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1-Page Summary of Other People’s Money
Overview
If you watch the news, you will notice that financial crises are a constant occurrence.
Most of us will remember the 2008 financial crisis, but few people will understand what caused it. Was it because of banks or businesses? Or governments? The problem is that it’s very complicated and difficult to explain. These key points set out to explain why finance is so important and how we can make sure our economy doesn’t collapse again.
Big Idea #1: History shows that a healthy financial system can improve lives and strengthen economies.
Today, the global financial system is one of the main causes of many problems around the world. However, it wasn’t always like this.
Finance was originally intended to make it easier for people to conduct business. It allows us to buy the things we need and connect those who have money with those who need money. It also makes insurance possible, giving people a chance to protect themselves from disasters or emergencies, as well as allowing them to organize their personal assets so that they can pass them along.
Another way to make money is by lending it. This can be done with mortgages, where people take out loans and pay them back later in life.
On a larger scale, the financial system can help society as a whole. One example of this is that we’ve made progress in several centuries.
A strong financial sector is necessary to become a world power. Therefore, it’s important for developing countries to have strong financial sectors so that they can spread their money and improve the standard of living in those countries.
We can see how the financial system in communist countries is unable to support businesses and leads to poor growth.
There have been many positive outcomes of capitalism, but some financial innovations haven’t helped society. In fact, they’ve hurt us. The global population has lost sight of what’s good and bad for the world as a whole because of this. We’ll get to the bottom of why that happened in the key points below.
Big Idea #2: The derivative market has driven finance further away from benefiting the real economy.
Finance used to be about helping people get the money they needed to realize their ideas. You could think of a bank providing capital for someone who wanted to open up his own bakery. However, we’re drowning in needless transactions that aren’t doing us any good because of financialization.
The growth of finance and trading has been so large that it’s called financialization. The problem is, it helps banks but hasn’t helped the economy at large or small businesses grow.
Financialization started in the 70s, when financial institutions became increasingly involved with trading more and more securities. However, it was really derivative securities that pushed financialization over the edge.
Derivatives are like contracts that depend on the performance of other assets. Depending on which kind of derivative is being used, one party can gain from an asset’s rise or fall in value.
A credit default swap is a financial derivative that allows banks to protect themselves against borrowers who don’t pay back their loans.
In a way, it’s like insurance. The institution that invests in the CDS is promising to pay if there’s a default by the bank, and the bank promises to reimburse them with interest later on. This is how we ended up in 2008: too many banks were giving out loans to people who couldn’t afford them, so they defaulted on their loans and all of a sudden everyone needed money from each other because there was no more money available. Technology made it easier than ever for people to trade securities and derivatives, which led to massive inflation of the financial sector. These practices are tantamount to gambling with other people’s money—which isn’t helping anyone at all!
