I just finished reading "Den of Thieves" by James Stewart which is about the junk bond scandal that hit wall street in the '80s. What is fascinating about it is the similarities between it and the recent financial meltdown. Just swap "toxic asset" mortgages for corporate loans (AKA junk bonds) and hit the fast forward button.
Since this is a blog, I'm going to skip all explanations (read the book) and just hop to my observations:
First off, the financial system essentially and intrinsically encourages abuse. Capitalism trends towards perfect markets -- therefore there is an ever decreasing profit spread for financial guys to take advantage of. But wall street types are self-selected to not be happy with ever decreasing profits. They will find or create an edge.
Second, the junk-bond related crimes were totally unnecessary; they just added a buck or two per share to an already over-inflated, highly profitable transaction and sometimes "encouraged" a deal to go through if it was stalling. Judging by the lack of major arrests in the toxic asset meltdown, Wall street learned that crime in fact doesn't pay nearly as well as the long, legal con.
Third, never trust finance guys even as part of a reputable institution! [In fact, let me go on a limb and say, its your life, don't trust anyone! For major life issues like financial and medical, respect the expert opinions but learn their biases (for example, surgeons LIKE to do surgery, duhh!) and then spend the time to figure it out yourself!]
Around 2007-2008 a couple of my friends were buying a house and I was alarmed at the tendency for people to trust the bank's evaluation of how large a loan you could bear. Essentially they ceded responsibility for picking a reasonable load to the banking "experts", and did not bother to do even the most basic math. "If the bank is willing to offer me that much I must be good for it" is how the thinking goes. I think that this happened on a nationwide level. But I would tell my friends "yes but the bank's goal is for you to be in debt for the rest of your life, your goal should be to not be in debt. Because when you are in debt, you are paying 10% or more to your creditor. You are going into debt to buy more stuff, but ironically you'll end up with less".
Little did we know that many banks did not even care whether the loan could be repaid...
Recipe for Wall Street Mega-Success
1. Identify an information advantage. Look in unregulated areas of finance. For extra credit, artificially create an information advantage in your favor. For example, bundle financial instruments so the underlying entities are hidden. Write contracts that only finanical lawyers can understand (insurance is a great area of opportunity for this method). Transform an out-of-favor, high-risk financial instrument into one that is "in-favor". Take advantage of people's trust in "experts" -- i.e. yourself.
2. Market, market, sell, sell, sell. Get college professors to write papers about how low risk your market historically was (before you entered it).
3. Jam increasingly ludicrious and high risk underlying entities into your framework since that maximizes your profit by reducing the base cost.
4. Use recursion to keep the aura of good times going -- if an issue is about to fail, grab it up, twist it around, and jam it back into the system (AKA refinancing).
3. ??? (this is where the optional crimes are committed)
5. You have 3-7 years; the fall will be from the summit, sudden and hard. be ready to bail.