Wall street ontrack to reward record pay

[jackace]

Originally posted by: BigDH01

Originally posted by: TheSkinsFan

Originally posted by: BigDH01

Originally posted by: TheSkinsFan

Originally posted by: BigDH01

Originally posted by: TheSkinsFan

Originally posted by: jackace
"Economic profit does not occur in perfect competition in long run equilibrium."

You're under the mistaken impression that this definition applies to every industry or circumstance. You're also under the mistaken impression that the financial industry resembles any/every other.

Ever taken a finance class?

It should apply in any perfect market situation. Of course, we never have perfect markets and every real world market is inefficient. Profit can be used as a measure of this inefficiency.

It is very difficult, if not impossible, to use profit as an accurate measure of efficiency in financial markets. You could argue that it should be possible, and that changes could/should be made to the financial industries to make that so, but it's not.

Do you think this is an argument that would be juxtaposed to someone arguing that it is?

Explain to me why profits in the financial sector can't be used as a measure of inefficiency without resorting to those prerequisites that have been enumerated when describing a perfectly efficient market.

One word might be enough: futures.

What about them?

I was going to ask the very same thing.

I was taught that economic profits being too high (over a period of time) is an indication that there are either:

a) not enough firms in a given industry to keep prices low

b) A firm is getting the benefit of some form of regulation, insider trading, etc that gives them an unfair advantage over others in the same industry.

Not sure how the futures market can change any of the above.

 

[BigDH01]

Originally posted by: jackace

I was going to ask the very same thing.

I was taught that economic profits being too high (over a period of time) is an indication that there are either:

a) not enough firms in a given industry to keep prices low

b) A firm is getting the benefit of some form of regulation, insider trading, etc that gives them an unfair advantage over others in the same industry.

Not sure how the futures market can change any of the above.

It doesn't.

a) is addressed by various game theory models like Bertrand and Cournot that demonstrate the a duopoly is really all that is required to drive profit to marginal costs of production. Of course, this assumes perfect substitution, which exists in a market with no barrier to entry (requirement for perfect efficiency). I would actually suspect that the financial market should have less profit than any other market because they do deal in products that are perfectly substitutable. The market should hopefully have less information asymmetry than most markets, which should also increase efficiency and drive down profits.

Besides regulation and insider trading, there can be collaboration. The firms could be signaling each other via pricing mechanisms and form a de facto cartel.

 

[Darwin333]

Originally posted by: miketheidiot

Originally posted by: Nebor
It's easy to get up in arms over big salaries, but when you look at the value added by these guys, it's probably not so bad.

the value added my many of these people is probably negative, a large portion of the industry amounts to little more than moving other peoples money around and getting paid for it. Goldman made billions being a brokerage for oil last year during the bubble, that added nothing to society and made a recession worse, and added to the already cyclical problems with investment facing the oil industry.

A few months ago there were a bunch of stories about GS and others making stacks of money by buying getting in between buyers and sellers in split second automatic transactions. This did nothing, had no value in arbitration, and hurt the two entities that were actually involved in the trade.

While I agree with you, I think the two of you are talking about different things. Those people did in fact bring value to the company if they made the company a profit. That doesn't mean that value was a net benefit to society or the market though.

Along with the high frequency trading GS has been either impossibly lucky or illegally front running the market for quite some time now. Wonder why there have been no investigations from either party? I am not sure if it is still going on but for a while high frequency trading accounted for over half of all market transactions on a given day and the vast majority where two or three stocks. Basically big ass banks buying and selling the same stock back and forth to each other.

 

[jackace]

Originally posted by: BigDH01

Originally posted by: jackace

I was going to ask the very same thing.

I was taught that economic profits being too high (over a period of time) is an indication that there are either:

a) not enough firms in a given industry to keep prices low

b) A firm is getting the benefit of some form of regulation, insider trading, etc that gives them an unfair advantage over others in the same industry.

Not sure how the futures market can change any of the above.

It doesn't.

a) is addressed by various game theory models like Bertrand and Cournot that demonstrate the a duopoly is really all that is required to drive profit to marginal costs of production. Of course, this assumes perfect substitution, which exists in a market with no barrier to entry (requirement for perfect efficiency). I would actually suspect that the financial market should have less profit than any other market because they do deal in products that are perfectly substitutable. The market should hopefully have less information asymmetry than most markets, which should also increase efficiency and drive down profits.

Besides regulation and insider trading, there can be collaboration. The firms could be signaling each other via pricing mechanisms and form a de facto cartel.

I agree that the financial products themselves are very easily substituted, one for another, but there are pretty large barriers to entry in the financial industry as a whole. Both, gaining employment and starting a new firm/institution can be all but impossible without the right connections. Most sources I have read use this reason to explain why Wall Street profit margins and salaries are so high, the players in the industry (including the government) are heavily restricting and limiting who can participate.

 

[jagec]

Originally posted by: GuitarDaddy

Originally posted by: IcebergSlim
this is regulation, reform and change we can believe in.

Yeah, Yeah Obama eats babies, and produces H1N1 in a large KFC bucket in his secrect liar in Kenya while eating watermelon and listening to old Hitler tapes:disgust: move along please

Fixed. ALMOST perfect.

Originally posted by: TheSkinsFan
Banking is a global industry wherein the salaries and bonuses of those involved is fairly standard everywhere in the world. If the U.S. government ever attempted to change the compensation standards for U.S. banks, permanently, they would very quickly lose their competitive edge on the world stage due to an almost instantaneous brain drain. In order for U.S. banks to continue to compete in the global economy, they will need to maintain the same compensation practices of every other bank, in every other country, in the world.

Jealousy is such an ugly character trait.

O RLY?

 

[BigDH01]

Originally posted by: jackace

Originally posted by: BigDH01

Originally posted by: jackace

I was going to ask the very same thing.

I was taught that economic profits being too high (over a period of time) is an indication that there are either:

a) not enough firms in a given industry to keep prices low

b) A firm is getting the benefit of some form of regulation, insider trading, etc that gives them an unfair advantage over others in the same industry.

Not sure how the futures market can change any of the above.

It doesn't.

a) is addressed by various game theory models like Bertrand and Cournot that demonstrate the a duopoly is really all that is required to drive profit to marginal costs of production. Of course, this assumes perfect substitution, which exists in a market with no barrier to entry (requirement for perfect efficiency). I would actually suspect that the financial market should have less profit than any other market because they do deal in products that are perfectly substitutable. The market should hopefully have less information asymmetry than most markets, which should also increase efficiency and drive down profits.

Besides regulation and insider trading, there can be collaboration. The firms could be signaling each other via pricing mechanisms and form a de facto cartel.

I agree that the financial products themselves are very easily substituted, one for another, but there are pretty large barriers to entry in the financial industry as a whole. Both, gaining employment and starting a new firm/institution can be all but impossible without the right connections. Most sources I have read use this reason to explain why Wall Street profit margins and salaries are so high, the players in the industry (including the government) are heavily restricting and limiting who can participate.

Thus, profits are indicating the market is inefficient.

 

[jackace]

Originally posted by: BigDH01

Originally posted by: jackace

Originally posted by: BigDH01

Originally posted by: jackace

I was going to ask the very same thing.

I was taught that economic profits being too high (over a period of time) is an indication that there are either:

a) not enough firms in a given industry to keep prices low

b) A firm is getting the benefit of some form of regulation, insider trading, etc that gives them an unfair advantage over others in the same industry.

Not sure how the futures market can change any of the above.

It doesn't.

a) is addressed by various game theory models like Bertrand and Cournot that demonstrate the a duopoly is really all that is required to drive profit to marginal costs of production. Of course, this assumes perfect substitution, which exists in a market with no barrier to entry (requirement for perfect efficiency). I would actually suspect that the financial market should have less profit than any other market because they do deal in products that are perfectly substitutable. The market should hopefully have less information asymmetry than most markets, which should also increase efficiency and drive down profits.

Besides regulation and insider trading, there can be collaboration. The firms could be signaling each other via pricing mechanisms and form a de facto cartel.

I agree that the financial products themselves are very easily substituted, one for another, but there are pretty large barriers to entry in the financial industry as a whole. Both, gaining employment and starting a new firm/institution can be all but impossible without the right connections. Most sources I have read use this reason to explain why Wall Street profit margins and salaries are so high, the players in the industry (including the government) are heavily restricting and limiting who can participate.

Thus, profits are indicating the market is inefficient.

That's how I see it as well.

 

[daishi5]

Originally posted by: BigDH01

Originally posted by: jackace

Originally posted by: BigDH01

Originally posted by: jackace

I was going to ask the very same thing.

I was taught that economic profits being too high (over a period of time) is an indication that there are either:

a) not enough firms in a given industry to keep prices low

b) A firm is getting the benefit of some form of regulation, insider trading, etc that gives them an unfair advantage over others in the same industry.

Not sure how the futures market can change any of the above.

It doesn't.

a) is addressed by various game theory models like Bertrand and Cournot that demonstrate the a duopoly is really all that is required to drive profit to marginal costs of production. Of course, this assumes perfect substitution, which exists in a market with no barrier to entry (requirement for perfect efficiency). I would actually suspect that the financial market should have less profit than any other market because they do deal in products that are perfectly substitutable. The market should hopefully have less information asymmetry than most markets, which should also increase efficiency and drive down profits.

Besides regulation and insider trading, there can be collaboration. The firms could be signaling each other via pricing mechanisms and form a de facto cartel.

I agree that the financial products themselves are very easily substituted, one for another, but there are pretty large barriers to entry in the financial industry as a whole. Both, gaining employment and starting a new firm/institution can be all but impossible without the right connections. Most sources I have read use this reason to explain why Wall Street profit margins and salaries are so high, the players in the industry (including the government) are heavily restricting and limiting who can participate.

Thus, profits are indicating the market is inefficient.

If it is true that the excessive profits in the area of finance stem from the high barriers to entry such as regulation, wouldn't increasing regulation further increase the economic profits they can sustain?

I know it can depend on the actual regulations, but it seems ironic to me that the group who complains the most about wall street profits are the most eager to put in even more barriers to entry.

 

[BigDH01]

Originally posted by: daishi5
If it is true that the excessive profits in the area of finance stem from the high barriers to entry such as regulation, wouldn't increasing regulation further increase the economic profits they can sustain?

I know it can depend on the actual regulations, but it seems ironic to me that the group who complains the most about wall street profits are the most eager to put in even more barriers to entry.

No, because in terms of firms the largest barrier to entry is likely capital requirement. We also saw profits increase in the era of deregulation as, frankly, the actors weren't acting rationally in as much as they weren't at least cognizant of the systemic risk they were creating with their actions or they weren't taken into consideration in any utility function.

Also, depending on the size of the firms and the amount of capital and debt they were insuring or moving, one player had the power to move the market, another violation of efficiency. The mere fact that we were told that the collapse of one company could send shocks that would destroy the whole system should throw up the red flag that the market isn't functioning correctly.

I don't want to throw up more barriers to entry, I want to prevent players from becoming so large that they can move markets and don't behave competitively. And given recent events, they haven't exactly proven they can act rationally when determining long-term systemic risk (and really, all discussion about markets and competition assumes that the actors are behaving rationally).

 

[TheSkinsFan]

Originally posted by: jagec

Originally posted by: TheSkinsFan
Banking is a global industry wherein the salaries and bonuses of those involved is fairly standard everywhere in the world. If the U.S. government ever attempted to change the compensation standards for U.S. banks, permanently, they would very quickly lose their competitive edge on the world stage due to an almost instantaneous brain drain. In order for U.S. banks to continue to compete in the global economy, they will need to maintain the same compensation practices of every other bank, in every other country, in the world.

Jealousy is such an ugly character trait.

O RLY?

yes, really. From your own article:

The United States is home to four of the nine largest banks in the world -- JPMorgan, Bank of America Corp, Wells Fargo & Co and Citigroup Inc. It is also home to four of the six most handsomely rewarded bank CEOs.

You mean there's some correlation between being the largest and receiving the highest pay? Whodathunkit?!

Besides, my point was mainly referring to their workers -- those who work at a certain level and receive certain global industry-standard bonuses associated with that level of employment -- financial advisers, traders, analysts, etc.

CEO's are another animal altogether, and some of them definitely need their compensation lowered to a point more commensurate with their current level of performance. That said, if their banks remain the four largest in the world, I'd expect their salaries to remain the four highest in the world as well -- unless, of course, those four large banks start bleeding money, or if they fail to fulfill their TARP obligations according to the agreed upon terms.

 

[daishi5]

Originally posted by: BigDH01

Originally posted by: daishi5
If it is true that the excessive profits in the area of finance stem from the high barriers to entry such as regulation, wouldn't increasing regulation further increase the economic profits they can sustain?

I know it can depend on the actual regulations, but it seems ironic to me that the group who complains the most about wall street profits are the most eager to put in even more barriers to entry.

No, because in terms of firms the largest barrier to entry is likely capital requirement. We also saw profits increase in the era of deregulation as, frankly, the actors weren't acting rationally in as much as they weren't at least cognizant of the systemic risk they were creating with their actions or they weren't taken into consideration in any utility function.

Also, depending on the size of the firms and the amount of capital and debt they were insuring or moving, one player had the power to move the market, another violation of efficiency. The mere fact that we were told that the collapse of one company could send shocks that would destroy the whole system should throw up the red flag that the market isn't functioning correctly.

I don't want to throw up more barriers to entry, I want to prevent players from becoming so large that they can move markets and don't behave competitively. And given recent events, they haven't exactly proven they can act rationally when determining long-term systemic risk (and really, all discussion about markets and competition assumes that the actors are behaving rationally).

Ok, I have never really looked carefully at big finance, so forgive some ignorance on my part. How would things such as Sarbanes-Oxley, and all the other legal regulations of financial institutions fit into this? I would expect that those would serve as barriers to entry, because you cannot just gradually implement them, you need to be fully compliant to even start, or am I wrong there?

I also keep hearing about reducing their exposure to risk, doesn't that create a capital barrier to entry? Again, not an area I know at all, but to enter into some of these markets, don't you need a very large amount of capital to even play the game. If you require that they can only have a certain % in these areas, then I would expect it would create an even larger capital requirement because now they need to raise not just X, but X+Y safety amount. I had been under the impression that regulations that are meant to ensure the stability of these companies prevent smaller companies from entering the market, because smaller entities are almost by definition unstable.

Good bad or indifferent it seems to me that when you regulate and police an industry to make sure it is always stable you are not just setting up a barrier to entry, but almost putting the existing players on an unreachable plateau. I am fairly certain a new business is never going to be considered stable, or even a decent sized business entering into a new market is not really stable. The only way I can think of someone breaking into the market would be to become a very large corporation in another area, and then branch out with the large corporations backing into the realm of these large financial institutions.

 

[BigDH01]

Originally posted by: daishi5

Ok, I have never really looked carefully at big finance, so forgive some ignorance on my part. How would things such as Sarbanes-Oxley, and all the other legal regulations of financial institutions fit into this? I would expect that those would serve as barriers to entry, because you cannot just gradually implement them, you need to be fully compliant to even start, or am I wrong there?

Actually, I would consider Sarbox to be more of a transactional cost than anything else, as it is a recurring expense to any firm. Yes, zero transactional cost is required for perfect efficiency. However, I would imagine this cost was borne more heavily by larger firms than smaller ones as it is cheaper to start Sarbox compliant than it is to retrofit.

You also have to remember that the government didn't just implement Sarbox to reduce efficiency. It implemented Sarbox as a result of several costly market failures. The externalities (costs) inflicted upon society were great enough to impose inefficiency on the market as this cost of inefficiency was less than the cost of the information asymmetry that existed between the failed corporations and their investors/stockholders/employees.

I also keep hearing about reducing their exposure to risk, doesn't that create a capital barrier to entry? Again, not an area I know at all, but to enter into some of these markets, don't you need a very large amount of capital to even play the game. If you require that they can only have a certain % in these areas, then I would expect it would create an even larger capital requirement because now they need to raise not just X, but X+Y safety amount. I had been under the impression that regulations that are meant to ensure the stability of these companies prevent smaller companies from entering the market, because smaller entities are almost by definition unstable.

Any start up capital required is a barrier to entry. These exist in any market, not just financials. And it's not just about government intervention. Established firms are usually less of a risk and can usually obtain capital more cheaply (across all industries). And capital is just one area. The established firms can have name recognition, established labor pools, established contracts, etc, etc. And the larger firms aren't just less risky because of regulation, but because they likely already have collateral, revenue sources, etc. It seems you understand this though, so you can understand why this barrier exists even without any government regulation.

And as far as what risk you have heard about, I really couldn't say without hearing it from the person who said it. It could simply mean reducing leverage within the framework of capital requirements. I don't know if this is really a barrier to entry as much as it just regulates how much risk you can assume based on how much capital you can bring to the table. It's not so much a barrier to entry as much as it prevents you from assuming the same liabilities as someone who can do it with less risk (in other words, more capital). The regulations simply say that you have to have so much capital on hand based on your amount of risk. Again, this was put in place for good reason. We're in the middle of a crisis that was at least somewhat precipitated by over-leveraging. A quick search on Wiki shows that it has a pretty concise section about this. This is another example where lack of regulation on capital requirements increased profit and ultimately created systemic risk, and market failure.

Good bad or indifferent it seems to me that when you regulate and police an industry to make sure it is always stable you are not just setting up a barrier to entry, but almost putting the existing players on an unreachable plateau. I am fairly certain a new business is never going to be considered stable, or even a decent sized business entering into a new market is not really stable. The only way I can think of someone breaking into the market would be to become a very large corporation in another area, and then branch out with the large corporations backing into the realm of these large financial institutions.

I think you are probably overestimating the impact that banking regulation has on barrier of entry and market efficiency. The last few years have shown us that lack of regulation and/or inability to enforce it only increased profits, reduced market efficiency, and caused market failure. I think there are much greater factors at play than any barrier to entry that might be caused by capital requirements or Sarbox. And really, in the perfectly efficient market, there are many many prerequisites.

It also ignores the problems in other markets that exist simply because of the nature of the product. You can look at almost any industry that creates capital intensive products and find that the trend has been moving to one or two large players. You can simply look at a market we are all familiar with, desktop CPUs. How many established companies and start ups used to make Intel clones or CPUs that competed with Intel (on the desktop)? How many exist now? As each progressive generation of CPU has become more difficult and costly to design and create, firms consolidated and/or dropped out. We are now left with what really amounts to 1.5 firms competing. What are the odds that any new start up could emerge that could build enough fabs to supply a substantial portion of the market and design a CPU that could be competitive? You're talking 10s of billions of dollars and a high risk of failure. I think any government regulation in this light would really add a miniscule cost (unless you are suggesting that companies be allowed to create Intel clones and violate patents, still not an easy task).

 

[daishi5]

Originally posted by: BigDH01

Originally posted by: daishi5

Ok, I have never really looked carefully at big finance, so forgive some ignorance on my part. How would things such as Sarbanes-Oxley, and all the other legal regulations of financial institutions fit into this? I would expect that those would serve as barriers to entry, because you cannot just gradually implement them, you need to be fully compliant to even start, or am I wrong there?

Actually, I would consider Sarbox to be more of a transactional cost than anything else, as it is a recurring expense to any firm. Yes, zero transactional cost is required for perfect efficiency. However, I would imagine this cost was borne more heavily by larger firms than smaller ones as it is cheaper to start Sarbox compliant than it is to retrofit.

You also have to remember that the government didn't just implement Sarbox to reduce efficiency. It implemented Sarbox as a result of several costly market failures. The externalities (costs) inflicted upon society were great enough to impose inefficiency on the market as this cost of inefficiency was less than the cost of the information asymmetry that existed between the failed corporations and their investors/stockholders/employees.

I did not mean to imply that Sarbox was intended to reduce efficiency, but I thought that the efficiency reduction was a trade off to prevent fraud and improve visibility. Although now that I think about it, better information could increase efficiency of the sector as a whole.

My entire exposure to Sarbox has been a few footnotes in books and interaction with IT departments who are responsible for making sure their system are compliant. From the IT side of Sarbox, it appeared to me that the big costs were the setup, and that the marginal costs were low or none. I guess, the devil is in the details, and I really don't know the details beyond that area.

I also keep hearing about reducing their exposure to risk, doesn't that create a capital barrier to entry? Again, not an area I know at all, but to enter into some of these markets, don't you need a very large amount of capital to even play the game. If you require that they can only have a certain % in these areas, then I would expect it would create an even larger capital requirement because now they need to raise not just X, but X+Y safety amount. I had been under the impression that regulations that are meant to ensure the stability of these companies prevent smaller companies from entering the market, because smaller entities are almost by definition unstable.

Any start up capital required is a barrier to entry. These exist in any market, not just financials. And it's not just about government intervention. Established firms are usually less of a risk and can usually obtain capital more cheaply (across all industries). And capital is just one area. The established firms can have name recognition, established labor pools, established contracts, etc, etc. And the larger firms aren't just less risky because of regulation, but because they likely already have collateral, revenue sources, etc. It seems you understand this though, so you can understand why this barrier exists even without any government regulation.

And as far as what risk you have heard about, I really couldn't say without hearing it from the person who said it. It could simply mean reducing leverage within the framework of capital requirements. I don't know if this is really a barrier to entry as much as it just regulates how much risk you can assume based on how much capital you can bring to the table. It's not so much a barrier to entry as much as it prevents you from assuming the same liabilities as someone who can do it with less risk (in other words, more capital). The regulations simply say that you have to have so much capital on hand based on your amount of risk. Again, this was put in place for good reason. We're in the middle of a crisis that was at least somewhat precipitated by over-leveraging. A quick search on Wiki shows that it has a pretty concise section about this. This is another example where lack of regulation on capital requirements increased profit and ultimately created systemic risk, and market failure.

I was referring more to the discussions here on P&N. I thought the governments proposals of more regulation were targeted at forcing them to reduce their exposure to risk especially to exotic things like the CDS.

The barrier I was referring to was the capital barrier. I feel that there would be less risk to the system as a whole if it was made up of smaller companies who were allowed to take larger risks to themselves. If you allowed a smaller bank to take on 50% of its assets in a certain risky category, ok no huge deal, it has a good chance of failing but it is a small bank. However, if you only allow a bank to have 5% in that area of risk, than you have limited the market to only banks that are 10X the size of that small bank, and if they fail, its a much bigger problem.

Good bad or indifferent it seems to me that when you regulate and police an industry to make sure it is always stable you are not just setting up a barrier to entry, but almost putting the existing players on an unreachable plateau. I am fairly certain a new business is never going to be considered stable, or even a decent sized business entering into a new market is not really stable. The only way I can think of someone breaking into the market would be to become a very large corporation in another area, and then branch out with the large corporations backing into the realm of these large financial institutions.

I think you are probably overestimating the impact that banking regulation has on barrier of entry and market efficiency. The last few years have shown us that lack of regulation and/or inability to enforce it only increased profits, reduced market efficiency, and caused market failure. I think there are much greater factors at play than any barrier to entry that might be caused by capital requirements or Sarbox. And really, in the perfectly efficient market, there are many many prerequisites.

It also ignores the problems in other markets that exist simply because of the nature of the product. You can look at almost any industry that creates capital intensive products and find that the trend has been moving to one or two large players. You can simply look at a market we are all familiar with, desktop CPUs. How many established companies and start ups used to make Intel clones or CPUs that competed with Intel (on the desktop)? How many exist now? As each progressive generation of CPU has become more difficult and costly to design and create, firms consolidated and/or dropped out. We are now left with what really amounts to 1.5 firms competing. What are the odds that any new start up could emerge that could build enough fabs to supply a substantial portion of the market and design a CPU that could be competitive? You're talking 10s of billions of dollars and a high risk of failure. I think any government regulation in this light would really add a miniscule cost (unless you are suggesting that companies be allowed to create Intel clones and violate patents, still not an easy task).

I don't feel that the financial market and the CPU market are similar though. In the CPU market, you need very specialized capital equipment, and you cannot build a lot of that equipment up in small pieces. However, the capital in the financial market is not specialized at all, and you can build it up slowly. Mitsubishi cannot just switch their equipment from making RAM and start making processors, but if a bank does well with small loans, and builds it's cash up, it can switch that cash over to other investments. Given the nature of financial capital, namely that it is divisible and fungible, I would expect that you would see small players rising up and entering new markets as their resources allow them to. I just don't see how a financial market would naturally gravitate towards a small number of large players. I know it takes a very large amount of capital to finance big projects, but small companies could divide the financing and share the risk out amongst several smaller entities to compete with the big companies.

I went back and reviewed this post, and I realize my ignorance is showing through. I don't know enough about the market to say much, but it just seems from all I hear that there must be a large barrier to entry, or other companies with money would be entering this market to share in these huge profits. But, I just don't understand how capital can be a barrier to entry, if it is just a requirement of having a large amount of capital, why are smaller entities not grouping together to share in these large profits. Maybe I am missing something, but I just don't understand why other companies are not trying to get into this market, either large companies from other markets, or small companies working cooperatively, unless there is some huge barrier to entry.

 

[BigDH01]

Originally posted by: daishi5

I was referring more to the discussions here on P&N. I thought the governments proposals of more regulation were targeted at forcing them to reduce their exposure to risk especially to exotic things like the CDS.

The barrier I was referring to was the capital barrier. I feel that there would be less risk to the system as a whole if it was made up of smaller companies who were allowed to take larger risks to themselves. If you allowed a smaller bank to take on 50% of its assets in a certain risky category, ok no huge deal, it has a good chance of failing but it is a small bank. However, if you only allow a bank to have 5% in that area of risk, than you have limited the market to only banks that are 10X the size of that small bank, and if they fail, its a much bigger problem.

But then we end up with basically the same situation. If 1000 small banks are overleveraged, it would have the same aggregate potential for destruction as if it were 100 banks overleveraged for the same amount of capital. After our recent calamity, I'm not really all that confident in the market as a whole to properly judge risk, as it wasn't just the large players that went down, you simply hear about them more often. You can go here and get a list of the failed banks in 2008. So while there might be less spectacular failures with many smaller banks, the possibility of large systemic risk would still exist.

I don't feel that the financial market and the CPU market are similar though. In the CPU market, you need very specialized capital equipment, and you cannot build a lot of that equipment up in small pieces. However, the capital in the financial market is not specialized at all, and you can build it up slowly. Mitsubishi cannot just switch their equipment from making RAM and start making processors, but if a bank does well with small loans, and builds it's cash up, it can switch that cash over to other investments. Given the nature of financial capital, namely that it is divisible and fungible, I would expect that you would see small players rising up and entering new markets as their resources allow them to. I just don't see how a financial market would naturally gravitate towards a small number of large players. I know it takes a very large amount of capital to finance big projects, but small companies could divide the financing and share the risk out amongst several smaller entities to compete with the big companies.

Well, they are similar in one respect. The larger institutions are able to get money for cheaper. And while we might like to believe that it takes awhile to accumulate capital, recent history as shown us that lacking capital reserves does not prevent a bank from taking liabilities above their capacity. Recent events have also shown us that when the possibility of large profit exists, this will accumulate these liabilites at their own detriment (the above failed bank list). And the drive to consolidate in the finance sector would be the same as any other sector. While having many small players split the cost of a loan might seem more beneficial at first, the aggregate risk of that loan failing still exists, only now you have the additional transactional costs of negotiation between different institutions, and the additional costs of acquiring capital. It actually reduces costs to consolidate and should increase the potential for profit.

I went back and reviewed this post, and I realize my ignorance is showing through. I don't know enough about the market to say much, but it just seems from all I hear that there must be a large barrier to entry, or other companies with money would be entering this market to share in these huge profits. But, I just don't understand how capital can be a barrier to entry, if it is just a requirement of having a large amount of capital, why are smaller entities not grouping together to share in these large profits. Maybe I am missing something, but I just don't understand why other companies are not trying to get into this market, either large companies from other markets, or small companies working cooperatively, unless there is some huge barrier to entry.

I think a lot of local banks and institutions did enter the market and many obviously failed. You simply don't hear about them as often. The whole market probably wouldn't have collapsed, as precarious as it was, based on the failure of a local bank alone, but eventually the whole market was going to fail. The collapse of the large institutions first probably just brought the problem into focus and accelerated the decline. And conslidation forces act in financial markets just like anywhere else. Instead of the transactional costs of negotiating between separate entities, it's cheaper just to consolidate and not duplicate resources, and as I said previously, it should reduce the cost of capital. It also allows you to offer capital to consumers at a lower rate than your competitors.

And you're not that ignorant. This is a far better and more reasoned discussion than most here on P&N :thumbsup:. But we are probably far off track the OP, so PM me if you want to discuss further and we can delve deeper into theory.

 

[Craig234]

Originally posted by: LegendKiller

Originally posted by: Ausm

Originally posted by: spidey07
They made the banks money. They deserve a cut of the revenue they brought in. Stop the jealousy and think logically.

Think logically??? When it was those assholes that almost brought down the western world with unparalleled greed? They screwed the tax payer out of billions on top of it without the courtesy of a reach around. The worst part of it is the resistance of Washington to incorporate any meaningful change because those assholes are right back doing the same reckless practices. :roll:

Yeah, none of this had to do with the borrowers. I forgot, the banks forced the borrowers to sign all sorts of loan docs.

Be fair, hold out candy to a baby and he'll take it, hold out attractive loans to borrowers and they'll take them.

If you really want to claim that you should base your loan industry on the borrowers' restratint, you will see remarkable disaster result, but you know this.

Sounds to me like you were just lashing out at there being no criticism of the borrowers, which is understandable, but not much thought out in terms of the policy.

The underlying flaw was in people being rewarded for offering irresponsible loans because of machinination in the financial indusry, not the borrowers grabbing them up.

This might not be the ideal analogy, but imagine if car companies boosted proftis by lobbying for an end to driver's licenses, and the substitution of a policy that each driver was responsible for ensuring that their driving skills and knowledge of driving laws was meeting the old standards - knowing this would create new car buyers.

When the accident rate skyrocketed as bad drivers surprisingly did not behave responsibly and deny themselves the right to drive, you could blame them for that irresponsibilty.

But you and I know the policy issue did not lie with them, and that the policy makers and the interests who pushed for the policy are the ones to blame, and where the fix belongs.

In my analogy, the carmakers were able to externalize the costs of accidents, and internalize the profits of the increase in car sales (and replacement cars for the wrecked ones in the increased accidents). In the financial situation, the issue lies in the regulatory system allowing things bad for society to be profitable. There was a serious demand for more bad loans because of those flaws. People profited a lot from the bad loans.