When Charles T. Munger weighs in with How We Can Restore Confidence, the world should take note of his wisdom.
Consider this paragraph:
There was also great excess in highly leveraged speculation of all kinds. Perhaps real estate speculation did the most damage. But the new trading in derivative contracts involving corporate bonds took the prize. This system, in which completely unrelated entities bet trillions with virtually no regulation, created two things: a gambling facility that mimicked the 1920s “bucket shops” wherein bookie-customer types could bet on security prices, instead of horse races, with almost no one owning any securities, and, second, a large group of entities that had an intense desire that certain companies should fail. Croupier types pushed this system, assisted by academics who should have known better. Unfortunately, they convinced regulators that denizens of our financial system would use the new speculative opportunities without causing more harm than benefit.
All human marketplaces seem to have a bucket mechanism and it is not hard to understand.
Take an extreme instance in price and time when all the buyers are full (the bucket is full of tickets) a new phase will begin (bucket out). Conversely when all the selling is done (the bucket is empty) a new phase will begin (bucket in).
In theory then an efficient market will trap the maximum amount of people in any instance in time.
See also Old Money Resurrects The Peoples Car.
What Munger is talking about is that if you introduce layers of leveraged derivatives like Credit Default Swaps (CDS) and Contracts for Difference (CFD) you are no longer betting on real objects (like stocks and bonds); you are betting on tickets in “bucket shops”. Leverage (financial pain) is the main loss trigger of “bucket shops”.
Human market places obey The Law of the Jungle – the strong prey on the weak; “bucket shop” activity encourages the formation of “Dark Pools” that seek the advantage of the “Big Stack”. These Big Money Pools may have an intense desire that certain companies should fail.
See also Madison Avenue Misadventure.
Please explain the advantage of the Big Stack.
I don’t understand econometric theories well enough to distinguish between ‘security prices’ and horse races, referred to in the article.
This article is too good and too important to let pass by me.
ALPHONSE re “THE BIG STACK” this an extract from the website: http://www.probabilitytheory.info/index.htm
If a game is fair like a coin toss [50/50], it nevertheless is still true that if it is played until one player loses all his money, then the player who started with most money “THE BIG STACK” has the better chance of winning.
The richer man’s “THE BIG STACK” advantage can be calculated.
Suppose player X, with 10 units, plays another player, Y “THE BIG STACK”, with 1,000 units.
A coin is tossed and for each head player X pays player Y one unit, and for each tail player Y pays player X one unit. The probability of player X ruining player Y is 10/(1000+10) or 1/101 Player Y has a probability of 100/101 of ruining his opponent, An advantage of over 99%.
Thanks I had no idea that the big money had such a pronounced advantage.
I’m in sympathy with the guy on the photo in the back row waiting for lunch!