Sandrabarracuda’s Weblog

October 14, 2008

Wall Street Crash: derivatives and sub-primes

Filed under: Politics — sandrabarracuda @ 10:45 pm
Tags: , ,

When learning arithmetic, we were always counseled to seek the lowest common denominator in order to avoid mistakes. The “masters of the universe” on Wall Street ignored basic math and common sense to invest in something that only the MIT math geeks in their back rooms understood. People no longer used brokers. They invested online and managed their own money.  A new profit center was needed and that profit center was “derivatives.”

Years ago, I read an article about “derivatives” and the fact that no one really understood them. For the past week, I’ve been reading the Wall Street Journal and the Investors Business Daily but it was Andy Kessler, a former hedge fund manager, who explained all in  an  article in the current edition of The Weekly Standard called “The Demise of a Giant Hedge Fund”  That fund is Wall Street.

“The neat thing about derivatives is that no one but the person who created them knows what they’re worth, so you can sell them at huge markups. Woo-hoo. Mammoth departments were created all over Wall Street to securitize everything that moved. With the Fed forcing low interest rates in 2002-2004, the higher the yield the better.

“Subprime home mortgages, because of higher risk (ooh, don’t say that word), had high yields and moved to the top of the list. When not enough of these loans could be bought from banks, firms like Bear Stearns and Lehman set up entire loan-origination subsidiaries, and in true Wall Street style were aggressive and rose to the top of the market-share tables. If you want to know why Wall Street CEOs made so much, it wasn’t from trading your 1,000 shares of Apple stock.”

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