Monday, June 05, 2006

iBanking - Investment Banking Basics

Investment banks may not effect you directly - but the actions they perform are large enough to effect the world economy.

Without getting too specific, investment banking salesmen create and distribute "asset management product" to huge investors. Government agencies, international corporations, hedge funds, and very wealthy investors are parties, and counter parties, to these special products.

Quantitative analysts, or quants, play with finance numbers and relationships so as to match products with a client. Investment banking traders take positions and dissolve them as they seek optimum return with minimal capital exposure - they hope.

Occasionally some of the products or the parties to the products blow up and there is a scandal or major bankruptcies - or both.

As sophisticated financial products are traded some of the parties may not understand all the consequences of unraveling their positions. Some of the positions may not be able to be unraveled in a timely manner. If your counter party fails, your position may drag you under also.

There have been major disruptions in the past decade with derivatives created and traded by investment bankers - but no first world countries have collapsed in the modern era.

Yet.

Some of the major bank mergers over the last few years may have been engineered by investment bankers to decrease counter party risks between the banks, or to rescue a bank in trouble due to derivatives. We do not know - they would not tell us.

If you think the quants and the government can control this huge, unbalanced system, keep in mind that
no one fully understands it.

Two or more parties frequently enter into a product swap engineered by investment banks - and all the parties show a profit on their income statement.
Is it worth spending a million of real cash to show a twenty million paper profit - even if you do not understand the convoluted math? Many companies think so. There is no real way to value these illiquid investments, so i-banker quants invent numbers that make everyone happy.

Until the next implosion.

This web of relationships creates extremely complex systems - even if each of the concepts and relationships seem straight forward when established (they aren't) - over time they change. With the end of the Glass-Seagall act in 1999, the levies have been lowered, a class 5 financial hurricane may be overdue.

If you want a job as an investment banker doing financial research and asset management for an investment bank; it is a very well paying job with lots of challenges. There are occasional large layoffs that sweep the employment field clean - so timing may be important. I'm sure any MBA college will offer you information on investment banker training.

If you are an investor, be aware that large shocks to the investment landscape are inevitable. Consider speculations and protective positions before an investment banking engineered earthquake hits.


The next one may be "the big one."


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4 Comments:

Anonymous copper prices said...

Investing on a large scale level like that will always be risky. As long as organizations are big enough to manipulate entire markets there will big gains and big disasters. Look at George Soros, he's made a fortune by manipulating entire countries' currencies.

12:34 PM  
Anonymous allan said...

Investing on at any level is risky.

The greatest danger of investing even a few dollars is found in thinking it safe.

George Soros made his big bucks speculating - not investing. He took big risks when he saw that government manipulation was failing - betting against their arrogance.

He keeps his losses small - admitting when he is wrong, and places big bets when he knows he is right.

You can read his books, or those of his early partner in the Quantum fund, Jim Rogers, to get a better understanding of large financial bets.

Price can be manipulated in the short term - but eventually manipulation will fail if it is against reality.

For smaller speculations - study risk and embrace it yourself.

Thanks for commenting.

1:44 PM  
Anonymous Helpful Links For Growth said...

"If you think the quants and the government can control this huge, unbalanced system, keep in mind that no one fully understands it."

am i the only one that finds that completely disturbing? why is this system in place if no one can fully understand it? wouldnt that explain why these implosions happen?

there needs to be a revision of this system and a grasp of all it entails before another "big one" happens.

4:16 AM  
Anonymous allan said...

Helpful,

I hope many people find it completely disturbing.

I place the problem at the feet of John Maynard Keynes.

Keynes is the source of modern Keynesian economics. Keynes recommended short term money fixes for complex problems -- and governments around the world love it.

Leaders of democracies recognized the power that gives them. That power will not be surrendered easily. They can look good for a short period - and their successors reap the problems.

Keynes most famous line to the accurate economic reasoning that easy short term fixes create long term problems - is that "In the Long Term we will all be dead."

12:48 PM  

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