The synthetic CDOs that caused the trouble were expensive bespoke instruments that were very profitable for the banks involved – JPMorgan was paid $19m to structure and market the Squared CDO alone before it got stuck with $880m in unanticipated losses. Their complexity meant that only a few professionals could grasp them – most “sophisticated” investors went by credit ratings.
For investors, it was akin to being informed by a mechanic at the local garage that your vehicle needs expensive new parts and servicing. The garage has an incentive to charge you as much as possible and the information asymmetry between professional and customer makes it easy to pad the bill.
As long as the structure encourages it, investment banks will place their interests above those of their clients, no matter what they say. That is one reason why the US and European reforms to push as much of the derivatives market on to to exchanges and clearing houses – and into sight – are vital.
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