Bye Bye Banks and Wall Street

[cirquelover]

I don't really understand all this either BTD!

[Alex]

Essentially, a lot of banks have debt that is failing in a big way, and the way that debt is structured makes it very difficult for them to reorganize it (when 19 institutions own part of a mortgage things get complex). And this has significant downstream ripples on other companies (which is why bad mortgages brought down AIG, an insurance company, earlier this week).

A lot of the problem here is the uncertainty as to just how bad it is going to be so nobody is willing to invest in entities heavily exposed to this debt.

So it looks like the government is saying they will step in and buy from the banks a huge portion of these bad mortgages. They'll do it at a significant discount but it creates certainty for the institutions. They can finally just write off actual losses and move on.

The government will then bear the risk of all these loans, but they can also be much more flexible in reorganizing them (of course, they might be too flexible) so while you'll hear numbers in the hundreds of billions as what the government will spend buying these loans that, in the end, won't be the final cost of them since most of the mortgages will eventually pay off and since the government will have purchased at a huge discount it could all prove ok in the end. Or the government could still take a bath.

[BarTopDancer]

YAY! Thank you Alex!

[sleepyjeff]

Originally Posted by Alex

A lot of the problem here is the uncertainty as to just how bad it is going to be so nobody is willing to invest in entities heavily exposed to this debt.

"Uncertainty"......like not knowing if the box has a billion dollars in it or if it sits empty?

[Alex]

No, not like that.

[sleepyjeff]

Originally Posted by Alex

No, not like that.

Darn, I was hoping.

[Alex]

Originally Posted by sleepyjeff

Darn, I was hoping.

Here's the key difference: in your example, everything about the system is known. Values can be assigned rationally. The only question then is risk aversion.

In your example you have 5,000 boxes, 4,900 of which contain $1MM. You may not be willing to pay $980,000 for a box because the risk is too big but there is also no reason for the person with the boxes to sell them for less than $980,000 because he would then be losing money. He has $4.9 billion dollars in cash, why would he sell it for less than $4.9 billion? Heck, why would he sell it for even exactly $4.9 billion; it wouldn't be worth his trouble. So he has to find people who are simply willing to gamble on the outcome and pay more than $980,000 for a chance at a box that contains $1 million. This is how the lotter works? If the jackpot on the lottery is $1 million the expected value of a single ticket is $0.055 (5.5 cents). So they go out and find people willing to pay a lot more ($1) than the value for the chance of a huge return (but the vast majority lose their dollar).

Investing is not this kind of system. You aren't looking at absolute odds and making a risk decision, you are guessing at the odds and making a compounded risk decision (the risk that your guess on the odds is wrong and then the risk that you lose as well). It is a fundamentally different type of uncertainty than you face at a roulette wheel.

Essentially, rather than being told "we've spread $4.9 billion in $1MM increments through 5,000 boxes" it is "we're asking you to buy one of our 5,000 boxes. We suspect that most of them contain $1MM but we aren't certain of that. We've been told, but can't confirm, that there is at least $4.9 billion in our boxes but we aren't sure how many boxes there are, it could be 5 or it could be 5 billion. How much would you pay for a box?"

Now, obviously, real investing isn't that random and ideally there are well informed decisions with all of the information laid out. What has been revealed over the last two years is not that there are 32 slots on the roulette wheel and you have to pick one, but rather than the people playing the game didn't actually know how many slots were in the wheel.

[sleepyjeff]

Originally Posted by Alex

Here's the key difference: in your example, everything about the system is known. Values can be assigned rationally. The only question then is risk aversion.

In your example you have 5,000 boxes, 4,900 of which contain $1MM. You may not be willing to pay $980,000 for a box because the risk is too big but there is also no reason for the person with the boxes to sell them for less than $980,000 because he would then be losing money. He has $4.9 billion dollars in cash, why would he sell it for less than $4.9 billion? Heck, why would he sell it for even exactly $4.9 billion; it wouldn't be worth his trouble. So he has to find people who are simply willing to gamble on the outcome and pay more than $980,000 for a chance at a box that contains $1 million. This is how the lotter works? If the jackpot on the lottery is $1 million the expected value of a single ticket is $0.055 (5.5 cents). So they go out and find people willing to pay a lot more ($1) than the value for the chance of a huge return (but the vast majority lose their dollar).

Investing is not this kind of system. You aren't looking at absolute odds and making a risk decision, you are guessing at the odds and making a compounded risk decision (the risk that your guess on the odds is wrong and then the risk that you lose as well). It is a fundamentally different type of uncertainty than you face at a roulette wheel.

Essentially, rather than being told "we've spread $4.9 billion in $1MM increments through 5,000 boxes" it is "we're asking you to buy one of our 5,000 boxes. We suspect that most of them contain $1MM but we aren't certain of that. We've been told, but can't confirm, that there is at least $4.9 billion in our boxes but we aren't sure how many boxes there are, it could be 5 or it could be 5 billion. How much would you pay for a box?"

Now, obviously, real investing isn't that random and ideally there are well informed decisions with all of the information laid out. What has been revealed over the last two years is not that there are 32 slots on the roulette wheel and you have to pick one, but rather than the people playing the game didn't actually know how many slots were in the wheel.

Very well put. Thank you.

[Morrigoon]

Hey BTD, here's an article for ya:
http://www.livescience.com/history/0...-industry.html

[Alex]

Because I figure someone will eventually call it out I just want to acknowledge a small mistake. The value of the lottery ticket is not 5.5 cents. That would be the value if any given number could be picked only once.

However, lottery number selections are not a random distribution (largely random but not completely) and the same sequence can be picked more than once.