Complexity as rent
Guest from Satyajit Ras at Yves Place:
The complexity of modern derivatives has little to do with risk transfer and everything to do with profits. As new products are immediately copied by competitors, traders must “innovate” to maintain revenue by increasing volumes or creating new structures. Complexity delays competition, prevents clients from unbundling products and generally reduces transparency. Frequently, the models used to price, hedge and determine the profitability also manage to confuse managers and controllers within banks themselves allowing traders to book large fictitious “profits” that their bonuses are based on.
The sheer importance and size of derivative profits means that it will continue to attract the best and the brightest who will continue to play these time honoured games.
Warren Buffet once described bankers in the following terms: “Wall Street never voluntarily abandons a highly profitable field. Years ago… a fellow down on Wall Street…was talking about the evils of drugs…he ranted on for 15 or 20 minutes to a small crowd…then…he said: “Do you have any questions?” One bright investment banking type said to him: “yeah, who makes the needles?
Derivatives and debt are the needles of finance and bankers will continue to supply them to all the Dr. Jekyll’s and Mr. Hyde’s alike for the foreseeable future as long as there is money to be made in the trade.
Why don't we turn the banks into regulated public utilities?