Wall Street

The London Whale Trade Scapegoats and What It Means for the Industry

If you’re a low-level employee at a financial firm, beware: you will not be spared if your bosses fuck up. In fact, your entire risk/reward is strongly skewed against you: you bonus is still meager (or non-existent), but your chance to be accused of wrongdoing is not commensurate with your compensation. Like that guy Julien Grout – a mere trading assistant who marked Iksil’s books and who is now facing charges on four counts. His bosses tell him how they’d like to see the positions marked and he goes ahead and delivers them the numbers they want to see. Bruno Iksil, his boss and the trader who put on those trades is not being charged. Instead, he’s cooperating with the authorities and ratting out his own boss and his trading assistant. The interesting part is that Grout, a low level employee who merely evaluated the desk’s P&L, devised a plan to get out of the position, before shit hit the fan, which would book about $500 mln in losses, but his bosses told him no thanks. And what are you going to do then? Are you going to do what your bosses tell you or run to the authorities? If answered honestly and with assessing all the upsides and downsides of either move, this question is easy to answer: you will do what your bosses tell you.

The sad part is that SEC might pump its chest and think it’s found its mojo. But the reality is such that if there’s an abundance of willing striving young men, dreaming of a career on Wall street, unable to say no to prospect of quick riches, there will always be room for such abuse.  It is only the lack of willing soldiers lining up to take those ungrateful jobs that will, well, do the job. When there will be no cache of low-level employees willing to take such uneven risks and then being made scapegoats, this is the beginning of the end. This story is a good warning to all those young jocks dreaming of Wall Street: If your boss loses money and it makes headlines, he’s not going the one taking the heat – you will. Perhaps the next generation of Julien Grouts will pause before wishing for that job on the trading desk after all.

And then, what if it is physically impossible to be honest on Wall Street? The whole system is so corrupt that even a fair-minded person will end up contaminated while on the inside.  When you’re a low-level employee you do what you do because you can’t say no to your boss. When you’re a mid-level employee you do what you do because there’s a big reward on the horizon – a promotion or a bonus. When you’re senior management you do what you do because you’re in the spotlight, sometimes sought, sometimes undesired.

None of those stages are welcoming to self-reflection. The pull of the flow, of the tide is so strong that it’s easier to just go with the flow. People have to stop wanting to do what they’re doing in order to bring changes to the entire system. Since neither government, nor legislators, nor regulators, nor public furor could do anything definitive to change the corrupt system, the system itself has to become unsustainable and collapse under its own weight. When I talk to my still surviving former comrades, many of them simply don’t want to do this anymore, they seek to leave the industry altogether. The pay sucks, the bonuses are zero, there’s more work to do with no reward, monetary or personal. When people refuse to be a part of it, not because they’re fair and civic-minded but because continuing to be a part of it goes against their own self-interest, that’s when there’s hope for any reform.

But we’re still far from it: You may hate your job that pays $200-250K base, but there’s nothing else out there that can pay that.

So, to use a zesty Russian expression to perfectly describe the predicament, Wall Street will continue to “fuck and cry”.

Do fines even work?

When someone sets aside $6.8 bn  just to pay fines, are they really scared of fines? Do fines and financial settlements even matter anymore? That kind of stash, that nowadays any self-respecting bank sets aside, is just a regular expense, a price of doing business. Isn’t it a time to think of some new recourse, like jail time and/or mandatory breaking of institutions into smaller parts?

Although, it’s not clear who would go to jail. So that leaves one option: break-up TBTF – not as a prophylactic measure, but as price for wrongful behavior.

Attention Hedge Funds! Bernanke is not exactly London Whale.

Brad Delong draws a nice picture of how hedge funds see the world.

Some in the industry like to draw parallels between the London Whale trade last year that cost JP Morgan $6bn and being short US sovereign debt: they think one day the trade has to be unwound in a quick and messy manner and then the shorts will cash in. There’s one big difference: JP Morgan can’t print money, Bernanke can. And then there’s a concern for inflation ( a strange concern for someone who’s supposedly short Treasuries).

But, the hedge fundies say: “What if the economy recovers and starts to boom? What if inflation shoots up? The Fed could loose $500 billion on its portfolio as it moves to control inflation! Why doesn’t that fear that?”

The Fed does not fear that. That is what it is aiming for.

Hedgies also upset that there’s no higher authority that can come in and right the imagined wrong done to them. Unlike London Whale (Bruno Iksil), Bernanke doesn’t have a boss who can force him to unwound this trade today. This fact really annoys the hedgies.

Who do the hedgies imagine are the Fed’s political masters who will tell it to shift and adopt policies that will bring on even massier unemployment? Rand Paul?

There is a reason that the trade of shorting the bonds of a sovereign issuer of a global reserve currency in a depressed economy is called “the widowmaker”.

The Fine Art of Being Wrong.

This is a link to Barry Ritholtz recent article on how to be wrong and move on. He applies it to trading, but the same philosophy could be used at anything. Admit your mistake, correct it and move on without dwelling on it. It helps not having a big ego – a rarity among the trading kind.

What does NOT admitting error look like? It is Apple investors, who double up all the whole way down from $700 to $400. It is the radical financial deregulators like Edward Pinto & Peter Wallison blaming the financial crisis on unrelated bank loans to poor minorities. It is the cacophony of excuses from the Gold community, blaming the 30% drop on central banks, Goldman Sachs, “paper” gold, the shorts and the dollar. My friend Albert Edward’s reiterated call for S&P500 at 450 — with the SPX kissing 1600 — smacks of a classic non-admission of error. His preference is to go down with the ship.

I would also include another category to this group: those who trade on political inclinations rather than on reality. John Paulson, one of the goldbugs (and a Romney donor) who saw his fund lose 27% last month (and 47% YTD) is one of those sophisticated guys who are no different from Glenn Beck, betting on the apocalypse. Why do they bet on the apocalypse? Because Obama is a socialist, thus the economy cannot possibly recover during his term. Although, I have to give John Paulson some credit – at least he bets his own money on entrenched personal sentiments. Glenn Beck types first scare regular folks about the upcoming Armageddon and then simultaneously peddle them gold coins. Nice, full-proof business model.

But still, I’m puzzled, and even fascinated how smart guys can be so blinded by political hatred that they allow it to envelop their thinking. John Paulson is not a stupid guy: he made billions betting against subprime in 2007-2008. How could guys like him not have put two and two together? For the last 3 years it was obvious to me that Bernanke will keep his foot on the QE gas pedal for as long as possible, and given the abject economic situation in 2009-2010, one could safely say that it’s going to be years, not months. This simple fact guided my being long stocks and withstand all the ups and downs. You don’t have to have a PhD to see what was going on. Whether QE is good or bad is secondary to this discussion: guys like Paulson don’t care about social implications when they make money; they only bring up social implications when they have lost all other arguments. Zerohedge guys, another famous goldbugs, are now annoyed to find out that without QE the market would have stayed flat. They want QE ended immediately because it was so successful and thus prevented their luddite, gold-obsessed worldview to be realized in real life! WTF?

Do you wanna be right, or do you wanna make money?

This has been my sentiment for the last 3 years. You can agree with the Fed’s monetary policy, you may disagree with it, but the trade for the last 3 years was to be long equities. And that’s that.

Jamie Dimon Should Embrace TBTF reform (My new article in the American Banker)

Here’s my new take on TBTF problem.

To summarize, to embrace the TBTF reform is a winning issue for Jamie Dimon. It has a limited downside/unlimited upside an has a potential to repair his tarnished reputation and turn him into  the industry leader. He holds a winning hand and doesn’t know it.

Inflation of Labor

Republicans now are rediscovering the “middle class”. Rubio made sure to make “middle class” the focus of his SOTU reply. It’s a welcome about face in a party that just a few months ago was celebrating business owners (as opposed to people who work for them) on Labor Day. It wasn’t surprising: the current Republican dogma coalesced around the idea that only business owners work hard; everyone else is either lazy or not entrepreneurial enough. In Republican mind, whoever didn’t become business owner or “made payroll” is implicitly a lesser member of society, a leech and a moocher.

Republicans love to keep their focus on inflation: there was no shortage of dire warnings coming from the right quarters about inflation that was just around the corner. The inflation that they had in mind never materialized, but in the meantime the other type of inflation – labor inflation has been devastating the communities for decades but received little attention of the doomsayers.

Back in the day, the time that many conservatives are nostalgic about, the 1950-60s, it was possible for a man with a high-school diploma to work at a factory and get paid enough to provide a middle-class lifestyle for his entire family. For a man with a college degree the career paths were wide-open and his chances of successful employment were even more robust. To achieve and maintain a middle-class lifestyle one didn’t need a double-income family and didn’t need to leave home and 6am and get home at 12am and be available on weekends. Since then “success” has been redefined. To be considered successful these days you have to negate your own self and turn into a machine.

Toiling away from paycheck to paycheck and working harder and longer hours is required nowadays just to keep one’s head above water. The world where business owners work 24/7/365 and everyone else works from 9 to 5 with an hour break for lunch is a fantasy. Let’s examine a minimum wage worker working shifts at Walmart. If he or she works 8 hours a day they would make roughly $15K a year. I would argue that if this person is presented with an opportunity to work longer hours or find another part-time job, say, at nearby Taco Bell, he would take it. Many do. We’ve all heard stories about people working 2-3 jobs. Or let’s even take an average Wall Street employee: no matter how entrepreneurial they might feel about themselves – they are still just glorified salary workers (with bonus). They are expected to be on-call 24/7 checking their blackberries at night and on weekends and they have acquiesced to this way of life as a default and some, in some masochistic way, even consider it a badge of honor. Working hard and especially reveling in your hard work is as American as apple pie. Our entire way of life now is treating the best-case scenario as a base-case scenario. In other words, there were times when working 8-hour days meant to be average and working 12-hour days and weekends meant to be successful. Now, for many, to work 12-hour days plus weekends is a given, a base-case scenario.

Humans have a great adaptive mechanism – we can get used to many things and we can accomplish remarkable feats especially if we’re in a survival mode. But we can only stretch our productivity so much, and after a certain point more workload becomes detrimental to an individual, counterproductive for companies, and eventually damaging to society. We physically can’t work more than 24 hours, we can’t be at 2 places at the same time, we can’t win on every trade. At some point there will be no room left to push harder. The benefits of longer hours and constant availability are becoming marginal. To take success onto the next level from what is considered successful career today is to become superhuman, develop magical powers or to rig the game. And if you have no way of doing it – you’re just an average, talentless, lazy schmuck. But don’t dare to complain about it – to complain is un-American.

There’s clearly an inflation of labor for those holding a wage job. Over the years the normalcy of 8-hour work days turned into 10-hour work days and then into 12-hour work days, but the benefits are failing to keep up with the contributing effort. The jobs for which a high-school diploma was sufficient, now require a college degree; and where before a college degree would provide job security for life, a graduate degree is required and yet it is no longer a guarantee of lifelong employment. It’s hard to say which came first: inflation of college degrees or inflation of labor. Surely, today this labor inflation can be attributed to high unemployment rate, but this phenomenon was prevalent even during the roaring years prior to the 2008 collapse.

The “moochers” that Republicans keep talking about are stretched too thin. They are one accident, one blown tire, one missed paycheck away from not being able to keep afloat. It is only in the imaginary world of self-declared “makers” everyone else lives off of the fruits of their labor. In the real world, “makers” expect everyone to be on call at all times for pennies and then have the chutzpah to accuse them of being lazy. Well, at least some in the GOP, who actually have to win elections rather than exercise their wits at the expense of an average Joe, are rediscovering that such attitude is damaging the brand. I’m following their transformation with great interest.

Why there are no shootings on Wall Street?

Why have no one ever gone postal on Wall Street? Is it not a back-stabbing, competitive, survival of the fittest shark tank? How many were passed over for promotion or stiffed around the bonus time? How many untold grievances have been absorbed and internalized to never be addressed in a violent manner? Greg Smith clearly was driven to the breaking point and yet he found a legitimate, albeit an omerta breaking, way of addressing his complaints.

First of all, it takes a special pedigree to join the ranks on Wall Street. People like Alex Jones would never have passed through the interview process. He would have a hard time hiding his oozing craziness. A silent, studious type, like the Newtown shooter, would also not fare well during the interview. I’ve heard many stories from frustrated headhunters when their brilliantly credentialed PhDs in math and physics couldn’t put a sentence together during the chat with a head of the trading desk. At the point where you made it to the actual interview, the hiring manager doesn’t care about your illustrious resume; he tries to gauge if he can sit next to you for 10 hours a day. He wants to assess whether or not you’re a weirdo, a douche or a “schmuck on wheels”. To get hired on Wall Street one has to project jocularity but not disrespect, charm but not servility, acumen but not conceit, thoughtfulness but not stupor, earnestness but not wild-eye fervor. They want to see if you’re “one of us, a good fella, a wise guy”. At one once venerable but now defunct bond shop they used to say “give me a poor and hungry kid from Brooklyn with a degree from Columbia”. They were essentially looking for a guy who wants to get shit done, get paid and is secure enough to take some level of abuse. There have always been a cache of such kids.

Such screening process weeds out a large number of oddballs. Weak, insecure egos like NRA loudmouths or underappreciated geniuses, like smart quiet loners, don’t make it that far but if miraculously they do, Wall Street has a way of molding them. That is not to say there are no psychos on Wall Street. But those kinds of psychos, when crossed, are not looking to go in a postal way. They can make a more memorable statement with a click of a mouse than with a machine gun. But at any level of the food chain, from the abused new recruits to the highest ranks, all accumulated grievances – against management or against colleagues – are mitigated by the Great Expectation. The Great Expectation is, of course, either an upcoming bonus or a promotion, or an opportunity to make a spectacular trade or all of the above and it is a powerful pacifier of any violent tendencies one might otherwise unleash. The employees in most other industries do not have such a powerful release mechanism. Then there are other, more mundane factors: bankers got expenses and a certain way of life – mortgages, wives at home, kids in private schools. It’s just too much to lose. To show up with a gun at work is to suffer the deepest ignominy, to be known forever as a douchebag, an anti-Mensch; and to condemn your surviving family to a humiliating existence. That’s worse than death.

Since we can’t administer the Wall Street screening process to every citizen and since we can’t award everyone a bonus, perhaps we can consider the following measure of fitness to carry a gun. Comedian Chris Rock made a great point about having a mortgage as a requirement to owning a gun. “Every mass shooting is done by guys who live with their mother. So I believe you should need to have a mortgage to buy a gun. A mortgage is a real background check. Even if you go to jail for 30 years, you’ve still got to pay your f—king mortgage.”

Having a mortgage will make you think twice before you decide to go in a memorable way. I do not, however, advocate loosening the lending requirements in an attempt to turn potential psychos into upstanding homeowners. We all know what can happen when we give away mortgages to all kinds of delinquents. Precisely!! In the aftermath of the mortgage crisis banks are now extremely prudent in deciding whom they are extending the mortgages to. Shouldn’t we then adopt the same kind of approach when it comes to gun ownership? Our goal should not be to have as many people with mortgages as possible so that they can buy guns. Our goal should be to allow gun purchases to the people who have demonstrated that they are responsible and prudent enough to be able to own a mortgage. Mortgage and, to the delight of conservatives, I’ll throw marriage in there too, should be a criterion for getting a gun. Alec Baldwin’s character from The Departed distills it simply: “Married guys seem more stable; people see the ring they think at least someone can stand the son of a bitch.” If you insist on defending your castle from intruders, you first have to demonstrate that you have it. And this approach will be applauded by budget hawks as there will be no additional spending required by establishing background checking venues – as mortgage, in itself, is a thorough qualifier.

There’s a palpable dichotomy between the qualities one is required to possess before being allowed near spreadsheets on Wall Street vs. the loose qualifications one needs in order to get a gun. Managing money gets more gravity of consideration than acquiring a tool whose only function is to kill. Perhaps, using mortgage and/or marriage as a requirement for owning a gun offers a simple solution that even conservatives can’t object to.

Happy New Year!

I want to wish everyone who reads this blog a very Happy New Year!

Also, I’d like to speculate about what the new year might bring in areas that I follow closely: politics and economics.

If the fiscal deal is not reached tonight (and it increasingly looks like it won’t be), we will begin the 2013 with Democrats in congress and Obama pushing for the middle-class tax cut. Republicans will grudgingly, and after some mandatory posturing and howling, accept it. The bigger wave on the horizon is the impending debt ceiling which will have to be raised somewhere in February. Unless debt ceiling is somehow dealt with during the tax cuts negotiations that will happen in January, we can have a repeat of August 2011 debacle. And Republicans will have the upper hand again, because as they have demonstrated earlier, nothing indicates their love of the country better than the willingness to hold it hostage to placate the far-right constituents in their home districts. If I were Obama I would deal with it now, while I have a better hand and can force some consessions. But there’s a silver lining here too – those who are looking to buy some stocks will be well advised to wait till Feb or March when the markets will dip during the certain debt ceiling debacle.

Here, I must say that I have been 70-80% long stocks for the last 3 years. It’s been a rollercoaster, but I held on during the 2010 flash crash and 2011 debt ceiling sell-off, notwithstanding several other, smaller dips. My strategy is not fancy, but rather straightforward,  and it worked for me during the past years and it will work for me again in 2013. In a nutshell, the reason why I’m long stocks is because of the deleveraging (a process where everyone pays off their debts and stores cash on their balance sheets) and low yields in pretty much all asset classes out there. In plain English that means financial institutions are sitting on  hundreds of billions of cash and have nowhere to put it. Bonds across the board (corporate, mortgage, Treasuries) have rallied so much that they earn zilch now. So stocks look more and more attractive to invest in. It’s riskier than bonds, but at some point (especially when the market dips again during the inevitable debt ceiling clusterfuck) many fund managers, pressed by their clients to deliver yield, will be forced to buy equities. Another powerful force that is behind my back on this strategy is Ben Bernanke who will stay as Fed Chairman through 2014 and will keep the rates low as he has been doing for years. Low rates are bullish for stocks.

I hope Wall Street will stop fighting the Obama administration and will come to terms with the new normal. The business model and the payoffs of the 2003-2007 era was an aberration and Wall Street handicappers, if they are as smart as they claim, should come to this realization.  

And as always, I wish Obama and the Democrats would learn to play the hand they’ve been dealt forcefully. Here’s a great poker parallel about the way Obama plays his hand now: “The negotiating style Obama has displayed in these instances is what poker players call “tight-weak.” A tight-strong player avoids throwing in his chips, saving them for a big hand, which he plays aggressively in hopes of a huge win. A loose-weak player plays lots of hands, bluffing frequently. Tight-weak is the worst of all worlds — when you have a weak hand, you lose, and when you have a strong hand, you fail to maximize your position.”

Happy New Year!

Memo To Wall Street: Victimhood is a losing trade

Major problem of the investor class these days is piles of cash and lack of investment opportunities. Major problem of middle class is lack of a stable paycheck, underwater mortgage and in many cases ruined lives. And yet it is the former who are quick to be offended and portray themselves as a persecuted minority, and it is the latter who quietly toil away paycheck to paycheck without seeking to make headlines.

For some reason it is the working stiffs who are required to view the world through the lens of hedge-fund billionaires, of self-made men, of entrepreneurs, but the opposite is not required of the billionaires. Every self-respecting billionaire has an “I lifted myself by the bootstraps from a scrappy childhood” story (even Mitt Romney has one, whose hardship included eating pasta and tuna fish as a student, the horror!). If adversity stories was something that money could buy there’s no doubt the narratives of hardship coming from the rich would make a poor man weep with empathy. But such stories, even if burnished to squeeze more sympathy from the audience, only matter, in the eyes of a self-made billionaire, when they are personal and in the past, not present day and coming from the wage-earners. Let others marvel at how hard you worked but don’t award them the same courtesy if they haven’t made it as far as you did. If somebody “didn’t make payroll” it’s almost grounds for derision in the world of Leon Coopermans. To understand and sympathize with financial titans is a poor man’s requirement, not the other way around.

The fact is our financial elite, that fancies itself to be trailblazers, rebels, brilliant innovators, have long ceased to resemble their favorite characters in their favorite movies. Somehow they lost their human qualities on the way to the top. They are now the bumptious judge in Caddyshack, the scheming Duke Brothers in Trading Places, the pretentious victims in Bonfire of the Vanities; not the scrappy ragtag team of clever misfits who take on the establishment. The financial elite demands respect, the admiration of the masses, the reverence from the government. Felix Salmon beautifully dissected the nature of their grievances – it’s part narcissism, part greed, part strategy. But somehow they look like they begin to believe their own narrative.

The revealing part of the mindset among the financial elite is a story of a letter sent by Leon Cooperman’s granddaughter to the President. Cooperman, who on many occasions compared Obama to Hitler, was upset that he didn’t get a response from the President. It’s ironic that Obama is expected to show magnanimity towards those publicly insulting him, while those who spew insults are notorious for lack of self-reflection and even a minor sense of gratitude. It was Obama administration after all that showered the financial industry with trillions of cheap credit, upheld AIG bonus contracts and did not prosecute a single person in the wake of the financial crisis. It was Obama who “stood between them and the pitchforks” in 2009, at risk of alienating his own base. He’d rather they just said thank you and went on their way. Taking offence is a crowded trade these days, but it is a sign of times.

The only people who are not offended today, or at least do not try to make headlines with their grievances – real not imagined – are those who work for a paycheck. They are too busy running on the treadmill, paying bills and keeping their heads just above water. They are too busy to write an angry editorial to Wall Street Journal and claim victimhood. But they have no shortage of advice. Edward Conard, Charles Murray know just what the working stiff needs to better his condition – self-discipline, religion and more hard work – as if it is laziness that afflicts the middle and lower-middle class.

I have no doubt that those who made it to the top, especially from a humble background, have worked very hard to get there. But what now? How does closing deals, buying companies, or making investments justify demands for public reverence? Why is it that that hunt for yield warrants more respect than the work that is done by miners in the mine or teachers in the classroom? Why is someone who does not aspire to own his own business is unworthy of sympathy? If everyone strived to be a businessman how would Leon Cooperman make his payroll?

From a strategic point of view the financial industry leaders have embarked on the losing trade. They may be frustrated, but bringing attention to their grievances will not resonate with the wider population and worse, will harm their case. They should instead lay low or play along, like in that scene in Star Wars where the rebels “arrest” Chewbacca and parade him around the enemy starship to get to the control room. Seriously, do financiers expect an unemployed worker in Ohio to feel their pain when their major headache is too much cash with nowhere to spend and being called names? Amazingly, the industry that praises itself as reality-based, Darwinian, strategic, mindful of opportunity and public mood is blind to the reality and the changing Zeitgeist around them. Wall Street, with few friends and strangely oblivious to its own toxicity, has the chutzpah to demand special treatment. It really is a losing proposition to complain about too much money on their balance sheets when half of the country is either unemployed or scraping by. For Wall Street and the hedge funds it’s time to cut the losing trade and move on.