Here’s an interesting Reuters article by David Cay Johnston entitled “Closing Wall Street’s casino“. It’s a good article, but whenever people employ the “Wall Street/Casino” metaphor, it’s always puzzled me. Wall Street is, fundamentally, like a casino, and I don’t see any way it can be made unlike a casino.
This is because investing is gambling, because gambling is simply taking an action based on what you expect to happen, but which is not certain to happen. In most cases, of course, money is involved. Whenever you make an investment, you are gambling.
Nobody wants to end all investment, of course. However, the lady quoted in the article, Professor Lynn Stout, thinks that certain types of investment that are not tied to anything in the actual world ought to be got rid of. As the article says “[her] approach would not stop derivatives that are backed by hard assets”, but would eliminate credit default swaps, which the article says are merely “bets on which one party wins and which one loses”.
The problem I have with this is that credit-default swaps are similar to (but not the same as) insurance, and all insurance constitutes “bets on which one party wins and which one loses”. This is basically what options are, as I understand them, and options are generally regarded as useful financial instruments.
My understanding–which, I freely admit, is purely that of an amateur–is that credit default swaps were a problem in the crash of 2008 because no one knew how many of them there were. Because the market in them was something of a mystery, it was not known what would happen to the economy should lots of defaulting occur.
Now we know.
In principle, it seems to me, there is no actual way to stop this sort of risk-taking. Investors who take these sorts of gambles are doing without properly assessing the possible outcomes correctly. I mean, that’s why there was a problem to begin with. I don’t understand how you can stop this kind of thing unless you just ban the trading of options completely.
But, like I said, I have only a layman’s knowledge of this stuff. If someone who knows more reads this, I would love to read his/her comments.