Michael Lewis has a piece in Vanity Fair that could as easily have been titled The Banality of Derivatives.
Yet the A.I.G. F.P. traders left behind, much as they despise him personally, refuse to believe Cassano was engaged in any kind of fraud. The problem is that they knew him. And they believe that his crime was not mere legal fraudulence but the deeper kind: a need for subservience in others and an unwillingness to acknowledge his own weaknesses. “When he said that he could not envision losses, that we wouldn’t lose a dime, I am positive that he believed that,” says one of the traders. The problem with Joe Cassano wasn’t that he knew he was wrong. It was that it was too important to him that he be right. More than anything, Joe Cassano wanted to be one of Wall Street’s big shots. He wound up being its perfect customer.
I often read/comment on Daily Kos, and one of the subtle surprises is the level of financial illiteracy you can find in a politically motivated, engaged population. These are the folks who vote in favor of rent control even when they do not occupy rent-controlled housing – it sounds like a decent, humane idea and they can’t understand what the consequences might be. Hell, they don’t seem incredibly able to understand how it could be that Microsoft shares trade for a lower number than Adobe shares, if it’s actually true that Microsoft is the larger company.
For these folks – and, I suspect, many others who are even less motivated to inquire of the world around them – the financial crisis of the last year is a giant conspiracy. A few men in NY got together and decided to soak the working man. It is of a piece with all conspiracy theories – the deck is stacked against us, there are a few people who know what is going on and they keep fucking us. In a way it is a very hopeful perspective. It implies that if somehow the good guys could access the levers of power, all of a sudden that tremendous, finely honed machine could be put to work for good and not evil.
The shame is that the world isn’t like this. The government is the group that brings us the Bay of Pigs and Desert One and the Department of Motor Vehicles. It’s a lot more of this:
And the private sector, well, let’s go to Lewis’ seminal work on the subject, Liar’s Poker:
[Gutfreund] would point out that Salomon Brothers carried eighty billion dollars of securities on its books overnight, every night. He would follow this observation by saying that, in asset size, Salomon Brothers was “the largest commercial bank in the world” and “one of the forty largest countries in the world.” As one (Jewish) mortgage trader said in response, “C’mon, John, you’re not talking about the Netherlands, you’re talking about a bunch of Jews who are leveraged.”
In this crisis, like the ones preceding and, no doubt, the ones that will follow, we ended up where we ended up by accident of good intentions. No one had a diabolical plan to tank the markets; in fact, people generally believed the market would work out the way they behaved. Calculated Risk discusses liar loans stated income loans here, and points out that even today there are advocates of what was a remarkably dumb idea. These folks aren’t trying to create a mountain of bad debt; they genuinely believe it’s a good idea, and it’s this good faith that makes the bad behavior so damn pernicious.
If AIG had been some garden-variety scam, some weird Bernie Madoff variant, you could be forgiven for believing that the solution is grand juries and investigations and more investigations. The reality, though, is that they were all-too-human and all-too-frail; they took massive bets they didn’t think could fail for no obvious reason other than that they had never failed in the past. I was told flatly by a derivatives originator (not at AIG) in 2006 that it was utterly impossible for there to be a nationwide house price decline, that I was describing some sort of Mad Max world that did not merit serious contemplation. And he made tons of money for having that perspective, which likely contributed to his depth of feeling about the underlying merit of his products. His firm had the liquidity to ride out the storm in a way AIG did not, and even today he is minting money doing the same thing he was always doing, now with at least one fewer competitor.
While on the subject of the distinction between negligence and criminal behavior, I have to say that I have been following the Goldman high-frequency trading story from some distance, and as best as I can tell their entire strategy is predicated on what is (or should be) a crime: front-running an open order. On a basic level, the Goldman equipment seems to interface with the NYSE clearing mechanisms such that Goldman is able to identify an order in the process of being filled, grab the allocation and resell it. A trade of 10,000 XYZ would match at $56.27, except GS – having already seen the incoming order from Buyco – puts in its own order, fills it from the delivered 10,000 XYZ shares from Sellco, and turns around to sell them to Buyco at $56.28. It’s not that different from playing blackjack with the ability to see the dealer’s hole card.
If it were true that the stolen portion of the code were such a threat to market integrity, why should Goldman be allowed to retain it? Strikes me as a bit like calling the cops to complain that your kilo of coke was stolen.