A Demon of Our Own Design

I previously mentioned A Demon of Our Own Design in a linkfest a few weeks ago. I enjoyed the book a great deal, and just about finished it over the long weekend.

The opening paragraph just reached out and grabbed me: 

Bookstaberdemon_jacket"While it is not strictly true that I caused the two great financial
crises of the late twentieth century—the 1987 stock market crash and
the Long-Term Capital Management (LTCM) hedge fund debacle 11 years
later—let’s just say I was in the vicinity. If Wall Street is the
economy’s powerhouse, I was definitely one of the guys fiddling with
the controls. My actions seemed insignificant at the time, and
certainly the consequences were unintended. You don’t deliberately
obliterate hundreds of billions of dollars of investor money. And that
is at the heart of this book—it is going to happen again. The financial
markets that we have constructed are now so complex, and the speed of
transactions so fast, that apparently isolated actions and even minor
events can have catastrophic consequences."

Terrific stuff.

Indeed, I enjoyed the rest of the book. Bookstaber was on the scene in the early days of many of derivatives now contributing to market turmoil. He rather deftly makes complex issues readily understandable, regardless of how much advanced mathematics you may have under your belt.

And, he names names. LOTS of names. All the usual suspects come under scrutiny, as well as a lot of folks who probably assumed they were not int he public eye. There will be a lot of people not very happy with his blunt, insider descriptions of the analytical errors made by major players — many of whom are still around today and in positions of authority and power. 

He also accepts a lot of responsibility for many costly errors he himself made.   

Overall, a fun, very informative read.

I was intrigued enough by the book that I contacted Bookstaber (the author) and Wiley (the publisher), and asked for their permission to reproduce the first chapter. They graciously sent me a pdf and text version, which you will find after the jump: All of chapter one, in both text form and PDF. I also included some mainstream media reviews after the chapter. 

I have pretty good relationships with many of the publishing houses — they all want to get a book or two out of me. Anyway, if it turns out you guys like this idea, perhaps we can offer up a book or two that I am reading every month in this same format. Maybe we can have an online reading group club — it could be a good place to have a full discussion. Share your thoughts.

Enjoy chapter one.

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Disclosure:  No, I don’t accept money for this — it was my idea, and I approached the publisher and author about this — not vice versa. Please don’t start bombarding me with offers to promote books I am not already reading. They will be unceremoniously deleted without response.

As noted in our disclosure section, we don’t do payola here (if you click thru and buy it on Amazon, I do see some scratch).

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A Demon of Our Own Design

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Here is the required and official legal notice:

"Excerpted with permission
of the publisher John Wiley & Sons, Inc. from A Demon of Our Own Design. Copyright (c) 2007 by Richard Bookstaber.
This book is available at all bookstores, online booksellers and
from the Wiley web site at www.wiley.com, or call 1-800-225-5945.

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You can download and print out chapter in PDF form — Download Demon Chapter_1.pdf

Or, you can read it here:

CHAPTER 1

INTRODUCTION:  THE PARADOX OF MARKET RISK

While it is not strictly true that I caused the two great financial crises of the late twentieth century—the 1987 stock market crash and the Long-Term Capital Management (LTCM) hedge fund debacle 11 years later—let’s just say I was in the vicinity. If Wall Street is the economy’s powerhouse, I was definitely one of the guys fiddling with the controls. My actions seemed insignificant at the time, and certainly the consequences were unintended. You don’t deliberately obliterate hundreds of billions of dollars of investor money. And that is at the heart of this book—it is going to happen again. The financial markets that we have constructed are now so complex, and the speed of transactions so fast, that apparently isolated actions and even minor events can have catastrophic consequences.

My path to these disasters was more or less happenstance. Shortly after I completed my doctorate in economics at the Massachusetts Institute of Technology and quietly nestled into the academic world, my area of interest—option theory—became the center of a Wall Street revolution. The Street became enamored of quants, people who can build financial products and trading models by combining brainiac-level mathematics with -massive computing power. In 1984 I was persuaded to join what would turn out to be an unending stream of academics who headed to New York City to quench the thirst for quantitative talent. On Wall Street, too, my initial focus was research, but with the emergence of derivatives, a financial construct of infinite variations, I got my nose out of the data and started developing and trading these new products, which are designed to offset risk. Later, I managed firmwide risk at Morgan Stanley and then at Salomon Brothers. It was at Morgan that I participated in knocking the legs out from under the market in October 1987 and at Solly that I helped to start things rolling in the LTCM crisis in 1998.

The first of these crises, the 1987 crash, drove the Dow Jones Industrial Average down more that 20 percent, destroying more market wealth in one day than was generated by the world economies in the previous two years. The repercussions of the LTCM hedge fund default sent the swap and credit markets, the backbone of the world’s financial system, reeling. In the process it nearly laid waste to some of the world’s largest financial institutions. Stunning as such crises are, we tend to see them as inevitable. The markets are risky, after all, and we enter at our own peril. We take comfort in ascribing the potential for fantastic losses to the forces of nature and unavoidable economic uncertainty.

But that is not the case. More often than not, crises aren’t the result of sudden economic downturns or natural disasters. Virtually all mishaps over the past decades had their roots in the complex structure of the financial markets themselves.

Just look at the environment that has precipitated these major meltdowns. For the crash of 1987, it was hard to see anything out of the ordinary. There were a few negative statements coming out of Washington and some difficulties with merger arbitrage transactions—traders who play the market by guessing about future corporate takeovers. What else is new? The trigger for the LTCM crisis was something as remote as a Russian default, a default we all saw coming at that. Compare these with the market reaction to events that shook the nation. After 9/11, the stock market closed for a week and reopened to a drop of about 10 percent. This was a sizable decline, but three weeks later the Dow had retraced its steps to the pre-9/11 level. Or go back to the assassination of President John F. Kennedy in 1963 or the bombing of Pearl Harbor in 1941. Given the scope of the tumult, the market reactions to each event amounted to little more than a hiccup.

There is another troublesome facet to our modern market crises: They keep getting worse. Two of the great market bubbles of the past century occurred in the last two decades. First, the Japanese stock market bubble, in which the Nikkei index tripled in value from 1986 through early 1990 and then nearly halved in value during the next nine months.
The second was our own Internet bubble that witnessed the NASDAQ rise fourfold in a little more than a year and then decline by a similar amount the following year, ultimately cascading some 75 percent.

This same period was peppered with three major currency disasters: the European Monetary System currency crisis in 1992; the Mexican peso crisis that engulfed Latin America in 1994; and the Asia crisis, which spread from Thailand and Indonesia to Korea in 1997, and then broke out of the region to strike Russia and Brazil. The Asia crisis triggered losses that wiped out the majority of the market value that the Asian “Tiger” economies had amassed in the prior decade of booming growth. LTCM seemed just as cataclysmic at the time, but it centered on a single $3 billion hedge fund in 1998, albeit one that had more than $100 billion at risk. As a debacle, it was later overshadowed by the spectacular failures of Enron, WorldCom, and Tyco after the dot-com collapse. Yet, did anyone even notice the convertible bond collapse that erupted for no apparent reason in 2005 or the $6 billion of losses by Amaranth in September 2006? It’s only money.

One of the curious aspects of worsening market crises and financial instability is that these events do not mirror the underlying real economy.  In fact, while risk has increased for the capital markets, the real economy, the one we live in, has experienced the opposite. In recent decades the world has progressively become a less risky place, at least when it comes to economics. In the United States, the variability in gross domestic product (GDP) has dropped steadily. Year by year, GDP varies half as much as it did
50 years ago. The same holds for disposable personal income. With greater stability in economic productivity and earnings, and with greater and broader access to borrowing—think of your home equity line of credit—the variability of consumption year by year is less than a third of what it was in the middle of the twentieth century. And while recessions still occur, they have become shallower. This same pattern is true in Europe, where both GDP and consumption have become more stable over the course of the past 50 years.

There is ample reason for the increased economic stability. In the United States, the federal government provides unemployment insurance and Social Security, most corporations support 401(k) accounts, and many provide pensions. Governments worldwide stabilize commodity and farm prices with massive subsidies. Monetary and fiscal policy has improved with experience and study, and it benefits from improving coordination and real-time access to data.

The workforce is more diversified, with a much greater proportion employed in noncyclical sectors such as technology and services than in the past. The economic sectors themselves are also far more diversified. In the early twentieth century, there were no technology, telecommunications, media, or health care sectors. The industrial economy revolved around a few highly integrated, large-scale industries. A coal miners’ or steelworkers’ strike would cripple the country, shutting factory floors and shipping yards. Even as late as the 1970s, the industrialized nations were so energy dependent that an oil shock precipitated a global recession. Today, high gasoline prices cause lots of grumbling, but little real pain.

Similarly, as progress and refinement reduce risk, so should they also level the playing field for market participants. There should be less of a gap between your investment returns and those of Wall Street pros. Do you think that’s happening? Sure, the trappings are there: Information is released more quickly and to a broader constituency of investors, and limitations are imposed on insider trading and nonpublic disclosure. Trading costs are a tenth of what they were 30 years ago. Ample liquidity and innovative financial products—all manner of swaps and options, weather futures, exchange-traded funds, Bowie bonds—accommodate trading in more areas. With all these improvements we are moving ever closer to the notion of perfect markets—and perfect markets should not offer unusual profit opportunities for a subgroup of investors and traders.

That does not seem to be happening. The market remains volatile and the returns widely uneven. In spite of 40 years of progress and a drop in real economic risk by 50 percent or more, the average annual standard deviation in the S&P 500 index was higher during the past 20 years than it was 50 years earlier. The fact that the total risk of the financial markets has grown in spite of a marked decline in exogenous economic risk to the country is a key symptom of the design flaws within the system. Risk should be diminishing, but it isn’t.

Meanwhile, there is a proliferation of hedge funds that continue to capture differentially higher returns. Over the past five years, the assets under management by hedge funds have grown over sixfold from $300 billion to more than $2 trillion. And this does not include the operation of the quasi-hedge fund proprietary trading desks at firms like Goldman Sachs or Deutsche Bank. It’s a zero-sum game, though, so if hedge funds are able to extract differentially higher returns, someone else is paying for them with comparably subpar returns. Maybe it’s you.

This is not the way it is supposed to work. Consider the progress of other products and services over the past century. From the structural design of buildings and bridges, to the operation of oil refineries or power plants, to the safety of automobiles and airplanes, we learned our lessons. In contrast, financial markets have seen a tremendous amount of engineering in the past 30 years but the result has been more frequent and severe breakdowns.

These breakdowns come about not in spite of our efforts at improving market design, but because of them. The structural risk in the financial markets is a direct result of our attempts to improve the state of the financial markets; its origins are in what we would generally chalk up as progress. The steps that we have taken to make the markets more attuned to our investment desires—the ability to trade quickly, the integration of the financial markets into a global whole, ubiquitous and timely market information, the array of options and other derivative instruments—have exaggerated the pace of activity and the complexity of financial instruments that makes crises inevitable. Complexity cloaks catastrophe.

My purpose here is to explain why we seem to be doing the right things but the results go in the other direction. The markets continue to develop new products to meet investors’ needs. Regulation and oversight seek to ensure that these advances land on a level playing field, with broad and simultaneous dissemination of information and price transparency. But the innovations are somehow making our investments more risky. And more regulation, ironically, may be compounding that risk. It would seem there is a demon unleashed, haunting the market and casting our efforts awry: a demon of our own design.

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MSM Reviews:

"A risk-management maven who’s been on Wall Street for
decades…Bookstaber’s book shows us some complex strategies that very
smart people followed to seemingly reduce risk—but that led to huge
losses." (Newsweek)

"Mr. Bookstaber is one of Wall Street’s ‘rocket
scientists’–mathematicians lured from academia to help create both
complex financial instruments and new computer models for making
investing decisions. In the book, he makes a simple point: The turmoil
in the financial markets today comes less from changes in the
economy–economic growth, for example, is half as volatile as it was 50
years ago–and more from some of the financial instruments
(derivatives) that were designed to control risk." (The New York Times)

"Bright sparks like Mr Bookstaber ushered in a revolution that fuelled
the boom in financial derivatives and Byzantine ‘structured products.’
The problem, he argues, is that this wizardry has made markets more
crisis-prone, not less so. It has done this in two ways: by increasing
complexity, and by forging tighter links between various markets and
securities, making them dangerously interdependent." (The Economist)

"He understands the inner workings of financial markets…A liberal
sparkling of juicy stories from the trading floor…" (The Economist)

"…smart book…Part memoir, part market forensics, the book gives an insider’s view…" (Bloomberg News)

"Like many pessimistic observers, Richard Bookstaber thinks financial
derivatives, Wall Street innovation and hedge funds will lead to a
financial meltdown. What sets Mr. Bookstaber apart is that he has spent
his career designing derivatives, working on Wall Street and running a
hedge fund." (The Wall Street Journal)

"Every so often [a book] pops out of the pile with something original
to say, or an original way of saying it. Richard Bookstaber, in A Demon
of Our Own Design: Markets, Hedge Funds, and the Perils of Financial
Innovation, accomplishes both of these rare feats."–Fortune

"a must-read amidst the current market chaos"–BusinessWeek.com

Amazon:  A Demon of Our Own Design

What's been said:

Discussions found on the web:
  1. SPECTRE of Deflation commented on Sep 4

    Finally someone willing to step up to the plate with knowledge and accountability concerning the so called spreading of risk oh these many years. We spread it so well that I’m afraid we are all screwed because this is glaobal in nature, and nobody is exempt.

    Barry, love your book review/discussion idea.

  2. KirkH commented on Sep 4

    Most novels are under 100,000 words, you’ve easily written a novel or three worth of text on this blog so if you toned down the post frequency for a little while and focused on a book you’d be done faster than Kudlow can say Goldilocks.

  3. The Financial Philosopher commented on Sep 4

    Interesting reading, Barry. Thanks for sharing…

    With regard to the current “crisis,” this sentence from Chapter 1 strikes me the most:

    “More often than not, crises aren’t the result of sudden economic downturns or natural disasters.”

    Financial markets are too complex for accurate forecasting. Similarly, the beginnings of bear markets are not usually marked by a sudden sell-off. The recent correction was too easily foreseen to mark the beginning of the end of the current cycle. If anything, though, it seems possible to have enabled the last leg up for this aging Bull…

    I would never be so foolish to make short-term market predictions but it seems the current financial crisis has become a distraction that has completely consumed the attention of investors. Now that the mainstream media is reporting on the mortgage meltdown and credit contagion, prudent investors are wise to look into 2008 for potential market influences…

  4. alexd commented on Sep 4

    I think creating a financial salon is a fine idea.

  5. Ross commented on Sep 4

    Thank you Oprah Ritholtz. A book like this could have been written in each generation for the last 600 years. “Confusions de confusiones’ comes to mind.

    ~~~

    BR: Yes, CDOs and Interest Rate Swaps were huge during the Middle Ages

  6. SPECTRE of Deflation commented on Sep 4

    Financial markets are too complex for accurate forecasting. Similarly, the beginnings of bear markets are not usually marked by a sudden sell-off. The recent correction was too easily foreseen to mark the beginning of the end of the current cycle. If anything, though, it seems possible to have enabled the last leg up for this aging Bull…

    This sounds like a Greenspan statement. Too complex is not the cause of our current debacle. Nobody saw a bubble in 2000? Nobody saw problems as far back as 2005 with mortgages? The system is always gamed by the elites who get first shot at all the new funny money/digi-dollars. It never ends well for the little guy who takes it in the shorts.

    Right now you have a P/E of 17.4 on the S & P 500 with forward earnings of about 5%. I see a big problem ahead because stocks are right now priced at perfection.

    The 3 month LIBOR is up another 3 ticks to 5.70% with the US being technically in default by exceeding the ceiling that congress had previously approved.

    The dollar has lost 1/3 it’s value. Who will be hammered, the elites or the little guy? The little guy is thinking the market has done wonderful for better than 18 months, while at the same time we lost a boatload of purchasing power which the little guy doesn’t care about at this point, but when everything is revalued, it will become very clear who was hurt and who wasn’t.

  7. KP commented on Sep 4

    All of these derivatives are being marketed as risk dilution, the reality is that because they are created out of thin air…they are nothing more than MORE leverage. Something that creates more volatility and bigger swings. Nothing complex about that.

  8. KirkH commented on Sep 4

    “Thank you Oprah Ritholtz”

    If they got married it would probably be:
    Barry Winfrey

    I think the book group discussion thingamajig is a great idea too, as long as you don’t invite us all to a Tupperware party afterwards.

  9. michael schumacher commented on Sep 4

    good idea……may be we could come up with a list and have people vote on which one(s) to feature. There are so many financial books available (and tastes to go with them) there should be quite a bit to choose from.

    The first person who votes for anything by Suze ormand gets black-listed….

    Ciao
    MS

  10. wunsacon commented on Sep 4

    >> Thank you Oprah Ritholtz.

    LOL!! Hey, is there a key to a new XSR48 under our chairs?? Who’s going to jump up and down on Barry’s couch — Cramer??

  11. SPECTRE of Deflation commented on Sep 4

    The Mogambo Guru talks market alchemy. I’m saying right here, right now, this is gonna leave a mark. Level 3…ROFLMAO! Ya, OK now I understand.

    Voodoo, Fraud, and Economic Fairy Dust

    by The Mogambo Guru

    With the economy in a funk, naturally there are rumors that there are going to be some layoffs, and so everyone is wondering who will be “let go” around here, and everybody thinks it will be me, and some are even saying to my face, “I hope it’s you, you Stinking Mogambo Creep (SMC).”

    So, obviously desperate for a way to juice up my performance statistics, I luckily happened upon an item at Bloomberg.com where, “Wells Fargo reported record net income of $2.28 billion, up 9 percent from a year earlier. Read the footnotes to its latest quarterly report, though, and you will see a new term in accounting lingo called ‘Level 3’ gains. Without these, the financial-services company’s earnings would have declined.”

    Wow! Instantly I thought, “It’s like magic! So what are these wonderful Level 3 gains? And can I get some, too? And can I get enough to bail my sorry butt out of the mess I have gotten myself into before next Tuesday at 4:00 PM?”

    The answer is apparently “yes” to all of the above, as Bloomberg admits that Level 3 gains are “Pretty much whatever companies want them to be.” Whee! This is tooOOOoo sweet!

    It is explained that “Level 1 means the values come from quoted prices in active markets. The balance-sheet changes then pass through the income statement each quarter as gains or losses. Call this mark-to-market.” This is the ugly “factual” stuff that is causing all my headaches and probably causing “career death” next Tuesday at 4:01 p.m.

    “Level 2 values are measured using ‘observable inputs,’ such as recent transaction prices for similar items, where market quotes aren’t available. Call this mark-to-model.” Ooh! I think we are getting warm here as regards usefulness to me, as this is obviously a source of balance sheet stuff to boost my bottom line, as I can already show where other executives at my level, with my level of experience and training, are never asked to clean the Executive Washroom, which is a huge corporate-wide benefit not accounted for in my department’s sub-ledgers.

    And which wouldn’t be so bad if they would at least flush after they use the toilet, but jeez! What a bunch of pigs! So me cleaning the place is worth a LOT, for which I should get credit!

    Anyway, as good as these gains are in making me look better, the real plums are, “Then there’s Level 3. Under Statement 157, this means fair value is measured using ‘unobservable inputs.’ While companies can’t actually see the changes in the fair values of their assets and liabilities, they’re allowed to book them through earnings anyway, based on their own subjective assumptions. Call this mark-to-make-believe.”

    In case anybody was watching, I appeared stoic and inscrutable, while inside I was happily exclaiming, “Whee! Whee! Here it is! Magical accounting dust! I can handily assume enough gain in, ummm, Goodwill (as the number of people and businesses who are suing me, and the company, goes down because they start finally giving up in disgust!) to offset the loss of the company’s precious damned cash and assets that they are always whining about.”

    Now, thanks to these new Level 3 gains, we made, in a manner of speaking, a huge, glorious, magnificent net-worth profit on the balance sheet, for which the company owes me Big Freaking Time (BFT)! Now, instead of blubbering and begging for my job back, thanks to Level 3 gains I can say, “So get your sorry butt out of my chair, out of my office and start arranging some kind of huge bonus for me as your way of saying, ‘Thanks, Mogambo! And we are sorry about calling you a thieving, incompetent liar in the company newsletter all the time!'”

    The idea is so deliciously appealing that in my overwhelming sense of utter gratitude at not only being saved from termination but actually reaping rewards, I sent an email off to Bloomberg.com saying, “Speaking for myself and all the other incompetent morons in the world who are in waaaAAAaaay over their heads, thank you, thank you, thank you for showing me how to hide our dangerous incompetence and look good doing it!”

    Amazingly, the next thing I read is Bloomberg.com saying, “You can thank the Financial Accounting Standards Board for this. The board last September approved a new, three-level hierarchy for measuring ‘fair values’ of assets and liabilities, under a pronouncement called FASB Statement No. 157, which Wells Fargo adopted in January.”

    And if you are looking for a news scoop, not even Bloomberg.com knows that Mogambo Inter-Planetary Enterprises, Inc. (MI-PE, Inc.) adopted good old FASB Statement No. 157 about ten seconds ago!

    Then, just when things looked like they were going to go my way for a change, Jack Ciesielski, who is, “publisher of the Analyst’s Accounting Observer research service”, proves that he is no friend of The Mogambo when he warns people about me and my new accounting ploy, and sends around a notice that says, “If you see a big chunk of earnings coming from revaluations involving Level 3 inputs, your antennae should go up. It’s akin to voodoo.”

    In my own defense, I urge you to disregard any pronouncement of Mr. Ciesielski, as he apparently doesn’t even know the difference between voodoo and desperate, deliberate fraud.

    So although he doesn’t actually mention me by name, you can tell that he is ratting me out, and when I ruin his credit rating in cruel revenge, he will probably get all upset and say, “Hey! You Stinking Mogambo Rat (SMR)! What in the hell did I ever do to you that you would ruin me like that?” and I will reply, “Like you don’t know! Hahahahaha!”

  12. MT commented on Sep 4

    Thank you Barry. Personally I find the chapter to overstate and overgeneralize. Perhaphs the remaining chapters tone it down. Words like “catastrophe” and “demon” do not reflect the actual data that I have experienced. For example, when Mr Bookstaber writes that the 1987 crash destroyed more wealth than had been created in the preceding two years, the word “destroyed” makes the statement clearly and extremely inaccurate. 20% of one’s wealth was only “destroyed” that day if one became fully invested at the preceding close and sold at the close on the day of the crash. Obviously that did not happen for very many people and certainly not for the whole world.

    I think there are grounds for concern, mainly in the amount of leverage that financial institutions are allowed to use to participate in illiquid markets securities and derivatives. And maybe one bad day the long-tail risks will in fact overwhelm the coping mechanisms in the economy in a way that has not yet happened. But I suspect the risks are exaggerated in part by participants who do not know what they are doing and media that do not understand what they are writing about. And I suspect the longer term problems of the real US economy – the ratio of the nonworking population to the working population, the size of the government’s take, diminishment of a mfrg base, poor science and math education, the entitlement and leisure themes in our culture – will cause greater losses of wealth over the long haul to the natin as a whole, than the unintended consequences of financial innovations. They are just harder fro the media to focus on because they are widespread and slow moving.

  13. Loco commented on Sep 4

    WOW,

    Some inflationary stuff there, This flies in the face of what the FED (Greeenspan and Bernanke) has been sayin lately about the all the good the “innovations” in the markets have done.

    Are we starting with this book?

  14. SPECTRE of Deflation commented on Sep 4

    I’m thinking Level 4 may be a consumer issue. It’s where we get to mark down our taxable earnings due to loss of purchasing power because of the dollar plunge. Everybody knock off 1/3 of their taxable earnings because we can at least put a real value on our figures as opposed to the outright fraud of the banks.

    Or Level 4 can be a trip to Amsterdam where you do shrooms with the FASB, all the Central Bankers and the alchemy crowd of high finance. This will lead to Level 5 which is a out of body experience with Mr. Bubbles taking you on a magic carpet ride, or a ride on his Yellow Submarine.

  15. dukeb commented on Sep 4

    Book club would be fun.

    I usually try to restrict my reading to titles I can pick up at our local library, either off the shelf or via their regional sharing system. Right now from them I have out Ken Fisher’s THREE QUESTIONS THAT COUNT, Kindleberger’s MANIAS PANICS AND CRASHES, Cramer’s SANE INVESTING, and Prechter’s CONQUER THE CRASH. I read about one chapter of at least two books each day instead of watching television. And I try to have a mix of outlooks on hand at any time.

    The only 5-star financial book I’ve read to-date is the revised edition of THE INTELLIGENT INVESTOR.

  16. Geoff commented on Sep 4

    Great reading and great posts. Count me in on the reading.

  17. Mike commented on Sep 4

    I like the book club idea. A couple great ones I’ve read recently: Peter Bernstein’s “Against the Gods: The remarkable story of risk” and Paul Seabright’s “The Company of Strangers: A Natural History of Economic Life” . Both may be more pedagogical than people want – but are amazing, well told stories!

  18. jm commented on Sep 4

    Paul Blustein’s book on the Argentine financial crisis, “And the Money Kept Rolling In — And Out” is another must-read, with relevance far beyond the events in Argentina.

  19. Marcus Aurelius commented on Sep 4

    I only read the title, the excerpt, and your blurb.

    We did not create a demon. We created a golem.

  20. Eclectic commented on Sep 4

    RUR?

    New subject:

    Spec-tre!…Don’t you know you could trigger an epileptic seizure?

    You wanna be responsible for that?

  21. andy in NZ commented on Sep 4

    Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives

    by Satyajit Das

    well worth a read. Light and funny in a car crash kind of way. Mr Buffet was right, financial WMD’s.

    We are all screwed!

  22. Jason R commented on Sep 4

    Yes to bookclub. However, unlike my spouse’s one has to read the book to get the wine and cheese…

  23. Davy Bui commented on Sep 4

    I think an online financial salon is a fine idea — hopefully, it’d cover a broad swath of investment approaches as opposed to just quant or value investing, etc. Where do I sign up?

    Also, am I the only person who found Graham’s Intelligent Investor to be tedious and poorly written? I concede that the actual concepts are top-notch but you can learn those concepts from others — Buffett, Klarman, Greenblatt, Pabrai, etc. — in more entertaining fashion and updated to boot.

    I found Jason Zweig’s commentary to Graham’s chapters to be more interesting than the original work. It’s like a Zen book or something!

    — Davy Bui

  24. Jonny Red commented on Sep 4

    I think a book section is a great idea. If you can include the first chapter or first few pages of a new book it would allow me to figure out if if it is something that interests me and is written in a format that is easily digestible.

    Since I don’t have much time to browse books in an actual bookstore, I think being able to review the books online would be pretty useful.

  25. Winston Munn commented on Sep 4

    Quoting the opening paragraph:

    “….The financial markets that we have constructed are now so complex, and the speed of transactions so fast, that apparently isolated actions and even minor events can have catastrophic consequences.”

    O.K., someone with more brains than I possess (yeah, that’s about everyone else, I know) please explain to me why this sounds a lot like chaos theory?

    You know…chaos theory…where a gnat farts in Africa and causes a hurricane to flatten Florida.

    Or is that a taxi driver in Modesto buying an $800,000 house with no down and that causes a financial crisis to flatten a bank in Germany…

  26. Denise commented on Sep 4

    this is great…intelligent feedback..imagine the possibilities..

  27. Ant commented on Sep 5

    Just wanted to chime in and say that I am totally down for the Big Picture book club.

  28. Jack commented on Sep 5

    Are the concepts of “spreading the risk” and “non correlation of assets” incompatible?

    It does seems that in the current situation, risks were spread around quite nicely. When European and Chines banks are taking part of the hit from a real estate crisis isolated in the US, it looks like the theory worked.

    However, the breadth of exposure caused markets to react together, undermining the ability to diversify.

    So, if risk is spread around, correlation occurs. If risk is isolated, there can be independant performance.

    True?

  29. Will commented on Sep 5

    That is a fantastic idea — would love to participate!

  30. Will commented on Sep 5

    How about holding a discussion on David Hacket Fischer’s: “The Great Wave”? It’s a great economics/history book which argues, as its central thesis, that inflation is caused by increase in aggregate demand and not increase in money supply.

    Jim Jubak wrote a very interesting review of this book and it would be great to hear your take:

    http://moneycentral.msn.com/content/P116250.asp

  31. Howard commented on Sep 5

    WE MADE CIVILIZATION TO IMPRESS OUR GIRLFRIENDS

    Written by a braniac with all the degrees from MIT and one of the guys who designed the derivatives systems now in place that collapsed, he blames himself and the complexities of the investment vehicles he designed.

    However I don’t think he is correct, keeping in mind that the only way I’d ever be allowed in a class at MIT is if I was inside a test tube, I think almost all markets move because of human response, and these responses are based in our most basic pasts.

    Permit some observations from the perspective of a cellar dwelling broker in the business for the sole purpose of making a buck off of other people’s money. I do this by luring gamblers into “investments” or, more precisely, tapping the unconscious need for most investors to become gamblers so they can show off for the guys and to look great at parties in front of thrilled and fawning women.

    It is my view, one that has been gleaned from twenty five years or so in the so-called “business,” that we miss a fundamental human element which dominates all that we do in the investing “game”. All men were formerly hunter gatherers. We were adventurous, foolhardy, brave, mean bastards who “brought home the bacon” so we could get laid by the inferior and weak women who stayed home and took care of the children and cooked our dinners. This was refined over a few thousand years into the effort to bring home the biggest haul of bacon in order to screw not only the most women, but the best looking ones. Life was good. The bigger the haul of bacon the better looking the babes at our beck and call. This is how it was. This was how it should be. This is a primeval condition of man.

    As the world got better, more than one sage observed that “we made civilization to impress our girlfriends”. Same can be said for all fortunes, great and small, all bridges tall and narrow, and all skyscrapers daring to be the highest and grandest of them all.

    We don’t accomplish the things it takes to impress the girls without risking our butts, or at least pretending that we are. We need to take risks. However most of us don’t really do it. We will go out of our way to bungee jump our way through life pretending to risk it all, when actually we have a little hedge fund called the length of the bungee cord that will almost always prevent us from getting so much as an “owie.” Deep deep down we know we are a bunch of chickenshits afraid to risk anything at all to accomplish the things we say we want.

    Many of the rest of us look down at the phony bungee jumpers who actually risk nothing and prove it to the world by allowing themselves to be dominated by ugly girlfriends or fat wives. We hold Hollywood in contempt while idolizing football players, boxers, NASCAR drivers and others who engage in sports that can easily result in terrible and visible ends. We are the ones with the great looking mistresses we can trade in just before their warranties wear out while dangerously keeping our wives in the dark, an activity that is loaded with risk, and only risk. The “what if she finds out?” frame of mind, one that keeps an edge on each and every day; a football game of sex and deceit; a frame of mind that makes life worth living. A life in which we tell everyone, our secretaries, friends, and stock brokers that we have this “secret” that nobody should know about. There is nothing in the world as satisfying as having the specter of murder hanging over our copulations. Trust me, I know. One of my girlfriends once pulled a gun on me and the result was an instant erection; I just had to have her. It was glorious.

    However, life dictates that there is always someone out there with a better looking mistress, a bigger house, more expensive cars, bigger yachts; a faster gun as it were. We must have more. And more. And more. We need to act this out. We have a primal need to bring home the most bacon. The only thing stopping most of us is fear of losing, of being wounded, or of death; fears that shame us to our souls.

    Anything that offers the prospect of “biggest” profits appeals to us on the most primal level. It appeals even more when all the “smart guys” are in charge. If even some phony smart punk like a Nobel Prize winner has the balls to jump in, what does that make me if I don’t? So I’m in. It’s called “the who the hell am I if I don’t win a Nobel syndrome.” We literally are driven to take risks in a public way, to have people fawn over us at cocktail parties, to have the big media talk about us.

    The so called “braniacs” simply filled a need. That there have been horrendous losses only validates the need to take outrageous risks. Trust me. I’ve talked to literally hundreds of “investors” who unconsciously brag about their losses. They almost never talk about their gains. Losing proves that “you’re a man.” Talk to any degenerate gambler. What do they talk about to “prove” themselves? Why losses of course: “I lost fifteen big ones on the fuckin’ games last week,” gets them admiration. If anyone should say they won fifteen big ones we think they are lying, demand that they prove it, and look at them like they had AIDS.

    Our markets have become unstable largely because people with lots of money are looking for the larger casino. Period. You need to get that. Nobody ever believed that you could honestly get LTCM profits. Everyone knew that there was “something fishy” about it, something they could not understand, but what the hell? Let’s shoot.

    As to all the howls about “getting real info” I say, “Get a life.” There ain’t no real info. All we morons can do is check the charts once we are in and have sell signals that will allow us to get out with minimal damage. Once the big institutions start to bail we have to be out instantly. The “real” information is buried in a black box of computer model gobledeegook that not even the fund managers understand. “Look at the charts, stupid,” is all you can do. Enron? Check the daily charts. There were sell signals for weeks before the stock collapsed including the penetration of the fifty day moving average. The buy and hold while shutting your eyes method is for saps. BTW, the main sell signal, one I never take because it “might go even higher,” is the gap or island top. You can always always get back in, something the gambler never considers.

    Getting in requires only any orderly and rigorous method of checking out investments, something almost nobody wants to take the time to do. To sum it up: hedge funds is gambling. Only willing gamblers were in them.

    The writer of the book seems to say that “The markets continue to develop new products to meet investors’ needs.” No, they develop new products to satisfy the need people have to gamble while telling their gutless wives they are investing. The need for NASCAR moments is paramount.

    To eliminate market breakdowns? Kill all the men.

  32. Greg0658 commented on Sep 6

    I liked your story Howard.

    I even was kinda dreaming about it as I woke up this morning, with a twist tho. My dream transformed the men to dog breeds.

    Collies herding sheep, shepherds sniffing bombs, huskies pulling sleds, pitbulls fighting.

    The story is missing the lover side of men. It’s there, they’ve got it in ’em.

    Most men work to play and play nice at that.

    The jock/trader and the artist/inventor was missing. Jocks vs Band.

    Thats why way back when, when speech and word was developing, religion was conceived.

  33. icebergfinanza commented on Sep 18

    L’ ERA GLACIALE: BRIVIDI IN ARRIVO!

    La pioggia secondo quanto sta scritto su Wikipedia la forma pi comune di precipitazione atmosferica e si forma quando gocce separate di acqua cadono al suolo dalle nuvole. Oggi una parte della pioggia che cade dalle nuvole della p

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