Many Wall Street experts have predicted that eventually the industry is headed for a financial meltdown, and Richard Bookstaber, who has spent his career designing derivatives, working on the street and running a hedge fund believes the same as well, according to The Wall Street Journal.“The financial markets that we have constructed are now so complex, and the speed of transactions so fast that apparently isolated actions and even minor events can have catastrophic consequences,” Bookstaber wrote in this new book, “A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation.”
Bookstaber runs hedge fund FrontPoint Partners, which was bought by Morgan Stanley last year.
“The odds are pretty high that we’ll see other dislocations that match the type of turmoil we saw with the crash in 1987 and with the hedge fund LTCM [Long Term Capital Management] crisis,” Bookstaber said. “Any one derivative, with some exceptions, may be easy to track. But the time you layer a lot of them one on top of the other, it becomes increasingly complex, so a small unexpected event can propagate in surprising and nonlinear ways, and there’s no way to anticipate all these possible events.”
The solution is for Wall Street to strive for less complexity and not trade every instrument that can be dreamed up, he said. He admits that doing this would require some government oversight, even though his book argues that regulation makes things worse by adding to complexity.
However, not all share his cynicism. Financial innovation and hedge funds have “greatly enhanced the liquidity, efficiency and risk-sharing capabilities of our financial system,” said Ben Bernanke, Federal Reserve Chairman in April.
The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.