Waldmann on Bank v. Casino

Hoisted from the other guy's comments:

This Lowenstein guy has some interesting things to say, but he is trying to make me throw another cow. He discusses synthetic CDOs and says

"In essence, they were simply a side bet — like those in a casino — that allowed speculators to increase society’s mortgage wager without financing a single house."

They didn't allow society to increase its average mortgage wager anymore than casinos make it possible for society to bet on red. There were two sides to the bet. The direct effect on society's wealth was zero no matter who won and how much. The gross mortgage bets increased. Net bets on mortgages staid the same.

Now I know he is doing this just to torment me, because he goes on to write"The *net* effect: investments like Abacus raised society’s risk for no productive gain."
There is no other explanation for his totally gratuitous use of the word "net." Oh and look if you are writing about finance, you shouldn't use the word gain without the other one, you know the l word (no not that l word). Abacus made it possible for more people to gamble on mortgages for no productive gain or loss. Since the alternative was building houses no one can afford to bet on defaults on their mortgages, the alternative would certainly have been a productive loss -- houses worth less than the cost of building them. By taking suckers to the casino and not Encino, Paulson and Goldman Sachs did the lord's work (not an original argument. I read it here and from Felix Salmon and besides it's obvious).

Now I'm really mad. He wrote "Allowing speculators to bet on entities in which they have no stake is similar to letting your neighbor take out an insurance policy on your life. " and he didn't cite me me meeeee http://tinyurl.com/2u2tx5c

Anyway, I agree with his policy proposals. The problem, however, is not that society's wager is increased by side bets, but that

1) Side bets can drive gamblers bankrupt and a strategy which will bankrupt a firm in the long run can be profitable in the short run and so attractive to managers who are paid short run.

2) bankruptcy is socially costly. There are capital requirements for a simple reason. CDSs written weren't considered for another simple reason -- 2 Gramms are stupid and evil.

3) with no reporting required, for a while in 08-09 no one knew which banks were solvent and which had bet the firm writing CDS and lost it. This caused the financial system to seize up.

Note all have to do with bankruptcy -- bankruptcy is costly and can be profitable especially to employee managers. Lowenstein doesn't mention bankruptcy of CDS writers in his op-ed (which is very odd indeed for an op-ed about CDS). The problem with allowing Wall Street gambling is that they can play heads they win, tails everyone loses a lot.

Tht's Robert Waldmann, oisted from DeLong's comments, and presented as a worthy effort to distinguish finance from--whatever. "Lowenstein" is this.