Wednesday, April 02, 2008

Reviewing a carnage

Excerpts from an excellent article on Wall Street by Shawn Tulley, CNN.
"....So what if investors only dimly understood CDOs, CLOs, and the alphabet soup of arcane instruments that dominated the business, not to mention the super-geek hedging strategies the firm's leaders kept bragging about? ....Wall Street was the black box that worked its own mysterious magic. ....Put simply, Wall Street firms used towering leverage to make lottery-like loot in a long-running bull market that blatantly underpriced risk. When investors think the world is getting safer, they demand less and less compensation for risk (and they begin to believe in magical stories, like bundles of dubious home loans can be transformed into bulletproof securities).
....Half the huge gains in Wall Street's profits from 2003 to mid-2007 could be attributed to increased leverage - otherwise known as gambling with borrowed money - that magnified earnings in a boom. ....Again, it's the curse of too much debt: If a firm's portfolio is leveraged at 33 to 1, it takes a mere drop of 3% to wipe out its entire capital.
....As long as we have capital markets and as long as it's possible for people to make vast sums taking big risks with borrowed money, we will have the kinds of booms and busts that are a way of life on Wall Street. The big gamblers will most likely work for hedge funds, private equity firms, or some new entity that hasn't been invented yet. We won't see tumbleweeds on Wall Street. Its cowboys may not be geniuses at making money. But they're geniuses at raising it and, above all, at perpetuating Wall Street's black-box mystique."

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