Monday, January 28, 2008

Rant - the financial mess

If you are interested in finance, the stock markets and that whole area as I am, you are probably well aware of the amazing stupidity, cupidity and downright duplicity of our "financial community". Little by little the news is getting out that these people are making the old "robber barons" like John D. Rockefeller look like pretty nice people.

The stories of the guy who brought down Barings Bank and now the guy who caused a French bank to lose something like $7 billion dollars (3.5 billion euros I think) are the stories of crooks. They get caught sometimes and go to jail sometimes and sometimes not. I don't really care about them. It's the other ones that bother me.

The people who have invented these incredibly complex transactions are the people who are scary. I was reading about this financial product called a TOB - a Tender Option Bond. What they do is buy a municipal bond - a bond issued by some local governmental agency. In the US the interest on such bonds is usually tax-free. Then they borrow perhaps 80% of the value of the bond using it as collateral; then they borrow more money, like the remaining 20%, from someone else again using the bond as collateral. Thus, you are getting interest tax free but have your money back as well while paying interest that is tax deductible for corporations. It is when the lender's start fooling around trying to reduce the chance of loss that things get hairy.

The problem is that it does get much more complicated from there. Interest rate changes, especially, are going to change the value of the basic bond; therefore the amount borrowed may no longer be secured. The people who work in brokerage houses can't tell the future any better than your horoscope. I don't believe they can see the problems inherent with these complexities either. That's why Warren Buffett keeps speaking out against derivatives - the more complex the transaction, the more likely it is to crash.

I wish there was a way to get the world out of this mess but it's going to be ugly if it ever does happen. It will make this subprime mess look like good days. So what can we do? 1. Try not to invest in weird things like this. 2. Sit quietly and hope like hell nothing happens! At least those are the only ideas I have. If you have any, I'd love to hear them.

2 comments:

Lee said...

My income is from shares and my philosophy is keep it simple; very, very simple.

Don said...

Well said!