Financial services rust belts

[bigbadwolf]

An excellently written and excellently argued piece in Asia Times:

Those who have visited Michigan recently or the Mahoning Valley of Ohio in the 1980s can recognize the symptoms of a rust belt. A hitherto prosperous industry, paying high wages to its employees, has been overtaken by market changes and is forced into harsh downsizing or even bankruptcy. As a result, the lives of many inhabitants degenerate into alcoholism, home foreclosures and welfare.

This time around, the decaying industry is finance, and the rust belt cities are London and New York.

As I have written previously, in and after the 1980s the central activity of the financial sector became not service but rent-seeking. Finance doubled its share of gross domestic product (GDP) in the 30 years to 2006, but very little of the addition represented products and services that provided true value to the economy as a whole.

... For the financial practitioners of New York and London, the future is thus bleak. Rewards will be greatly reduced, as the market operates ferociously both on the income side and the employee costs side of their employers. Headcount will also be greatly reduced, as functions are eliminated, work is outsourced to the Third World and the weaker entities go bankrupt or are merged into competitors. The decline in practitioners' incomes might be as much as 80%, even after a modest market recovery, though the number of practitioners should reduce by only 50% to 60%.

In New York, the "rust belt" effect will be severe but not overwhelming - it will be 1970s Cleveland rather than 1980s Youngstown. Many of the skyscrapers of the financial district and the luxury residential areas will become ghost buildings, as their predecessor buildings did in the 1930s, but they are unlikely to descend to the chain-round-the facility guarded-by-a-Rottweiler-and-a-tattooed-thug state symptomatic of the worst industrial blight.

London will be the Youngstown of this downturn, an excellent market for Rottweilers, wire mesh and tattooed thugs. The city's Docklands area in particular will revert to its 1970s squalor, albeit with some very expensive buildings scattered around. Few of the financial institutions that have prospered so lavishly in the London of the past couple of decades are British owned, and those that are were excessively involved in the British mortgage market - an even bigger disaster than the US market because home values were even more outrageous at the peak.

Given that the financial sector will be downsizing anyway, will top management in Frankfurt, New York or Tokyo want to keep its stable of expensive London whiz-kids in order to continue participating in a market that was never central to their overall strategy and is now unprofitable? I doubt it.

Even the Russian mafia may leave, though probably to Cyprus rather than Moscow. Whereas New York's downturn may produce municipal bankruptcy, London's downturn has a fair chance of producing national bankruptcy. Going forward, British youth will have to find a new way to make a living - single-malt Scotch and tourism cannot support a nation of 60 million people.

 

[RussianMike]

finance is not dead. We will discover new products and move forward.

 

[Stefan Zota]

Reading these topics opened by bigbadwolf, it seems that he is looking for all options to prove finance is dead, even the concept of financial product. It is good to have all points of view, a contradiction is always more useful than a consensus. It forces people to think.
And that is what the wolf is trying

 

[bigbadwolf]

I would hope I am advancing a more nuanced point of view than that "finance is dead" and your description of my outlook made me wince, I must admit.

Finance is not dead, but it's role in the economy is going to be reduced. And this will have repercussions on finance employment -- both in terms of numbers employed and compensation received. Surely this is a plausible argument? One which the cold-eyed and dispassionately objective quants on this forum would have no problem understanding. After all, we are not a bunch of bible-belt evangelicals who deny facts and arguments, are we ...?

Reading these topics opened by bigbadwolf, it seems that he is looking for all options to prove finance is dead, even the concept of financial product. It is good to have all points of view, a contradiction is always more useful than a consensus. It forces people to think.
And that is what the wolf is trying

 

[Stefan Zota]

Finance is not dead, but it's role in the economy is going to be reduced. And this will have repercussions on finance employment -- both in terms of numbers employed and compensation received. Surely this is a plausible argument?

In the short term (<5 years), yes I agree with your statement.
In a longer term, hard to estimate. Other triggers/markets may activate. If we compare today with 2004, we can have an estimate of the possible growth for some markets in a short time period

One which the cold-eyed and dispassionately objective quants on this forum would have no problem understanding. After all, we are not a bunch of bible-belt evangelicals who deny facts and arguments, are we ...?

Not sure about this part

 

[bigbadwolf]

If the article's contention has a 60% chance of being correct, and a copy of the 7th edition of Hull is currently going for $170, then what should the value of a one-year vanilla put (on Hull's book) with a strike price of $40 be? (Assume risk-free rate is 0.25% per annum.)

 

[RussianMike]

I would hope I am advancing a more nuanced point of view than that "finance is dead" and your description of my outlook made me wince, I must admit.

Finance is not dead, but it's role in the economy is going to be reduced. And this will have repercussions on finance employment -- both in terms of numbers employed and compensation received. Surely this is a plausible argument? One which the cold-eyed and dispassionately objective quants on this forum would have no problem understanding. After all, we are not a bunch of bible-belt evangelicals who deny facts and arguments, are we ...?

That was my point, its role will not be reduced, it will be enhanced. Without finance you cannot do most of the things we do. Like I said new theories/models will be proposed and we will use them just like we have been using other ones. Your argument is quite plausible but history repeats itself so we can assume with 100% probability that we will have another bubble, the question is when and where(what product, etc). I think energy is best reserved for finding that new new thing rather than worrying about current status unless of course you have no choice but to do that.

 

[Stefan Zota]

If the article's contention has a 60% chance of being correct, and a copy of the 7th edition of Hull is currently going for $170, then what should the value of a one-year vanilla put (on Hull's book) with a strike price of $40 be? (Assume risk-free rate is 0.25% per annum.)

Subjective probabilities are not relevant for pricing options. Risk neutral probabilities do not change unless volatiliy changes

 

[Uncle Max]

we will have another bubble, the question is when and where(what product, etc). I think energy is best reserved for finding that new new thing

Health Care is another good candidate for this.

 

[bigbadwolf]

Subjective probabilities are not relevant for pricing options. Risk neutral probabilities do not change unless volatiliy changes

I'm thinking along the lines of a one-step binomial tree. But I don't know what the uptick and downtick will be.

 

[xoxqun]

If the article's contention has a 60% chance of being correct, and a copy of the 7th edition of Hull is currently going for $170, then what should the value of a one-year vanilla put (on Hull's book) with a strike price of $40 be? (Assume risk-free rate is 0.25% per annum.)

As long as 'money', 'wealth', and 'assets' matter, finance seems not to be going away.

That being said, 'commodity' is dead, 'value' and 'innovation' will always be at premium.

Definition of 'commodity': Easy-inexpensive substitutes. Price in the eye of beholder.
Example of 'commodity': Current 7th edition of Hull: NEW ($29.00 to $384.08+)
(A fair guess of low end: $0.00 in the underground market of digital goods on the Web)
Arbitrage opportunity, anyone?

Lesson learned: "Never take any 'information' for granted." - The Devil's Advocate

 

[IlyaKEightSix]

Finance indeed is dead.

For the brown-nosers and MBAs and all the imbeciles (thanks NNT) spewing out of business schools across the nation that never belonged there to begin with (thanks Andrew Lahde).

Now it's about time we did away with the chaff and the parasites and left the field not to the negotiators and three-piece-suiters, but to the people who are genuinely smart and know what to do with the masses of numbers and where to look for the nuances to make a genuine profit, rather than about how to overcharge a nuclear reactor to the point that it melts down.

You wouldn't entrust a businessman to create drugs, or to design a nuclear reactor.

It's about time that finance stops getting recognized as "business" and starts getting recognized as a legitimate science privy only to those that have the brains to do it correctly.

 

[Sanket Patel]

Why do I get the impression that you think everyone at Leigh and everyone around you, in general, is a complete and utter moron?

 

[IlyaKEightSix]

That's a loaded question! I prove your statement false by contradiction.

Assume Ilya thinks everyone at Lehigh is in general, a moron.
Ilya really admires the two Ph.D quants at Lehigh as well as the people working with him in his math class (and quite a few others) at the student level.
Therefore the assumption is false.
Thus, Ilya respects some students at Lehigh.

Including a handful of people in the business school.

But other than that, it's the engineering culture indoctrinated into us by the top statistician who taught my sim class.

 

[xoxqun]

Finance indeed is dead.
For the brown-nosers and MBAs and all the imbeciles (thanks NNT) spewing out of business schools across the nation that never belonged there to begin with (thanks Andrew Lahde).

The million dollar question is 'Who's Andrew Lahde?' [pun intended] Anyone heard of him before? If not, now you know:

"Andrew Lahde (b. 1970 or 1971) was a California-based hedge fund manager who in 2007 earned some fame for achieving return rates in the vicinity of 1000%[1] with his Lahde Capital, based in Santa Monica, California. The fund speculated on increases of U.S. subprime mortgage defaults[2]. He earned a Bachelor's degree in Finance from Michigan State University and an MBA from the Anderson School of Business at the University of California Los Angeles.[3]."

"In September 2008, Lahde closed his fund, telling investors that credit problems - the basis of his profits - were likely to continue, but that possibility of defaults by counterparties was too high.[4] On October 17, he released an open good-bye letter to his investors, in which he said that the "low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking." Lahde criticized the harried life of the rich, and said that "Capitalism worked for two hundred years, but times change, and systems become corrupt." He suggested that George Soros "start and sponsor a forum for great minds to come together to create a new system of government that truly represents the common man’s interest". He concluded his letter by proposing to legalize hemp and marijuana, saying that hemp been used for at least 5,000 years for cloth and food, as well as just about everything that is produced from petroleum products, and thus should be part of making the U.S. "truly become self-sufficient". He also said that marijuana is only kept illegal because "Corporate America, which owns Congress, would rather sell you Paxil, Zoloft, Xanax and other addictive drugs, than allow you to grow a plant in your home without some of the profits going into their coffers."[5][6]"

Lesson: Always, always check your references first hand before you quote them. "Never take any 'information' for granted."

Here are some other 'lessons' for neophytes in both finance and math from the masters in both:

"Not everything that counts can be counted, and not everything that can be counted counts."
- Sign hanging in Albert Einstein's office at Princeton

"As far as the laws of mathematics refer to reality, they are not certain, and as far as they are certain, they do not refer to reality." - Albert Einstein

And all of us already know about NNT i.e., Nassim Nicholas Taleb (don't we?):"Taleb holds an MBA from the Wharton School."