From the title I expected the article to inform me about why this wasn't a rogue trader, that is, some new information about this particular case.
Instead I get a long rant about the evils of investment bankers. Might be a great political point, and it was certainly a nice rant, but it had nothing to do with the title except in the broadest sense.
In short, I felt tricked to read the piece. There was only a sentence or two to directly support the title. The rest was a screed on the generic problem. This is the kind of article where people who are pissed about bankers (and I count myself among them) will read and nod their heads and totally agree with the author -- all the while forgetting that the meat of the article provides much heat, little light.
I'm basically an Ayn Rand cultist, and I think the article delivers. It is now obvious that the CEOs running Lehmans, Bear, and Citibank in 2007 had absolutely no idea of what their assets were or how they were funded. They were as far outside their "risk limits" and "authorized positions" as any of these "rogues". But their limits were phrased with far less clarity and with far more wiggle room. The criminality of these "rogues" is defined by their failure to comply with clear and easily adjudicated policies. No such criminality could be applied to the CEO's deviation from their duties. The difference between the CEO and the rogue trader isn't in their basic behavior but in the standards that apply to them.
That problem cannot be solved by law or policy governing behavior. The standards applied to these CEOs do not admit of the precise specification needed for clear differentiation between error in judgment, bad luck, malfeasance or dereliction of duty. Hofstadter talks about the "computability" problems addressed by Godel and such, trying to determine which problems are and aren't resolvable by computation. Governance at that level is a similar kind of problem.
The implications of this are profound. Since we can't legislate / regulate right behavior, we have to motivate it through incentive alignment. Thirty years ago these banks were partnerships -- if they failed, they wiped out most of the saved capital of their retired partners and senior employees. You can be very sure those folks were both willing and able to apply the qualitative judgments of risk unavailable to a policy driven review.
Those partnerships were converted to publicly held equity because this was less risky for those partners and allowed the companies to achieve larger scale, momentarily conveying cost advantages. But public equity holders don't, and can't, understand these entities as well as those partners did, and therefore cannot discipline management nearly so well. The real long-term costs of that dilution in risk management are now more apparent.
None of this would be any of my business if banking weren't a necessary component of modern money creation and thus inherently intertwined with the government. As such, any citizen has a stake and a voice in the stability of these institutions and their role in the creation of money. The latest regulatory revisions seek to obtain the needed stability by improving the foresight of the regulation, backstopping any failure with an implicit government guarantee on the system. Since the regulation _cannot_ be improved, we are headed for another bailout at some moment to be determined. Meanwhile we are essentially underwriting excess compensation for those managers and traders who can figure out the extraction of cash from the system before the equity again falls to zero.
There are alternatives. Each of these institutions should be a lot smaller, so the system can tolerate the collapse of any several. And they should be generally capitalized by investors who can understand their assets and liabilities, who are in a position to get the confidential information needed to the institution's specific balance sheets, and who _cannot_ hedge or diversify away enough risk to become indifferent to the institution's success. Publicly traded equity fails on all of those conditions.
The consequences of partnership equity are obvious. It rolls back the scale, and with it the momentary cost advantages, enabled by larger, dumber, indifferent public capital. Those large institutions managed with integrity (e.g., JP Morgan) will be f*ed. Capital costs will rise, in part due to induced scale and liquidity inefficiencies, but in part due to the reflection of the real risks of these institutions. But the policy problems of moral hazard and public subsidy of private speculation will be removed. We will be spared the logical contortions required to explain away the obvious immorality and idiocy of many of the people running these institutions. We will avoid the corruption of language and thought that necessarily follows from attempting the impossible task of policing an unspecifiable morality. Most important, we will remove dangerous political corrosion that follows from associating that intellectual corruption with such extraordinary potential for private gain.
tldr; "Rogues" differ from CEOs only in the ability to specify position limit violations. The inability to specify CEO position limits implies that financial stability is unavailable through regulation. Stability thus only available through alignment of management and equity incentives and knowledge. The only equity with proper incentive and knowledge would be partnership equity.
tldr(tldr;) CEOs differ from rogues only in the impossibility of specifying their "position limits", so CEOs can only be managed by equityholders as knowledgeable and focused as they are -- e.g., partners, not public equity holders.
"In the financial press you're called a "rogue trader" if you're some overperspired 28 year-old newbie who bypasses internal audits and quality control to make a disastrous trade that could sink the company. But if you're a well-groomed 60 year-old CEO who uses his authority to ignore quality control and internal audits in order to make disastrous trades that could sink the company, you get a bailout, a bonus, and heroic treatment in an Andrew Ross Sorkin book."
I can find at least 4 paragraphs directly related to the title, explaining why the author considers this is not a case of a "rogue trader" but of a "rogue industry". That's about 25% of the article devoted exactly to what the title says (the rest of the article giving useful background for the author point in this 4 paragraphs).
I think his point is that all traders are "rogue traders" when they're making their bets with money sitting in federally-insured commercial bank accounts. They're just called such when they lose.
Yes exactly. Having worked for several big banks it is simply inconceivable that no one knew what this guy was doing. Which is probably why his immediate boss resigned immediately after the police took him away.
That's not exactly the point he is making, though:
They’re not "rogue" for the simple reason that making insanely irresponsible decisions with other peoples’ money is exactly the job description of a lot of people on Wall Street. Hell, they don’t call these guys "rogue traders" when they make a billion dollars gambling. [...]
In the financial press you're called a "rogue trader" if you're some overperspired 28 year-old newbie who bypasses internal audits and quality control to make a disastrous trade that could sink the company. But if you're a well-groomed 60 year-old CEO who uses his authority to ignore quality control and internal audits in order to make disastrous trades that could sink the company, you get a bailout, a bonus, and heroic treatment in an Andrew Ross Sorkin book.
The CEO should resign. Either the company lost $2B and is now pinning it on a 'rogue' trader or their security is flat out incompetent. Either way, all of the CxO positions should be tossed out.
The whole things stinks really. $2B is A LOT of money to lose. With that sort of money flying around and the amount of power those involved likely have, it's easy to see them leveraging the criminal system to CYA and stick this to some underling.
I disagree, these sort of losses are usually caused by failures in risk management systems or procedures. Nick Leeson was permitted to settle his own trades while being head of a trading desk (which is never a good idea), and Jerome Kerviel had previously worked in the middle office at Societe Generale and used his knowledge of their systems and procedures to hide his trades. Kweku Adoboli had previously been a trade support analyst (a middle office position) and UBS is currently undergoing a major restructuring of its risk management systems, so it wouldn't surprise me at all if he were able to circumvent their systems to escape detection. The universe seems to be telling us that middle office people shouldn't be moved to front office positions on a delta one desk.
I'm not sure what the relevance of investment banker's "huge appetite for risk" is.
The current crisis was caused by people making AAA-certified safe bets, most of which were done in order to comply with Basel II and other capitalization requirements [1]. And even ignoring capitalization-driven demand, a long position on housing was considered a safe bet.
If anything, we needed more risk taking and more derivatives - bankers willing to bet against the crowd, and derivatives which give them the ability to take a short position.
[1] If a commercial bank wants exposure to housing, all they needed to do is make some loans. But various bank safety regulations encouraged them to hedge their risks by selling off the loans and purchasing AAA paper in order to hedge against mortgage risks in their local market.
The relevance is: "investment banking" may have done more harm than good. (As in, consider their whole existence. What might the world have been like without investment banking?)
It actually makes sense. If you run the IT department, you have to risk giving almost all the code to developers who can then put it in an email to themselves.
The alternative is draconian restrictions that stifle creativity, freedom and leadership.
Well my friend, u've just drawn the wrong analogy here. Perhaps you have little or no idea of large scale software development. No developer can take a piece of code with him/her - implications are horrible. Even if they did, the code is probably worthless unless they managed to steal the entire code base. Assuming someone manages to accomplish this, it'll still take time for the damage to occur and by then the theft will be discovered.
What these traders do is, from my understanding, far more risky and the chances of someone discovering their 'wrong trade' before the damage is incurred is probably nil. That's why u always hear that the trade lost so much money. U never hear, the trade was about to lose so much money and someone averted it.
I don't know why you were downvoted, but it's usually best not to mention it in the post. Most of the time it gets fixed by later moderators. (At least if the story is popular.)
As long as we structure the incentive of organizations to get them to take on as much risk as possible (though bailouts on the downside), arbitrary external limits on how much risk they can take on will just result in them finding ways to work around them. Like by giving lots of freedom to ambitious young guys and saying "Don't do anything too risky, though if by some chance you make lots of money we'll give you a big bonus".
I'm still very interested in these fraud cases. The main reason being that one person has effectively social engineered/hacked their way past bank internal controls. Imagine if UBS had inadvertently hired a crew of Anonymous, they would be totally sunk.
"I think even I could code the little trading computer with something like "if bet>$1 trillion, deny authorization." Or, ok, these things are complicated, how about if "Probability of loss>$1 trillion is >.00001 then deny authorization."
The devil is in the details, specifically in working out the probability of loss. The whole point is to know that a bit better than the other guy. See also: putting your trust in AAA rated mortgage-backed securities.
I worked for a bit on the mid 90's on a distributed real-time risk management tool that was based on simplified VaR calculations.
From what I recall, the calculation of a "risk" value for an individual trade isn't too bad but it gets exciting when you try to do this for a lot of trades across a complex portfolio - especially when you have to factor in other kinds of risk (e.g. forex).
I was the lead software guy and it was fascinating to work with the ex-traders who were providing the financial knowledge. A shame that the product died horribly due to litigation on contractual issues.
It's not just investment bankers that have an appetite for this. It's a human problem - greed, and short-term thinking. Given the right environment and rules, and most humans would act the same way. The key is to prevent that environment from flourishing. Don't give them so much leverage. If you got $100 million in the bank, don't freaking let them trade $1 billion. Don't let them loan $1 billion. If I ask for $100 million back today, you better give it back TODAY.. not tomorrow.. not next week.. NOW.
The analogy in the internet world is SEO, and gaming the search engines.
[+] [-] DanielBMarkham|14 years ago|reply
Instead I get a long rant about the evils of investment bankers. Might be a great political point, and it was certainly a nice rant, but it had nothing to do with the title except in the broadest sense.
In short, I felt tricked to read the piece. There was only a sentence or two to directly support the title. The rest was a screed on the generic problem. This is the kind of article where people who are pissed about bankers (and I count myself among them) will read and nod their heads and totally agree with the author -- all the while forgetting that the meat of the article provides much heat, little light.
[+] [-] chernevik|14 years ago|reply
That problem cannot be solved by law or policy governing behavior. The standards applied to these CEOs do not admit of the precise specification needed for clear differentiation between error in judgment, bad luck, malfeasance or dereliction of duty. Hofstadter talks about the "computability" problems addressed by Godel and such, trying to determine which problems are and aren't resolvable by computation. Governance at that level is a similar kind of problem.
The implications of this are profound. Since we can't legislate / regulate right behavior, we have to motivate it through incentive alignment. Thirty years ago these banks were partnerships -- if they failed, they wiped out most of the saved capital of their retired partners and senior employees. You can be very sure those folks were both willing and able to apply the qualitative judgments of risk unavailable to a policy driven review.
Those partnerships were converted to publicly held equity because this was less risky for those partners and allowed the companies to achieve larger scale, momentarily conveying cost advantages. But public equity holders don't, and can't, understand these entities as well as those partners did, and therefore cannot discipline management nearly so well. The real long-term costs of that dilution in risk management are now more apparent.
None of this would be any of my business if banking weren't a necessary component of modern money creation and thus inherently intertwined with the government. As such, any citizen has a stake and a voice in the stability of these institutions and their role in the creation of money. The latest regulatory revisions seek to obtain the needed stability by improving the foresight of the regulation, backstopping any failure with an implicit government guarantee on the system. Since the regulation _cannot_ be improved, we are headed for another bailout at some moment to be determined. Meanwhile we are essentially underwriting excess compensation for those managers and traders who can figure out the extraction of cash from the system before the equity again falls to zero.
There are alternatives. Each of these institutions should be a lot smaller, so the system can tolerate the collapse of any several. And they should be generally capitalized by investors who can understand their assets and liabilities, who are in a position to get the confidential information needed to the institution's specific balance sheets, and who _cannot_ hedge or diversify away enough risk to become indifferent to the institution's success. Publicly traded equity fails on all of those conditions.
The consequences of partnership equity are obvious. It rolls back the scale, and with it the momentary cost advantages, enabled by larger, dumber, indifferent public capital. Those large institutions managed with integrity (e.g., JP Morgan) will be f*ed. Capital costs will rise, in part due to induced scale and liquidity inefficiencies, but in part due to the reflection of the real risks of these institutions. But the policy problems of moral hazard and public subsidy of private speculation will be removed. We will be spared the logical contortions required to explain away the obvious immorality and idiocy of many of the people running these institutions. We will avoid the corruption of language and thought that necessarily follows from attempting the impossible task of policing an unspecifiable morality. Most important, we will remove dangerous political corrosion that follows from associating that intellectual corruption with such extraordinary potential for private gain.
tldr; "Rogues" differ from CEOs only in the ability to specify position limit violations. The inability to specify CEO position limits implies that financial stability is unavailable through regulation. Stability thus only available through alignment of management and equity incentives and knowledge. The only equity with proper incentive and knowledge would be partnership equity.
tldr(tldr;) CEOs differ from rogues only in the impossibility of specifying their "position limits", so CEOs can only be managed by equityholders as knowledgeable and focused as they are -- e.g., partners, not public equity holders.
[+] [-] jsherry|14 years ago|reply
"In the financial press you're called a "rogue trader" if you're some overperspired 28 year-old newbie who bypasses internal audits and quality control to make a disastrous trade that could sink the company. But if you're a well-groomed 60 year-old CEO who uses his authority to ignore quality control and internal audits in order to make disastrous trades that could sink the company, you get a bailout, a bonus, and heroic treatment in an Andrew Ross Sorkin book."
[+] [-] pardo|14 years ago|reply
I wouldn't say that the title is deceiving.
[+] [-] rayiner|14 years ago|reply
[+] [-] danssig|14 years ago|reply
[+] [-] morsch|14 years ago|reply
They’re not "rogue" for the simple reason that making insanely irresponsible decisions with other peoples’ money is exactly the job description of a lot of people on Wall Street. Hell, they don’t call these guys "rogue traders" when they make a billion dollars gambling. [...]
In the financial press you're called a "rogue trader" if you're some overperspired 28 year-old newbie who bypasses internal audits and quality control to make a disastrous trade that could sink the company. But if you're a well-groomed 60 year-old CEO who uses his authority to ignore quality control and internal audits in order to make disastrous trades that could sink the company, you get a bailout, a bonus, and heroic treatment in an Andrew Ross Sorkin book.
[+] [-] matwood|14 years ago|reply
The CEO should resign. Either the company lost $2B and is now pinning it on a 'rogue' trader or their security is flat out incompetent. Either way, all of the CxO positions should be tossed out.
The whole things stinks really. $2B is A LOT of money to lose. With that sort of money flying around and the amount of power those involved likely have, it's easy to see them leveraging the criminal system to CYA and stick this to some underling.
[+] [-] sek|14 years ago|reply
[+] [-] bd_at_rivenhill|14 years ago|reply
[+] [-] unknown|14 years ago|reply
[deleted]
[+] [-] iqster|14 years ago|reply
A: Managing Director
- Heard this on CNBC just now (attributed to the "Twittersphere")
[+] [-] yummyfajitas|14 years ago|reply
The current crisis was caused by people making AAA-certified safe bets, most of which were done in order to comply with Basel II and other capitalization requirements [1]. And even ignoring capitalization-driven demand, a long position on housing was considered a safe bet.
If anything, we needed more risk taking and more derivatives - bankers willing to bet against the crowd, and derivatives which give them the ability to take a short position.
[1] If a commercial bank wants exposure to housing, all they needed to do is make some loans. But various bank safety regulations encouraged them to hedge their risks by selling off the loans and purchasing AAA paper in order to hedge against mortgage risks in their local market.
[+] [-] palish|14 years ago|reply
[+] [-] Joakal|14 years ago|reply
The alternative is draconian restrictions that stifle creativity, freedom and leadership.
Trust, is very important.
[+] [-] deepGem|14 years ago|reply
What these traders do is, from my understanding, far more risky and the chances of someone discovering their 'wrong trade' before the damage is incurred is probably nil. That's why u always hear that the trade lost so much money. U never hear, the trade was about to lose so much money and someone averted it.
[+] [-] ars|14 years ago|reply
[+] [-] shapeshed|14 years ago|reply
Feel free to fork and improve.
[+] [-] cpeterso|14 years ago|reply
[+] [-] Symmetry|14 years ago|reply
[+] [-] teyc|14 years ago|reply
[+] [-] chopsueyar|14 years ago|reply
[+] [-] ddw|14 years ago|reply
"I think even I could code the little trading computer with something like "if bet>$1 trillion, deny authorization." Or, ok, these things are complicated, how about if "Probability of loss>$1 trillion is >.00001 then deny authorization."
[+] [-] StrawberryFrog|14 years ago|reply
[+] [-] arethuza|14 years ago|reply
From what I recall, the calculation of a "risk" value for an individual trade isn't too bad but it gets exciting when you try to do this for a lot of trades across a complex portfolio - especially when you have to factor in other kinds of risk (e.g. forex).
I was the lead software guy and it was fascinating to work with the ex-traders who were providing the financial knowledge. A shame that the product died horribly due to litigation on contractual issues.
[+] [-] gwern|14 years ago|reply
[+] [-] Hisoka|14 years ago|reply
The analogy in the internet world is SEO, and gaming the search engines.