Banks and Bucket Shops

There are basically four ways people hand over money to financial institutions: 1. Bank deposit accounts. You deposit your money and the return of principal and interest is guaranteed. Banks are required to hold enough capital to deliver on that promise. 2. Insurance. If you suffer a loss, you are guaranteed recovery. Insurance companies are required to hold capital to meet that guarantee. 3. Gambling. If your bet wins, you are guaranteed your winnings. Casinos and racetracks are required to hold enough funds to ensure payouts. 4. Investment. There are no guarantees when you invest in a stock or a bond. You could lose everything. Appropriately, investment bank capital requirements are much lower. The first three categories contain guaranteed payments against future events; the fourth is merely aspirational.

via FT.com / Comment / Opinion – We modernised ourselves into this ice age.

That’s a very nice way of summing up the financial options in this world. The article provides other insights such as why the credit default swaps were like the bucket shops at the beginning of the 20th century. A financial blowout was more or less inevitable. When insurance products (credit default swaps) are treated like investment products as regards capitalization, the ultimate outcome is hard to doubt.

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