No matter how much traders make loss, their risk exposure is limited. For the worst case, they just get “fired”. No obligation to compensate for the loss. This position is so called ”owning put ” in a financial term, as their loss is floored but profit has no cap.
Therefore, it is reasonable for traders in an investment bank to leverage out the company’s capital to take more risks.
If this business is lucrative, why they become public companies after a hundred years of their history? Not to continue to be partnership that allows partners to own their profits?
I think the reason is, the original investment banking businesses such as advisory on mergers, fund raise were indeed lucrative, so that it becomes extremely competitive. As a result, investment banks have become investing banks with high-risk exposure and it was a rational decision to let the companies go to be public to realize capital gain.
The problem of the current economic system is the systemic risk embedded with credit settlement. To increase demand, each participant pay by credit, which means “I OWE YOU”(IOU). Others can use this IOU as asset, so that the owner of IOU could expand his/her credit further based on this IOU.
In this way, IOU is money and each time participant pay by credit, contributing to “money creation” and chaining one’s credit to another.
The worst comes when the last chain connects to the first. The credit of participant relies on the one of another interdependently, results in domino structure causing the systemic failure such as the current financial meltdown.
On the other hand, when people settle by debit, there is no space for IOU and each transaction is closed not to impact one another. There is no systemic failure to be triggered with debit.
With the economic system of debit settlement, we cannot stretch out our purchasing power by credit, which means less demand in the economy. The only way to increase the demand is to increase the velocity of money circulation. That is to increase the number of transactions with the given amount of money.
The profile of the new Bretton Woods Two is yet to be known, however, it is clear that the next bubble is inevitable as long as the demand relies on credit expansion. And the country in a position to expand credit will have the strongest economic power again in the global economy and the next ground zero of financial meltdown.
Reference:
http://www.boj.or.jp/type/exp/seisaku/expkess.htm
Note:
This article has been posted to newspapers, and no reply. Thereby posted to my blog here
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