I understand slightly more, which is good because before my understanding was “nothing”.
I wish a banker could explain to me, in terms acceptable for a 10 year old, why there have to be so many layers/processes/rules/rates to the banking system anyway. Didn’t it work when money actually meant dollar bills that existed in real life? I am so confused.
@cmcm Money never actually meant dollar bills that existed in real life.
At the end of the day, banking isn’t all that complicated, but they have to make it sound that way to justify their exorbitant salaries and so they can say “Nobody could have possibly known! Rocket science!” when they fuck up.
EDIT: The tree metaphor is whack, though. I’m not sure where she’s going with that.
@stuffisthings The tree metaphor is great! She’s basically explaining tranching, which is when banks package up mortgages/loans/what have yous and sell them to other banks, investors, etc. who used LIBOR, so American banks started using LIBOR and now everyone uses LIBOR (it’s fun to say, really).
@lalaland But the metaphor doesn’t make sense. She says the motivation for tranching is that the trees can catch on fire. So you chop them up into firewood and trade them around, and everyone ends up with a big pile of firewood instead of an orchard full of living trees? Isn’t that far more of a fire hazard? Also, a tree is alive and “grows” (continues producing money) while firewood is dead.
I mean if it was supposed to be some wry comment on why tranching is NOT a good idea, OK, but that’s a little too subtle for a “What is LIBOR?” article, and far too blunt as a metaphor for sophisticated readers because it doesn’t address the putative motivation for splitting loans into tranches, which was to better control risk.
@stuffisthings Haha touche. Maybe not the best metaphor, and possibly a slight against tranching, I just imagined little mortgage trees sprouting and was pleased. I re-read it, it sounds like the mortgage trees are already dead (?):
“hundreds of thick, heavy mortgage trees would pile up in the tiny backyard”
So either way there are dead trees and fire, it’s just large dead trees and big fire in one place vs. lots of little logs and potentially smaller fires in lots of places (which just turned into lots of big fires in lots of places in 07-08). Ahh I don’t know. What would be a good metaphor for tranching?
@lalaland Betting all your money on one horse, versus betting a little bit on a lot of horses? Or investing in the S&P 500 rather than putting all your money in one blue-chip company? Does it have to be non-money related? Not putting all your eggs in one basket? And then selling the different baskets of eggs to different people? Only SOME OF THEM ARE SPOILED!
I never really got why the idea was so complicated, personally. Like I said, I think financiers and financial journalists just like to make things SEEM complex to justify their high-paying, high-status jobs…
@stuffisthings It definitely has to be non-money related. The horse one would be like if you had an okay horse but then chopped it up with other, sometimes better, sometimes worse, horses and then tried to sell it as an above average horse. Maybe instead of chopping up, breeding? Less bloody, but would take longer.
I think some of the idea/things financiers make up are actually (unncessarily, purposefully) complicated but only so they can keep shuffling things around and skimming a bit off the top as they shuffle.
@lalaland I just wanted to add here that the reason I keep saying this idea is not that complicated is not so I can seem like a genius. Indeed, the basic concept of chopping loans into tranches and using these tranches to manage risk would take about as long to explain to my barista as it would take her to show me how to make an iced mocha (Consider this: if I loan $100 to someone who has a 5% chance of defaulting at 10% interest, how much is it worth? I would write down “$105″ for accounting purposes, but when the loan came due I’d either make $110 or lose $100.) In fact, the idea makes a lot of sense and in theory should actually reduce risk. The problem was that lots of people and organizations systematically lied and intentionally defrauded each other.
So saying “oh it’s all so complicated, and probably a bit silly to begin with” — as financial journalists love to do — is not only condescending, it helps to obfuscate the real problem!
@stuffisthings Anyway, the explanation of LIBOR was just fine. The only omission I noticed was that if Barclay’s lying and reporting too-low LIBOR rates HAD influenced the markets, the result would actually be LOWER rates for consumers on their mortgages and other loans. So to the extent that it happened at all, the fraud was actually against other banks to the benefit of consumers.
@stuffisthings Wouldn’t it actually be worth (0.95*110)+(0.05*0) = 104.5? And then wouldn’t you have to discount that by the rate of inflation in order to figure out the net present value of that $104.50 (assuming you were going to sell the loan to someone else at that moment)? And also, if the risk-free nominal interest rate for the same period were more than 4.5%, wouldn’t it be a bad decision to make the loan in the first place at all?
Any or all of this could be wrong, I’m just not sure where the value of $105 is coming from. I also don’t know accounting, though, so forgive me if this is ignorant.
I understand slightly more, which is good because before my understanding was “nothing”.
I wish a banker could explain to me, in terms acceptable for a 10 year old, why there have to be so many layers/processes/rules/rates to the banking system anyway. Didn’t it work when money actually meant dollar bills that existed in real life? I am so confused.
@cmcm Money never actually meant dollar bills that existed in real life.
At the end of the day, banking isn’t all that complicated, but they have to make it sound that way to justify their exorbitant salaries and so they can say “Nobody could have possibly known! Rocket science!” when they fuck up.
EDIT: The tree metaphor is whack, though. I’m not sure where she’s going with that.
@stuffisthings The tree metaphor is great! She’s basically explaining tranching, which is when banks package up mortgages/loans/what have yous and sell them to other banks, investors, etc. who used LIBOR, so American banks started using LIBOR and now everyone uses LIBOR (it’s fun to say, really).
@lalaland But the metaphor doesn’t make sense. She says the motivation for tranching is that the trees can catch on fire. So you chop them up into firewood and trade them around, and everyone ends up with a big pile of firewood instead of an orchard full of living trees? Isn’t that far more of a fire hazard? Also, a tree is alive and “grows” (continues producing money) while firewood is dead.
I mean if it was supposed to be some wry comment on why tranching is NOT a good idea, OK, but that’s a little too subtle for a “What is LIBOR?” article, and far too blunt as a metaphor for sophisticated readers because it doesn’t address the putative motivation for splitting loans into tranches, which was to better control risk.
@stuffisthings Haha touche. Maybe not the best metaphor, and possibly a slight against tranching, I just imagined little mortgage trees sprouting and was pleased. I re-read it, it sounds like the mortgage trees are already dead (?):
“hundreds of thick, heavy mortgage trees would pile up in the tiny backyard”
So either way there are dead trees and fire, it’s just large dead trees and big fire in one place vs. lots of little logs and potentially smaller fires in lots of places (which just turned into lots of big fires in lots of places in 07-08). Ahh I don’t know. What would be a good metaphor for tranching?
@lalaland Betting all your money on one horse, versus betting a little bit on a lot of horses? Or investing in the S&P 500 rather than putting all your money in one blue-chip company? Does it have to be non-money related? Not putting all your eggs in one basket? And then selling the different baskets of eggs to different people? Only SOME OF THEM ARE SPOILED!
I never really got why the idea was so complicated, personally. Like I said, I think financiers and financial journalists just like to make things SEEM complex to justify their high-paying, high-status jobs…
@stuffisthings It definitely has to be non-money related. The horse one would be like if you had an okay horse but then chopped it up with other, sometimes better, sometimes worse, horses and then tried to sell it as an above average horse. Maybe instead of chopping up, breeding? Less bloody, but would take longer.
I think some of the idea/things financiers make up are actually (unncessarily, purposefully) complicated but only so they can keep shuffling things around and skimming a bit off the top as they shuffle.
@lalaland I just wanted to add here that the reason I keep saying this idea is not that complicated is not so I can seem like a genius. Indeed, the basic concept of chopping loans into tranches and using these tranches to manage risk would take about as long to explain to my barista as it would take her to show me how to make an iced mocha (Consider this: if I loan $100 to someone who has a 5% chance of defaulting at 10% interest, how much is it worth? I would write down “$105″ for accounting purposes, but when the loan came due I’d either make $110 or lose $100.) In fact, the idea makes a lot of sense and in theory should actually reduce risk. The problem was that lots of people and organizations systematically lied and intentionally defrauded each other.
So saying “oh it’s all so complicated, and probably a bit silly to begin with” — as financial journalists love to do — is not only condescending, it helps to obfuscate the real problem!
@stuffisthings Anyway, the explanation of LIBOR was just fine. The only omission I noticed was that if Barclay’s lying and reporting too-low LIBOR rates HAD influenced the markets, the result would actually be LOWER rates for consumers on their mortgages and other loans. So to the extent that it happened at all, the fraud was actually against other banks to the benefit of consumers.
@stuffisthings Wouldn’t it actually be worth (0.95*110)+(0.05*0) = 104.5? And then wouldn’t you have to discount that by the rate of inflation in order to figure out the net present value of that $104.50 (assuming you were going to sell the loan to someone else at that moment)? And also, if the risk-free nominal interest rate for the same period were more than 4.5%, wouldn’t it be a bad decision to make the loan in the first place at all?
Any or all of this could be wrong, I’m just not sure where the value of $105 is coming from. I also don’t know accounting, though, so forgive me if this is ignorant.