Friends don't let friends get into finance
techcrunch.com
techcrunch.com
First, it is an ethical problem. The idea of producing things is not taught in elite colleges, nor is the idea that it is possible to make a positive contribution to society (e.g. rms) without becoming superrich (no offense to those for whom this is their primary motivation).
Second, a lot of the products of which the GDP percentage is based upon simply involve repackaging and selling debt. (e.g. http://ow.ly/1sf8Rp ). In other words, a lot of the economy is based upon accounting tricks.
Repackaging and selling things is foundational to creating value. The insurance industry is perhaps the quintessential example. They create no direct expected value, and yet they create societal benefit by creating risk-adjusted expected value.
What is manufacturing but repackaging?
This advice may be two years too late, but may help someone just getting in now. The decision to leave a high-paying Wall Street firm is foolhardy and one that you will more than likely live to regret later. It would be much more prudent for you to stick around at a firm for 5-6 years, put away $500K-700K in cash, get some experience, make connections and then make your move. Otherwise, you'll probably end up stuck at a startup that is not really going anywhere anytime soon (maybe it will, but maybe it won't), and it will be too late to go back to Tier-1 firms to make some cash.
So the lesson for you young guys out there: Don't pull the trigger too soon IF YOU ARE ALREADY IN A MONEY EARNING JOB.
Wait it out for several years, build a small safety net, and stash away some capital for your entreupreneural endeavors a couple of years later.
No better way to ensure you'll never follow your dreams than set yourself up to be dependent upon a large salary and plan on pursuing them "a couple of years later."
If creating a CDO creates more value to the economy than designing an automobile why shouldn't engineers focus on building those?
People forget that prices and money are essentially information about the supply and demand of a good. As we progress in the information age deriving information from price will consume and produce ever more of our GDP. Spending money efficiently and directing it to the right purposes is a VERY valuable thing for a nation to do. Perhaps, dare I say it, more valuable than engineering widgets.
If YC had engineers figuring out algorithms to determine the best startups and they found one that worked it would be a very valuable piece of information. Or more relevantly, what if you had a site that required a lot of bandwidth and you could buy a bandwidth future? If you could buy that sort of thing you could offer 4 year contracts to your customers with out taking on any risk.
How about this instrument, a YC Summer 2014 startup future, it estimates the expected return from S14 and pays you if the return is less than expected. YC could sell them today and gain the advantage of knowing how many startups they could fund in S14. It would allow all sorts of people to pool their knowledge about what the Summer 2014 startup scene is going to be like. You might want to buy one right before the S14 season because you know that some great startup is applying, etc. If you held office space in SOMA you could use this as a hedge against losses incurred due to a poor S14 startup season.
Most complicated financial instruments are actually risk mitigation and/or information pools. The fact that that kind of thing is pricable due to these engineers spreads all sorts of great information to our economy that you can use to make informed decisions about how to conduct your affairs and you don't even need to participate in the market to use it.
Want to know what the best guess as to the price of oil in 6 months? Check the oil futures market. This one number contains the all the information known to man, vetted by experts as to what the supply and demand of oil is going to be in a few months. It also allows anyone with new knowledge to monetize that information and communicate it to all participants almost instantly. Southwest can offer cheaper flights because they use oil and jet fuel futures to buy jet fuel, the brilliant thing is that Exxon also gains knowledge of what Southwest and every other airline expects their passenger load to be in a few months and can make decisions accordingly.
Once you get off being coupled to supply and demand the cost of bailouts far out weighs any short term value
The price increase in CDSs against CDOs in retail mortgages alerted Goldman to the fact that people were very interested in a CDS against what they thought was a very solid asset (CDO consisting of residential mortgages).
This is also why AIG got bailed out, GS had enough CDSs with AIG that if AIG went so would GS. I definitely agree with you that in the long run bailouts create an atmosphere of moral hazard and irrational exuberance.
The problem also largely stems from political economics, as a representative you want to remain elected, therefore if you can kick the economic collapse can down the road a few years or spread its impact over many years you can stay in office. Therefore the rational economic choice for politicians is to favor bailouts. Very few people will not vote for you because 5 years later their taxes are 10% higher, but most will not vote for you if they lose their job. By the same token most people would rather take a 10% pay cut for 10 years than have no income for 1.
It's easy afford outrageous salaries when your revenue comes from government assisted theft.
Given that schooling is heavily funded by the gov't it would only seem natural to follow the funding train. They're practically begging people to go to engineering school and become a financier the way they fund things.
The biggest beneficiary would be banks. They would be trading it with a focus less on spotting good companies and rather on extracting profits from the activity of trading. Computers would be doing most of the trading. They'd have algos less focused on the quality of the applicants and their ideas, and more focused on how [black box X] can take money out of the system overall. The startup community would stop applying to YC because it's much more excellent to work at a bank, finding ways to manipulate the YC stock for fun and profit.
That's assuming that all that work does end up effectively and appropriately distributing capital at the end of the day. If you read up on the recent financial bust, you'll quickly realize that all is not well in the world of finance. Many complicated instruments such as CDOs have sometimes not been designed to benefit the buyer. Papers have been written establishing that it is impossible to know if a CDO has been designed to fail. Check out propublica's reporting on magnetar for an example of how CDO trading flew off the rails.
I could go on. Suffice to say that there are regulatory issues (no regulation, basically) there are issues with defining, standardizing, and regulating these complicated derivatives, there are issues with high frequency trading, issues with predatory consumer financial services, and finally there is the giant issue of a clear moral hazard now that the government has saved everyone's tail.
What is the optimal amount we should spend to efficiently allocate capital? I don't have a principled reason to be able to pick a number; all I have is a gut feeling, which isn't worth anything.
"CDOs provide value! We're making people rich!"
> People forget that prices and money are ... information
No, prices and money are imaginary measurements of imaginary things that do not exist except in our collective consciousness[1]. Cars, computers, buildings, aircraft... these things are not imaginary and provide real value.
Google and Facebook, for example, merely provide a convenient way of getting information quickly. Markets and price discovery do the exact same thing.
To understand what I mean by "imaginary" you have to understand (and accept) that a dollar, or a pound, or a real, or whatever, represents our agreement that we'll all play the same game. It doesn't represent a real thing. Google and Facebook provide information about actual things, like people, places and events.
Money provides information about itself. Which, hey, I like having an agreed-upon exchange rate so I can trade my labor for stuff (RIP Carlin). The problem is that exotic derivatives create an insane level of abstraction to the terms of our social agreement. Once you take away the ability of people to understand what money is for (I mean, seriously, buying insurance against the failure of a company you don't own? slices of a house's future value?) that agreement starts to corrode.
And yeah the short-term profits of these abstractions does create PROFIT, but it's an unsustainable cash flow. It didn't arise from producing a better quality product.
To say that Google's search service and CDOs are essentially the same thing shows a pretty poor understanding of both concepts.
This is not an effective argument. The computer software industry is also producing a larger than ever percentage of GDP. In other news, the building wooden ships sector is not responsible for much of the GDP in recent years. Is that a problem?
Economists' whole basis for their arguments is through empirical data and mathematical facts. Saying economists just relies on dreams is absolutely absurd and shows complete ignorance of the field.
The private goods-producing sector value added fell 6.4 percent in 2009, after a 4.2 percent decline in 2008. The private services-producing sector declined by 2.1 percent, after a 0.4 percent increase in 2008. The finance and insurance industry grew 6.1 percent in 2009, partially offsetting the widespread economic decline. The increase was primarily driven by the strong recovery of the insurance carriers industry.
From a December 2010 report from the government's bureau of economic analysis.
http://www.bea.gov/newsreleases/industry/gdpindustry/gdpindn...
So what? Infrastructure isn't inherently parasitic. Lots and lots of infrastructure isn't even necessarily bad.
I view finance as infrastructure. The machinery that hooks investors up with investees is fundamentally useful. The machinery that lets people and businesses manage risk, that lets them define very specifically what gains and losses apply to them in what events . . . that's really darn useful stuff. If it's complex sometimes--even incomprehensible--in order to achieve something, so what? So is software. So is engineering in general.
Some people practice finance badly, I don't doubt; some engineers are snake oil salesmen, too, hiding behind the inherent complexity of problem and solution. The government bailed out finance and that's bad, but it bailed out auto, too. That doesn't make car manufacture generally parasitic.
Those are historical specifics, justified complaints against individuals and events. But I don't see anything here justifies the demonization of the industry in general.
There may be many or even most individuals who are acting in good faith, but the sector as a whole appears to be broken.
This isn't about demonization. It's about pointing out a serious threat to society's continued prosperity.
And as for the auto industry - they shouldn't have been bailed out either - that doesn't somehow make it better that the financial industry was. Also the auto bailout was a rounding error compared to the financial bailout.
What industries are declining, and why do you believe that finance has failed them?
That's a quote from a December 2010 report from the government's bureau of economic analysis.
That's not the general trend, however, that's just a blip caused by the recently ended recession.
http://www.nber.org/cycles/cyclesmain.html
That's roughly the point where GDP growth became positive again.
http://research.stlouisfed.org/fred2/graph/?chart_type=line&...
[edit: can't respond to your post, but June 2009 is also the time period when industrial production and retail sales started growing, and when the stock market recovered.
http://research.stlouisfed.org/fred2/data/INDPRO.txt http://research.stlouisfed.org/fred2/series/RSAFS?cid=6 http://research.stlouisfed.org/fred2/series/SP500?cid=32255 http://research.stlouisfed.org/fred2/series/ALTSALES?cid=98 http://research.stlouisfed.org/fred2/series/DGORDER?cid=98
The period Jan 2009-Dec 2009 was bad, but Jun 2009-present was a period of growth for most sectors. ]
Well, I don't know that I find that very persuasive. Industries rise and fall all the time, for many reasons; the world is a complex place. Perhaps a useful financial instrument now is keeping things from getting worse somewhere else. Or perhaps it will bear fruit in a decade, as one would generally expect with an investment. Such an argument seems hasty without a good understanding of what the relative growth rates of different industries under different conditions should be -- a rather tall order.
I do certainly see the moral distinction between George Soros' currency manipulation and Warren Buffett's shrewd investment, despite the fact that both men made their money with money. But I don't think it would make sense to reckon their true productivity by comparing their fortunes. Likewise, if one is going to suggest general dysfunction in the financial industry, I'm much more interested in what you think it's doing wrong specifically -- where the growth that you think is unhealthy is coming from -- than how big it is.
To talk in concrete terms, I think I read elsewhere that a lot of the recent growth in finance has been in insurance. It seems sensible to me that if a lot of people have lost money, insurance, and its role in mitigating financial risk, would be more important. Without it, we might see people completely unwilling to take on financial risk at all until they had more money, which would be devastating. At a first glance, I don't see anything unhealthy about such an industry's growth being decoupled from the rest of the economy--or even inversely correlated.
And as for the auto industry - they shouldn't have been bailed out either - that doesn't somehow make it better that the financial industry was.
Oh, indeed, I am not arguing that. Both were terribly bad. I was arguing only that a bad, but specific, historical event doesn't make the industry as a whole fundamentally bad. No one would say, "The government bailed out the auto industry -- making automobiles is fundamentally parasitic on society!" I mean, making those particular automobiles, sure. But all automobiles ever? That's overblown. But people do seem to take the financial bailouts as evidence that the industry as a whole is amoral.
Contrast this with the finance sector. What would happen if Goldman was not bailed out. What investment banking firm would still be standing and what would it look like?
This is an industry that has an increasing percentage of our smartest minds. Add to that its extreme proximity to all money anywhere. The result? It's obvious that this industry is going to drift towards increasingly smart ways of capturing as much of our money flow as possible.
The finance world seems to become increasingly centralized, where very few companies become better at leveraging their size to increase their share of smart minds, money and power. That is the opposite of what competition is meant to do. With all these advantages, it seems insane that the industry needed a bailout.
It's not a few companies being bad. It's a market structure that can only result in bigger banks needing to pay their staff bigger bonuses to compete with each other, getting more power, extracting more money from everybody else. How could it be otherwise?
Attacking finance is the popular theme of the days, but finance has done a huge amount in supporting global economic growth. From providing debt and capital financing to reducing foreign exchange costs.
Oh - I get it now - the finance industry has provided support for itself to grow.
Completely false and absurd. Supply follows demand. GDP has grown throughout every industry that hasn't seen a decrease in its demand (e.g. railroads, newspapers, etc.). That includes technology, consumer goods, and technology. The economy doesn't exist in a vacuum. The finance industry provides capital to all industries.
US GDP today is seven times higher today than it was 60 years ago.
At the worst point in the recession US GDP dropped to the same level it was in 2005. Yes, the US GDP grew as much between 2005-2009 as it shrunk during the recession.
I'm relatively unfamiliar with this stuff, but do you really think GDP can grow exponentially? It looks like we're at the bottom of the skyrocket to the moon on your graph.
And then there are those who say, let me do a few years on Wall St and then I'll pursue the startup thing. What happens during that time is they lose their entrepreneurial edge (they become corporate dull) or they take on a lifestyle (nice house, cars etc = high fixed costs) which makes startup life less feasible.
Of course, in startup land, you have your occasional stellar upside scenarios a la Zuckerberg, but if economics is the main motivator, Wall St is a logical, rational choice esp if you work to live (and not live to work).
I say all of this as an NYC startup who feels this pain at times (although I think it is overblown and more of an excuse). I just don't think bellyaching about it achieves much.
Yes, yes, I know you want a secure source of income. Well, try think about ethics first, if not only.
A bank/VC that gives a loan/investment to small business/startup. That's finance. Hardly unethical.
Allowing people to get a car today while paying for it over time (instead of paying upfront). Hardly unethical.
Yes, there are bad actors in finance as there are in every space. Don't the Zyngas and others of the world via their offers engage in "ethically questionable" tactics?
Ultimately, we live in a pretty free agent society and if Wall St can pay more (no matter the reason), the rational engineer whose primary motivation is money should take that job. There is nothing wrong with that. The engineer who is motivated by money and other factors (building something valuable, being his/her own boss, etc) also has avenues a la doing a startup.
If the financial industry had actually had to bear the consequences of the risks they take in the same way that entrepreneurs do, the decisions would be rational. As it is, the finance sector is protected by the government whereas startups are not.
Merely commenting on your point as to why the "finance sector is protected by the government whereas startups are not".
If you don't seriously expect Facebook to get bailed out it's not a particularly meaningful thing to bring up.
But nevertheless, I'll go back to my original point. If the gov't thought that Facebook (or any startup) presented systemic risk, it'd likely get bailed out. I'll leave it at that.
I believe that there's a systemic problem with the industry and its role in society and that it is damaging our future prosperity.
Yes, any sufficiently powerful institution could, in principle pose such a problem, but why distract ourselves with imaginary problems when we have a real one sitting in front of us?
Unless you're a founder, having a five-year startup exit strategy that pays out similarly to the income you could have obtained in a straightforward manner in finance is a microsoft/google/facebook/twitter-style long shot. And, the latter two haven't even IPO'd yet to allow full vested share liquidity...
All my friends consider it a fairly soulless industry. Though they joke about patent troll/NPE firms in the way most techies joke about financial firms.
Bah. The mistakes will be repeated and the bailout question will arise again. And it will be worse next time.
We should have had the guts to say "fail and die." It would have sucked, but not as much as crushing debt and a sequel.
Goldman Sachs, JPMorgan Chase etc. deal with an inordinate amount of the world's liquid assets. If they had failed, the problems wouldn't have been a few quarters of negative GDP growth--we could have seen the collapse of financial markets everywhere along with prolonged global depression. Should we have had the guts to deal with that too?
1. Financial institutions cannot transfer funds between each other as usual and they cannot accurately predict who might fail next, so they pull back credit access. Spreads blow up as money supply decreases, causing a sharp decline in equipment investment and a big rise in consumer interest rates. Shit gets worse from there.
2. Banks die and, in conflict with everything we know about liquidity, money continues to flow perfectly. Banks are not afraid of failure so credit flows freely.
What do you see as more likely? Can you sum it up in a one-word answer?
However we're still in serious trouble because of the moral hazard created. Banks have been given the greenlight to take similar risks again because they know they'll be bailed out in future.
Frankly, without also taking steps to force banks back into smaller entities that we can afford to let fail, all we've done is compound the problem and delay it until later when it will be worse.
If we've merely postponed this problem and are waiting for Round II, then yes, we should have had the guts to have a depression resulting from irresponsible investments rather than a depression resulting from irresponsible investments AND governments up to their nostrils in debt.
How are internet startups any different?
Also, even the bankers and sales traders are providing a service that apparently people want. If you can judge them as not creating societal value, why can't I say that the Nth photo sharing website is not creating value?
Some financial organizations provide important liquidity. They offer you a loan when you need one. But many exist only to shuffle around money in a clever way, so that some percentage of that money goes into their coffers. And it seems like the smarter the employees, the less likely they are to actually be providing any real services to people. After all, smart employees are the ones who can make truly spectacular exploits of the game... exploits that are lucrative but pointless.
And I don't know anything about the details, but I can't help but wonder... when you write a brilliant algorithm that scrapes money out of the markets... or you set up a clever instrument that lets you capitalize on structural regularities in the market... whose hide does that money come out of? I honestly have no idea, but my instinct is that it's coming from people who are already disenfranchised.
I would call this a negotiation that they are winning. Just like startup founders win in their negotiation with employees for equity.
"People generally won't use your site unless it helps them in some way."
And people generally won't trade with you unless it helps them in some way. Again, how is this different?
Not necessarily. People engaged in real trade set up financial institutions, but once these institutions are set up, a game is in place. That game may be beneficial overall to the businesses, but individual players aren't necessarily beneficial... even if they are participating according to the agreed upon rules.
It's like cashing in a Groupon deal and then never returning to that business. The company loses money on you and they only agree to serve you because it works for them at scale. But at the micro scale you are hurting them.
People who do so have every right to, but they are not contributing to the economy. They are just making a lot of money by making other peoples' lives more difficult.
Since the value of currency evaporates, the only way to maintain your savings is to have it in a non-currency form. Stocks are a pretty liquid asset. This pushes people away from savings and into speculation (the stock market), where many lose their shirts.
1) inflation makes it costly to hold money
2) inflation forces you to make stupid speculative investments and frequent trades
The second doesn't follow from the first.
My point is simply that for years, fund managers such John Bogle have made a big deal about the fact that an efficient market doesn't allow stock picking funds to beat the cheaper index funds, etc, etc. True enough, but the next logical step is to drop the index funds and manually reproduce their trivial work.
Someday, a smart brokerage is going to offer a service to do this automatically, with cut-rate commissions. This would save people billions and billions of dollars.
You are absolutely right. ETFs are basically mutual funds, but with greater liquidity and lower fees. That's the reason for their existence - mutual funds, but better.
Let me ask you a very basic question: why do market makers (the people you trade against when you buy or sell SPY) make money? They aren't stealing from you. They are providing you the service of liquidity. Market makers connect people who want to buy/sell now with people who want to buy/sell in the future. In the interim, they take on the risk of holding that position that you didn't want. On average, they are compensated for that risk.
The way you say "they allow quants to make money on arbitrage" implies that the quants are just "extracting money" from the markets without doing any good at all. This is the complete opposite of the truth, and more people need to understand this.
Many investors are just looking to store their savings. They're not Warren Buffets, they don't study markets to make educated decisions, they just go into index funds and hope for the best.
But it's like having your bank in the lobby of a casino. You don't have to play --- but you're already there, and look at the flashing lights...
This makes your other points about the benefits of the financial industry and your defense of them 'not stealing' seem incoherent at best.
The equivalent to today's finance world was the .com boom and crash. When that crashed, the world continued and the S&P500 recovered just fine after a brief hiccup. The .com universe deleveraged and stayed so, but it just didn't affect the rest of the world that much.
During the latest crash, the rest of the world went into a huge recession. House prices and new-house sales have just hit multi-year lows again, two years after the event. The job market only looks better because so many have left it so aren't counted as job-seekers anymore! The non-finance world is still paying the bill for the latest recession, even though the big banks have forgotten about it and are paying bigger bonuses than ever.
New home sales:
http://cr4re.com/charts/charts.html?New-Home#category=New-Ho...
Unofficial problem bank list is still at or near a record. Good to be a big bank that gets government money:
http://www.calculatedriskblog.com/2011/03/unofficial-problem...
"The Labor Force Participation Rate declined to 64.3% in December (blue line). This is the lowest level since the early '80s."
http://www.calculatedriskblog.com/2011/01/december-employmen...
Let's illustrate with an example. Suppose you buy theft-insurance, there's 10% chance of being robbed and the cost of robbery is $100000. Then, E[a] = 0.1 * -100000 = -10,000. So you'd be maximizing U(-10000). This is different from maximizing E[U(a)] because in this case it's 0.1 * U(-100000) + 0.9 * U(0).
It's different if you are not completely neutral.
Another roundabout approach to counter this phenomenon is greater regulation to curb non-transparent / overly risky / exploitative instruments. Arguably, better regulation will help flatten the casino-eque boom (and bust) fortunes that we've been seeing in recent years. In turn, this may eventually translate to more moderate compensations in financial careers and may eventually reduce the outsized finance field demand for engineering talent. The rub is that government regulators are simply no match for the sharp pointy minds and enormous resources high finance firms can muster - the financial regulations of today will be easily be circumvented by the clever finance and accounting tricks of tomorrow.
Were it implementable (fantasy), the people who create and subsequently sell these fancy financial products should be paid with their own products and be required to hold them until maturity.
f.
If high frequency trading is so needless, why does the entire market go into shock when the traders panicked and left on may 6th 2010?
Most importantly- if these products are useless and harmful, why do people keep buying them?
Because HFTs, who enjoy the privilege of walking away from the market at the worst possible moment, had largely displaced traditional market makers who make expensive commitments not to do that. Nobody specifically chooses to do business with them, they're exploiting flaws in the way trades clear to front-run them and become unwanted middlemen.
Could you explain the mechanics of how this works?
Near as I can tell, the only way to become a "middleman" is to offer a better price than your competitors or to offer the same price at an earlier time. Is there a "front-run my competitors" FIX command I'm not aware of?
When a HFT buys and sells with a holding time in milliseconds, they are in no way guiding the correct allocation of our economy's resources, they are merely bleeding those who are. That they can do so profitably is showing us what we should fix about the way trades clear.
On net, the institutional trader is gaining $0.01 at the expense of retail investors.
Now, in a world with professional HFTs, the institutional investor can't do this as easily and must pay the retail investors $20.01. How horrible!
It's hard to see why you are calling the HFT an "unwanted middleman". I mean sure - the institutional investor would love to keep taking money from the retail investors. But the retail investors want to keep their pennies - they certainly want the HFT to be present.
As I said, the only way to become a middleman is to offer a better price than your competitors.
No one may explicitly choose to trade with HFT firms, but that doesn't mean they don't value their presence
"Although Vanguard does not engage in "high frequency trading" and does not operate a "dark pool," we believe much of the public concern over "high frequency trading" is misplaced and believes such activity, appropriately examined, contributes to a more efficient market that benefits all investors."
I could not tell if you were talking about finance or cigarettes.
Entrepreneurs do a little of this too, but foolishly allow themselves to be distracted by an irrational desire to also make novel and valuable contributions to society.
Eventually the entrepreneurs will learn that a part time effort won't cut it and they can't beat the guys who give it 100%
All needed bankers to get them access to capital and grow faster, helping them hire more employees and contribute to our economy's growth and standard of living. I'd highly recommend you rely your points on empirical evidence over populist talking points.
I'd highly recommend that you rely your points on empirical evidence than empty claims.
There's more demand. Therefore, there's a larger supply. Simple, basic, very elementary economics.
Your simple, basic, elementary economics don't apply when an industry is being protected by the government.