One of the central themes of this blog is Wall Street’s business model of selling opaque investments.

Wall Street understands everyone likes a good story.  However, a good story is not the same as a good investment.  What makes for a good investment is the ability to Trust Wall Street’s good story AND Verify the story is true.

Wall Street also understands it makes more money selling opaque securities than transparent securities.  Investors rely on Wall Street’s story for how to value opaque securities.  Investors or independent experts hired by the investor can choose their own method for valuing transparent securities.

As a result, Wall Street has an incentive to wrap the opaque securities they create inside of a good story and go phishing for fools.

It is a lot easier to find fools than you might initially imagine.  David Dunning gave a great explanation for why this is true:

As the humorist Josh Billings once put it, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

Why does this occur?

the problem of unrecognized ignorance is one that visits us all. And over the years, I’ve become convinced of one key, overarching fact about the ignorant mind. One should not think of it as uninformed. Rather, one should think of it as misinformed.

An ignorant mind is precisely not a spotless, empty vessel, but one that’s filled with the clutter of irrelevant or misleading life experiences, theories, facts, intuitions, strategies, algorithms, heuristics, metaphors, and hunches that regrettably have the look and feel of useful and accurate knowledge. [emphasis added]

Shorter: a little bit of knowledge is dangerous.  Particularly when it comes to Wall Street and the investors’ financial health.

This clutter is an unfortunate by-product of one of our greatest strengths as a species. We are unbridled pattern recognizers and profligate theorizers.

Rather than think through an investment and ask questions like “do I have enough information to make an informed decision”, people tend to apply shortcuts like pattern recognition and theorizing to make a decision.

But our genius for creative storytelling, combined with our inability to detect our own ignorance, can sometimes lead to situations that are embarrassing, unfortunate, or downright dangerous…

Naturally, Wall Street understands this and recognizes it as the key to selling high margin opaque securities.  That is why opaque securities are paired with a good story.  In the absence of the story, nobody would buy the opaque securities.