I’ve been reading Liar’s Poker recently and it’s given me a better understanding of how market’s
don’t work. To save time for novice investors I’ve created a few helpful definitions to guide them in their investment choices. In no particular order:
Bank – the generic term for an organisation that seeks to profit by controlling the flow of money.
Market – a mechanism to exploit the foolishness gap (often slim) between someone who has the means and desire to buy something and someone who knows what it’s worth. Innovations in the market have effectively rendered the “means to purchase” an outdated concept. Markets have the trappings of formality and the veneer of structure.
Risk Management – The process of substituting a relatively reputable product like insurance for bonds of indeterminate risk with the objective to save money over a specified term.
Corporate Bond – a financial innovation that has gone through more re-inventions than a certain David Robert Hayward-Jones. (who? exactly!) At it’s core it’s a piece of debt that is bought because the issuer promises to give you more money than you’d get if you put your cash on deposit. In the past, high interest rates indicated higher risk. While this is worth bearing in mind, rating agencies have helped liquidity by decoupling risk from rates. (see liquidity, rating) A vital tool in Risk Management.
Rating – the formal process of labelling a sows ear as a silk purse and the promotion thereof.
Liquidity – the ability to turn crud into cash. A descendant and logical progression of the practice of alchemy.
Financial Innovation – A scheme that uses abstruse mathematics to show how a financial product or service can defy common sense. To be adopted a Financial Innovation should generate vast wealth for those controlling financial markets while distributing risk among those who had the least to gain from the underlying transactions.
Systemic Failure – What happens when a critical mass of people understand they’ve been conned.
Sucker – anyone who is exposed to the risk that is not commensurate with their potential for reward. If you don’t know who the sucker is, you are one.
Corporate banking – the unglamorous process of helping businesses to prosper.
Investment banking – the glamorous process of helping economies collapse.
Trading – the process of remaking reality, minute by minute for the purpose of owning yachts, ferraris, corporate jets etc. Closely resembles the practice of bucaneering during the 17th & 18th centuries.
Hedge fund – a pool of investors’ money that is multiplied using leverage to create a concentration of cash so dense that it can distort reality. Hedge funds use this distortion in reality, stretching space & time, to widen the foolishness gap in a market and reap vast rewards.
Leverage – like guns, leverage doesn’t actually kill by itself.
I hope these definitions can be useful to somebody, if only to encourage them to stay in bed with the mattress pulled up over their heads rather than go near a financial market.