Comment by DanielBMarkham | Hacker News Reader

Comment by DanielBMarkham | Hacker News Reader

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"...The only solution is to forbid money management as we know it..."

That's a bold and provocative statement. I'd feel a lot better if the author actually proposed some way of ending "money management as we know it" instead of just throwing the blurb out willy-nilly.

Nobody disagrees about the premise: markets will always seek to find loopholes in the system and in the human condition. Some people see this as a source of growth -- after dozens or scores of such blowups, beginning way before the Dutch Tulip Bubble in 1637, markets have continue to grow and become more and more sophisticated. Whatever the fundamental flaws, it's obvious they haven't prevented outstanding growth over the last several hundred years or so.

To propose a dramatic new solution, it's your job to make the case that the benefits outweigh the drawbacks. Otherwise it's like speaking out against eating because of all of the cases of food poisoning -- you're missing the point.

Well, according to WaPo, 40% of all the "profits" in 2007 came from Wall Street. Did those profits actually exist? Were they short-term book-cooking so that they got their bonuses?

By 2007, when Wall Street's profits amounted to an astonishing 40 percent of all American profits, the business of American finance was no longer American business -- providing loans for domestic production, technological innovation, that sort of thing -- but swapping bets and hedges on bets and hedges, all for hefty commissions.

http://www.washingtonpost.com/wp-dyn/content/article/2009/01...

Apparently $70 Billion of the bailout package has gone out as bonuses to the same idiots on Wall Street who got us into this mess.

I really don't think Seymon has a real solution. Money managers who think they have a foolproof scheme will willingly bet their own money. Sure limiting compensation is a good thing, but not a cure. The best suggestion that I have seen is a requirement for the issuers of derivatives to maintain a reserve. Regular insurance is a kind of derivative and insurance companies are required to maintain a reserve to pay off policies. The same should be true of other kinds of derivatives. A reserve requirement slows down the explosion of derivatives, because eventually the total reserves are greater than the value of the underlying instrument. We might still have failures of individual firms, but total collapse of the financial system would be less likely.

There is still a need to put realism back into lending, because we are getting these crises every few years: loans to South American dictatorships, the savings and loan crisis, the Asian financial meltdown and the current mortgage and derivatives failure, all in the past 40 years.

Though he doesn't suggest it in so many words, I understood him to be proposing that money managers must be paid a flat rate rather than by commission based on returns or total money managed, that it would remove their incentive to take short-term risks to run up their personal reward.

That doesn't work.

If I'm paid a flat fee to manage money, the people handing me money to manage are still going to look for the manager with the highest returns (that's human nature).

So, I still have an incentive to chase riskier short-term gains; I see less of the upside than if I were also getting a cut of the gains, but the incentives that arise from competition with other money managers remains in place.

I think lots of people are ready to forego higher returns for higher security. That's what I ask from my banker.

For a short while I was looking for a bank that would just have a portfolio that follows the market instead of trying to beat it, and that would take less fees because it took less effort to manage. I contacted two other banks, but they didn't have anything like that. I found it was extremely tiring to speak to bankers, they all seem to want to drown you with words. I eventually stayed with my original bank just to stop wasting time.

I thought such things were common?

http://en.wikipedia.org/wiki/Index_fund

They are common.

The problems they don't solve is how to allocate the assets between currencies. Also part of my money is in fixed income papers. So even when not trying to beat the market, there are some decisions I would like to leave to a professional.

Dimensional Fund Advisors (http://en.wikipedia.org/wiki/Dimensional_Fund_Advisors) diversify among currencies, markets, and asset classes according to some math I don't really understand. They seem pretty sharp, though, and they're low-load for the buy-and-hold version (they have market timing funds designed to lower the fluctuation at the cost of lowering the long-term return).

Yes, maybe after a market crisis more people look for security, but I think that over time they forget the last crises and move back to chasing returns until it gets bad enough for the next crises to occur.

He is suggesting that top executive and trader pay be based on the long term performance of the fund. In particular, their own money should be invested in everything they do, and likely also for a number of years after they leave.

One interesting thing to me is that even if you do this (correlate compensation with longer term results) a lot of the same problems still happen. Take, for example, the first big hedge fund blowup: Long Term Capital. Shortly before they blew up, they kicked most of the third party money out of the fund and even levered up their own individual positions (see the book "When Genius Failed").

I'm not saying that misalignment of incentives doesn't play a significant role in a lot of what we are seeing now, but never underestimate hubris.

We can't solve hubris, but perhaps we can highlight it to investors.

Funds that too hard to value or are highly leveraged should switch from regulation by the SEC to regulation by state gambling commissions. It would be tricky to find the right cutoff, though, but if an investor would have to travel to a Native American reservation to buy credit default swaps, they might start thinking about whether they really understand what they're investing in.

How about the following regulation:

No restrictions on what funds can do, no government bailouts, but full disclosure so that clients may impose their own restrictions.

A lot of strange things happen when the players have diffrent amounts of information.

EX: Would you bet 1 billion dollars with slightly less than even odds?

Well if you don't have a billion dollars then your real risk could be much lower vs. your potential gain. The real question is who would trust you to actually have a billion dollars? That's the real sucker, unless he also lacks a billion dollars.

If they hadn't paid out that dividend, LTCM would have had enough in reserves to survive, but no one seems to have learned from that, least of all Alan Greenspan.

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