Financial Innovation, Financial Schminovation

Just look at an instrument called the reverse convertible.

James Kwak has a hard time wrapping his head around this until he realizes that it's nothing more than a way for bankers and brokers to screw their customers.

It's so corrupt that it boggles his mind:

In a reverse convertible, you give $100 to a bank for some period, like a year; it pays you a relatively high rate of interest, say 10%. The $100 is virtually invested (no one actually has to buy the stock) in some underlying stock, like Apple. If at the end of the period the stock is above a threshold, like $80, you get your $100 back; if it is below the threshold, you get the stock instead. (The terms can depend on whether the stock ever went below the threshold and where it is at the end of the period, which makes the deal worse for the investor, but that’s the basic idea.)

The simplest thing to compare this to is just buying the stock. Compared to buying the stock, there are three outcomes:

The stock ends up below $80: In this case, the reverse convertible is slightly better, because you got the$10 in interest, which is probably more than the dividends you gave up.

The stock ends up between $80 and $110: Again, the reverse convertible is better, because you got $110 (your principal plus interest); it’s a little better if the stock ends up close to $110, a lot better if the stock ends up at $81.*

The stock ends up above $110: Here, you do anywhere from a little worse (if the stock ends at $111) to much, much, much worse (if the stock goes over $200).

And then he asks, with no small justification, "What the hell is the point of this product?"

This is why I think that a financial regime needs to be established with the idea that that which is not explicitly approved is prohibited, because the current regime, even under Obama's updates, gives us this toxic waste.