Why is finance so complex? (2011)

http://www.interfluidity.com/v2/2669.html

by mayukh • 11 years ago

164 144 11 years ago

fsk2• 11 years ago

Finance is complex because:

1. If a transaction is complex, it's easy to sucker people into buying. Why would anyone buy a structured product?

2. If a transaction is complex, both sides can claim an immediate profit based on their idea of how it should be valued.

3. A lot of complexity in finance is driven by the fact that big banks can borrow at 0% while true inflation is higher. Via various derivatives, this government interest rate subsidy is packaged and sold. For example, I can't borrow at 0% to buy stock, but if I buy a call option, the bank can borrow at 0% to finance their hedge.

4. Because different people have different interest rates (banks borrow at 0%, large corporations borrow at 5%), banks can price a derivative at 3%, and both sides can LEGITIMATELY claim an immediate profit on the trade. (Bank borrows at 0% and lends at 3% to finance the derivative hedge. The corporation is borrowing at 3% instead of the 5% they normally would pay.)

britknight3• 11 years ago

Banks don't necessarily borrow at 0%. Granted, they are able to borrow at a much lower rate than you or me (closer to the Federal Funds Rate managed by the U.S. Federal Reserve), but they still pay interest on their loans.

Of course, real interest rates have gotten close to zero, but in general real interest rates of 0% are nonsensical in stable, developed economies. Economically speaking, if rates were 0%, it would in the long run make sense to bulldoze the rocky mountains to save money on gas, because there is no marginal cost to consider.

jameshart2• 11 years ago

"if rates were 0%, it would in the long run make sense to bulldoze the rocky mountains to save money on gas, because there is no marginal cost to consider"

Wait, run that by me again more slowly.

In general, it does make sense to make large infrastructure investments in order to increase long term productivity, especially when interest rates are low, but in general, it's always the case. Hell, bits of the Rockies WERE bulldozed (And dynamited) to save money on railroad or freeway construction that would pay off on a fifty to a hundred year timescale. What does zero percent interest have to do with that? Presumably there are even some positive interest rate values for which the eventual gas savings outweigh the cost of hiring the guys with the bulldozers, if those are the only costs you care about.

If there's a quadrillion dollars worth of hydrocarbons on Titan, and it'll cost me a trillion dollars and fifty years to bring them to earth, it makes economic sense for me to do it, even if interest rates are 5%. I don't think it's the interest rate that makes these projects make sense or not make sense.

What's the magic that happens at zero that causes otherwise nonsensical projects to make economic sense?

stretchwithme• 11 years ago

Its possible to borrow money, blow through the cash on some unproductive investment and then be unable to repay the principle on the agreed-upon schedule.

pbreit• 11 years ago

Credit (including fractional reserves) definitely makes things a lot more common located.

pgwhalen• 11 years ago

Financiers are buyers and sellers of risk. They do so at prices that are generally advantageous to them. They are able to do so because they make a profession out of it: they have a lot of capital to work with, and they spend a lot of time thinking about it.

To call finance intentionally opaque is a perhaps true, but it shouldn't be vilified much more than other goods and services, the providers which all maintain some level of "opacity" towards their customers. In a sense, it's a fundamental part of any capitalistic transaction. A farmer sells an apple for more than it costs for her to make it, but you're willing to pay her for it because you aren't that good at growing apples. To her, it might be worth what it cost her to grow it, but to you, it is clearly worth what you are willing to pay for it, because you have the added benefit (or requirement) of being able to eat it and survive. So it is worth more to you, less to her, and she profits.

One could see similarities in insurance (much closer to finance than apple-growing, if not finance itself). An insurer charges you (or maybe an aggregated group of "yous") more than it costs to provide a certain protection (or hedge against a certain risk). You are willing to pay the premium because clearly the risk protection matters more than getting some "theoretically optimal" price.

With increased availability in technology and information, certain kinds of finance are becoming easy to do "on your own" - the most salient example is perhaps index investing. Many people are realizing that financiers cannot add value and they need less of a middleman.

I thought I'd share my contrasting thoughts, but I very much enjoyed the read.

applecore• 11 years ago

Consider that the Brownian model of financial markets was discovered by Bachelier in 1900, five years before Einstein, and the pace of financial innovation in the intervening century, and you have your answer for why finance is complex.

[1] https://en.wikipedia.org/wiki/Louis_Bachelier

aet• 11 years ago

The only good innovation in the intervening century was the ATM..

johnloeber• 11 years ago

The fundamental reason is because we may create financial products. They can be socially very useful, they may endow their creators with vast profits, or both. So the creation of financial products is strongly incentivized both from the buyer- and seller-sides.

However, there are only really two things that we can use to create these products: debt and risk. Thus, when we try to create financial products, we create structures composed entirely of debt and risk, which become very complex. The reason why they become so complex is similar to any other case in which you try to make highly sophisticated structures from only very simple/basic components: there ends up being a great number of details.

slg• 11 years ago

The core purpose of status quo finance is to coax people into accepting risks that they would not, if fully informed, consent to bear.

That is a pretty loaded statement. That would be like saying the core purpose of the software industry is to destroy jobs and in turn collect part of the salary that those jobs previously paid. It might technically be true, but it is twisting things to make them sound intentionally evil.

pessimizer• 11 years ago

But it's actually true. I've personally had the experience (as a freelancer) of watching people that I had just recently met be laid off because of what I was being generously paid to do. I did not like it.

I could at least comfort myself by the fact that what I was doing was actually useful (and creating efficiencies that destroyed jobs), whereas concealing risk is actively deceitful and destructive.

Lorento• 11 years ago

According to the article though, this deceitfulness is actually good, not destructive. It puts us into a more productive Nash equilibrium than we'd be if we each individually assessed the risk of our single investment and said "na, too risky".

techbio• 11 years ago

Efficiency is therefore deliberately harmful, except when in the form of a paycheck, QED.

Well done, good luck.

Tycho• 11 years ago

Derivatives are instruments for transferring risk from those who understand it to those who do not.

jerf• 11 years ago

Article appears to answer the question why does finance exist, not why is it so complex.

I think the answer for why is it so complex is that it is a human domain that rewards complexity.

First, humans that turn their full brain power on something inevitably make complicated structures. If you think about it, this becomes clear that it's true, even if there's absolutely nothing there. For instance, it's almost worth picking up a practitioner's book on numerology or astrology, a really "good" book that goes deep into the details and history, not just a superficial "intro" jobber, to witness the incredible complexity humans bring into a field that 90%+ of the readers of this comment will agree there is virtually no reason for it to possess, because there's no "there" there.

How much more complexity and richness we can bring to an already complex field!

And as others are pointing out already, finance also rewards complexity, both because people can hide things in the complexity and because people can fool themselves into thinking they understand the complex things, and because the interaction of all these complex things is even more complex.

You want another domain that works much like that? Consider any ol' pile of code that a software company runs on. It's bad enough that all software companies of any size are trying to solve a non-trivial problem, but throw a few hundred random developers at it and before you know it the "simple billing system" has 100-line buggy sorting functions sitting next to the double-booking accounting algorithms and all the other endless monstrosities we sometimes swap stories about on HN or various reddits. And then one day a trivial quirk in that sorting algorithm accidentally erases all the data in your customer database when it accidentally decided everybody had failed to pay their balances for over a thousand years or something. Computing is complicated even before humans start humaning the place up, but then it gets even worse.

h8trswana8• 11 years ago

The world of finance makes these aspects of your life function:

* Allows you to get a mortgage

* Allows you to protect yourself with health/car/life/home/title/etc insurance

* Pays for your highways/stadiums/schools and other public works

* Protects your deposits

* Pays for your retirement

* Funds the college fund that paid for your school

* ... Or the student loans that allowed you to attend school

* Supports the global supply chain that brings you your iPhone, stocks the grocery store/your favorite restaurants with food, and puts the clothes on your back.

* Funds the growth of corporations large and small, giving you the job that allows you to buy an iPhone

* Funds the massive philanthropy expenditures that help those in need everyday

* Pays the pensions of the elderly

Financial innovation make our lives more predictable and less sensitive to chance. One could argue a huge amount of human progress is owed to modern-day financial institutions.

Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten. Finance is an art, not a science. Sometimes we make products that we don't always completely understand until later. But the vast majority of financial innovations are deeply ingrained in the good life that you get to enjoy every day.

branchless4• 11 years ago

Allows you to get a mortgage which is a function of available credit which is near limitless and so becomes a function of your expected lifetime earnings. Times two now they lend at "household" income.

Education prices are also a function of available credit that tops out at expected total salary less food/rent expenses.

It's enslaving you. Unless you ride it and enslave others.

Your list reads like a wide-eyed econ grad. This is not the real world.

Also note the "we" in the statement. Vested interest.

Spooky232• 11 years ago

All of these were done 25, 50, or 100 years ago. The basis for the mortgage industry as we know it was developed during the new deal.

I need some serious convincing that the effects securitization of everything has been a net win.

The markets for most of this stuff are made or directly supported by the Federal government.

branchless4• 11 years ago

I think it's fine:

http://www.tradingeconomics.com/embed/?s=unitedstamonsupm0&d...

Look at that innovation! How is your life doing recently? I feel like mine is four times better. Oh no wait land is way more expensive and I'm working to pay my landlord every month. Should I go to my bank and make a huge bet on record low rates or wait for them to print some more whilst wages are static?

vasilipupkin2• 11 years ago

securitization is just the process of transferring risk from those who think they can't hold it to those who think they are very good at holding it. It is a tool, and it is a very good tool. A shovel is a tool and if I take a shovel and kill someone with it, that doesn't make the tool itsel bad

obrero• 11 years ago

Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten.

The reality is, the derivatives market is larger than the actual market. More capital is invested in calls guessing if Google is going up than is actually invested in Google. This is a sign something is rotten.

This article from 2008 has a lot of interesting data from after the subprime crash ( http://monthlyreview.org/2008/12/01/financial-implosion-and-... ). It then has an analysis of that data. Whether or not you agree with the analysis, the data it points to is interesting.

kazagistar• 11 years ago

Out of curiosity, where does the capital sit when it is "invested in derivatives"?

kristjansson• 11 years ago

The nominal value of the notes in the derivatives market is extremely large. However, we can't equate $500B notional of e.g. CDS written against Apple debt with $500B of Google stock. The CDS represents (1) to the seller, an small initial premium and a large, extremely low-probability liability requiring some collateral, and (2) a stream of future payments from or to the buyer, depending on the cost of insuring the debt. Up until a credit event, the only money exchanged is the premium, and perhaps some collateral, both of which are (for highly rated debt) orders of magnitude smaller than the notional value of the contract.

avmich2• 11 years ago

Well, there could be some counterarguments.

Allows you to get a mortgage

Wonder if that was always so? Didn't people manage somehow to have a house without something which name suggests it will be paid for the whole life?

Allows you to protect yourself with health/car/life/home/title/etc insurance

A casino, right? On average you lose, but for a price you buy a hedge against unforeseen? At least unforeseen for you?

Pays for your highways/stadiums/schools and other public works

I thought my taxes pay for that :) . Do you mean "finances" as "machinery which helps moving money"? I think there are several definitions there.

Protects your deposits

That's great and helpful

Pays for your retirement

Nah, that's those same deposits. I largely pay myself for retirement, by saving the whole life. There is also an element of "societal insurance", when I pay a little extra to help myself in case I suddenly become disabled. Or dead. Or, well, not so little; that depends.

Funds the college fund that paid for your school

Again, it's either another example of "moving money", or an oddity - as people managed to get educated even without banks.

... Or the student loans that allowed you to attend school

Same thing.

Supports the global supply chain that brings you your iPhone, stocks the grocery store/your favorite restaurants with food, and puts the clothes on your back.

Yes, that's another important role - bringing together lenders and borrowers, for a fee. One ought to assume the fee in the computerized XXI century should be small?

Funds the growth of corporations large and small, giving you the job that allows you to buy an iPhone

Same thing. Banks don't "fund" - they "serve". Money aren't theirs, but theirs', banks', depositors.

Funds the massive philanthropy expenditures that help those in need everyday

Talked about that already.

Pays the pensions of the elderly

We already talked about that.

So, to boil down - banks provide money-related services, like "guarding" deposits (you pay for the privilege) or "investing" deposit money (you ought to share risks and benefits). Other than that...

branchless4• 11 years ago

Most states provide a state backed deposit guarantee. It's not guaranteed by the banks.

Plus regarding "funding" education etc they do no such thing, this is funded by the state. The post you reply to is littered with incorrect statements. Well done for calling some out.

superuser2• 11 years ago

You seem to be confusing finance with retail banking.

Didn't people manage somehow to have a house without something which name suggests it will be paid for the whole life?

Well, for a while people were indentured farmers, then you got people renting tenements and apartments in cities, with some land-grant family farms/homsteads being passed down through inheritance. Mass suburban home ownership is mostly a post-WWII phenomenon, and mostly funded through credit. Though for a time, most people got their mortgages from community credit unions (or similar), those were still financial institutions, just in decentralized cooperative form. Big banks ended up being able to provide better rates through sheer scale.

A casino, right? On average you lose, but for a price you buy a hedge against unforeseen?

My mother had a brain hemorrhage last week, we paid about $1000 for $500k+ of medical care. The insurance industry works only because insurance companies can invest their giant pool of money and see large enough gains to both cover all their costs and make it worth their while. Insurance premiums aren't sitting around as cash.

Your point?

that's those same deposits

Nope, it's the interest on those deposits, the core service of the financial services industry. Retirement is entirely predicated on compound interest.

Same thing. Banks don't "fund" - they "serve". Money aren't theirs, but theirs', banks', depositors.

It's hard to imagine how you could possibly be more wrong. We're not talking about business checking accounts here, we're talking about banks investing in businesses. Banks absolutely do fund businesses, and own (shares in) those businesses in return.

An investment bank owns a business and, in turn, its checking accounts in retail banks.

I don't think you understand banks' roles in philanthropy and education - successful nonprofit institutions like universities draw their operating budgets from interest on their endowments. Were it not possible to park $x billion in account and draw $y million a year in interest for literally forever, many such institutions could not exist.

britknight3• 11 years ago

I thought my taxes pay for that :) . Do you mean "finances" as "machinery which helps moving money"? I think there are several definitions there.

You are correct in that the money used to build highways etc. does start as your tax dollars. However, I would imagine that it is then held (and allowed to appreciate) in the form of a reasonably liquid portfolio of cash, bonds, and equities. I suppose you could technically reduce finance to "moving money around", but that is such a gross simplification that it would be like saying programmers just type for a living.

Nah, that's those same deposits. I largely pay myself for retirement, by saving the whole life.

If your entire retirement savings are in simple savings accounts (i.e. in a bank instead of a brokerage account), I am afraid you are losing out on quite a substantial return that could allow you to either retire earlier or enjoy a higher annual income during retirement (or both).

> Funds the college fund that paid for your school Again, it's either another example of "moving money", or an oddity - as people managed to get educated even without banks.

The statement that college funds, loan programs, and scholarship endowments (all powered by "finance") pay for the education of practically every student in the country is true, unless you save for college in a piggy bank.

you ought to share risks and benefits

If you want to share the risks and benefits, there's an easy way to do that: get a brokerage account. If you have deposited your money, the basic assumption is that you are willing to accept a lower rate of return in exchange for a (practically) risk-free place to store your money.

depends on how much you want to rely on the FDIC

saryant• 11 years ago

> Pays for your highways/stadiums/schools and other public works I thought my taxes pay for that :) . Do you mean "finances" as "machinery which helps moving money"? I think there are several definitions there.

If your local municipality can go to Big Investment Bank Inc to arrange a bond issue, they can time-shift their tax receipts in order to build that new school/library/highway overpass now rather than 10 years from now.

nisa• 11 years ago

*If you life in a first world country and come from at least a lower-middle class background

You are talking about money. Not modern wall-street finance.

huge amount of human progress is owed to modern-day financial institutions.

Like synthetic credit default swaps?

Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten.

Complexity that can't be coped with is rotten! The Linux kernel is quite complex but each part of it is well understood and there are a lot mechanisms in software to reduce complexity.

But the vast majority of financial innovations are deeply ingrained in the good life that you get to enjoy every day.

Tell that to Greece people that got into the Euro because of clever CDS from Goldman Sachs or the masses of people that are stuck in debt from their education or credit cards.

Sometimes we make products that we don't always completely understand until later.

That does not stop you from selling them and acting like you do. However recent financial crises have shown that banks offering these products for the most part understand them... the persons buying them don't.

Funds the massive philanthropy expenditures that help those in need everyday

That shouldn't be needed in the first place if there wouldn't be such a huge inequality. Philanthropy is not a good idea for a good-working society. There are laws and a justice system that is more fair than a few far too rich persons with a selectively good cause.

Finance is an art, not a science.

And it should be a tool not an art. A means to an end.

irln• 11 years ago

*If you life in a first world country and come from at least a lower-middle class background

I'd say this used to be true, but now ZIRP (Zero Interest Rate Policy) hurts any class of savers first world et al

7Figures2Commas• 11 years ago

Like synthetic credit default swaps?

If you're against CDS, you should explain why.

Like any financial product, CDS is not perfect, but it's also intellectually dishonest to argue that it doesn't offer any benefit to society. For example, CDS is used widely by the insurers that the parent noted help individuals protect themselves and their property.

Complexity that can't be coped with is rotten! The Linux kernel is quite complex but each part of it is well understood and there are a lot mechanisms in software to reduce complexity.

You apparently assume that the financial markets are too complex to be managed but poll people on a busy street in any major city and many will probably tell you they feel computer software is unmanageably complex too. Should we call software rotten because some people who used it have suffered some loss as a result?

Tell that to Greece people that got into the Euro because of clever CDS from Goldman Sachs or the masses of people that are stuck in debt from their education or credit cards.

It takes two to tango. It would be unfair to pretend that some of the near countless individuals and companies active in providing financial services have not acted immorally or even illegally, but it's intellectually dishonest to pretend that every person who has taken on more debt than he or she can manage is a victim who was coerced into making financially imprudent decisions.

This applies to countries too.

However recent financial crises have shown that banks offering these products for the most part understand them... the persons buying them don't.

Save for Lehman, which was allowed to fail, the large banks were bailed out. If they were as savvy as you seem to think, why did they need bailouts?

forrestthewoods2• 11 years ago

"Complexity that can't be coped with is rotten!"

I respectfully disagree.

https://en.m.wikisource.org/wiki/I,_Pencil

sseveran2• 11 years ago

Like synthetic credit default swaps? You mean a synthetic CDO? CDS don't need to be synthetic.
Tell that to Greece people that got into the Euro because of clever CDS from Goldman Sachs The people of Greece (and their political leaders) wanted to get into the Euro. They spun their own fiction.

Ntrails• 11 years ago

The Linux kernel is quite complex but each part of it is well understood and there are a lot mechanisms in software to reduce complexity.

Well understood by experts, as is the appropriate section of the financial system. You chose to learn about the kernel, someone else chose to learn about asset backed securities. The guy who learned about Bach probably considers both to be very complex.

random_6hm9v3• 11 years ago

I bet you don't own an iPhone (because the explanations were solely for that specific category of people)!

</sarcasm>

vezzy-fnord• 11 years ago

The fallacy here is assuming that because it does all of those positive things, it must therefore holistically be optimal.

Like a software system, it's extremely naive to think that complexity is a sign that a system is rotten.

Why would such an assumption be naive?

It doesn't seem naive to me at all. I was reading a 1994 paper that I posted recently called "A Uniform Name Service for Spring's UNIX Environment" which made me think how simplified a modern Unix could be if it adopted the name service primacy described therein from its onset.

It is just as naive to assume that all complexity is intrinsic and not incidental or the result of inadequate abstractions.

gbog2• 11 years ago

Yes. For instance, before invention of vector notation, many laws of physics were extremely complex. Before Copernicus system, describing the movements of planets was very complex too.

While not hundred percent sure, it is highly possible that finance complexity will magically disappear once we get a proper model for money transactions. I certainly hope so, because a better model means more means to solve economic issues.

Right now economists are like the physicians in the time of Molière, they understand nothing and have only two cures: bloodletting and lavement (change interest rate and remove taxes)

amelius• 11 years ago

This is why we should have more software architects and systems engineers working in politics. They know how to deal with problems at multiple levels of abstraction, and they know how to keep complexity down.

jsprogrammer5• 11 years ago

* Allows you to get a mortgage

Simply the base artifact of modern finance. Why do I need a mortgage? (hint: to supply interest payments to banks AKA the institutors of the world of modern finance)

* Allows you to protect yourself with health/car/life/home/title/etc insurance

See above.

* Pays for your highways/stadiums/schools and other public works

"Pays". A meaningless word.

* Protects your deposits

Only through magic. If deposits are lost, they are merely re-created as modern finance is an arbitrary mathematical construct.

* Pays for your retirement

"Pays for your retirement"

* Funds the college fund that paid for your school

"Funds the fund" that "paid". Again, meaningless except insofar as your school depends on magic numbers being circulated.

* ... Or the student loans that allowed you to attend school

Ah, yes, the loans; again, the foundational unit of modern finance, without which the "world of finance" would be radically different.

* Supports the global supply chain that brings you your iPhone, stocks the grocery store/your favorite restaurants with food, and puts the clothes on your back.

Supports in name, but is curiously not actually involved in any physical aspect of realizing any of those things.

* Funds the growth of corporations large and small, giving you the job that allows you to buy an iPhone

"Funds" ... "giving [me] the job"

* Funds the massive philanthropy expenditures that help those in need everyday

"Funds", because the actual work is done by real people.

* Pays the pensions of the elderly

I guess the system isn't complete evil.

bluedevil2k• 11 years ago

You need a mortgage because you don't have $400,000 in cash sitting around.

You need insurance because you don't have the personal finances to adequately cover the risk of "life"

tjradcliffe• 11 years ago

Why do I need a mortgage?

If you want to see what life is like without access to modern financial tools, got visit an Indian Reserve in Canada. Housing is cheap there.

Lack of access to modern financial instruments--municipal bonds in particular--is a major block in the way of First Nation's prosperity. Last year a new kind of "aboriginal bond" was floated for the first time to get around this, and hopefully more will come.

So you have an example of what life looks like in your dream world. It isn't pretty. And like everyone else who is pro-finance here, I'm not saying there aren't issues with what we've got. We can fix them. What we can't fix is the massive poverty that comes without access to financial tools, however morally repugnant those tools seem to naive outsiders.

_nedR2• 11 years ago

Financial innovation make our lives more predictable and less sensitive to chance.

lol.

Seanambers• 11 years ago

Go live in a world where theres no securitization of debt, no interest on debt, no mitigation of risk, no insurance against risk, hell even no banks.

No banks means no jobs, bad housing, no tools, no pc's, no security, no stores - but that dosnt matter, cause you dont have any money either, bad food, no mass production++

Most people commenting in this tread has no concept about what finance is and does, so it must be inherently evil.

Well, the world is more complex than that. Without finance your standard of living would probably be below one tenth of what it is now -unless you already live on the street of course. But then you wouldn't care because you'd probably be a alcholic or druggie. You won't get hold of any drugs or boose either so your fucked as well.

Tldr; The world runs on debt & oil. Get used to it, it isn't going to change anytime soon.

dabeeeenster• 11 years ago

All these things were available 50 years ago.

jaawn4• 11 years ago

Exactly. The adjective "innovative" has an inherent timeframe associated with it. I don't think we can consider mortgages "innovative" in 2015.

tempodox• 11 years ago

Financial innovation make our lives more predictable...

Not necessarily. It may also make our lives a game of chance or a house of cards. You didn't say what kind of innovation.

Altay-• 11 years ago

Banking allows us to get mortgages.

"Finance" gives us 2% down payment mortgages which are than packaged and sold to Japanese pension funds with currency and interest rate hedges mixed in... which then go on to screw everyone involved since NO ONE reads or understands the terms of the investment vehicle besides the financial engineers who wrote & sold them.

The same holds true for all the points you listed.

Fortunately, Capitalism has a fail safe. All this financial nonsense would have been fixed if the banks were allowed to fail in 2008. The US federal government is largely to blame for the continued parasitical rent seeking of the high finance class.

jaawn4• 11 years ago

Financial innovation...

This vague phrase is very misleading. It is certainly not true that all "Financial Innovation" makes our lives more predictable and less sensitive to chance. Please see 2008 for reference.

Sure, there are some benefits to basic finance and lending, but "basic finance and lending" are not really "Financial Innovation" at this point either. I think we would all benefit if you defined your terms better.

rorykoehler3• 11 years ago

Currently the financial system generates profit while destroying value. It's out of control and only serves the interest of those who already have considerable amounts of capital.

reactor• 11 years ago

https://www.youtube.com/watch?v=iFDe5kUUyT0 series is a good watch and will give you an idea why they "made" it complex.

icanhackit• 11 years ago

Animal spirits are game theory

Human behavior is a large part of the complexity because we try to use things like game theory to predict how someone will act based on a confined set of conditions which totally ignore the very long game which has been playing from long in the past and will continue long in the future. There are too many factors to account for which can make an actor appear irrational given the posited conditions, however the truth is there can never be a rational actor until we map every input and interaction in someones life. This is why the idea of a rational actor is horseshit.

Nick Szabo did a recent post that covers this:

A small-game fallacy occurs when game theorists, economists, or others trying to apply game-theoretic or microeconomic techniques to real-world problems, posit a simple, and thus cognizable, interaction, under a very limited and precise set of rules, whereas real-world analogous situations take place within longer-term and vastly more complicated games with many more players: "the games of life".

http://unenumerated.blogspot.com.au/2015/05/small-game-falla...

brownbat• 11 years ago

Or, some investment decisions resemble Keynesian beauty contests:

https://en.wikipedia.org/wiki/Keynesian_beauty_contest

querious• 11 years ago

I think of it as an arms race between traders and regulators. The more complex the security, the longer it will take regulators to pass rules against its misuse, figure out taxation, etc. In the meantime, the inventor stands to make an enormous amount of money.

Also, there's an inherent information asymmetry favoring the inventor.

curiousjorge• 11 years ago

because it attempts to quantify and model the unpredictable and lot of people are paid very well to keep that image going for as long as they can.

conductr• 11 years ago

Because telling the future is complex

hartator• 11 years ago

Taxes also had a lot to do of the complexity of the system.

rcarrigan87• 11 years ago

Finance is just a set of tools. Just like anything else it really comes down to the moral fiber of the individual wielding that tool.

Fischer Black and Myron Scholes weren't sitting in front of their white board thinking about all the people they could rip off. They were genuinely trying to find a way to price options as a tool to mitigate risk.

I can use a hammer to build a house or sink the hammer into my enemies head. Either way, it's still a hammer.

innguest4• 11 years ago

"The study of money, above all other fields in economics, is the one in which complexity is used to disguise truth or to evade truth, not to reveal it."

John Kenneth Galbraith, Money: Whence It Came, Where It Went (1975), p. 5

hiram112• 11 years ago

FWIW, I'm relatively quick, pick up languages (both CS and natural), frameworks, algorithms, etc. without much trouble.

But I've tried again and again to understand how our basic Federal Reserve System functions - Gov't debt, banks, reserve margins, mortgage loans, etc. etc.

I've NEVER gotten a basic "THIS IS HOW IT WORKS in 21 DAYS", Stack Exchange-type-answer. Lots of opinions...

This itself leads me to believe that Finance is corrupt.

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.

T. Jefferson

iolothebard3• 11 years ago

Lmao, can't understand it so it's corrupt.

Sounds like all the people that think the same about IT. It's "magic".

Buy and read some books, it's laid out pretty clearly. If you're not sure what to read, email some of the professors in finance at the University you went to.

Sone7• 11 years ago

I'm curious what makes you so sure you really understand it? It seems to me that when wealth is being concentrated more and more into the hands of the wealthiest all over the world, there is something deeply wrong with the financial industry and its textbooks.

jaawn4• 11 years ago

If you think you understand the truly complex parts of finance, I would encourage you to re-evaluate. The world economy is still in turmoil and slow recovery because a huge amount of the experts didn't even properly understand the "innovative finance" they were using in 2008.

I don't understand it, and I have seen countless interviews and articles from respected economists who say there are financial products they don't totally understand either.

To "understand" something in finance is not quite the same as other disciplines. You can understand all the pieces and all the rules of something, but not truly "understand" it entirely. Economics involves a lot of sociology/psychology and difficult-to-predict human behavior. It is likely that no one is completely aware of all of these factors when it comes to any given financial instrument.

So, I don't think you should be laughing at someone and telling them to read books as if this is algebra or something.

tedunangst• 11 years ago

Stop quoting lies. http://www.monticello.org/site/jefferson/private-banks-quota...

jaawn4• 11 years ago

It may be inaccurate, but it is hardly "lies." It is clear from the other verifiable quotations on your link that Thomas Jefferson would probably agree with the misquote anyway.

Animats• 11 years ago

"The core purpose of status quo finance is to coax people into accepting risks that they would not, if fully informed, consent to bear."

This. If you have money, and let it be known that you have money, you will be offered a large number of stupid deals. There is a huge range of financial products out there which underperform the market. Amazingly, people buy them. Wealthy people.

The deals offered poor people, such as payday loans, and crap auto loans, suck even worse. Most Americans were better off when we had regulated savings and loans, tightly regulated banks, and a much narrower range of financial products.

erebus_rex• 11 years ago

The inherent role of finance is NOT to hide risk. Its role is to connect people who have one type of asset they no longer want with someone who does.

In that way bankers are just like lawyers and accountants. You pay someone to do things you don't have the time to do (or even learn how to do) so you can focus on your job. Its division of labour at the macroeconomic level and everyone benefits from specialisation.

Now, I agree that contemporary finance is bloated with opacity and that banks do benefit from this via corruption (tax code and compliance reform are needed ASAP). But its disingenuous to say that the value of finance is entirely "placebo".

kmonad• 11 years ago

Curiously, placebos work even if the patient knows it is a placebo. Hence http://placebobutton.com/

More on topic, this article is full of red herrings and poor analogies such as the above. Why on earth would you use game theory's payoff matrices as an analogy to what could perfectly be put into words? The authors thoughts on "financial institutions buffering fear" really don't require invocation of another complex framework unless he somehow wants to derive credibility from this, which would of course be poor form.

KaiserPro• 11 years ago

Finance is not complex. It really isn't. if you know the right people you can find out all the information you need. However:

The very foundations of Finance are built on sand

What do I mean by that? Finance is built on the concept of value, or worth. "How much is this gold worth?", "how much is the client willing to pay for this service?"

The concept of value and worth are subjective. They are in the eye of the beholder:

If you ask a thirsty backpacker stranded in the middle of the Sahara: How much are you willing to pay for a 2 litre bottle of water? The answer, most likely is many monies & possible limbs.

Now trying flogging the same water to city trader in a champagne bar.

I can hear you scoffing, "Oh but that's a silly example, the backpacker was practically dead" Correct, worth is subjective. Its based on your circumstances. There are many other examples, the Turner painting in a jumble sale, the sale of a sports car when the wife becomes pregnant, etc, etc.

Complex derivatives are really not complex. They are normally a "RAID" of different types of contracts. What then happens is the end user is deliberately bamboozled into not asking questions.

jackgavigan• 11 years ago

Finance is complex because it's basically math. And math can get very complex.

ostyn• 11 years ago

Definitely read "fiance". Maybe I'm just projecting.

bakhy• 11 years ago

This reminded me of the concept of demurrage in currency [1]. The idea was brought up to solve that exact problem. The messy system of inflationary fiat currencies won, and even though it is probably better and more practical, the demurrage would have had the advantage of making it clear what we're trying to achieve. Inflation seems to be hated by many people which, judging from their other political viewpoints, should be supportive of it...

[1] https://en.wikipedia.org/wiki/Demurrage_%28currency%29

fiatmoney• 11 years ago

There was a nice result a while back that the efficient market hypothesis is true IFF P=NP.

http://arxiv.org/pdf/1002.2284.pdf

ryeguy_24• 11 years ago

I disagree with the main thesis here. The author states that complexity is due to opacity. This may be true in some cases but there are a number of complexities in finance that are not opaque. For example, look at all the optionality and contingent payouts in an 'Power Reverse Dual Currency' derivative. It's a really complex thing. However, the term sheets tell you everything about the transaction and the ultimate payout of the derivative (it may be 50 pages long, but it's all there).

To say that all things in finance are complex because they are opaque is pretty wrong. Maybe the author is talking about a different dimension of finance (e.g. the unpredictability of human behavior, I mean sure, that's opaque, but that's not finance).

Why is finance so complex? (2011)

Related Stories