It Was Mother

It was Ten

It Was Ten
Wayras Olivier
DECEMBER 2017


TEN YEARS AGO Bloomberg Businessweek published Emanuel Derman and Paul Wilmott's charitable post-crisis contribution. It was published twice. Once before Christmas and once after. Perhaps to measure whether or not the market’s attitude shifted upon witnessing a specter. An example of just two of the pledges, out of a possible five, from The Financial Modeler’s Manifesto, which they scribed and sub-headed as “The Modeler’s Hippocratic Oath” for engineers, and the industry in general, to consider and recite: “I will never sacrifice reality for elegance without explaining why I have done so” and “I understand that my work may have enormous effects on society and the economy, many of them beyond my comprehension.”

One may not comprehend nineties-Clinton, who incidentally had the time during his impeachment, to repeal Glass-Steagall, the great bastion of sensibility that was put in place in 1933 to prevent unwelcomed and opaque advances like proprietary banking. Which, among other things, clearly allows commercial and investment banks to knock each other up. Deregulation could be delivered into the bathwater and adopted by banks to keep them more than just afloat, while their fiduciary responsibility to the corporations they trade with could be abandoned in the name of their own ledger. This was no longer, on paper, called fooling around. Finance, a conduit deployed to grow the economy, could also leave without anyone having to look the other way if and when it intentionally went nowhere real, or grew anything useful, other than the bank with its prodigal return.

Knocking up banks became a free choice. A choice that required models; financial models, which enjoined acute and energetic agility. “It’s all just numbers really, just changing what you are adding up,” Zachary Quinto admits in Margin Call “and to speak freely,” he concludes, “the money here is considerably more attractive.” Such was the reason engineers and mathematicians chose Wall Street over Main Street in the late nineties. (Right around the same time that the credit card juggernaut, Providian, was in the midst of a subprime scandal for intentionally holding back the monthly minimum payments made by their barely credit-qualified clients in order to penalize them with increased interest rates.) Nevertheless, banks, in no time, trading with corporations, soon matriculated consumers into their trade mix. Mutating the Mortgage-Backed Security (MBS), which had been, since the late seventies when Lewis Ranieri first conjured them up, relatively benign; relatively exclusive to the mortgage broker; and kept relatively in check by Glass-Steagall for nearly a quarter of a century.

But not to question the consequence of risk is to summon the oldest saying in business: if you walk into the boardroom and can’t spot who the sucker is, it’s you. However, all the bankers knew that risk ties up capital. So no suckers, only lollipops. To the ones who discovered that risk could be separated from a loan; making risk itself an entity; one that could be offloaded or swapped to prevent anyone from ever having to take a real licking. As long as risk continually moves around the market, the sweet-sounding flavours expertly coated the confections’ sour center.

Enter Credit Default Swaps (CDS). Which, when swapped, both rewarded one, the insurance seller, for selling so many positive positions on an MBS, (the belief in its ability to endure escalating interest rates) and two, the insurance buyer, for taking a negative position on the MBS, believing that the mounting interest rates would eventually break the new homeowner. (Pop-Budump-bump-bump.)

Thus, the secret to perpetual motion—regardless of which side of the transaction one was on—had finally been discovered. Also, risk, on the CDS itself, if packaged correctly, could be securitized, graded, and marketed as a synthetic Collateral Debt Obligation (CDO), an idea for a derivative that just got brainier and brainier: Just one CDO, in addition to being an explicit measurement of the current risk swelling inside a near infinite amount of CDSs, could also be wagered a near infinite amount of times against just one CDS.

This so-called explicitness, the market’s credit rating agencies accurately rating toxic CDOs as ‘Speculative Grade,’ C class or lower, rather than the ‘Investment Grade,’ triple B or higher, (which indeed the toxic CDOs were receiving) marginally inhibits systemic risk. (Trust in this rating process is what blinded Steve Carell, in The Big Short, for so long before finally seeing that that the rating agencies were not straight.) As we were to learn from The Financial Crisis Inquiry Commission’s nineteen-day hearing held in 2010, heads of the good rating agencies defended their knotty rating process by declaring that they were merely “opinions.”

In contrast, asset or retirement portfolios are generally made up of ‘regular’ securities when the banker forgoes “opinions,” because long ago, it was learned that ripples (when a single commodity index shifts; whereupon a bond index shifts; whereupon a currency index shifts, so on and concurrently so on) could be smoothed out via negative correlation. A lighthouse, in other words, that guides volatility safely to shore in an investor’s portfolio by ensuring that their pool of securities are not on the same wavelength.

The bankers’ general sentiment, again, at the FCIC, was that they were simply unable to see just how positively correlated the MBSs were to the CDSs and CDOs flooding the market. Or they did see, as the commissioners believed—they just didn’t care. (Arrr, at sea, the eye patch makes it difficult for us to see.) Positive correlation mushrooming across the investment spectrum produces, as mentioned before, systemic risk—the very thing bankers fear most. A barefaced contradiction then, to the aforementioned accusation of the bankers not caring, unless the bankers hallucinated that they would be, without question, bailed out of their bad trip.

Finally, to take a slight jab at the disappointing Wall Street 2, which, unlike Margin Call, failed to convincingly reconnoiter how intimately connected indolence is to financial ruin, one must acknowledge Margin Call’s acute employment of the “MacGuffin” (a conceit in a film’s narrative that propels the drama forward yet, ironically, keeps the audience’s attention on the character’s reaction to the drama rather than what caused it)—as the crisis that the executives, and analysts in Margin Call fell into was caused by a single “model” they incorrectly calibrated. The model, as a MacGuffin, frees this exceptional film of laborious and indulgent conversations about CDSs, CDOs, and MBSs so that it may scrutinize the management culture of superabundance, as the firm’s players opine amongst themselves, over the course of twenty-four hours, how the great majority of them (in spite of the model’s complexity) knew in advance that the model would be unsustainable. Apparently common sense itself is sufficient to adjudicate complexity. Of the seven deadly sins, then, the one that they were all guilty of was the one that succeeds greed.

Something that the moneylender in Dickens’ glorified yuletide novel was never guilty of. Whose first name, as a side note, if divided, spells out the location in Bronze Age Palestine where two sanctimonious tribes turned acrimonious. Eben-Ezer himself, however, never succumbed to subprime lending even when his cupidity was being spelled out to him, loud and clear, during his encounter with the indigent children “Ignorance” and “Want.”

W.

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