Woodcrafters vs. Bankers

[Mr. Blonde]

Kremlin mentioned something to me trying to explain what those in the financial district do compared to a woodworker. I would like to further explore these analogies to better understand the finance world.

What it comes down to is that most Americans do not understand what it is exactly that you guys do, how you make lots of money and where that money comes from (and I have mentioned before that if bankers and traders don't want to be hated, they should make this much more clear), which is why it's so easy to hate "Wall Street" and think they are evil. It's obviously easy and very human to fear/dislike what one doesn't understand and most people can't comprehend how someone seemingly very similar to themselves can make fuckloads of money ostensibly sitting at a computer all day switching money around.

I'd rather understand than just be an unthinking populist, but I need examples.

[thekremlin]

OK so a farmer clearly "makes" something, and a farmer who grows turnips and sells them at the market is clearly not being a selfish leech on society. In fact, the country is clearly a better place with turnip farmers in it. If turnip prices go up, the turnip farmer is happy, but if they go down too much, he goes out of business. The possibility that turnip farmers all go out of business simultaneously is clearly a bad thing.

Luckily, the turnip farmer can sell turnip futures, i.e. lock in a price. So if turnips are currently selling for $1 a turnip, he would be happy to sell next year's turnips at 99 cents. He's giving up a theoretical penny, but he doesn't have to worry about price movement, and he doesn't have to worry about losing his farm in the next year. The banker/trader is the guy who faces him in this trade, and it isn't hard to see that he recieves a theoretical penny to do so. He has effectively become an insurance provider for turnip farmers.

This is one of many services provided by the finance industry, it is a simplistic answer, but I hope it illustrates one way that bankers/traders are able to actually provide a service, not just leech from society.

[Mr. Blonde]

Originally Posted by thekremlin

Luckily, the turnip farmer can sell turnip futures, i.e. lock in a price. So if turnips are currently selling for $1 a turnip, he would be happy to sell next year's turnips at 99 cents. He's giving up a theoretical penny, but he doesn't have to worry about price movement, and he doesn't have to worry about losing his farm in the next year.

Why does this work, and why does it feel "wrong" to me?

Please remember I used to hate math and went to school for Criminal Justice.

[thekremlin]

It feels wrong because the banker hasn't grown a turnip. And you want to see a turnip, or a table, to understand that work has been done.

It works for a variety of reasons. One, the banker is able to do the opposite trade with the guy who makes turnip pies, who is naturally afraid turnips will get more expensive. In a perfect trade, the trader buys a turnip future at 99 cents and sells it at $1.01. In a realistic world, he has to hold onto the turnip exposure for a week before he realizes this 2 cent profit. The difference is that if this turnip trade goes against JP Morgan, JP Morgan doesn't go out of business, whereas the farmer would. The trader is willing to assume RISK, and he gets paid to do so.

(BTW, this is again, only one example of what traders do, and it is a pretty literal description of what FC and I do. Remember that it is also not obvious that the turnip is worth $1, and that is why the trading companies are full of people who studied turnip agriculture in college, or in the case of equity and rates trades, math and economics.)

[Beebs]

Originally Posted by Mr. Blonde

Why does this work, and why does it feel "wrong" to me?

Please remember I used to hate math and went to school for Criminal Justice.

It's the farmer considering his risk of losing money and possibility of making more money, weighing them, and then transferring that risk to somebody for stability.

[Mr. Blonde]

Originally Posted by Beebs

It's the farmer considering his risk of losing money and possibility of making more money, weighing them, and then transferring that risk to somebody for stability.

So how does the risktaking work? How can the traders guarantee price locking? By always finding a partner (in this case turnip pie makers)?

[SittinOnDubsWGW]

Originally Posted by Mr. Blonde

So how does the risktaking work? How can the traders guarantee price locking? By always finding a partner (in this case turnip pie makers)?

*I might be a little off, and Kremlin/FC/whoever knows more tell me if I am*

The price lock is for that farmer only. He's selling his future product at 1 cent cheaper than what he did for this year.

If the traders buy the turnip stock at .99 and later everyone interested in turnips says "fuck you, I'm only willing to pay .95 for turnips." Reasons for the price drop in the future could be a large increase in turnip production for that following year. That is their assumed risk.

[thekremlin]

Right. So in my example, if things don't move, the trader pays .99 and sells at 1.01 for a 2 cent profit. In real life, the price moves. Let's say the trader buys it for .99 when the fair price is 1.00. Let's say the price goes down to .95. Now the trader sells at .96 to a piemaker, a 3 cent loss. But if the price had gone up to 1.05, he could have sold at 1.06, a 7 cent profit. His expected value, in any case, is the same 2 cents (.5*-3+.5*7). Basically he has gotten paid 2 cents to take the risk. Accepting risk is a real service that financial firms provide.

[DJ FC]

I dont feel like playing this game anymore

[angry pancake]

Originally Posted by DJ FC

I feel like this thread is somehow directed at me as my father is the man who helped found and runs a wood crafting factory and I'm the one who works in finance.

Probably not the case.

[Mr. Blonde]

I had no idea that your father was a woodcrafter. Actually just yesterday I was trying to remember if I ever knew what he did, and for some reason I thought he was a man of the cloth -- but maybe that was just Menny's dad I was thinking of.

Just trying to learn here.

[Beebs]

Originally Posted by Mr. Blonde

So how does the risktaking work? How can the traders guarantee price locking? By always finding a partner (in this case turnip pie makers)?

The risk is that it may go up or down, obviously. The trader guarantees the price either by buying the shit outright at that price, or makes sure it is locked in via contract, he is legally obliged to pay the price at a given time if the farmer wishes.

Keep in mind with every trade, both people are getting what they want, or at least asked for. It can be mutually beneficial in the farmer example; the farmer wants less risk, more guaranteed money, less possible extra. The trader wants the opposite, both are happy.

[DDTempest]

Ok the concern is that the farmer could just sell the turnips to the turnip pie maker for 99 cents and both would have been happy, instead there is a trader in the middle trying to take "value" out of someone else's transaction ... THAT is why people get mad. The trader has effectively jacked the price of turnips for the pie maker by two cents!

[Mr. Blonde]

I was going to ask that too, but then thought of this:

Originally Posted by dubs

and later everyone interested in turnips says "fuck you, I'm only willing to pay .95 for turnips." Reasons for the price drop in the future could be a large increase in turnip production for that following year. That is their assumed risk.

So how come we don't hear more about trading companies going under? Certainly the risktaking business of trading can't be always good, right? Makes me think of house odds in a casino.

[THEINCREDIBLEdork]

I'm a woodcocker.

[Beebs]

Originally Posted by Mr. Blonde

I was going to ask that too, but then thought of this:



So how come we don't hear more about trading companies going under? Certainly the risktaking business of trading can't be always good, right? Makes me think of house odds in a casino.

Because you don't live and die on one trade. You make large number of trades on good information, you hedge against them so the loss is minimized, you move onto another area, do the same.

Over enough time, with the right information, the right analysis, and the hard work, you come out ahead.

You're casino reference is the wrong one, think of the guy who sets the betting line at the sports book, obviously he can't always be right, but over time he will be more often than not or else he will be gone.

[Mr. Blonde]

Originally Posted by Beebs

You're casino reference is the wrong one, think of the guy who sets the betting line at the sports book, obviously he can't always be right, but over time he will be more often than not or else he will be gone.

No idea what this means.

[Beebs]

Originally Posted by DDTempest

Ok the concern is that the farmer could just sell the turnips to the turnip pie maker for 99 cents and both would have been happy, instead there is a trader in the middle trying to take "value" out of someone else's transaction ... THAT is why people get mad. The trader has effectively jacked the price of turnips for the pie maker by two cents!

He could have only sold what he had, and at whatever price the buyer is willing to buy, and only however many the buyer would buy at a time. The contract is written for future turnips, all at once.

It is what both parties want. Both parties benefit from the transaction.

The farmer gets security and liquidity, pays for it with possible future opportunity cost.
The trader gets that future opportunity, pays for it with risk.

The entire system of free exchange is based on the fact that people are willing participants in a mutually beneficial transaction. You seem to be losing sight of that.

[Beebs]

Originally Posted by Mr. Blonde

No idea what this means.

A sportsbook is where you bet on sports; the oddsmaker says "team x is a 7 point favorite" so you can bet that they will win by more than 7 or not. Or he says if you want to just bet on the outcome, you can bet 125 to get 100 back, since that outcome is more likely, etc.

In an actual casino there is a rake, as in if you bet both sides you will lose a little bit of money, but the general point is the same.

[Mr. Blonde]

Originally Posted by Beebs

The entire system of free exchange is based on the fact that people are willing participants in a mutually beneficial transaction.

....under a system where they are kind of forced to if they want decent prices, where traders ostensibly earn far more than many business owners for a comparably small amount of work, no?

[Beebs]

What does the amount of work have to do with anything? Get over this leftover puritan bullshit that manual labor is somehow inherently good.

The trader gets "paid" what he earns by providing his service well, no customers wanting his trades, no money.

The farmer isn't forced to do anything; the entire point is that you again are forgetting the basic rule of mutual benefit; people won't buy turnips for 99 if the other farmer is suddenly selling them for 50.

So the greedy farmer forces the poor merchant to take a bet on the farmers own product, but only because those asshole turnip consumers won't pay what the farmer wants them to anymore. Who is the real badguy?

It's all free exchange, it's all mutually beneficial, all of it.

[DJ FC]

A few thoughts:

People who work smarter rather than "harder" are going to be rewarded. By smart I mean leveraging your skills. What is leverage? I mean to say you use a tool to apply your product to a much wider audience. For example: A man might be one hell of a mechanic and engineer. He might even be the best in the world, but if he stays a mechanic he can still only work on one car at a time. If he goes and works for an Auto manufacturer, however, his knowledge is leveraged many times over and his imput goes into not just one car on the road, but millions. His benefit to society is many fold greater than the car mechanic fixing the one car. Even though the mechanic got his hands dirty and probably has back problems whereas the engineer spent most of his time in front of a computer.

In my example I do very, very specific things for the whole of Europe whereas my dad does very general things for a handful of customers in Elkhart County. Yes he gets his hands dirty and yes he can show you a finished product. But I'm doing it for hundreds of millions of people and only a few thousand ever see the results of his work.

Secondly: it also helps to think of finance like an insurance company, in many regards. The reason banks don't often lose money is because they are much bigger in size than the counterparties they are dealing with. I buy some fire insurance from the insurance company and if my house burns down I'd be fucked without it. But to the insurance company my house is just a small loss, in fact it was a calculated risk and they have made enough money from the premiums of all the other policies that they are able to pay out to me. Their size and sophistication allows them to take risk and diversify it away.

[THEINCREDIBLEdork]

these are hard things for a barn rat to comprehend.

[thekremlin]

Originally Posted by Mr. Blonde

I was going to ask that too, but then thought of this:



So how come we don't hear more about trading companies going under? Certainly the risktaking business of trading can't be always good, right? Makes me think of house odds in a casino.

When you do it right, you're exactly like the house at a casino. This is a good business model, not a bad one.

[DDTempest]

Originally Posted by Beebs

He could have only sold what he had, and at whatever price the buyer is willing to buy, and only however many the buyer would buy at a time. The contract is written for future turnips, all at once.

It is what both parties want. Both parties benefit from the transaction.

The farmer gets security and liquidity, pays for it with possible future opportunity cost.
The trader gets that future opportunity, pays for it with risk.

The entire system of free exchange is based on the fact that people are willing participants in a mutually beneficial transaction. You seem to be losing sight of that.

I am not losing sight of anything. My point is that its a system in place to provide a process for companies that need commodities to essentially pre-buy and people who make said commodities to pre-sell. There doesn't NEED to be an asshole in the middle skimming 2%.