Usually these types of book take a well trodden route - the 1987 crash, Kidder Peabody, Barings, LTCM and so on. Similarly they are usually written by seasoned financial journalists with an eye for the extreme and the salacious. On the first count this book is no different. On the second however Bookstaber's story is a very different one. As he points out very early on in his treatise, not only was he there at the time of these happenings, but for the most important events (the Portfolio Insurance debacle and the LTCM crash) he was actually directly involved - selling PI when he was at Morgan Stanley and acting as Head of Risk Management at Salomon's as "Saloman North" (i.e. LTCM) collapsed.
Despite the fact that Bookstaber is a pointy-headed academic from MIT, he writes well and cogently - even for the unitiated reader. As an asset management person myself, he also gives a wonderful representation of the workings and culture of a Wall Street Investment Bank and the poitical machinations and ruthlessness of the individuals that work therein (bankers are people with pointy elbows as my wife likes to say).
The book therefore tells an autobiographical journey from academia to Hedge Funds via a couple of Wall Street behemoths. He paints a none-too-optimistic picture of the various "events" that befell the investment commuity in those years (perhaps strange for a Risk Manager) but interestingly does not lay blame at the feet of any individuals or institutions, but rather decomposes the events to find that the issues lay in the interconnectedness of the markets and firms in those markets that caused the "liquidity spirals" that were a consequence of much smaller events and that then led to such large losses for those concerned.
I found his final conclusions strangely in agreement with the message that I am delivering to my current client. Firstly (again oddly for a Risk Manager) he says that Risk Management of known risks is basically a huge waste of money - as the risks that you need to manage are actually those that you do not know of (though he is of course coming from the point of view of a Wall St Investment house who spend most of their time and money hedging everything that moves - I would not recommend that a long only manager take this attitude!). And secondly that Hedge Funds will not be the strange "Alternative" group that people seem to think that they are today. In time they will become the norm. This - he reasons - is because Hedge Funds are essentially unquantifiable. They are merely pursuing an infinite number of different holding/trading/sectoral strategies unconstrained by the investment mandates of the long only world. However over time the long only world must die out by the very fact that there will always be a competing number of hedge funds to each long only fund that are not constrained and should therefore generate better returns. Lastly he critques the paradigm of the efficient market and suggests that we would be better off watching our liquidity levels and modelling them rather than running too many mathematical models based on this premise.
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Wednesday, May 23
A Demon of Our Own Design - R Bookstaber
by
Sean Sprackling
on Wed 23 May 2007 17:10 BST
OTC Derivative Volumes hit $415 trillion - June 2006
by
Sean Sprackling
on Wed 23 May 2007 13:23 BST
The figures for end June 2006 from the BIS (Bank for International Settlement) are out and show continued (though slowing) growth for OTC derivative amounts outstanding - hitting a frightening $415 trillion dollars. Details are below:
I have not really had a chance to dissect the figures yet but the things that really leapt out at me were: - A huge 24% jump in Interest Rate contracts - A rise in Equity linked contracts of 17% - Falling growth in Commodity contracts from 27% to 17% - Another huge rise in CDS of 43% From the buy-side's perspective I do not think there is much to shock here. Clearly most of the volumes are still sell-side driven, but growth is starting to come from buy-side initiatives like LDI (and thus the use of both IRS and CDS contracts) as well the increasing fear of Equity volatility that seems to be driving people towards Equity Derivatives. As Anthony Bolton noted lately, equities have been touching record highs on both sides of the Atlantic and investors are looking to lock in these prices by using simple stock/index options or (increasingly) by more exotic items such as variance swaps that are capable of isolating volatility (Buying a variance swap is like being long volatility at a pre-agreed level). The only concern would therefore be that, although the industry as a whole appears to have sorted the confirmation backlog for CDS by automation, the rest of the asset classes are lagging behind and represent significant systemic risk. I suspect that, as happened in 2005, the Fed and the FSA will soon jump in and start demanding action. For Buy Side firms the volumes traded may not be significant (yet) - however I continue to advise my clients that putting the correct tools in place now (such as DerivServ, Swapswire, BClear etc) will save a great deal of pain in the years to come as OTC derivatives become a hygiene factor rather than an exotic sideshow. DerivServ and Swapswire are already starting to battle it out for hegemony in the equity derivative sphere, and new services such as those provided by Euronext are likely to be joined by others entering the fray. I often am asked to speak at conferences on the topic of post trade servicing of OTC derivatives and am constantly amazed at the lack of knowledge in the investment management world of the issues involved and (more importantly) the automation options open to participants. The sooner we automate these processes the sooner we can get on with the really interest stuff.... |
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