optimized to perform those functions while minimizing risks. I don't see why you were offended by this.

I haven't read the book, but putting it down for making this simple analogy seems weird.

eastbay

[DcifrThs]

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but comparing the improvement of bridges & construction to the financial engineering & economic volatility vs. financial market volatility i think is a poor logical route to take.

i just don't recommend reading this book.

Barron

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Both markets and bridges have functions, and their designs should be optimized to perform those functions while minimizing risks. I don't see why you were offended by this.

I haven't read the book, but putting it down for making this simple analogy seems weird.

eastbay

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when a bridge is improved, the structure is better and risk is automatically reduced.

when the economy becomes less volatile, the financial markets don't necessarily become less volatile as well (which is his implication). as derivatives are introduced & financial engineering goes nuts w/ tons of new innovations, there is no guarantee that risk would automatically be reduced. i.e. it isn't inherent to to plan b/c the GOAL of those securities is profit for their creators. THERE IS though an element of risk reduction in their creation typically since speculators often take the other side of the transactions vs. hedgers, but human beings are bad at speculating as a species since we learn poorly (see my BSAM post for some trumped up talk about that). further, the system really hasn't been tested.

so i don't think that comparing a bridge technological improvement, where the sole function of improvement is to make the bridge safer to financial market innovations, where there are other functions and the relationship is not necessarily risk reduction is a good analogy. i am not offended by it, just disappointed a guy w/ this dude's resume would look at it that way.

Barron

[eastbay]

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but comparing the improvement of bridges & construction to the financial engineering & economic volatility vs. financial market volatility i think is a poor logical route to take.

i just don't recommend reading this book.

Barron

[/ QUOTE ]

Both markets and bridges have functions, and their designs should be optimized to perform those functions while minimizing risks. I don't see why you were offended by this.

I haven't read the book, but putting it down for making this simple analogy seems weird.

eastbay

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when a bridge is improved, the structure is better and risk is automatically reduced.


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No. A bridge may be expanded primarily to increase throughput, for example. Only with careful thought and design will this also be done without increasing risk.

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as derivatives are introduced & financial engineering goes nuts w/ tons of new innovations, there is no guarantee that risk would automatically be reduced. i.e. it isn't inherent to to plan b/c the GOAL of those securities is profit for their creators.


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Of course not, but I would think that's exactly the point. It's not automatic, it has to be designed into the system, just as safety is designed into a bridge.

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so i don't think that comparing a bridge technological improvement, where the sole function of improvement is to make the bridge safer


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A bridge is not built to make people safer. It is built to get people from point A to point B, and safety should be a design constraint. I suspect the author thinks the same ideas should apply to markets. I don't see why that is a "disappointing" idea.

eastbay

[DcifrThs]

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but comparing the improvement of bridges & construction to the financial engineering & economic volatility vs. financial market volatility i think is a poor logical route to take.

i just don't recommend reading this book.

Barron

[/ QUOTE ]

Both markets and bridges have functions, and their designs should be optimized to perform those functions while minimizing risks. I don't see why you were offended by this.

I haven't read the book, but putting it down for making this simple analogy seems weird.

eastbay

[/ QUOTE ]

when a bridge is improved, the structure is better and risk is automatically reduced.


[/ QUOTE ]

No. A bridge may be expanded primarily to increase throughput, for example. Only with careful thought and design will this also be done without increasing risk.

[ QUOTE ]

as derivatives are introduced & financial engineering goes nuts w/ tons of new innovations, there is no guarantee that risk would automatically be reduced. i.e. it isn't inherent to to plan b/c the GOAL of those securities is profit for their creators.


[/ QUOTE ]

Of course not, but I would think that's exactly the point. It's not automatic, it has to be designed into the system, just as safety is designed into a bridge.

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so i don't think that comparing a bridge technological improvement, where the sole function of improvement is to make the bridge safer


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A bridge is not built to make people safer. It is built to get people from point A to point B, and safety should be a design constraint. I suspect the author thinks the same ideas should apply to markets. I don't see why that is a "disappointing" idea.

eastbay

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i still think it is pretty clear though i am obviously failing miserably at expressing myself.

when derivatives were designed, yes, their initial purpose (dating back to farm products hundreds of years ago) was for farmers to hedge against price falls and for producers to hedge against price increases.

in the more recent history though, it isn't necessarily the demand that 100% drives the creation of products. ivnestment banks create products to sell to clients for profit. their goal isn't the construction such that the result makes the markets less risky.

the goal of the bridge construction is to get from point A to point B SUCH THAT the journey loses less than X lives in Y trials or whatever metric for less risk is used.

i see a clear distinction there between newer financial products and securities since their construction is not subjected (like bridges) to the constraint of market less risky.

there are some similarities as you've pointed out but i don't think there are enough to warrant such a strong analogy.

also, it appears that the author made another mistake.

he claimed that personal incomes have become less volatile, where a recent study released showed they have actually become more volatile.

also, his assertion that less volatility in production & income #s should result in less financial market volatility i don't think makes sense either.

Barron

[eastbay]

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ivnestment banks create products to sell to clients for profit. their goal isn't the construction such that the result makes the markets less risky.


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This is going in circles, so I will say it one last time: I think this is exactly the point which you seem to have missed. They don't, just as you could expand a bridge to increase throughput (the parallel of increasing profits for clients) without considering safety (the parallel of market risk). But I think the author's point is that they should, just as safety should be and is an integral part of bridge design.

eastbay

[DcifrThs]

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ivnestment banks create products to sell to clients for profit. their goal isn't the construction such that the result makes the markets less risky.


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This is going in circles, so I will say it one last time: I think this is exactly the point which you seem to have missed. They don't, just as you could expand a bridge to increase throughput (the parallel of increasing profits for clients) without considering safety (the parallel of market risk). But I think the author's point is that they should, just as safety should be and is an integral part of bridge design.

eastbay

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i see what you're saying, now. the phrase "supposed to work" i missed greatly in the meaning.

it is interesting though to see what would lead to breakdowns. he does outright claim that widespread engineering should lead to fewer breakdowns vs. more as he cites. but it seems to me that the more humans involved in something where they have an inherent gift of NOT improving itself would be the main cause of more breakdowns, not fewer. that i think may be contentious so if you want to discuss that, lets [img]/images/graemlins/smile.gif[/img]

i still feel bookstaber isn't the guy to read. the audacity of his claims alone is enough, nevermind the rest. certainty only comes in #s in physics & instances where the average won't be greatly affected by a 25 standard deviation event. i like the analogy of the coffee cup jumping off the desk. sure it is possible that all the molecules in the cup & coffee move simultaneously and leap, but the gaussian law applies well to the trillions of molecules that would need to move in tandem.

claims of that sort of certainty related to mkts is a signpost to me to beware. a few times in the intro is enough to warn others. thats what i tried to do here but got carried away. for that i apologize

Barron

[DcifrThs]

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It sounds like his argument is that widespread use of leverage and derivatives might cause extreme market moves in certain conditions. This is not a trivial concern. I've seen quotes basically saying the same thing from Warren Buffet, Alan Greenspan, and the editorial page of The Economist. The truth is that no one really knows whether there is some thread out there that, when unraveled, will cause the entire financial system to collapse (this exact fear is what prompted the LTCM bailout). This guy does seem like a [censored] writer but his concern is legitimate.

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also, i promise you, bookstaber didn't cause the 1987 crash, nor the dotcom boom.

i've probably read the same speeches and definitely the same editorials. the concern he brings up isn't the problem i have w/ him.

Barron