The changing economy

When you talk to your parents you will notice that they have a completely different view on the economy and the markets. They still think that the stock exchange is a place where you can buy and sell stocks and where investors give money to companies that they can employ people, produce their products and so on. But this is far away from the truth. Nowadays it’s all about arbitrage and how to make more money. All participants are looking for the best opportunities to make more profit. They don’t even care about the risk any more as everything is “high risk”, so it won’t matter much if you have a bit more risk with one trade than with another one. And this is toxic. That means that investors and banks need to look for opportunities to make more profit and they are willing to take more and more risk. The result is that participants create products they don’t even understand. Just to offer other an opportunity for higher profits. (see also occupy wallstreet)

Best example are CDOs, one of the reasons for the subprime crisis. Banks where bundling mortgages to sell them to other investors. This is generally a good thing – when done properly. But the started to take the mortgages from customers with the best ranking, sold them and then took the rest of the bunch and they bundled it again and again. So when you decided to buy such a bunch of mortgages you did not cover the mortgages itself but just other CDOs where you don’t know what’s in there. And the main problem is that these mortgages correlate with each other – more than everybody thought. So once the prices for real estates went down, there were more and more defaults and a lot of these CDOs were hit.

There are also other trends in the economy like day trading. I don’t say that these are a generally bad thing. It’s also just a market. It’s a zero sum game. When you think that the yield for Greece bonds will go up, you can bet on it and somebody else has to bet against it. So you can speculate that a certain country or company is in trouble. Some say that these traders that are going short are responsible for crisis like the subprime crisis or the EU debt crisis. But that’s not true. You can even say that these traders make any crisis less worse because they help to find the correct price faster and taking out uncertainty. This uncertainty is an accelerator for every crisis! And there are other trends that are more or less gambling. They don’t have a real effect on the economy as these trading practices are made by very small investors with amounts like $10. Best examples are Forex trading and binary options trading.