"We risk becoming the best informed society that has ever died of ignorance"
- Rubén Blades

"You can't make up anything anymore. The world itself is a satire. All you're doing is recording it"
- Art Buchwald

"It's getting exciting now, two and one-half. Think of everything we've accomplished, man. Out these windows, we will view the collapse of financial history. One step closer to economic equilibrium"
- Tyler Durden

"It is your corrupt we claim. It is your evil that will be sought by us. With every breath, we shall hunt them down."
- Boondock Saints

Monday, November 25, 2013

Wall Street Ethics

The Guardian has put a great write up on on man's view (corroborated by other documents such as Den of Thieves, The Joris Luyenidijk Bankers Blog, any of the recent blatant scandals we've heard about from the core of the financial industry, and more) regarding long ingrained corruption on the street. 

Most of it isn't new regarding money made, how it worked inside banks, how unethical behavior was expected but it serves as a great reminder as we progress through the current state of affairs in the market.  I'm posting this piece here so I have it for easy future reference but also because I wanted to give you guys this intro and ask you check other posts I have here.  Consider the corruption in place, either intentionally or unintentionally created, that is highlighted daily in our financial markets.  

Our current structure, though argued is to a sole net benefit, offers easy ways for nefarious, unethical people to manipulate our assets to their benefit.  Whether you're a trader or investor, we all have money at the line at some point.  The impression was that Wall Street was for the public good.  The citizens would put up capital to cover the banks costs to bring a firm public.  

The banks initial investment, later recuperated or expanded upon if the secondary offering did well, helps spur a business that produced products to help grow the "economy" and expand our standard of living.  Now we have for profit exchanges that have inserted themselves into this flow that now cater to those with deep pockets, and ability to make markets, and also provide execution for third parties helping to bring in more "flow".  This process that was originally designed to our national benefit is now being structured to help "volume producers" sub-penny retail order flow and take advantage of our lesser informed citizens.  We owe to step back and objectively analyze what we have evolved our secondary offer market system into.  

This isn't only happening in common equity markets either.  Aside from infrastructure manipulation, we have currency manipulation, LIBOR fixing manipulation, and commingled client fund manipulation to name a few.  No one wants to jump the gun ahead of time and call bullshit lest they ruin the good time everyone is having but after things go tits up, every scrambles to follow those people or think they way they do (think Roubini, Taleb, Schiff, Shiller, Black & Scholes, etc).  The Department of Defense believes we have the potential now to see some sort of terroristic event in our marketplace, through means of some shell brokerage that might take advantage of the micro-structure to unleash financial warfare and cripple our sovereign financial system.

So consider that when you read this.

My first year on Wall Street, 1993, I was paid 14 times more than I earned the prior year and three times more than my father's best year. For that money, I helped my company create financial products that were disguised to look simple, but which required complex math to properly understand. That first year I was roundly applauded by my bosses, who told me I was clever, and to my surprise they gave me $20,000 bonus beyond my salary.

The products were sold to many investors, many who didn’t fully understand what they were buying, most of them what we called “clueless Japanese.” The profits to my company were huge – hundreds of millions of dollars huge. The main product that made my firm great money for close to five years was was called, in typically dense finance jargon, a YIF, or a Yield Indexed Forward.

Eventually, investors got wise, realizing what they had bought was complex, loaded with hidden leverage, and became most dangerous during moments of distress.

I never did meet the buyers; that was someone else's job. I stayed behind the spreadsheets. My job was to try to extract as much value as possible through math and clever trading. Japan would send us faxes of documents from our competitors. Many were selling far weirder products and doing it in far larger volume than we were. The conversation with our Japanese customers would end with them urging us on: “We can’t fall behind.”

When I did ask, rather naively, if this was all kosher, I would be assured multiple times that multiple lawyers and multiple managers had approved the sales.

One senior trader, consoling me late at night, reminded me, “You are playing in the big leagues now. If a customer wants a red suit, you sell them a red suit. If that customer is Japanese, you charge him twice what it costs.”

I rationalized that our group was careful by Wall Street standards, trying to stay close to the letter of the law. We tried to abide by an unwritten "five-point rule": never intentionally make more than five percentage points of profit from a customer.

Some competitors didn’t care about the rule. They were making 7% or 10% profit per trade from clients, selling exotic products loaded with hidden traps. I assumed they would eventually face legal charges, or at least public embarrassment, for pushing so clearly away from the spirit of the law.

They didn’t. Rather, they got paid better, were lauded as true risk takers, and offered big pay packages to manage similar businesses.

Being paid very well also helped ease any of my concerns. Feeling guilty, kid? Here take a big check. I was, for the first time in my life, feeling valued for my math skills – the ones I had to hide throughout my childhood, so as not be labeled a nerd or egghead. Ego and money are nice salves for any potential feeling of guilt.

After a few years on Wall Street it was clear to me: you could make money by gaming anyone and everything. The more clever you were, the more ingenious your ability to exploit a flaw in a law or regulation, the more lauded and celebrated you became.

Nobody seemed to be getting called out. No move was too audacious. It was like driving past the speed limit at 79 MPH, and watching others pass by at 100, or 110, and never seeing anyone pulled over.

Wall Street did nod and wave politely to regulators’ attempts to slow things down. Every employee had to complete a yearly compliance training, where he was updated on things like money laundering, collusion, insider trading, and selling our customers only financial products that were suitable to them.

By the early 2000s that compliance training had descended into a once-a-year farce, designed to literally just check a box. It became a one-hour lecture held in a massive hall. Everyone had to go once, listen to the rushed presentation, and then sign a form. You could look down at the audience and see row after row of blue buttoned shirts playing on their Blackberries. I reached new highs on Brick Breaker one year during compliance training. My compliance education that year was still complete.

By 2007 the idea of ethics education fell even further. You didn't even need to show up to a lecture hall; you just had to log on to an online course. It was one hour of slides that you worked through, blindly pushing the “forward” button while your attention was somewhere else. Some managers, too busy for such nonsense, even paid younger employees to sit at their computers and do it for them.

As Wall Street grew, fueled by that unchecked culture of risk taking, traders got more and more audacious, and corruption became more and more diffused through the system. By 2006 you could open up almost any major business, look at its inside workings, and find some wrongdoing.

After the crash of 2008, regulators finally did exactly that. What has resulted is a wave of scandals with odd names; LIBOR fixing, FX collusion, ISDA Fix.

To outsiders they sound like complex acronyms that occupy the darkest corners of Wall Street, easily dismissed as anomalies. They are not. LIBOR, FX, ISDA Fix are at the very center of finance, part of the daily flow of trillions of dollars. The scandals are scarily close to what some on Wall Street believe is standard business practice, a matter of shades of grey.

I imagine the people who are named in the scandals are genuinely confused as to why they are being singled out. They were just doing what almost everyone else was, maybe just more aggressive, more reckless. They were doing what they had been trained to do: bending the rules, pushing as far as they could to beat competitors. They had been applauded in the past for their aggressive risk taking, no doubt. Now they are just whipping boys.

That's the paradox at the core of the settlements we're seeing: where is the real responsibility? Others were doing it, yes. Banks should be fined, yes. But somebody should be charged. Yet the people who really should be held accountable have not. They are the bosses, the managers and CEOs of the businesses. They set the standard, they shaped the culture. The Chuck Princes, Dick Fulds, and Fred Goodwins of the world. They happily shepherded and profited from a Wall Street that spun out of control.

A precedent needs to be set, to slow down Wall Street’s wild behavior. A reminder that rules are there to be followed, not exploited. The managers knew what was going on. Ask anyone who works at a bank and they will tell you that.

The excuse we have long accepted is ignorance: that these leaders couldn't have known what was happening. That doesn't suffice. If they didn't know, it's an even larger sin.