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• Friday, August 17, 2007 02:04 AM

  Badly written, badly edited article.

  Strictly speaking, a derivative is a financial doohickey whose value derives from some underlying asset. A mortgage loan is an asset.

  Please be aware that Strictly speaking is term with a well-defined meaning. A classic example from linguistics is to compare the sentences

  Technically, Richard Nixon was a Quaker.

  Strictly Speaking, Richard Nixon was a Quaker.

  The first sentence is true, because Nixon satisfied the dictionary definition of Quaker. The second sentence is not true, because strictly speaking adds additional requirements; in the case of Quakers, it adds an ethical approach and world view that Nixon did not share.

  And strictly speaking, a derivative is not a doohickey. It is a financial instrument. Can we be grownups here, please?

  A pool of mortgage loans grouped together into a security that can be traded on markets is a derivative. . . . Derivatives belong to what should be called -- but never is -- the unreal economy, a place where speculators make bets about what will happen in the real economy.

  A securitized pool of mortgage loans may be a derivative, but more importantly it is a basket or portfolio security. Investing in one mortgage involves the risk that the borrower will default. Investing in a pool of mortgages diversifies that risk. It is socially useful and beneficial to allow investors to reduce their risk by diversifying. It is no more “unreal” than investing in a mutual fund instead of picking individual stocks. And all financial investment involves making bets about the financial future.

  . . . collateralized debt obligation. . . . Don't worry about the name. Call it an extra-special funky doohickey if you like. It's not important.

  It is important. Words are for communicating. Serious authors, editors, magazines, and websites use real names for things.

  Wall Street calls these slices "tranches," but that seems to be a word that makes the brains of normal people freeze up, so we'll ignore it.

  Do you have any evidence that the word tranch causes problems for “normal people”?

  But it becomes a much more severe problem when you're trying to figure what is going wrong when the trains start derailing.

  I thought we were talking about financial investments, or mortgage-backed securities. We also brought in sports metaphors. Where did trains come from? And what is the metaphor supposed to mean? Trains derailing is analogous to what, exactly, in the financial world?

  . . . the same games that Wall Street played with subprime are likely being played in every sector of the economy.

  Every sector, huh? What is your evidence for that?

  —eyesay Read eyesay's other letters
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