The $2 Billion UBS Incident: 'Rogue Trader' My Ass
rollingstone.com
rollingstone.com
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.
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.
I'm sure you don't mean that literally, according to Why People Believe Weird Things she is supposed to have run something that was rather close to a personality cult:
http://www.amazon.com/People-Believe-Weird-Things-Pseudoscie...
NB This is not an ad hominem attack on her ideas, just an observation that according to some accounts she was a rather odd individual.
But again, limitations on bank capital ownership would be an anti-Randian regulation. And the analysis hasn't occurred to prominent Randian Alan Greenspan.
No, I'm not a Rand cultist. She's important for her notice of the distortion of values and language by self-interest posing as selflessness. But it's a mistake to justify outright selfishness on the basis of those dangers.
I did notice it was downvoted! Because it suggested a limit to the efficacy of regulation? Are there similar knee-jerk downvotes to progressive opinions?
EDIT: Downvote HERE! For mentioning downvoting?
When I'm downvoted for politics, that ain't the rules, not as I understand them. And I'm gonna break'em to let people know it's happening.
If not's politics, tell me why so I can stop whatever it is I'm doing wrong. But it _always_ happens on comments expressing right-wing opinions.
Greenspan was an excellent central banker, but he repeatedly stepped out of the role to champion and provide cover for Republican political policies (primarily tax redistribution) which provided a drag on aggregate demand and made the United States much more dependent on monetary policy and debt-financing to push growth following 2001. There is an element of hypocrisy in his attitude towards social security as well.
So I feel there is a lack of critical introspection or intellectual honesty there and it is somehow related to the way the Randian viewpoint encourages romantic oversimplification instead of... well.. regression analysis and empiricism. That said, I wouldn't downvote you for the flourish and have upvoted in fact - the rest of your comment was thoughtful and worth reading.
Greenspan has admitted "shock" at banks' risk management, he expected that equity would insist on more attention. But he may have overlooked the fact that his reference history of risk management occurred under a very different ownership structure, and so implied less about current conditions than he expected. Even if my story is right, Greenspan's oversight is what we'd expect from someone focused on the power of incentives.
And we should expect Burkean conservatives to make a different set of errors, underestimating the power of incentives to drive adaptations to changes in institutions. They're different perspectives, with different blind spots.
I'm also a fan of Matt Taibbi but recognize that his hyperbole tends to distract from the message (he tends to channel the spirit of Hunter S. Thompson). Despite this, he's one of the few journalists out there who is actively taking on the greed-heads who are looting the US economy.
Yes, probably.
Don't complain about downvoting.
No, it doesn't matter how justified your complaint is. (And, absent any proof that you can read minds, you don't know why folks are downvoting.)
I suspect if you subject a random group of people to intense scrutiny, attention and deep info dives you'd find the majority of them qualify as 'odd'.
Yes, the partnerships went public to transfer risk away from the partners, to externalize it. It was the only way. How else do you maintain profits when the economy has flattened out?
Yes, it is economic cannibalism, but what's the alternative? They can't change to a steady state model, and they are too strong to just give up and fail. So, they burn the furniture.
You know, I really hope it doesn't get any worse than this. I am afraid they won't stop with just the furniture, that they will continue to burn and burn until there is nothing left, and we have a violent revolution or something. And I wonder whether there is some disruptive technology on the horizon that will change the game--a distributed source of energy perhaps? My crystal ball is very cloudy.
Of course it can. Glass Steagall prevented the kind of meltdown we just experienced for decades, until it was repealed under the Clinton administration.
You could try to regulate the money funds, but now you're trying to regulate investment banking risk, something GS never really tried in the first place.
There are no "old days" for this financial structure, the configuration of the size / public ownership / complexity / funding environment of these institutions is entirely new.
Take for example FDIC insurance, as mentioned in the article. Ostensibly, it's intended to help people with money in their bank accounts. But it also means that banks can be riskier with trades, and count on the government to cover certain losses. The same is true for agency-backed mortgages.
"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 wouldn't say that the title is deceiving.
If that's not deceiving, then anybody can write an article about just about anything. Just move to the general case, throw in a lot of invective, and dance a bit. You could write stuff like this on an assembly line.
I'll put this a different way: this is an editorial piece. As such, it's a nice one. I liked it. But it's not a news article, which was what I was expecting. It just takes a news article and sticks it on top of some pre-canned outrage.
You were expecting a news article from something with a title ending in the words "My Ass"?
Any more I just ignore that kind of language -- I don't think you can tell anything from it.
What was I expecting? A logical teardown of the facts of the case, with a new conclusion the MSM had missed. Perhaps a smoking gun. I love irreverent authors who poke through stuff we already know and find new stuff. People who hack news stories. I've seen quite a few articles with profanity in the title where I came away going "wow! Very cool analysis"
This was not one of them.
Not me. I feel that they contribute to the atmosphere in a negative way. The problem is that you can't dismiss these articles out of hand, they sometimes contain valuable insight. That doesn't mean they are to be liked for their titles. I'd prefer to see that as an 'in spite of'.
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.
That's a good point.
Let me ask a serious question.
What if some rogue google employee some how changed the search index so image searches always returned porn.
Should Larry Page be fired?
Both situations are cases where "security is flat out incompentent"
is this about the lack of accountability or is this strictly about the loss of money?
Given the multiple levels of security and review at Google, this would be nearly impossible. Even if accomplished, it would be almost immediately reversed. If Google ran such a sloppy operation that such changes were both possible and not easily reversed, then all higher ups really ought to be fired.
This also isn't just about what the rogue trader did, but how long it took the bank to find out. Sure a rogue Google employee could change the index to only point at porn, but how long will that go unnoticed? I don't know Googles internal processes, but other than a select few people do they have relatively junior guys hot patching untested code directly into production?
is this about the lack of accountability or is this strictly about the loss of money?
It's about both really, and the amount of money is important. Stealing is stealing, but when implementing checks and balances I would assume they want to find situations that deviate too far from the norm. A million here or there in their type of business likely wouldn't have been noticed for awhile until a quarterly or yearly full audit had been done, but $2B? To me that shows hubris and incompetence, or compliance.
Accountability comes into to play if the higher ups knew what was going on and let it fly because they had made or were hoping to make a lot of money off of the situation. It didn't pan out, so blame the trader and wash their hands of the it.
To bad someone did a drive by downvote of a serious question:)
> Accountability comes into to play if the higher ups knew what was going on and let it fly because they had made or were hoping to make a lot of money off of the situation. It didn't pan out, so blame the trader and wash their hands of the it.
If this was the case, then I agree.
You need to use a lot of money to work with if you want to do arbitrage on a fraction of a percent for a couple of minutes to make more money than the operation itself costs.
Not all trades are profitable.
Also, losses like these are always a double failure of sorts. The trader is a given, but there is also an oversight problem.
$2 billion dollars is a parking ticket: http://www.reuters.com/article/2009/01/11/ubs-idUSLB34005520...
A: Managing Director
- Heard this on CNBC just now (attributed to the "Twittersphere")
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.
It's a seen-and-unseen problem. Wages rising for the same activity is actually rare and historically really weird. The chief way people improve in the world is to automate/creative destruction old professions in favor of more modern ones, and through lower costs due to efficiency. Investment banking enables and accelerates both of those processes.
It's a stretch, but not insane to think that, say, streaming video or iPads might not exist without investment banking.
Someone replies, who cares about iPads or streaming video? But how much have, say, TED talks enabled thinkers to make progress on hard important problems?
The causal chains here are long and complex, it's hard to say for sure. But creative destruction and replacement of old industries with new means better professions, and reducing costs is the other chief way to prosperity. You know about the huge blowups because they're noteworthy, you don't consider what industries wouldn't exist without a gradual re-allocating and efficiency, freeing up more people to do higher level work and driving costs down.
It's hard to do mentally, inevitably someone will reply, "LOL, this guy thinks without investment banking there'd be no iPad!! That's all Jobs and Woz dude!!" I don't know. Maybe. But why is South Korea so much nicer to live in than South Vietnam? Why did South Vietnam start to improve rapidly when they liberalized the banking system and started taking foreign investment? Capital allocation really pulls the world forwards, but many of the gains are subtle and hidden while the failures are prominently on display.
Let's try this again. Pretend you're trying to convince Feynman that investment banking is a Good Thing. What specific points would you raise?
(No one would disagree that iPads / streaming video are good. We would, however, disagree on how much "investment banking" has contributed to their existence.)
He gives an example of some airline that announces it has financial troubles - immediately people holding the bonds they issue are pretty keen to sell, pretty much at any price. The bank have had very smart researchers who spot that the airline looks like it will be in trouble and then estimate how much the airline is really worth and then buy at below this price (based on their assets - planes).
The people offloading the bonds are presumably pretty happy as they are worried they might be worthless and the bank is making some money off of the risk that their research might be wrong.
Sounds like a pretty fair way of making money to me.
What I mean is, that airplane example consists entirely of gamblers.
Are you saying "humanity is better because people can continue to fly with the airline"? Then why not use a different airline?
So I'm struggling to see why the world wouldn't be better off letting the airline fail, as opposed to risking a bunch of other people's money.
Their clients think they provide an economically useful function - otherwise they wouldn't use them. Do businesses really need more justification to exist than that?
Also:
- The bank wasn't directly interacting with the airline, they were buying bonds from other organisations who were holding them
- Lots of people risk other peoples money - fund managers, pension companies, VCs, hedge funds etc. - with varying degrees of risk and exposure by the people actually doing the investing.
1) Money exists to serve humans. It doesn't exist for money's sake. The end goal is to help people. The airline helped people get from A to B. Dropbox helps people send files.
2) The people holding the bonds are still gamblers. Your example consists entirely of gamblers!
Do you think the VCs who invested in Dropbox would do so if they knew that Dropbox would never allow itself to go public or be acquired?
By your definition, if I purchased Apple stock I would be "gambling" - Apple wouldn't see any of my money. In a certain respect I sort of agree with this, but it's also clear that when Apple went public the money raised was built on the expectation of future free trading in the stock so, as far as I can see, it is very difficult to divorce "investment" from "gambling".
So what do you think should be done about the present situation, if anything? I have no idea.
http://www.scribd.com/doc/26993356/Worlds-Biggest-Companies-...
[NB As I write this I am maybe 100m from their old headquarters!].
No, it doesn't. Either that, or everyone is a gambler.
Everything involves risk. The amount of risk tolerance is very context dependent and varies. For example, I'm much more willing to make an (inflation-adjusted) $10k "bet" now than I was 20 years ago. In another 20 years, I'll be less likely than I am now.
The problem is that these traditional investment bank functions only make up something like 12% of the revenues of a traditional investment bank like Goldman Sachs: http://www.wikinvest.com/stock/Goldman_Sachs_Group_(GS)#Inve...
Most of the rest of the revenue comes from trading and other activities of questionable utility.
do you think the market for YC startups would be hot if there was no public stock market for companies to raise the money to buy them?
The current crisis was caused because too many investment bankers were risk averse in the same way, not because they were risk taking.
OK, the second is probably a bad thing. "Major corporation" seems to leave a bad taste in my mouth, though. Probably because monopolistic companies are run like Soviet Politburos with idiotic wasteful top-down planning -- "corporate communism".
The alternative is draconian restrictions that stifle creativity, freedom and leadership.
Trust, is very important.
What these traders do is, from my understanding, far more risky and the chances of someone discovering their 'wrong trade' before the damage is incurred is probably nil. That's why u always hear that the trade lost so much money. U never hear, the trade was about to lose so much money and someone averted it.
(The edit stated I was at -2 and asked why I was downvoted)
Feel free to fork and improve.
get_hot_stock_tip() {
ACTIONS=($"Buy" "Sell");
ACTION=${ACTIONS[$((RANDOM%2))]};
STOCK=`</dev/urandom tr -cd A-Z | head -c$((RANDOM%4+1))`;
echo "$ACTION $STOCK";
}
Sell GUF
Sell LNT
Buy WILK
Buy EWM
Sell RLAO
"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."
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.
The analogy in the internet world is SEO, and gaming the search engines.