Re: Wall Street's complexity
A reader sends in this story:
Back when I was in law school (30 years ago, oy!), a group of friends and I started playing a regular poker game. Over the years, most of us stayed in the area. We've drifted apart some, but we still get together a few times per year and play. Also, over the years, many of us have advanced in our profession, to the point where we at least know some Very Important People.
In 2008, we had a game that was right after the first cracks in the financial system started to show (it was summertime or fall I think, perhaps after the first failure?) and one of the guys told an interesting story. It went like this (the guy who told it to me knew the players personally, and he told it first-hand).
One of the firms they did business with was a financial firm. One Friday they were offered a major deal on some derivative deal, and were told that they had to decide whether to purchase or not by Monday. The head of this financial firm said, "We'll consider it, but you have to send over every last bit of documentation." They did -- it was a rather large stack of documents. Then this firm turned to one of their resident geniuses (one of those guys who writes a financial industry newsletter that other firms pay a lot to subscribe to) and told him to read it over the weekend, and make a recommendation on the following Monday.
Monday rolls around, and this genius comes in to the head honcho all apologetic. He says that he can't make any recommendation, that he (the genius) spent his entire weekend going over the documentation, and the structure of the deal was so complex that he couldn't figure it out, and there was no way to assess the risk involved. The head honcho decides: if our genius can't understand it, we're not going to touch it. They turned the deal down.
My poker playing friend, a member in this firm, told us: This is the tip of the iceberg. You ain't seen nothing yet, all hell was going to break loose.
By
Ezra Klein
|
April 21, 2010; 3:32 PM ET
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Posted by: luko | April 21, 2010 4:33 PM | Report abuse
If the poker-playing friend would have made 3% on the sale, it would have gone through.
Posted by: AZProgressive | April 21, 2010 5:57 PM | Report abuse
He says that he can't make any recommendation, that he (the genius) spent his entire weekend going over the documentation, and the structure of the deal was so complex that he couldn't figure it out,
Ezra,
the same can be said of the tax code.
And CMS regulations.
And just about everything else government touches.
glad to see you're for smaller, simpler, less intrusive government!
Posted by: visionbrkr | April 21, 2010 6:40 PM | Report abuse
This reminds me of the story of Warren Buffett who said that he didn't invest in Enron because he couldn't understand their business model as outlined in the SEC filings.
*glad to see you're for smaller, simpler, less intrusive government!*
Yeah, how'd that work out, 2001-2009? You got all you wanted-- tax cuts and deregulation galore. Gutting of federal agencies and a decimation of the resident experts so that government would be less "intrusive." Turns out that when you do that, things go south in a big way.
Posted by: constans | April 21, 2010 7:06 PM | Report abuse
If a company can't explain its product to you the chances are very high it is a scam. If the product can't be explained to an expert, the odds are probably 99% in favor of scam. The thing I can't understand is why anyone could be stupid enough to fall for these scams. And the infuriating thing is that we bailed out a bunch of the stupid companies and stupid high-paid employees that lost all their money in a shell game.
Posted by: AuthorEditor | April 21, 2010 7:18 PM | Report abuse
Interesting anecdote. There's actually a good deal of research to back this up. It turns out that figuring out the structure of some of these types of deals is literally too hard for anyone to do. The computational complexity involved is actually beyond the scope of what is achievable, regardless of how powerful/smart computers or people get.
Here's more info, from the people who actually know.
http://www.freedom-to-tinker.com/blog/appel/intractability-financial-derivatives
Posted by: GovtSkeptic | April 21, 2010 11:09 PM | Report abuse
The thing that's amazing is this claim that that firms are so heavily invested in things that they don't understand. It sounds too fantastical to be true; it sounds like an over-simplification, or a pathetic exaggeration . . . and that's what I would have thought, too, if I didn't hear such stories myself.
I think that this "too complex to understand" idea is an underappreciated and/or underestimated (and certainly under reported) factor in this whole mess.
Posted by: ADCWonk | April 22, 2010 12:07 AM | Report abuse
Hmph. The genius could have been spared a weekend of headscratching if his boss had just responded properly to the phrase "...they had to decide whether to purchase or not by Monday."
Smells of Honest Ed's Used Cars, to me.
Noni
Posted by: NoniMausa | April 22, 2010 12:42 AM | Report abuse
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I think there will be a lot of war stories like this come out. There was some crazy sh*t going on in the industry towards the end there. I got a couple myself. What does that mean for the future? I think we tend to forget that sure as the sun rises, some guy in a suit is going to try to sell us on a deal that's too good to be true and we gotta remember to run the other direction.
Why these charlatans get to have implicit guarantees and FDIC insurance, though, is really beyond my pay grade.