Friends don't let friends get into finance

http://techcrunch.com/2011/03/26/friends-don%E2%80%99t-let-friends-get-into-finance/

by mayukh • 15 years ago

140 139 15 years ago

ulugbek2• 15 years ago

Only way you compete with Wall Street is you increase the utility of expected payoffs, not just the wage. People who are going to WS have different risk profiles than entrepreneurs. You can have low participation in entrepreneurship as long as participating ones are competitive and innovative. It is better use of talent and time if those who would have failed anyways (because they don't have the guts, etc) go and make themselves useful elsewhere.

orijing• 15 years ago

I think you have it backwards. It's not about max_a U(E(a)), but of max_a E[U(a)]. Otherwise insurance wouldn't work.

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.

ulugbek2• 15 years ago

You are right

secretasiandan5• 15 years ago

the quant finance that takes the best and the brightest (as opposed to the bankers and sales traders), uses informational and computational advantage to make money.

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?

erikpukinskis2• 15 years ago

People generally won't use your site unless it helps them in some way. It makes their life easier, it helps them move information around, or they enjoy it. It's debatable whether the specifics represent a net good for humanity (cough Zynga cough) but there's at least a decent chance that you're helping folks out.

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.

secretasiandan5• 15 years ago

"And it seems like the smarter the employees, the less likely they are to actually be providing any real services to people"

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?

rbarooah29• 15 years ago

Will the government bail out the photo sharing sites when they fail?

med5558• 15 years ago

Photo sharing sites doesn't cripple the entire economy when they fail.

fleitz4• 15 years ago

If photosharing sites can make enough campaign contributions it should definitely be possible.

richardw3• 15 years ago

Well, we don't transfer our pensions, salaries and every bit of capital and risk through startups. If we did, I'd say we need to watch startups a lot more carefully.

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...

tedunangst• 15 years ago

"They note that the finance sector today produces a greater percentage of GDP than at any time in history."

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?

rriepe• 15 years ago

They follow up with why it's noteworthy in the very next paragraph: "Historians will tell you that empires collapse when they become too dependent on finance, but I’m not so pessimistic."

med5558• 15 years ago

...and economists will tell you something completely different. His points are awful and rely on no empirical evidence.

rbarooah29• 15 years ago

It's a problem because unlike other activities finance produces benefits to society only when it well, finances people doing things other than finance. Other activities are valuable in themselves.

med555i2• 15 years ago

You do realize companies that provide those valuable goods can grow faster, hire more people, and grow our economy's GDP much quicker, with more capital, correct?

Dove2• 15 years ago

I still find it hard to parse that as a problem. I mean, power generation only provides a benefit to society when someone uses the electricity to do something.

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.

ig13• 15 years ago

The report was produced by the Kauffman foundation, a foundation dedicate to improve entrepreneurship. It's not exactly an unbiased piece of research.

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.

rbarooah29• 15 years ago

Presumably this growth that the finance has supported is happening somewhere other than in the US?

med5558• 15 years ago

Ummm, growth is still happening in the U.S., and has continuously happened aside from a few quarters here and there. The point is not if we're growing, but how much faster we can grow. This is very basic economics.

ig13• 15 years ago

http://timetric.com/topic/us-gdp-all-statistics/

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.

asanwal6• 15 years ago

Article is totally absent of any substantive suggestions to "fix the problem". The real issue is that if you look at the risk-adjusted reward of doing or working at a startup, it doesn't compare well with working on Wall Street.

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.

Jd2• 15 years ago

The title is a suggestion. Discourage your friends from putting their energies into creating financial products of dubious value and instead encourage them to engage in substantive work that makes a clearly positive contribution.

Yes, yes, I know you want a secure source of income. Well, try think about ethics first, if not only.

asanwal6• 15 years ago

These generalizations about finance being unethical are misguided and misinformed.

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?

larsberg• 15 years ago

It's not even about a secure source of income. Unless you're a founder, simply low-single-digit employee number doesn't give you enough equity to beat even a low-end finance job. Simple math: if you do your business, 9-to-5 only, you'll be in the 150-200k range within 5 years of graduation. If you decide to manage and make it up a rung or two, join a financial startup, or just make "tech lead/architect" double that income.

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.

richcollins3• 15 years ago

It's easy to fix the problem. Stop the government from stealing money and giving it to the banks.

med5558• 15 years ago

Please explain how the government is "stealing money" for the banks. That is completely absurd. Monetary policy keeps the system in check to stabilize the economy.

rbarooah29• 15 years ago

Finance firms put 100% of their time and energy into finding ways of making money out of existing money without producing any other value.

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%

med5558• 15 years ago

Google. Zynga. Facebook. Intel. eBay. Apple. etc.

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.

rbarooah29• 15 years ago

The evidence is that the finance industry has grown faster than all of the other sectors, proving my point.

I'd highly recommend that you rely your points on empirical evidence than empty claims.

haploid• 15 years ago

Zynga contributed to the economy's growth? Really? Farmville increased average worker productivity?

Jd2• 15 years ago

I'm of the opinion this understates the problem.

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.

secretasiandan5• 15 years ago

Not all ideas can or should be taught in (elite) colleges. The framework to analyze any idea should be and generally is taught at colleges.

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?

jbooth• 15 years ago

Fair enough, but culture matters. When you're surrounded by a culture of people who glorify rent-seeking jobs like finance and lawyering, "building stuff" tends to be regarded as lower-status and as such gets less of the top talent, even though it's the most important thing.

maigret2• 15 years ago

Insurance creates value, and so do banks. The problem really begins when the banks try to get more revenue than the value they can possibly generate. That's when it goes into bubbles and finally breaks. Insurance has its risks also, but the insurance system doesn't crash every couple years from itself (major natural events, terrorist attacks etc not taken into account).

hammock• 15 years ago

Repackaging debt is not an "accounting trick," it's creating liquidity. Which in turn allows more more "real" transactions to take place, more trade, more production, more manufacturing, more jobs, etc.

chopsueyar8• 15 years ago

So far, so good.

mattdeboard4• 15 years ago

It's an accounting trick that artificially stimulates the economy by tricking people into thinking their imaginary dollars are worth more real goods than they actually are.

techcrunchtroll• 15 years ago

Some career advice for all of you on Hacker News.

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.

gfodor• 15 years ago

"Life is what happens to when you are busy making other plans"

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."

jgamman• 15 years ago

pay bulk of your salary into a savings account. get used to living on say, 20% of it. you'll see pretty soon if you're 'following you dream' or getting hooked on cash

Dilpil• 15 years ago

If investment banking is so needless, why did the economy falter when lehmen brothers went bankrupt?

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?

prodigal_erik2• 15 years ago

> 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?

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.

yummyfajitas9• 15 years ago

...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?

secretasiandan5• 15 years ago

Can you tell me more about these commitments and what makes them expensive?

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."

http://www.sec.gov/comments/s7-02-10/s70210-122.pdf

rbarooah29• 15 years ago

If brain tumors are so unnecessary, why do people die from having them removed?

chopsueyar8• 15 years ago

Most importantly- if these products are useless and harmful, why do people keep buying them?

I could not tell if you were talking about finance or cigarettes.

fleitz4• 15 years ago

Perhaps it's not a problem with finance but a problem with other industries that don't pay their people well. Who is to say that a CDO isn't a valuable economic activity?

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.

shareme• 15 years ago

all derivatives are not coupled to supply and demand hence their economic value as less than zero...

Once you get off being coupled to supply and demand the cost of bailouts far out weighs any short term value

astrofinch• 15 years ago

I find your arguments plausible, but many finance companies were bailed out in a big way by the government recently. I think it's possible that some of these companies were playing games that gave them a high probability of a decent gain and a small probability of a catastrophic loss. It seems unlikely that playing this sort of game contributes to more accurate pricing.

fleitz4• 15 years ago

Well actually some of the guys who did VERY well did so by buying CDSs (credit default swaps) against CDOs (collateralized debt obligations) it's very likely that the bubble was curtailed before it got even further out of control as some very smart individuals were able to short the housing market via a CDS against a CDO. This pricing differential was essential to Goldman getting out of CDOs and into CDSs against CDOs after they figured out what John Paulson and others were up to.

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.

richcollins3• 15 years ago

The problem isn't the ability to create financial instruments. It's the fact that the people that created and purchased these ill-advised investments were given the resources of those that didn't make bad decisions (through inflation and taxes).

It's easy afford outrageous salaries when your revenue comes from government assisted theft.

fleitz4• 15 years ago

I definitely agree with you that the bailouts are a huge problem, however, it's not like the alternatives presented for engineers in the article also don't get a sizable portion of their funding from the gov't.

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.

nhebb• 15 years ago

I'm tempted to create a 1000 fake accounts just so I could upvote you more.

JGuo• 15 years ago

Complex financial derivatives may not be as tangible as other engineering endeavors, however they do have tremendous value to businesses looking to hedge their risk and offer flexibility to their business models. The economic collapse caused by these complex financial instruments was not due to the Phd's that created these derivatives, but by the traders that didn't full understand the limitation of the risk models, as well as the moral hazard in packaging toxic assets into CDO's knowing they would easily be able to pass it along. Having said that, I'm glad I didn't sell my soul and become a banker ;)

richardw3• 15 years ago

So give the YC futures market idea a couple years. What would the result be? My guess:

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.

billjings• 15 years ago

It all comes down to allocation of capital, though. It's all economic overhead. How much are we spending to efficiently allocate capital? About nine percent of the whole economy, apparently.

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.

lotharbot• 15 years ago

> How much are we spending to efficiently allocate capital? About nine percent of the whole economy, apparently.

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.

mattdeboard4• 15 years ago

Your argument falls apart at the predicate. CDOs (and other exotic financial instruments) do not provide real value, not in the long term, anyway. This argument is exactly how Wall Street bankers & traders justify their crappy activities.

"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.

[1]http://en.wikipedia.org/wiki/Unidade_real_de_valor

yummyfajitas9• 15 years ago

Many of the uses of computers provide only "imaginary value" (to borrow your phrase).

Google and Facebook, for example, merely provide a convenient way of getting information quickly. Markets and price discovery do the exact same thing.

jleyank• 15 years ago

paul kennedy. Britain. 1914.

Genmai• 15 years ago

The real challenge underlying Wadhwa's article is how to incentivise traditional engineering careers to counter the lemming run to investment banks and hedge funds that the best technical minds make these days. Because high finance careers offer lucrative compensation according to market demand for talent, perhaps the demand itself needs to be adjusted.

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.

Friends don't let friends get into finance

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