Synthetic CDO's, Spanish 21, And Sports Betting

By Kid Dynamite

As expected, my last post, "Fiduciary Duty and the Victim Mindset" sparked a lot of discussion. There are several intelligent comments on both my site, and on the republished version at Seeking Alpha, most of which I've done my best to respond to with clarifications of why I think my post is reasonable and accurate.

I had the epiphany this morning that the proper analogy with these CDO's lies in sports betting. I left the following comment (edited slightly here) on another blog this morning:

"To me, financial markets are not unlike sports bookmaking. In the bookie world, you have the "Squares" who are analogous to the retail investors. These are the guys who say things like "oh man - Tom Brady is wicked pissah - the Pats are SO totally gonna cover the 7 point spread," with little or no reasoning or analysis to back up their decision. They also might be guys who pay someone else (like a newsletter writer) to pick games for them (of course, these newsletters are almost always scams)

Then there are the professionals - I actually know a guy who was one of the biggest NFL bettors in the 80's. He still handicaps NFL games - he spends 30 hours+ a week analyzing the different matchups, weather, psychology, etc. Some weeks he finds several good bets, some weeks he finds none.

Now, in the investing world, pension fund managers need to be the PROFESSIONALS - they can't be in the "square" camp, and just say "hey - I paid the newsletter (ratings agency!!!) for the picks, if they lose, it's not my fault." That's amateur (square) thinking, and I could possibly be convinced that it's an acceptable excuse for RETAIL, amateur investors (but note, again, the culpability lies with the RATINGS agency here). Professionals, however, can't be allowed to make such excuses, or the system will never change! Similarly, you can't blame the bookie when you lose for having offered you an unfair bet.

Both sports betting markets and financial markets are efficient ENOUGH that you have to do your own work - and LOTS of it - if you expect to generate alpha.

Some people will deride me for making the analogy of markets to a casino or bookmaking operation - but I'm reasonably certain that most traders (myself, and everyone I know at least) do expected value calculation on their trades just like you'd do in the casino or in the sports book. It's not "Kid Dynamite is a naive immature gambler" - it's the realization that in both financial markets and in gambling markets, it's not a crime to have more information than the guy on the other side of the trade/bet."

People keep throwing the word "fraud" around here. As the NY Times article which prompted my original post explained, Goldman was creating these synthetic CDOs as far back as 2004. It took YEARS for them to blow up. I find it hard to use the fraud label there - it's just another case of most of the investing world being totally ignorant to the risks involved. There were few who saw the risks, and they positioned themselves accordingly - GS was in this camp on these synthetic CDOs, it seems. Sellers of synthetic CDOs didn't have to, as Tommy Boy so eloquently put it, "Take a dump in a box and mark it guaranteed," and coerce investors into buying them. Investors were screaming for yield- they were begging to buy these products. Blame it on the system, blame it on the ratings agencies, blame it on the investors - but don't put the lion's share of the blame on the virtual bookies - the sellers of the CDOs.

When you bet the Patriots, the bookie doesn't have to tell you that Tom Brady is out with a bad shoulder - you have to do that research yourself. Similarly, when you buy a synthetic CDO, which you can't do if you're a retail rube, you shouldn't expect the seller to tell you why he thinks you're on the wrong side of the trade.

You can read the rest here (and you should).