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May 23, 2008
How To Play Poker, The Bear Stearns Way
I was reading a poker book today, and came across the following quote on the topic of risk management:
Commercial banks make money by managing risk. They solicit deposits in savings and checking accounts. Then they lend these deposits out to others at a higher interest rate and pocket the difference.
You can tell that was written more than a year ago. It's been a while since anyone used banks as an example of good risk management. Nowadays that chapter might continue:
Many of the people to whom they lend those deposits have poor credit histories and/or low incomes. Loans to these risky borrowers, called subprime, are then rolled together into massive portfolios and sliced into tranches which get repaid in descending order from senior to equity. They then package them into shares, called collateralized debt obligations, and trick the credit rating companies (which isn't a very hard task) into rating the top tranches as investment grade.
Because the loans were made as adjustable rate mortgages with an initial discount to people who were already struggling to make their monthly payments, banks and other holders of CDOs leave themselves exposed to massive foreclosures as interest rates rise or the economy slows.
The poker lesson here? Just keep going all-in. Works every time but one.
Posted by themaroon at May 23, 2008 2:25 AM