Tweet Mystery of Life

Ah, sweet mystery of life, at last I've found you.

— Young Frankenstein

Time wasters of the world, unite!

Inspired (or perhaps goaded) by Alltop: Economics, which has begun to run Twitter feeds of some of its most popular economic bloggers and mainstream media sites, I have decided to take the plunge and join the Twitter tsunami.

I fully expect this experiment to end badly.

I mean, after all, why does anyone who is not already on Twitter need twitter pointers to articles and blog posts (WSJ Econ, The Economist, Paul Krugman) which already show up in the RSS feeds of people who care and on multiple aggregator sites like Alltop anyway? And, frankly, I know Nouriel Roubini is an important and successful guy and all, but do we really need a blow-by-blow account of his blind taste test of Bolivian and Colombian cocaine this week? Sure, some people might be interested, but they can follow him on twitter.com or facebook directly. Spare me. Please.

Quibble though I may, however, I realize the train of cultural relevance is pulling out of the station. Now is no time to be an old fuddy duddy. I'm hip. I'm with it. I'm down with the 411.

So, as a special treat, for those of you who cannot bear to be without my searing wisdom and blistering insight into all things economic and cultural, I have set up my very own Twitter feed. It will be amusing to witness whether a medium which values concision, brevity, simultaneity, and wit will be one in which your Dedicated Bloviator can thrive. I have my doubts.

You should certainly expect far less insightful and thoughtful analysis and far more snarky, smartass comment-sniping than you normally receive in these pages. (No comments, please.) It is difficult to wrap current events and trends up neatly with a bow when you are limited to 140 characters. I realize we live in a soundbite era, but really.

In any event, given past experience, I would not expect frequent updates from me, if I were you.

Then again—shit—if John McCain can figure this out, so can I.

© 2009 The Epicurean Dealmaker. All rights reserved.

Diogenes' Lantern

"Your old man is worth a hundred million bucks, Mrs. Loring. I wouldn't know just how he got it, but I know damn well he didn't get it without building himself a pretty far-reaching organization. He's no softie. He's a hard tough man. You've got to be in these days to make that kind of money. And you do business with some funny people. You may not meet them or shake hands with them, but they are there on the fringe doing business with you."

— Raymond Chandler, The Long Goodbye (1954)


* * *"I am looking for a man." ¹

— Diogenes of Sinope (ca. 412 – 323 BC)

Having idled away much of my ill-spent youth in Southern California,² Dear Readers, your Dedicated Bloggist has long been a devotee of Raymond Chandler's detective stories set in and around Los Angeles during the thirties, forties, and fifties. I can personally verify that there is no place seamier than the underbelly of America's Paradise, and Mr. Chandler gets the atmosphere pitch-perfect.

But his stories are dark. They do not normally appeal to the casual reader, or to the distracted beachgoer in search of fast cars, hot sex, and cheap heroics. They are soaked in a sort of existential despair, a cynical world-weariness that permeates the novels like the woof underlying the warp of mystery narrative and character development. Don't get me wrong: the stories are tough, fast, and entertaining, and there are plenty of heroics on display, especially by the main character, Philip Marlowe. They are also funny, in places, in a cynical sort of way, and leavened throughout with dialogue that carries a snap and fizz 21st century conversationalists can only dream of emulating.

If you want to understand why the Marlowe novels are this way, you could do no better than read an excerpt from a letter Chandler wrote in 1949:

Time this week calls Philip Marlowe "amoral." This is pure nonsense. Assuming that his intelligence is as high as mine (it could hardly be higher), assuming his chances in life to promote his own interest are as numerous as they must be, why does he work for such a pittance? For the answer to that is the whole story, the story that is always being written by indirection and yet never is written completely or even clearly. It is the struggle of all fundamentally honest men to make a decent living in a corrupt society. It is an impossible struggle; he can't win. He can be poor and bitter and take it out in wisecracks and casual amours, or he can be corrupt and amiable and rude like a Hollywood producer. Because the bitter fact is that outside of two or three technical professions which require long years of preparation, there is absolutely no way for a man of this age to acquire a decent affluence in life without to some degree corrupting himself, without accepting the cold, clear fact that success is always and everywhere a racket.³

This is strong, bitter stuff. I'm not sure I buy it, totally.

Chandler, while a successful writer and Hollywood screenwriter, lived a less than charmed life himself. He struggled with drinking, personal tragedy, and frustration, as well as the siren lure of the Great Babylon of the West, who always disappointed him in the end. He had lots of reasons to be bitter about the price of success. And let us not forget that his novels are detective stories. By their very nature, they deal with the dark underbelly of human nature: greed, deceit, larceny, murder. These are hardly the better qualities of anyone, rich or poor. Almost no-one comes out of his stories smelling like a rose.

Then again, based on recent events in the economy and on Wall Street, I'm not sure I don't buy it, either.

* * *

Wall Street sure seems to have been a racket. At least that is the conventional wisdom on Main Street and in the halls of Congress. It is hard to argue they are completely wrong.

I myself have recently pointed out—only partly tongue-in-cheek—that senior executives seem to require the character traits of a psychopath to succeed in finance. Whether this is true or not, it is abundantly clear that reams of senior professionals on Wall Street have been unapologetically greedy and pathologically tone deaf, to boot. Why is that?

I wish I knew. I do know that dozens if not hundreds of my current and former colleagues in investment banking are honest, upright, hard-working professionals, who everywhere and always try to do the right thing. They are not bad people. In fact, most of them are downright admirable: ambitious, intelligent, and productive members of the finance sector. Some of them even kiss their kids goodnight.

But let's be honest, folks. These are not the type of people who usually make it to the top of the slippery pole. These are not the type of people who set corporate policy.

You know what they say? "Honesty is its own reward." Well, that's absolutely true in investment banking, because most of the time you sure as hell aren't going to get any other rewards for being honest. The entire nature of the business—high-pressured, time-sensitive delivery of hard-to-measure, extremely expensive, irreducibly intangible intermediary services—depends absolutely on the self-policed integrity of those doing it. Therefore, it is tailor-made to reward people who cut corners, who steal credit for good deals and disavow responsibility for bad ones, who persuade clients to do bad deals or bad trades, and who backstab and scheme against their partners and colleagues to boost their own prestige, power, and bank accounts.

Smaller firms, like the old investment banking partnerships, could generally minimize such bad behavior because everybody knew each other, and their work, very well. (The same was true for external clients, as well.) But the bigger investment banks became, the less you understood what other bankers you didn't know personally were doing, and the more your internal reputation at the firm depended on how you managed your relationship with your boss and his bosses. Presto! Up popped functional silos, political fiefdoms, and obsequious toadying on an epic scale: investment banking feudalism.

The only ones in a position to prevent this, or at least control it, are the senior managers of the firm. But most of them nowadays have grown up in this system, and they know firsthand the advantages of gaming it. Besides, as long as someone delivers the revenues and profitability they are looking for, they don't really care who does it. Allocating credit, and assigning blame, becomes a political exercise. Earning money becomes less a result of delivering value for the firm and its clients and more a marker of personal and political status within the organization.

This sort of reward system, usually conducted under a hypocritical banner of "teamwork, integrity, and partnership," renders new recruits to the industry cynical very quickly. Some leave, some get fired, and a few—mostly those least encumbered by principles or integrity—flourish. The mechanism becomes self-selecting for institutionalized bad behavior. Is it any surprise that investment banks took reckless risks, cut dangerous corners, and helped drive us off a cliff?

* * *

But really, is success in investment banking "always and everywhere a racket," as Chandler says? Notwithstanding my 20 years in the business, I can't really say for sure. I have not seen enough of the industry to know. But I will say that opting out of the political racket in big firms is simply not an option anyone who wants to succeed can afford. You might think that putting your head down and delivering revenues will keep you safe, but you would be wrong. If you are successful, colleagues with better political connections will magically attach their names (and sometimes their persons) to your deals and take credit for them. You will get paid less. If you hit a rough patch, names like yours, with no political protectors among the high and mighty, end up on top of the layoff list. This doesn't even account for the low-life slimeballs who maneuver behind your back to steal your deals, your team members, and your position.

And these are the clowns who get profiled in the pages of The Wall Street Journal.

* * *

As for the rest of the economy, how many other "rackets" did the rest of us participate in? Housing? Hedge funds? Private equity? Tax avoidance?

When I am in a dark mood, I wonder just how many successful people in this country could well and truly look themselves in the mirror and declare that they never participated in something that didn't walk, talk, and smell like a racket at some point in the past seven years. Something they were tempted, at least once or twice, to wink at and look the other way because it seemed just too good to be true. Something they got a guilty twinge of conscience just thinking about.

Show me those people, and I will show you the next group of senior executives on Wall Street.

¹ The ancient Greek philosopher's supposed response when asked why he was carrying a lighted lamp in broad daylight. Some have rendered it as "I am looking for an honest man." To be fair, Diogenes apparently was a weird dude: "Sympathizers considered him a devotee of reason and an exemplar of honesty. Detractors have said he was an obnoxious beggar and an offensive grouch." While I deny that I am an obnoxious beggar, I do see how some might consider me to be an offensive grouch, too.
² "Aha!," you squeal, "a clue!" Okay, okay, I admit it: I am Iron Man.
³ Raymond Chandler, Later Novels and Other Writings. New York: Library of America, 1995, pp. 1038–1039.

© 2009 The Epicurean Dealmaker. All rights reserved.

Lawyer Up, Boys

"We're not gonna get rid of anybody! We're gonna stick together, just like it used to be! When you side with a man, you stay with him! And if you can't do that, you're like some animal, you're finished! We're finished! All of us!"

— The Wild Bunch

Crack muckraking over at the Wall Street Journal this morning, detailing how the top 10 earners at Merrill Lynch pulled down $209 million in compensation last year while Mother Merrill soiled her undergarments to the tune of $27.6 billion. Citing "documents and interviews with people familiar with Merrill's compensation," the WSJ reveals a raft of details, dishing dirt and naming names with abandon.

It is amusing to speculate who spilled the beans to our intrepid reporters. While the article is laced throughout with (mostly) favorable tidbits concerning the business unit performance of many of the grandees spotlighted, the overall tone and content of the article is sure to get Joe Sixpack and his six-term Congressman's blood boiling. If New York Attorney General Andrew Cuomo's staff was not intimately involved in the leaks, then I am sure the scene at his office this morning was an interesting mixture of screaming and burst blood vessels that some finance rag got the story first and unbridled glee that pitchfork and torch sales across the country just shot through the roof. It would not be outlandish to consider the Merrill executives' bonus pool as the latest and largest campaign gift toward Mr. Cuomo's 2010 gubernatorial run.

* * *

There is some effort made in the article, either by the Journal reporters themselves or their informants, to emphasize that these compensation decisions were not completely unhinged from Merrill's deteriorating financial condition at the end of 2008. For one thing, the article notes that a mere 11 employees were paid more than $10 million each in stock and cash last year, versus 28 lucky bastards who broke the ten-bar barrier during the halcyon days of 2007. Attention is also drawn to the fact that the stock portion of these players' compensation has taken it on the chin since it was awarded, although one would have to know the effective grant date and corresponding grant price to calculate just how much pain they have suffered in tandem with non-insider shareholders and the US taxpayer.

Two big hitters, the heads of rates and commodities at Merrill, pulled down relatively modest pay packages in the high teens, even though both their units made money. David Sobotka made $13 million, a mild drop from his 2007 comp, even though his unit wheeled almost $36 billion in small bills out onto the sidewalk and set them on fire with lighter fluid. Apparently the buck burning was not his fault, as we are led to believe the Executive Committee had already booked the ceremony before he arrived. I guess we can presume his bonus was a big thank-you kiss for not adding more shareholder wealth to the flames.

Poor Andrea Orcel had to make do with only $33.8 million, down 6% from 2007's $36 million, even though the article tells us the IB honcho personally took credit for generated over half a billion dollars of investment banking revenue for the firm. This is almost comically tightfisted, as everyone knows that the other 578 Merrill bankers who helped originate and execute his deals could not possibly have delivered such a bounteous harvest without Andrea's personal and dedicated attention to every possible detail. The man must be a true force of nature, since he was paid a special $12 million bonus in 2007 for advising RBS and others on the acquisition of ABN Amro, a deal which involved so many competing parties and advisors that Merrill Lynch would have had to shutter all their European offices and disconnect their telephones in order not to get a role on the transaction. I guess Andrea answers his telephone in a uniquely persuasive manner.

I won't even get into a discussion about Thomas Montag or Peter Kraus¹, who made $40 million and $30 million under contracts for five and three months' work, respectively, other than to say that Lloyd Blankfein should mail John Thain a big fruit basket for taking these yobbos off Goldman Sachs' hands. Canceling the unvested GS stock Thain bought out to get these guys to jump ship to Merrill must have added at least a penny a share to Goldman's earnings.

* * *

The contrast between Merrill's largess to its senior executives during a year (and particularly a quarter) when the repo man was banging on the front door of its headquarters and the pay practices of a traditional investment banking partnership could not be more stark. At the latter, when the firm has a bad year, the partners pay the operating bills and their non-partner colleagues first, then they distribute whatever is left over among themselves. If a partner doesn't have enough cash to pay his bills, he draws from or borrows against his equity in the partnership and tells the wife she better put plans for a vacation home on Mustique on hold for a year or so. A partner who has a bang-up year when everyone else doesn't mans up, accepts perhaps a slightly larger equity stake in the partnership in recognition of his outperformance, and eats rice and beans with the rest of his colleagues. That's how it's done when you play with your own money.

But that's not how it worked at Merrill. Thain and his partners in crime were playing with other people's money, in this case Bank of America's, so they played by different rules. Anecdotal evidence and the Journal article itself indicates that lots and lots of Merrill bankers got whacked—and whacked hard—in terms of total pay last year (e.g., 17 fewer senior bankers and department heads breaching the $10 million mark), but the cabal at the top seem to have gotten off relatively unscathed. No wonder John Thain was rumored to have initially proposed a $40 million bonus for himself. After all, he couldn't let Montag, Orcel, and Kraus beat him in the moolah sweepstakes, could he?

This sort of every man for himself, winner-take-all philosophy makes a mockery of the idea that investment banks are team-based businesses. If the generals salve their wounded pride on the beach with Mai Tais and cigars while the troops get slaughtered and the shareholders get bankrupted, you have all the conditions necessary for a revolution. Most of the battered troops remaining in the industry will look at this self-serving behavior with disgust. Many will desert, never to return. One or two might even roll a fragmentation grenade into the Executive Committee meeting room during morning call. A few, of course, will grin with delight, convinced in their psychopathic little hearts that they, too, will be sitting on top of the greasy pole in a few years.

Shareholders and taxpayers will seethe with anger and offer themselves as eager acolytes to vengeful prosecutors and irresponsible demagogues alike. Trust and respect for investment bankers and businessmen in general will languish for a generation, with knock-on effects to the general economy that will do nobody any good. Taxes and regulations alike will smother innovation and enterprise, and investment banking itself will return to its somnolent roots as a backward refuge for the idiot sons of men of privilege.

Some may smile at this prospect, but I think it's a damn shame.

I hope those Mai Tais were worth it, boys.

¹ Kraus is poster boy extraordinaire for the conventional wisdom that "Wall Street firms ... need to pay top dollar to big producers to keep them from jumping ship." Say, just how did paying Kraus 30 million clams prevent him from hopping to Alliance Bernstein three months after he joined the Thundering Herd? Inquiring minds want to know.

© 2009 The Epicurean Dealmaker. All rights reserved.

Fooled by Arrogance

Where are all the good men dead
In the heart, or in the head?

— Grosse Pointe Blank

Nassim Nicholas Taleb is at it again.

Apparently he was not content simply to inflate an interesting and thought-provoking little metaphor for our habitual blindness to randomness into a globe-straddling causal mechanism explaining the entire social, cultural, and economic history of the human race, as well as all the most interesting bits of our personal lives.¹ No, our one-man Black Swan licensing machine and talk show bête noir has now turned to pontificating on public policy.

The results, I am sad to say, are less than illuminating.

Were I more confident of Mr. Taleb's capacity for self-criticism and self-awareness than his writings and public appearances have led me to be, I might point him to the credo he so proudly displays on his own website and homepage [emphasis his]:

"My major hobby is teasing people who take themselves & the quality of their knowledge too seriously & those who don’t have the courage to sometimes say: I don’t know...." (You may not be able to change the world but can at least get some entertainment & make a living out of the epistemic arrogance of the human race).

Based on this avowal, it does not strike me as too cheeky to suggest he make a little fun of himself.

I will not hold my breath.

* * *

Mr. Taleb spends the bulk of his time on the soapbox stomping rather loudly and self-importantly over the well trodden ground of what he calls the trader's "free option," the allegedly mismatched and corrupting compensation scheme which Yves Smith calls the "heads I win, tails you lose" syndrome. As certain members of the sniping class have observed, this is somewhat akin to announcing that the sky is blue, or, perhaps more aptly, that Adolf Hitler was a very naughty man. Few people nowadays will be a) surprised or b) tempted to disagree with you.

I have written on this topic before, as well, and usually not sympathetically. Nevertheless, while I am not now nor have ever been a trader, and while the bulk of my career as an investment banker has generally been spent at various kinds of loggerheads with traders—either because they have not given me what I want, or have seized political power from me and my kind at my employer, or have torpedoed my annual bonus with yet another one of their boneheaded trading mistakes—I would like to take this opportunity to mount a little defense of traders and their compensation system. In all fairness, I believe that a little clarification and correction of certain misconceptions furthered by Mr. Taleb and his fellow travelers is called for at this juncture.

First of all, for those of you who have stumbled onto this site from Perez Hilton and who have no conception what a "trader's option" is, I offer the following brief explanation. Traders at commercial and investment banks (and elsewhere) trade stuff for a living. They buy, they sell, they cross-breed CDOs with Persian longhaired cats—whatever. At the end of the year, their boss totes up the profit and loss in their trading book to see how much money they have made (or lost) for the bank. If they made a lot of money—let's say $250 million—they will usually get a big bonus—let's call it $10 million, just for laughs. If they lost a lot of money—for symmetry, let's also call it $250 million—they usually get a $0 bonus and a swift kick in the pants out the door toward the unemployment line.

This is why people call it an option: the trader gets an asymmetric payout depending on his results: $10 million if he wins, and bupkus if he screws up. His bank, on the other hand, unfortunately has a roughly symmetric payout: a $240 million gain before expenses and taxes if the trader wins, and a $250 million loss if he fucks up. Replace the term "bank" in the preceding description with "investor," and you have a general description of the dynamics of a trading operation. Traders, in their purest form, are simply employees, or agents, of their investors, who are the people who have the money to invest.

Now, a careful reader of the preceding will see that the provocative and tendentious characterization of this incentive scheme currently in vogue—"heads I (the trader) win, tails you (the investor) lose"—is not completely accurate. To be fair, one should characterize it as "heads both of us win, and tails you lose but I don't." The mismatch of returns is still there, and the trader still has every incentive to swing for the fences rather than play it safe, but it becomes more apparent why investors and banks have been willing to enter into this kind of bargain with traders from time immemorial.

It also should be clearer why a good trader—one who consistently makes money and avoids or minimizes losses—is worth his or her weight (and then some) in gold.² (At $1,000 per troy ounce, a consistently successful trader who weighs 185 pounds should clear the market for around $2,697,855³, by my calculations.) Adjusting for risk, good traders such as these are cheap. Every investor or bank with money to put to work should hire one.

* * *

Of course, "adjusting for risk" is not a trivial thing. A trader who makes $250 million a year trading a risk-neutral, matched book of stocks or bonds really is worth far more than his weight in gold, whereas a trader who made $250 million a year trading risky, long-tailed mortgage-backed securities should have been handled more like radioactive plutonium, at least in retrospect. It is also a measure of how efficient securities trading markets have become—thanks to the free-market, private enterprise magic of all those would-be $10 million a year traders competing for bonuses—that the former are practically extinct nowadays. This same efficiency is also why so many banks and investors looking for $250 million a year in profits per trader began gravitating toward riskier, more complicated markets which presumably compensated for their greater risk. It turns out, sadly, that many of them did not.

Now, given the differing motivations and incentives of pure traders and pure investors, there are really only two proven ways for the investor to control his trader's assumption of risk. The first is close supervision, monitoring, and control: the investor limits what securities and positions the trader can assume, he monitors daily trading activity and marks positions to market daily, and he intervenes when things go off the rails. This is the simplest model, and it is the one that used to obtain back in the dark ages before investment banks became large, externally funded, global trading houses. Yves Smith points out that this is the model the old Goldman Sachs partnership used to use, before it went public. There really is nothing better to keep some young Turk under control than some grizzled, grouchy old bastard seated next door who used to trade the very same markets you do and whose personal partnership stake you are trading for a living.

This model, as we have seen over the past 18 months, begins to break down when the span of control gets too broad and the chain of supervision becomes too attenuated, like it did in today's huge global banks. Complicated Value at Risk models and professional risk managers are no match for crafty and devious traders, particularly when the money they are trading belongs to some absent, passive institutional investors whom no-one gives a damn about. Markets are too fast today, and securities are too recondite, to make supervision at a distance very successful.

The second way for investors to control their traders' assumption of risk is to make them investors, too. Make a trader eat his own cooking, so to speak, and you will see a marked change in how he handles and assumes risk. The trader will supervise himself. After all, it's his money too. Many hedge funds do this, by paying their important traders in shares of their own trading book, or the overall book of the firm. Investment and commercial banks have been doing this for some time, too, by paying traders—along with everyone else—substantial portions of their annual compensation in long-vesting restricted stock of the firm.

The problem with this method is twofold. First of all, you need to make sure that enough of the trader's compensation and total net worth is tied up in this way; otherwise, he will just view unvested compensation as "house money" to play with, and he will have little incentive to care. The temptation to swing for the fences, or assume dangerous risks, will overwhelm any proprietary instincts for preservation of personal capital. Second, even if the trader has a substantial portion of his wealth tied to the overall results of his firm, the firm cannot be too big in relation to his stake, or he will feel that nothing he does will matter anyway. The rubber band tying his personal trading performance to the price or value of his employer's equity will be too elastic and contingent on the actions of others to act as a real incentive. This is the problem faced by large investment banks, where a trader holding even $50 million in unvested stock feels that nothing he can do—good or bad—will make a difference to the price of Citigroup stock.

Finally, neither of these methods controls for another importance source of trading risk: ignorance. It does not require a dishonest trader and an incompetent risk manager to screw up a trading book (although I am sure some instances of these happened). All it takes is for both of them to be honestly unaware of the real risks embedded in their positions. I think this fairly characterizes a helluva lot of the blowups we have been suffering over the last year and a half. It does you no good to have perfectly aligned incentives and top-notch supervision and control if both your trader and your risk manager haven't a clue about the risks they are running. Here Taleb and I converge a little, although I disagree with his implicit assumption that most traders consciously pursued short-term profits (and current bonuses) at the expense of long-term catastrophic risks. I think most of them just didn't know.

* * *

Pace Mr. Taleb's casual invective about invidious incentives and "capitalism for the profits and socialism for the losses," I am unpersuaded that he has come up with an effective solution to our current dilemma or even an accurate description of the problem. The trader's option and its variants have been the preferred method of compensating traders forever, even by banks and investors who are fully cognizant of the risks they entail. (And no, investment banks and commercial banks are not comprised entirely of traders, so their corporate interests and incentives cannot be so neatly identified with those of their traders.) Does he think he has a better way, one no-one else has thought of in the last 50 years? Please, don't keep us in the dark.

He wants traders and banks to be subject to disincentives that counteract the trader's option, citing as justification the claim that "[e]ntrepreneurs are rewarded for their gains; they are also penalised for their losses." But how, in fact, are entrepreneurs—and capitalist firms in general—penalized for failure? They lose their jobs, their investments, their savings, they go bankrupt. Which of these things has not already happened to multiple investment and commercial banks and perhaps hundreds or even thousands of individual traders and other investment bankers? Virtually all traders' incentives have been aligned with those of their investors for quite some time now. The fact that this did nothing to prevent the multi-car pile-up we are digging ourselves out of now gives me little comfort that the problem was misaligned incentives in the first place, and even less confidence that fixing it is a simple matter of designing "better" incentives.

He wants to nationalize "the utility part of banking," whatever that is, without specifying how government control would offer a better solution, rather than just an opening for the intrusion of politics into the relatively less compromised world of finance. Where would we draw the line around "utility" finance: commercial lending, retail lending, residential lending, commercial real estate lending, leveraged finance, asset-backed lending, securities underwriting, securities trading, insurance? How could we prevent contagion from the unnationalized bits—where, presumably, private banks would be free to succeed and fail relatively unconstrained—back to the nationalized ones? At what cost in efficiency, the price of money, political interference?

Those private individuals who commit their capital to the pursuit of risky returns, investors, pay taxes on their gains (at least most of the time). When they make money, we taxpayers benefit, and when they lose money, we taxpayers suffer, even if we are not investors ourselves. It is willfully shortsighted to deny that we already have an extremely robust, multifaceted system in this country for socializing both gains and losses from the activities of private capital. (Job creation, anyone?) It is appallingly disingenuous to assert that investment and commercial banks were the only entities which benefited from the multi-year credit bubble, and therefore should suffer disproportionately. And it is laughably ludicrous to compare military and security personnel—much less Roman legionnaires—to finance professionals. For the same reason I do not want to pay soldiers for the number of enemies they kill and security personnel for the number of threats they forestall, I do not want to pay a commercial banker for the number of loans he declines.

It is the height of epistemic arrogance to claim otherwise.

Back to the drawing board, Nassim.

¹ You think I exaggerate? I do not:

A small number of Black Swans explain almost everything in our world, from the success of ideas and religions, to the dynamics of historical events, to elements of our own personal lives. Ever since we left the Pleistocene, some ten millenia ago, the effect of these Black Swans has been increasing. It started accelerating during the industrial revolution, as the world started getting more complicated, while ordinary events, the ones we study and discuss and try to predict from reading the newspapers, have become increasingly inconsequential. ...

Fads, epidemics, fashion, ideas, and the emergence of art genres and schools. All follow these Black Swan dynamics. Literally, just about everything of significance around you might qualify.

— Nassim Nicholas Taleb, 2007, The Black Swan: The Impact of the Highly Improbable. New York: Random House, p. xviii.

I am particularly impressed that Mr. Taleb can claim with confidence that these effects have been increasing since the Pleistocene. He must be older than he looks on TV.
² Good luck trying to figure out whether a "good" trader has generated superior returns because he is skilled, or just because he is lucky. Some people, channeling Napoleon, might claim that you shouldn't care: good is good. Then, even if you can figure out the source of his outperformance, decide whether you want to bet that his skill or his luck will continue in the future. That way lies madness.
³ Correction, 27 Feb 2009: A kind reader has gently reminded me that gold is priced in troy ounces, whereas humans are priced weighed in avoirdupois pounds. At approximately 14.583 troy ounces per avoirdupois pound, my previous calculation overpriced said trader by $262,145, for which you could purchase a couple of decent analysts or the services of a Ukranian hooker for a couple weeks. This sort of error is inexcusable: I abase myself before you for epistemic ignorance.

© 2009 The Epicurean Dealmaker. All rights reserved.

To Catch a Thief

I'm very well acquainted with the seven deadly sins
I keep a busy schedule trying to fit them in
I'm proud to be a glutton, and I don't have time for sloth
I'm greedy, and I'm angry, and I don't care who I cross

I'm Mr. Bad Example, intruder in the dirt
I like to have a good time, and I don't care who gets hurt
I'm Mr. Bad Example, take a look at me
I'll live to be a hundred, and go down in infamy

— Warren Zevon, Mr. Bad Example

Watching Barney Frank and the House Financial Services Committee attempt to grill the heads of the eight largest bank recipients of TARP funding in front of the cameras recently, I was reminded of a conversation I had with the Chairman of a very large and prestigious private equity firm several years ago.

It transpired at a small dinner party, held at the Chairman's summer home in the Hamptons. Wives, children, and sundry other non-combatants were present, so the occasion was strictly social. Nevertheless, amidst the introductory chit-chat, Your Humble Correspondent revealed the slightly tawdry fact that yes, he was indeed employed at a certain not-to-be-named investment bank and therefore responsible for all sorts of reprehensible behavior. The Chairman chuckled indulgently at that—being, by virtue of his own profession, no stranger to unarmed robbery—and turned the discussion toward those individuals at NTBN Bank whom we might know in common.

Naturally, being a relatively lowly worm in the vast and ever-expanding bowels of NTBN at the time, I could not profess close acquaintance with many of the senior grandees the Chairman was familiar with—people he knew from their frequent trips to his Midtown offices to lick his shoes—but I offered a diplomatic comment or two on a couple of them. I ventured that one particularly poisonous specimen was indeed extremely bright, successful, and ambitious, and we both agreed that he was blessed with quite a remarkable quantity of self confidence.

Apropos of nothing, the Chairman turned contemplative for a moment. Then, looking straight at me, he remarked that, in all his many years in the business, he had never met anyone who had risen to head an investment banking operation who possessed the least measure of humility. I think, in retrospect, this was his kind way of warning me away from ambitions above my station, given my deplorable failure in our conversation to claim sole credit, as a junior investment banker, for more than 50% of NTBN's annual earnings.

* * *

Since that evening, Dear Readers, I have become older, wiser, and more traveled in my industry, and I have seen nothing or no-one that disproves my old friend's comment.

In fact, I will go further and say that I have yet to encounter a senior executive manager at a large investment bank who does not demonstrate a very substantial number of the commonly accepted markers for psychopathy.

From Wikipedia:

Common characteristics of those with psychopathy are:

• Grandiose sense of self-worth
• Superficial charm
• Criminal versatility
• Reckless disregard for the safety of self or others
• Impulse control problems
• Irresponsibility
• Inability to tolerate boredom
• Pathological narcissism
• Pathological lying
• Shallow affect
• Deceitfulness/manipulativeness
• Aggressive or violent tendencies, repeated physical fights or assaults on others
• Lack of empathy
• Lack of remorse, indifferent to or rationalizes having hurt or mistreated others
• A sense of extreme entitlement
• Lack of or diminished levels of anxiety/nervousness and other emotions
• Promiscuous sexual behavior, sexually deviant lifestyle
• Poor judgment, failure to learn from experience
• Lack of personal insight
• Failure to follow any life plan
• Abuse of drugs including alcohol
• Inability to distinguish right from wrong

Looking back over my career, I can recall encountering individuals who were clearly destined from a very tender age for greatness in investment banking. With the exception of the tendency toward physical aggression and violence—investment bankers, as a rule, are the wimpiest and most cowardly of creatures, when it comes to nonverbal violence—and sexual promiscuity and deviancy—for which one only has the self-reported "evidence" of these supposedly superhuman young Lotharios—I find it hard not to ascribe some measure of all these characteristics to those individuals I know who have risen to high management responsibility within an investment bank.

As I have written elsewhere, investment banking is a business which both attracts and rewards individuals with cast iron egos who can stab their closest ally in the back minutes after buying them a drink. (Not everyone in the industry is like this—in fact, the vast majority are not—but the ones who claw their way to the top either are that way to begin with or become that way on the climb up.) People outside the industry decry its participants as slaves to greed, but the real truth is that money is primarily a measuring stick and an enabler for an investment banker's self worth. This is entirely consistent with behavior at the top, where we have seen senior executives grant themselves bonuses and guarantees so large as to be effectively meaningless, except as a way to keep score. This is narcissistic personality disorder writ large, and the nastier aspects of psychopathy are simply the tools necessary to survive and thrive in the free-for-all cage fight that is the executive suite of a major investment bank.¹

* * *

But if this is true, it poses a particularly tricky challenge to the government's new program to rescue and regulate the financial industry from the current economic crisis.

Careful watchers of the hearings this week will have noted that the US Congress came away from the proceedings at least as badly damaged as the investment and commercial bankers nominally on the hot seat. The hearing format—anodyne opening statements from the eight banks involved, followed by an apparently endless series of five minute time slots for Congressmen to fit moral outrage, political grandstanding for the constituents back home, and a couple of desultory questions into—was patently ill-designed to get to the root of the problems which have occurred and the culpability and behavior of the banks involved. Many Congressmen and women came off as woefully, even laughably ill-informed about the very basics of finance, much less the tortured intricacies of the securities, markets, and practices which led us into our current predicament.

In contrast, the bankers for the most part kept their cool, answered idiotic questions patiently, and avoided revealing any information that could be of real use magnificently. They came across as smooth, smart, and plausible.

Psychopaths.

* * *

Many observers of the smoking wreckage which now passes for our banking system have opined that, in addition to being hobbled by a fragmented regulatory system riddled with overlapping and ill-defined responsibilities, the regulators who were supposed to be watching the chicken coop were woefully overmatched by the foxes. Staffed primarily by lawyers, on government pay scales, the SEC almost by definition is not up to the task of monitoring Goldman Sachs, JPMorgan, or anyone else, if by "monitoring" we should expect true informed oversight and control. If Harry Markopolos couldn't get the SEC Enforcement Division to understand and investigate what appears to have been a particularly simple—if breathtakingly successful—Ponzi scheme, how can we possibly get comfortable that our government watchdogs can effectively oversee the hugely complicated, mind-numbingly sophisticated, globally distributed trading operations of a modern investment bank?

This shortfall in regulatory intellect has been exacerbated by what the Japanese call amakudari, or "descent from heaven": from time immemorial, a steady stream of former regulators has resigned their posts to assume positions on Wall Street, sometimes at the very firms they had been charged with overseeing. There is very little incentive to push a little harder or dig a little deeper into a question if it irritates a powerful firm that might be your future employer. Furthermore, this practice provides a steady stream of inside knowledge on current regulatory focus, practice, and ignorance that is of tremendous value to oversight-minimizing investment banks.

The answer, of course, is obvious, if politically difficult to put into effect. Staff the SEC, or whatever "Super Regulator" the government decides to deputize to oversee this mess, with a bunch of highly-paid, tough-as-nails, sonofabitch investment bankers. You will have to pay them millions, just like regular bankers. (You can tie their incentive pay to improvements in the value of securities held under TARP and TALF, if you like.) Pay them well, and investment bankers won't be able to treat them like second-class citizens at the negotiating table. Pay them like bankers, and your regulators won't hesitate to read Jamie Dimon or Lloyd Blankfein the riot act, because they won't give a shit about getting a job from them later.

Trust me, these are the kind of people you will need on your team: highly educated, financially sophisticated, psychotically hard-working, experienced professionals who know or can figure out CDOs, SIVs, balance sheet leverage, and credit default derivatives just as easily as the idiots who created and trade this shit. Leading your enforcement and supervision teams you need a bunch of smooth, smart, plausible, grandiosely self-confident senior bankers who will not hesitate to tell Vikram Pandit to go fuck himself, his mother, and the cow she rode in on if he ever tries to fuck with the United States government, the US taxpayer, or the pizza delivery boy again. You know: psychopaths.

This is not a new idea. For yonks, the Brits have known that the best person to hire as gamekeeper on your ancestral estate is a former poacher, someone who knows what they know, how they think, and where to punch them in the genitals to get maximum negotiating effect.

Or, as I like to think of it, the best person to send to kill a bunch of mercenaries is another mercenary:

Roland the headless Thompson gunner
Norway's bravest son
Time, time, time
For another peaceful war
But time stands still for Roland
'Til he evens up the score
They can still see his headless body stalking through the night
In the muzzle flash of Roland's Thompson gun
In the muzzle flash of Roland's Thompson gun

— Warren Zevon, Roland the Headless Thompson Gunner

Sounds like fun. Where do I send my resumé?

¹ Fun fact: "According to DSM-IV (in a 1994 publication by the APA), Antisocial Personality disorder is diagnosed in approximately three percent of all males and one percent of all females." Hmm. Do you think this might help explain the persistent underrepresentation of women in investment banking? Come on, girls, get your freak on!

© 2009 The Epicurean Dealmaker. All rights reserved.