Investing and speculation

It is pretty obvious that in order to undertake a venture, capital is needed. One can use one's own capital to fund the venture but since many ventures are far too expensive and/or risky for this, you can borrow capital.

Depending on the type of venture, the capital may be offered as a gift, or more commonly with a promise of repayment with some sort of reward (interest or a share in the profits). Clearly in either case the money is normally only ventured if the risk associated with the venture is by comparison less than the potential reward.

Now it would clearly be impractical in most cases for the people setting up the venture to go out and ask random individuals for money, so we have set up various banks and markets for the orderly use of capital either via stocks (promising a share of the profits) and bonds (promising to pay interest).

Now it is safe to say that when you either buy stock, or a bond, there is a degree of speculation involved. However, it should be noted that the speculative issue revolves around the success or failure of a particular venture or in the case of mortgages, the ability of the mortgagee to repay.

Now, humans being quite clever, it was fairly easy to add more speculation to the process. You can buy rights to invest at a future time, call options. Obviously someone is selling you that right. You can do the same thing to guarantee a specific selling price for an investment in the future. These types of investments are called derivatives because you are no longer investing in a business venture, but speculating about how the investment instruments will do. This is a situation which effectively is equivalent to gambling.

The situations related to options is in fact a quite primitive form of derivative speculation, and one that is fairly well regulated. There are other ingenious methods of packaging investments in such a way that one can place a highly leveraged bet with really almost no real idea of the risk involved. Most folks are aware that the drop in real estate prices and subsequent financial crisis was caused to some extent by the easy credit provided to sub-prime mortgagees, but why was this credit so readily available? Because you could issue these high risk loans, backed by housing that wouldn't have been built under normal circumstances, since their wouldn't have been buyers, and then take that high risk mortgage, bundle it up with many others and sell it at a profit, giving you more money to lend.

Effectively we had a real estate pyramid scheme in which buyer/speculators were buying with the expectation that real estate would increase in value and they could sell at a profit and settle their mortgage. Of course the basic problem with all pyramid schemes is that the number of new people eventually drys up.

The fact that a certain number of gamblers lost on their bets is normally not a matter of public concern, but, because the Government had eased banking restrictions during our anti Government period, some of our largest institutions were effectively placing bets on instruments that were really riskier that a slot machine. Many banks would not have lent money directly to these high risk individuals, but they were happy to buy second or third derivative instruments that were backed by loans they wouldn't have issued.

So now the President has issued some regulatory guidelines designed to prevent this from happening in the future. It is like the police just broke up a crap game in a back alley the way these gamblers are scrambling. These regulations are going to make the banks less profitable? Didn't most of them almost go bankrupt? We need our banks and large financial organizations that are trusted by the American public and where we guarantee deposits, to act responsibly. If you believe they can do that without oversight, do I have a financial crisis for you!