I recently read “Paper Fortunes Modern Wall Street; Where It’s Been and Where It’s Going” by Roy C. Smith.  This was a lot to absorb – as it made me realize just how complicated the financial system has become.  We’ve all seen the catastrophic results of chaos in the financial markets – so I’ve been trying to understand more.

This was a fascinating book – in that it showed me how little I really know about the complexity of financial markets.  It provides enough history to help you understand how things have come along – from simple roots to the complex financial system we have today.

There were 2 eras mentioned in the book that significantly involved technology:

  • Backroom Crisis of 1968
  • Complex derivative products

Paperwork Crisis of 1968

In 1968 there was a problem in the financial system- the paperwork involved in a growing number of trades was getting lost.  Back in this era mostof the trades moved by hand – in that a piece of paper had to move from one person to another.   This manual system couldn’t keep up with the volume of trades – therefore a computerized system had to replace this manual paperwork system.  I know today it’s hard to imagine buying a stock or mutual fund and having to mess with paper – but that was where it started.  And computerizing the system made it feasible to handle the large volumes that an expanded financial system brought.

Complex Derivative Products

One of the areas of the recent meltdown had to do with complex derivative products. A derivative product is one where you don’t buy the thing – but something related to it.  For example the most common object of this era was collective mortgage obligations – a package of mortgages together sold for their value.  The value of this package is a function of the underlying assets – or in this case the value of the payments coming from those mortgages (cash flow).

Technology also came into the forefront as these financial objects that can be invested in become more complex.  There was also a lot of financial modeling going on – trying to locate underpriced assets, predict the market, etc.  To support all this a large (and probably still growing) amount of hardware and software had to be developed to support this businesss.

Conclusion

I would recommend this book to others – in that it will help get a sense of what’s going on in the Financial world.  I still don’t understand it all – but I appreciate the complexity of the system much more now.  From a geek perspective it would interesting to know how I would feel now if I had created some of the code that helped sell these complex derivatives that subsequently fell apart.  That said I also can see that as technology evolves it will be easier to understand what the risks and benefits of these packages are -as we continue to gain more information and how to process it better.

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