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Still The Masters of the Universe

Tom Wolfe writing in Bonfire of the Vanities created the term – ‘Masters of the Universe’: “He considered himself part of the new era and the new breed, a Wall Street egalitarian, a Master of the Universe, who was only a respecter of performance.” Wall Street bond trader Sherman McCoy, the original Master of the Universe, came to personify the avariciousness and self-aggrandisement of financiers.

Human history is a sequence of “ations” – civilisation, industrialisation, urbanisation, globalisation interspersed with actual or threatened “annihilation”. The most recent “ation” is “financialisation” - the conversion of everything into monetary form (also known as another “ation” – “monetisation”).

New paper economies emerged directly from the demise of the gold standard that removed restrictions on the ability to create money, especially debt. Finance inexorably displaced industry with trading and speculation becoming major activities as financial engineering replaced real engineering. In an earlier age, Heinrich Heine, the German poet, too had identified the change: “Money is the God of our time….” The rise of financiers is intimately linked to this financialisation of the global economy.

Financial innovations such as securitisation (the packaging up and sale of loans) and derivatives (effectively risk insurance) enabled banks to extend more credit. Banks could literally by increasing throughput, making more loans and selling them off to eager investors, magically increase returns to their investors. Bankers had invented a ‘money machine’.

Bank also began to trade more actively with their shareholders money, following the advice of Fear of Flying author Erica Jong: “If you don’t risk anything then you risk even more”.

All of this, of course, meant increased earnings for the bank and its star performers. As people who work in financial institutions know, it is primarily an enterprise that is run for the employees with an afterthought for shareholders.

Sherman McCoy could with a single phone call make $50,000 and, even better, a share of that was his and his alone. At the height of the boom, top hedge fund and private managers could make more in 10 minutes than the average worker earned in an entire year. In 2007, James Simons of Renaissance Technologies earned $1.5 billion and David Rubinstein of The Carlyle Group earned $260 million in the ethereal “economic stratosphere.” In Australia, Macquarie Bank employees rejoiced in the sobriquet – the ‘Millionaires factory”.

The ability to earn high rewards only becomes a problem where the promise of a share of profits encourages excessive risk taking and a focus on short-term earnings. It also becomes a problem where the basic measure of performance is ambiguous and can be systematically manipulated. Unfortunately, ‘earnings’ proved to be the result of wildly inaccurate models, accounting tricks and risks that had not been accurately captured.

Finance is also problematic when it comes to dominate the economy. In the U.S.A., financial services’ share of total corporate profits increased from 10% in the early 1980s to 40% in 2007. The combined stock market value of these firms grew from 6% to 23% over the same period.

It is now conventional wisdom to accept the central role of financial services. Gordon Brown, the Chancellor of the Exchequer under Tony Blair and then Prime Minister, harboured secret dreams of a Scandinavian-style social welfare state with low taxes funded by the growth of the City. In 2007, he told bankers: “What you have achieved for the financial services we … now aspire to achieve for the whole of the British economy.” Alistair Darling, Gordon Brown successor as Chancellor, was no less loquacious describing financial services as “absolutely critical” to the economy.

The golden age seemed to come to an end with the GFC. Initially, the world viewed the destruction of storied financial institutions in Global Financial Crisis as an entertaining blood sport.

Some bankers lost their jobs by the thousands. Others lived with the psychological fear of firing by text message.

In New York, bankers confessed it was hard to live on less than $500,000 – after all, the children’s private school fees, the maid, the Pilates lessons etc all cost money. They economised by buying cheaper cuts of meat. In London, families deferred moves to more expensive suburbs. The latest Gordon Ramsay restaurant was no longer a must have.

The effects of belt-tightening were seen in a fall in bookings at luxury hotels, holiday resorts and sales of super yachts – some of the plutocrats were down to their last billion. Once rich hedge fund managers were back in court trying to renegotiate the terms of their divorce pleading ‘poverty’.

For some women, the aphrodisiac quality of a young unattached male purring “I’m an investment banker” in a certain type of bar lost its allure. Some professions – personal trainers, dog walkers, personal dressers, children's party organisers – were in danger of extinction.

There was a sense of Schadenfreude as the Masters of the Universe received their comeuppance. Unfortunately, the “financial” crisis quickly spread to the “real” economy – jobs, consumption, and investment- becoming everybody’s problem. “Too large to fail” financial institutions had to be bailed out by governments, that is the ordinary taxpayer. In a perverse piece of income redistribution, the less fortunate now were subsidising the masters of universe because it was in their best interest.

Commentators briefly dared hope that the power and influences of finance and financiers would be reduced. Finance would revert to being a facilitator rather than the central driver of the economy.

The Economist wrote: “Over the past 35 years it has seemed as if everyone in finance has wanted to be someone else. Hedge funds and private equity wanted to be as cool as a dot.com. Goldman Sachs wanted to be as smart as a hedge fund. The other investment banks wanted to be as profitable as Goldman Sachs. America's retail banks wanted to be as cutting-edge as investment banks. And European banks wanted to be as aggressive as American banks. They all ended up wishing they could be back precisely where they started.”

Unfortunately, those hopes are misplaced. Low or zero interest rates, heavily managed markets, reduced competition and state underwriting of solvency has helped surviving banks prosper.

Bank risk levels have increased to and in some cases beyond pre-crisis levels. The higher levels of risk taking reflect increasing comfort in central bank support of financial institution’s liquidity and their ability and willingness to intervene to limit price risks.

In 2008 in Canary Wharf, the financial district in London’s docklands, I meet two affable recruiters from the English Teachers Union who explained that there was “a bit of financial crisis”. Well-educated and highly motivated bankers who were losing their jobs by the thousands might like to consider a new career teaching. I questioned the adjustment in salaries that the change in careers would necessitate. One recruiter’s responded: “If you haven’t got a job then it’s not relevant is it? It was never real money and it wasn’t going to ever last was it?”

Over the last 30 years, talent has increasingly been lured from productive profession into finance and the speculative economy. The rewards available mean that the brain drain into these professions is unlikely to stop. The excesses of the financial economy are also unlikely to be easily tamed.

The Masters of the Universe that survived the carnage are back to their old tricks. The ‘fight for talent’ means that bonuses and remuneration guarantees for new employees are all back in vogue.

Government attempts to deal with the problems of the financial system, especially in the U.S.A., Great Britain and other countries, illustrate Mancur Olson’s thesis - small distributional coalitions tend to form over time in developed nations and influence policies in their favor through intensive, well funded lobbying. The resulting policies benefit the coalitions and its members but large costs borne by the rest of population.

The “finance government complex” (dubbed “Government Sachs” by its critics) and financiers have proved exquisite masters of the game of privatisation of profits and socialisation of losses. Many countries now practice Chinese socialism with Western characteristics.

A year after the collapse of Lehman, the near collapse of AIG and the grande mal seizure in financial markets, the Masters of the Universe are still firmly in charge. As Giuseppe di Lampedusa, author of The Leopard knew: “everything must change so that everything can stay the same.”

© 2009 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

Greed & The Other Seven Deadly Sins!

Greed is back already, perhaps it never went away. On the back of revived earnings, compensation for star bankers is looking up. Even signing and guaranteed bonuses are stirring.

Excessive executive remuneration is widely viewed as a symptom of ‘greed’, one of the seven deadly sins.

For some, excessive pay contravenes ideas of ‘equality’. Bankers should be paid the same as a nurse who should be paid the same as a doctor.

This misunderstands the concept of equality. Anatole France observed: “The law, in its majestic equality, forbids the rich as well as the poor to sleep under bridges, to beg in the streets, and to steal bread.” It challenges concepts of motivating achievement through reward. Objective assessment of different contributions is also likely to prove difficult.

Concern about excessive pay also focuses on ‘allocation’; ‘who’ gets ‘what’. Mark Twain once admitted: “I am opposed to millionaires, but it would be dangerous to offer me the position.”

For others, the issue is ‘proportionality’; a chief executive’s reward is disproportionate to his or her contribution.

Tight, in-bred circles of directors and consultants determine senior executive salaries. ‘Benchmarking’ exercises merely reinforce the ‘norm’ with packages being justified as ‘needing to buy the best talent’ or ‘meeting the demands of a competitive market’. Results are also easily manipulated to meet specified performance hurdles for bonuses. Recent severance payments highlight that failure is better rewarded than success.

John Kenneth Galbraith identified this pattern long ago: “The salary of the chief executive of the large corporation is not a market award for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.”

But who is responsible? Many people are now shareholders, directly or through superannuation schemes. Critics ironically acquiesce in the award of generous senior executive packages. They either actively vote in favour of these contracts or fail to challenge the arrangements, as is their right.

There may be a double standard. Critics were willing to hand executive generous pay packets so those talented managers would make them richer. Many turned a blind eye to excesses when they became richer through higher share prices and dividends. George Orwell reminds us: “People sleep peaceably in their beds at night only because rough men stand ready to do violence on their behalf.”

Criticism of excessive remuneration packages ironically necessitates committing the other six deadly sins. Critics secretly perhaps ‘lust’ after the same riches that they are now censure. Their desire for increased wealth to fuel excess consumption – the sin of ‘gluttony’ – drives greed.

Critics are guilty of ‘sloth’ in their laziness in not exercising their power as shareholders to rein in compensation excesses. Critics may be guilty also of the sin of ‘wrath’ as they now indulge their righteous anger. They commit the sin of ‘envy’ as their stand may be merely resentment at those in the world who have done better.

Finally, critics are almost certainly guilty of ‘pride’, being conscious of their superiority in making their principled stand against greed.

In truth, critics are looking for scapegoats and simple answers to the losses suffered as a result of the Global Financial Crisis. This is evident in the return of large paydays as share prices have rebounded. John Stuart Mill cautioned: “Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works”.

Excessive executive remuneration is not a simple matter of ‘greed’ but symptomatic of deeply flawed economic and social systems. In their classic 1933 book – The Modern Corporation and Private Property – Adolf Berle and Gardiner Means argued that companies were akin to feudal kingdoms run by “princes of industry” consistent with their own interests. Half a century later, directors and managers (with modest shareholdings) in conjunction with, for the most part, benign investment managers still run enterprises in a manner not always consistent with the interest of ‘absentee’ shareholders.

John Maynard Keynes was aware of this: “Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone.”

All systems are flawed. The real issue is their effectiveness. Unfortunately, as Keynes wrote: “The decadent international but individualistic capitalism in the hands of which we found ourselves …. is not a success. It is not intelligent. It is not beautiful. It is not just. It is not virtuous. And it doesn't deliver the goods.”

Genuine reform of executive remuneration requires understanding of the true problems and reforming the economic system rather than merely treating one of the symptoms.

© 2009 Satyajit Das

Satyajit Das is the author of ‘Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivative’. This article is based on a contribution to the Adelaide Festival of Ideas.

Job Description for "Rogue Trader"

Job Description – Rogue Trader

Position Title (Rogue) Trader. (The “rogue” term is generally not to be used explicitly especially with senior management, directors, shareholders and clients for fear of misunderstanding.)

Reporting Line

The position reports along “functional’ and “geographic” lines to the Head of Trading and Head of the Region. (Nobody, really. A multi-dimensional matrix structure is currently in operation so that everybody reports to several people allowing a total absence of accountability.)

Location Optional. (Some candidates may have a preference for working in head office where total confusion and chaos reigns facilitating successful rogue trading. Other candidates may prefer a remote location where benign neglect and absence of supervision may provide rogue trading opportunities.)

Organisational Environment

? A leading edge investment bank with a global brand, presence in key financial markets, superb product range and unparalleled client list. (Our PR firm told us this.) ? A global trading team trading in a wide variety of cash and synthetic instruments, including a number of “proprietary” structures. (You can lose money pretty much any way you like. There are some trades that even we don’t understand but the models say we are making money). ? Supported by a world class risk management team (they are readily identifiable by their guide dogs) and operational staff and systems (they have been specially chosen for their total ignorance.) ? Excellent career prospects (We have sinecures for everybody who has failed to perform.)

Key Responsibilities

? Trading with the bank’s capital to achieve targeted risk adjusted returns on capital under the bank’s unique Economic Capital Allocation system. (If you are half as smart as you think you are then you will be able to game the system from day 1. Everybody else has.) ? Developing innovative trading strategies. (You need to be able to come up with hare brained trading schemes based on the relationship between the El Nino cycle and market prices.) ? Closely managing trading positions. (You need to be able increase your bet when your position shows losses until you bankrupt the firm.)

Major Challenges

? Develop proper models and valuation procedures (You need to ensure that all pricing models are impossible to understand and give the valuations that you want by simple unverifiable changes in model inputs.) ? Risk management of positions (You will need to fudge all the Greek risk measures. We suggest you start to report risk data in an ancient Nubian dialect that is purely oral. You will ensure that your risk always appears miniscule irrespective of market conditions. People have a tendency to panic otherwise.) ? Monitoring (You will need to be able to disguise breaches by not booking the trades or taking advantage of systems deficiencies.) ? Control losses and volatility of earnings (You must disguise losses either by recording them as amounts owed to you (the Leeson gambit), undertaking off-market trades such as deep in-the-money options (the Rusnak variation) or incorrect valuations (Rogue Trading 101).) ? You need to be able to take the trading function to a new plane. (You need to show larger losses than the last rogue trader the firm employed.)

Selection Criteria

? Detailed knowledge of financial markets and trading techniques. (You should wax lyrically about obscure markets (the Zambian Kwatcho and Islamic finance techniques) and complex mathematics (field theory; neural networks; fractals; Frank copula models). Everybody will think you are a genius or a fool but will be unsure of which.) ? Detailed knowledge of derivatives, including exotic and non-standard structures. (Everybody knows that derivatives allow highly leveraged positions that are impossible to understand or value accurately.) ? No minimum formal educational qualifications or direct previous experience in a similar role is necessary. (Nobody believes your CV. It is merely a statement of your aspirations. Nobody will believe you if you said that you had rogue trading experience.) ? Ability to communicate and work closely with senior management. (You will need to make sure that you generate enough “phantom” profits to make sure their bonus expectations are met.) ? Ability to work closely with operational staff (You must bully them or cajole them into concealing limit breaches and losses.) ? Strong leadership qualities (You will claim all profits are the result of your perspicacious skills. All losses will either disappear or if found will be hedge losses offset against gains in other positions.)

Desirable Criteria

? Preferred age – under 30 years. (Have you ever heard of an old rogue trader? There is an exception for Japanese rogue traders who are generally older.) ? Strong personal qualities. (You will have “attitude”. A year round sun tan and a wisp of beard underneath your chin is good. You will treat everybody around you as idiots incapable of understanding the complex nature of your trading strategies.) ? Highly motivated. (You will need to be able to hide losses and limit breaches. The Japanese rogue traders never took holidays.)


Negotiable including a strong performance linked component. (You don’t need to be paid as it is assumed that you will defalcate ample amounts.)

Social Responsibility Statement

We are proud to be an equal opportunity employer. (We do not discriminate on any basis. How else can you explain the calibre of Directors and Senior Management not to mention risk managers and auditors that we have?)


The above is an extract from Satyajit Das Traders, Guns & Money: Knowns & Unknowns in the Dazzling World of Derivatives (2006; Pearson Education) © 2006 Satyajit Das

Note: The idea is based on a column published by Trevor Sykes (writing as Pierpoint) of the Australian Financial Review [see “Indispensable Guide For Rogue Traders” (30 January 2004) Australian Financial Review] However, the text is different.

Rough Trade

Sales people are “girlie” men. Traders are “real” men, even if they are women. They are the “big swinging dicks”, the “masters of the universe”.

Traders, well, trade. The key thing for the trader is to make profits. There is only one way to make money – you buy low and sell high. Sorry, forgot the second rule – sell high, buy low. Listening to traders, you get an entirely different view of their business, especially its complexity.

Traders are not noted for being literate let alone classical scholars. But when talking of trading, traders frequently turn to tracts such as Sun Tzu’s The Art of War or Thucydides’ The Peloponnesian Wars. The traders haven’t read the books of course. What they know has been acquired second hand – snippets from overheard conversations, incorrect quotations in hilarious pulp books on trading. One trader attributed his success to the following maxim from Sun Tzu: “For the impact of armed forces to be like stones thrown on eggs is a matter of emptiness and fullness.” My personal favourite (incidentally the only thing from The Art of War I can remember) is: “Draw them in with the prospect of gain, take them by confusion.”

Success in trading relies on simple rules. Overwhelming force is generally good. You just have more money than everybody else and can hang on until everybody is forced out of the game. Ganging up is effective. You just get together with other traders and fall upon a weakened animal like hyenas or wolves. Ambush is also good. You know something that the other guy does not know, at least not yet.

In the late 1990s, I was visiting Mumbai in India. The stock exchange was debating a move to electronic trading. There was resistance to the move. They invited a Nobel Prize winning US financial economist to speak at a conference seeking to win over the brokers to electronic trading.

The economist spoke eloquently and movingly of “greater trading efficiency”, “lower transaction costs”, “lower commissions”, “improved price discovery” and “greater pricing transparency”. The audience was almost in tears, from laughter. After the speech, I found myself with some brokers and the celebrated guest speaker.

“I cannot be understanding how you could have been gotten the Nobel Prize, Sir. You will be being a complete fool”. One of the brokers addressed the eminent American economist with refreshing directness. “I will be dealing in market circumstances when my clients will not be having a clue as to what the price will be being. Tata shares may be trading at Rupee 100. My client will not be knowing that factor. I will be being telling him that Tata is trading at Rupee 105. I will then be selling him the shares at Rupee 105 plus my spread of one Rupee plus my commission. He will be being most happy. I will also be being most happy. If he knew the price then he would be very unhappy. I would also be most unhappy. I do not understand why being most efficiently is good. We will be being most happy as we are. I will be thinking that Americans are being mostly stupid.”

The guest speaker looked stunned. He was at a loss for an argument. He resorted to platitudes about “efficiency” and “transparency”.

Trading depends upon being able to predict future prices. Traders invest heavily in forecasting methods. Increasingly, this takes the form of quantitative analysis involving arcane mathematical and econometric techniques. Traders are also increasing applying technology to trading. This has its own risks. One quant programmed his machine to short all insurance stocks when the word “hurricane” and “Florida” appeared on electronic new services. This may lead to some unexpected and bizarre consequences. Imagine the widespread selling of insurance shares when a newspaper reports that the highlight of Bob Dylan’s farewell concert in Miami, Florida was his rendition of “Hurricane” – his song about ex-boxer Reuben “Hurricane” Carter.

Science adds mystique and method to trading, it does not increase the prospect of success. Better still to be a lucky fool.

Human beings trade. “Behavioural finance” analyses the psychological basis of economic decisions. Daniel Kahneman, one of its founders, shared a Nobel Prize for his work. It seems people are over-optimistic about outcomes. Americans seem especially prone to over-optimism. 40% of Americans believe they will end up in the top 1% of income earners. Over optimism translates into over confidence with people exaggerating their own skill, overestimating their level of control over events and ignoring the skills of the competition.

Behavioural finance itself is evolving. One recent study showed “conclusively” that stocks with easy to pronounce names performed better after IPOs. There is now a rush to consult behavioural economists together with marketing gurus, brand consultants, feng shui experts etc in naming companies. “Conclusive” by the way in the context of research generally means that the author of the study selected data specially that haven’t to prove the hypothesis conclusively

Fascination with behavioural finance leads to some odd trading decisions. One trader confided that after a course in Kahneman’s work he implemented a new strategy. If he had a hunch or particular expectation, then he bet against it.

In the final analysis, trading is about the future. Forecasting is difficult. Traders should study the story of Croesus.

Croesus was the King of Lydia. He developed gold and silver coins creating the world’s first imperial currency. At the height of his power, Croesus decided to attack Persia. It was a pre-emptive strike. He wanted to destroy Persia before it posed a threat to Lydia. Croesus consulted the oracle at Delphi. Just to be safe, he also consulted six other oracles from Greece and one from Libya. Ever cautious, he even tested their forecasting accuracy. Each messenger consulted the oracle on a pre-determined day. Each messenger asked the oracle what Croesus was doing on the day. Croesus planned an act that it was unlikely a charlatan would be able to guess. He planned to chop up a turtle and lamb and boil them in a pot.

Only the oracle at Delphi passed the test of authenticity. Croesus plied the oracle with gifts receiving, according to the historian Heredotus “rights of first consultation without a fee”. The oracle prophesied that Croesus would “destroy a great empire”. Croesus went to war against the Persians and was defeated. The Delphic oracle had been right. A great empire had been destroyed - the Lydian empire. As he was being burnt as an offering to Persian gods, Croesus is said to have cried out to Solon. Solon had reminded Croesus years earlier: “human beings are the creatures of pure chance”.

It is a truism that trading thrives on information – “information”, “dis-information”, “mis-information”, “inside information”. It has always been that way. Financial news isn’t like normal news. In normal news, we are passive spectators to the great, the good, the evil and Paris Hilton. Financial news is about finding out information that affects the business. It shapes what traders buy and sell. It shapes the price that traders are willing to pay. The trader also wants to know what everyone else is doing. But the trader doesn’t want others to know what they are doing. It’s all a bit tricky.

This leads to a strange pas a deux between the financial press and the traders:

Reporter So, what’s going on? Trader You know, stuff. Not a lot. But stuff. You know. Reporter Any particular stuff? Trader Nah, just the usual stuff. Reporter I heard that a pretty big deal went though. Exotic. Large size. Hedge funds. Did you guys see it? Trader (extremely animated) Really! Who did you hear that from? Reporter Did you see the trade or what? Trader So, who told you? Reporter Look, did you see the trade? Bid on it? I think it’s one of your big clients. Trader Maybe. We bid on so much stuff these days. It’s hard to keep track, you know. What was it? Who did it?

Donald Rumsfeld summed it up astutely. “Anyone who knows anything isn’t talking and anyone with any sense isn’t talking. Therefore, the people that are talking to the media, by definition, are people who don’t know anything and people who don’t have a hell of a lot of sense.” That pretty much describes the exchanges between traders and the financial press.

Information, even priceless information, requires careful analysis. On a trading floor in London, the PA to the Head of FX called across with the enigmatic statement that: “The Fed’s in.” Dealers scrambled for their phones taking positions before the PA could finish her statement. The PA continued: “The Fed’s in. They’re in reception waiting for you!” Suddenly all the traders were trying to unwind the position that they had just taken. (See Euromoney (May 2006) at 8).

In the 1960s, a Canadian academic, Marshall McLulhan built a reputation on his views of modern culture. He is best remembered for the pithy phrase: “the medium is the message”. Nobody quite really knew what McLulhan was getting at. In press coverage of finance and markets, the medium is the only message. McLulhan also understood the value of the secret information that everybody in financial markets covets. “This information is top security. When you have read it destroy yourself”. ________________________________________________

The above is an edited extract from Traders Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das (2006, FT - Prentice Hall, London, ISBN 0273 70474 5) available at all good book stores or online at www.pearson-ed.com. _________________________________________________

Satyajit Das is a specialist in the area of financial derivatives and risk management. He is the author of a number of key reference works on derivatives and risk management. His works include Swaps/ Financial Derivatives Library – Third Edition (2005, John Wiley & Sons) (an 4 volume 4,200 reference work for practitioners on derivatives). He is also the author of Credit Derivatives, CDOs and Structured Credit Products –Third Edition (2005, John Wiley & Sons) and Structured Products & Hybrid Securities – Second Edition (2001, John Wiley & Sons). He is the author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (forthcoming, April 2006, Pearson Education), an insider's account of derivatives trading and the financial products business filled with black humour and satire. He is also the author (with Jade Novakovic) of In Search of the Pangolin: The Accidental Eco-Tourist (forthcoming, June 2006, New Holland), an unique travel narrative offering passionate and often poignant insights into the natural world and the culture of eco-travel.