Sunday, February 26, 2012

Socially Useless (financial engineering)

I wrote the paragraph on my note book around early 2010 when Goldman was investigated by Senate. A colleague think Senate investigation into Goldman's dealing right before the financial crisis is witch hunt. I disagreed with him.

My argument is as follows:
What is the purpose of synthetic CDO?
Why do you need to restructure sub-prime mortgage, making it looks safe, before selling it to banks and pension funds?
Isn't it because investors would not buy the sub-prime outright?
Why is it that four of the five major investment banks have a new boss after the financial crisis, but not Goldman?

Wall Street firms are proud of their "intellectual capital" that created CDO. But most of that financial engineering are socially worthless, because the bottom tranche was sold to investors who will take flight when the market get into trouble. They are not "stable insurer" of the credit risk. In the end, complex structure only serves to mask the risk, make it hard to discern. And when risk is hard to comprehend you have a credit expansion that is global in scale.

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