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INEFFICIENT MARKETS - Devil's Dictionary of Finance

A selective guide to what's happening in today's markets.

Part II of a modern financial lexicon, inspired by Ambrose Bierce's The Devil's Dictionary. Part I appeared in the August issue.

M * Mark-to-model: The use of a mathematical model to value complex securities. "The combination of precise formulas with highly imprecise assumptions can be used to establish practically any value one wishes" (Benjamin Graham). Useful to investors who wish to delay the recognition of a loss. See CDOs.

Master limited partnership: A clever corporate structure favored by private equity and hedge funds for going public. Provides investors with few governance safeguards while allowing asset managers to avoid paying corporate taxes on their earnings.

Mortgage broker: A person who, in exchange for a fee, will exaggerate the income of a mortgage applicant.

Mortgage-backed securities: A former blue chip of the Wall Street casino that is rapidly losing currency. See withdrawals.

N * Negative amortization: Mortgages provided to people who can't afford the initial interest payments. Principal accrues for a year or so, after which interest payments rise and the home is repossessed. Increasingly popular for funding buyouts, where neg-am loans go under such fancy names as "nonaccretive interest rate swaps."

Ninja loans: Loans provided to people with "No Income, No Job and no Assets." An example of mortgage broker wit.

O * OverconÞdence: The willingness to pay large fees to fund managers in hopes of achieving above-average returns. See institutional investors.

P * Prime broker: The unit of an investment bank that services hedge funds. Prime broker loans to hedge funds are now securitized and sold on to... hedge funds.

Private equity: A branch of the investment industry run by deal makers rather than investors. This may explain why despite a quarter century of generally rising asset prices and falling interest rates and huge dollops of leverage, investors in buyout funds would, on average, have been better off leaving their money in the stock market. The same cannot be said of private equity's general partners.

Q * Quantitative Þnance: The misbegotten attempt to turn Þnance into a branch of physics.

Quants: The name given to mathematicians and physicists who surrender science and scruples in exchange for Porsches.

R * Rating agencies: The highly proÞtable cartel of Þrms that provide investment ratings on bonds. Bondholders cannot complain about the quality of these ratings because a) they are paid for by the issuers of debt, and b) the rating agencies are only expressing an opinion.

Regulators: Government-employed lawyers who, having failed to get employment on Wall Street, have trouble understanding what's happening on Wall Street.

Risk: The flawed attempt to precisely measure an uncertain future.

Risk premium: A gauge of investors' willingness to lose their clients' money. A high premium occurs only after a lot of clients' money has been lost and reflects money managers' fear of losing their jobs.

S * Structured credit: An invention of modern Þnance that conceals risk in complexity while facilitating the extraction of fees by investment banks, rating agencies, hedge funds, etc.

Subprime lending: The practice, initially profitable, of providing credit to those who can't be trusted to repay.

T * Toggle notes: Loans to leveraged buyouts that, at the borrower's behest, switch from payment of interest in cash to payment in kind, or further notes. As the toggle is likely to be exercised when cash has run out and the notes are near worthless, kind is not an apt description of this type of payment.

U * Underwriting standards: The outcome of the conflict between a banker's fear of losing money and his desire to earn a bonus.

V * Valuation: An argument with the market price. See mark-to-model.

W * Withdrawals: The belated action of investors on waking up to discover that a hedge fund manager has been playing fast and loose with their money. The hedge fund industry is trying to remove this inconvenience by "locking up" its investors.

Y * Yachts: An out-of-town visitor was being shown the wonders of the New York Þnancial district when a guide indicated some ships off the Battery and said, "Look, those are the bankers' and brokers' yachts."

"Where are the customers' yachts?" asked the naive visitor.

(An ancient story, retold by Fred Schwed Jr.)

Z * Zombies: A plague of the corporate living dead. See Þnancial engineering.

Edward Chancellor, an editor at, is the author of Devil Take the Hindmost, a history of Þnancial speculation.