Trader’s Narrative

This is a response to Smith’s essay in the Wall Street Journal on February 7th, 2009 titled “Greed is Good“. In the essay Smith, a former partner at Goldman Sachs argues that bonuses are a necessary part of compensation on Wall Street and that changing this would damage the competitive nature of firms as the best and brightest would leave for greener pastures. Smith uses exhortations and an anecdote from his own past to make his case:

I was … horrified to learn that my annual take-home pay would be limited to my small salary, which accounted for about a quarter of my previous year’s income. Fortunately the partners decided to pay a small bonus out of their capital that year to help employees like me get by.

This was 1973, a time of tremendous economic shock for the average American. What Smith conveniently leaves out is just how much his salary was. I’m willing to bet that even without the bonus (that he did end up getting) he wouldn’t have had to rely on food stamps like many of his fellow citizens.

Of course, the problem is that unlike the story he recounts from the 70’s, current investment banks are not private partnerships but public enterprises which have a fiduciary responsibility to their shareholders. When you look at the amount of shareholder wealth that has been nuked and compare it to the billions that were paid in ‘bonuses’ to generate these losses, you get a glimpse into the lopsidedness of things. Oblivious to reality, Smith expects Wall Street firms to act as if they are still private partnerships when in reality they are public.

We seem to be living in an altered reality: one where a $700 billion ‘blank cheque’ can be written to corporations based on nothing more than the flimsy support of vague promises on 3 pages, while a similar amount for everyone’s benefit has to run the gauntlet of Congress and go on for hundreds of pages in detail. One where banks claim that bonuses are needed to keep ‘talent’… yes, the very same so called ‘talent’ that replaced Wall St. with a giant maw. One where capitalism’s banner is raised proudly when the money is flowing in but where it is hastily lowered and stowed away for CEOs to play the mendicant. One where a person receiving welfare has to jump through hoops and tolerate intrusive government involvement in their personal lives but where banks rage against even the smallest concession when receiving billions of tax-payer’s money.

Camel-Birds
The best analogy to describe this is a Persian parable that I grew up hearing when I would make excuses to evade sacrifice or hard work. As preamble, in Farsi, the word for an ostrich is shotormorgh, a composite of two words: camel (shotor) and bird (morgh).

The story goes that an ostrich was approached and asked to help carry a load. It balked saying, ‘How can you ask this of me? Can’t you see I’m just a bird?’. Then it was asked to fly and take a message for a faraway town. To which it then replied, ‘What? you ask me to fly even though you can see clearly that I’m a camel?’

This insistence to have it both ways has become a hallmark of Wall Street. Just recently there have been a spate of hedge funds that have decided to simply shut down when faced with large losses. Prentice Capital and Tontine Associates are two of them with losses of 88% and 60% respectively. Rather than work hard at earning back the money they lost to clients and reach their high-water mark, they want to start a new fund and start to earn 2/20 commissions right away. Heads, I win - tails, you lose.

As far back as 12 years ago the Bank of England saw the inherent problem with a system that compensated employees for profitable risk-taking, but refused a consequence for any potential losses. Daniel Davies, a senior economist at the Bank of England wrote in 1997:

Employees’ contracts almost always involve limited liability; they may share profits from favorable trading outcomes but it is difficult or impossible to make them compensate their employers for losses…

The recommendation was to stretch out the time period for bonuses but it was firmly rejected by the City who saw it as intervention and an attempt at regulation. Of course, now these same laissez-faire disciples have no problem demanding that the taxpayer rescue them. The Royal Bank of Scotland is 68% owned by the UK government and yet, they are fighting tooth and nail to keep their bonuses.

Heads, I win - Tails, you lose
But beyond this paradox the lesson here is that greed is not good. That may be an odd thing to read on a blog about trading but I say that because, in fact, anything taken to excess will, eventually, create its own downfall. This is a truth that is self-evident. To all, that is, that choose not to ignore it. The rampant excess, hubris and sense of entitlement on Wall Street would make Caligula blush.

The obvious answer is if you want a market economy, then you take your losses along with your profits. If you want to bask in a performance based compensation, then you can’t be compensated as a star when you are the biggest loser. These watershed moments are what underlie cultural shifts. It isn’t just coincidence that the number one movie in the US is Slumdog Millionaire a story of a poor young man triumphing in a society where the rules are written by the wealthy, not the sequel to Wall Street.

Since last year we’ve heard rumors about a “Wall Street” sequel in the works from Hollywood. Amazingly enough, the latest news is that it is in fact going forward and will probably have Michael Douglas reprising his role as the infamous Gordon Gekko.

As any trader knows, “Wall Street” is the classic trading movie which came out in 1987. What most people assume that it came out before the crash in 1987. Which is probably why it has gained a false reputation as a contrarian indicator for the crash. But in fact, the movie was released on December 11th, 1987 when the Dow was around 1,900 - off the lows of Black Monday, but still every one was completely shell shocked.

It looks like the sequel will also come on the heels of a crash of sorts. That is assuming we don’t have another leg down from now till the movie is released