Traders, Guns & Money

Title: Traders, Guns & Money
Author: Satayajit Das
Year:2006
Publisher: Prentice-Hall
ISBN: 0 -273-70474-5

Summary

This book deals chiefly with financial derivatives. Derivatives offer an excellent possibility to cause massive financial damage is misused, and this book offers a smorgasbord of examples in which this indeed happened. It reads a little bit like a gossip magazine at times, only in this case, the main subjects are not celebrities, but derivatives traders - not nearly as well-known, but often at least as rich as celebrities. Furthermore, the book is essentially a list of anecdotes with little structure - probably a good thing, as the theory behind finance isn't nearly as exciting as the colossal blowups.

Prologue

In the prologue, the author describes how an Indonesian noodle maker is obliterated by a bad derivatives trade. Both the selfish greed of the bankers that set up the trade (and receive a 30% slice in their personal bank accounts), and the profound stupidity of the noodle makers for agreeing to a transaction they didn't understand are spelled out.

Financial WMDs - derivatives demagoguery

This chapter starts with different opinions about derivatives - necessary or evil? and then with an explanation about what derivatives (in particular options) are, which is rather good. He then goes about to explain the quaint concept of basis risk, and explains some swaps. Of course, all the ways to screw this up are described in vivid detail.

Beautiful lies - the sell side

This chapter deals with the sell side, which are the banks making derivative structures to provide to investors, often pension funds, insurance companies and other banks. The important role of alcohol and more carnal pleasures in securing the deal are detailed. The investment advise seems sound: if there are investors near limousines in an "interesting" investment opportunity, you are too late. Apart from the entertainment, the cleverness of the sell side is painted.

True lies - the buy side

In this chapter, the buy side is described. Given that most of us, as private investors, are part of the buy side, it's an interesting chapter, especially given that the different flavors in which you can get ripped off are detailed. The bottom line is that trading and derivatives are an excellent ways of parting fools with their money.

Show me the money - Greed lost and regained

This chapter is essentially a collection of anecdotes about trading in general, and some spectacular blowups in particular. Good reading, but not the most interesting part of the book.

The perfect storm - risk management by the numbers

The abject failure of risk management in banks and hedge funds is explained using the example of Long-Term Captial Management, a famous hedge fund that blew up in 1998. The basic reasons why risk management is done wrong, and if done right, misunderstood are explained well. I'd like to add the personal observation that if a person is canny enough to be a good risk manager, he/she would also be canny enough to be a good trader or quant and make roughly 4 times more. I

Super models - derivative algorithms

This chapter is about quants - quantitative analysts. Quantitative analysts are supposed to be smart people, usually with a PhD, typically in physics. They apply exact methods to the not always very exact world of trading. Furthermore, geeky academicians and jock traders create an... interesting atmosphere which is caught well in the book, although it must be said that as trading is getting more professional, the traders are becoming more geeky themselves. The Black-Scholes formula, the heart of modern derivatives trading, is explained, but this is done rather poorly. The principle of delta hedging is explained rather well.

Games without frontiers - the inverse world of structured products

A Structured product is a financial construction - a contract, really - with a non-standard payoff. In practice, this can mean that anything is possible, up to a bond that pays interest based on the amount of rain days (useful for hedging the price of frozen concentrated orange juice-duh!). It starts with a discussion of the blowup of Orange County in Florida by the stunning mismanagement of its treasurer. Furthermore, the interesting antics of the Japanese yen and its zero percent interest are discussed, especially how people lost money on it. The structures are described in detail, but again, I find the explanation a bit hard to follow.

Share and share alike - derivative inequity

The wonderful practice of dividend stripping using options is explained, along with some other very interesting ways of dodging government rules using options. This is a pretty solid chapter for a professional, because these types of arbitrage can still be done.

Credit where credit is due - fun with CDS and CDO

This is a very impressive chapter in the sense that it accurately describes the danger the credit market is in just before the whole thing came crashing down. It makes it quite clear what the huge risks were that banks and in particular insurers took. These risks lead to the current credit crisis and the bailout of Freddie Mac, Fannie Mae and AIG.

Epilogue

The fate of the Indonesian noodle maker is revealed. This story is the only story that continues through the whole book.

Opinion

For the average hobby investor the book is probably interesting, if at times a bit technical. You can skip over the parts where the more... creative derivatives are discussed and still enjoy the book, though. The descriptions are not particularly illuminating, although Google should be able to fix that. Especially a beginning professional can pick up some useful ideas and concepts from this book. While there are no really concrete money - making ideas in it, a good grasp of the principles can help in avoiding problems - learning from other people's mistakes is better and certainly cheaper than learning from your own.

This is an account of the experiences of the author in investment banking, an industry that is partly glamour and mostly drudgery and an intensifier of some of the least admirable vices - greed, bombast and dishonesty.

IB has many segments but its core is the securing, and/or manipulation of large sums of money (or representations thereof). This is known as the sell side. The other side is asset management and trading - the buy side. The author worked on both sides sequentially, and so writes from a place of knowledge and experience. He also worked in the 80s when structured products and derivatives were becoming mainstream; the 90s when they wrecked prestigious firms in the West and entire regions elsewhere; and the 2000s when the chickens came home to roost and the subprime crisis led to the issues of 2008. While the book talks briefly about all these eras, it focuses mostly on structured finance and derivatives, which is both a strength and a weakness.

The strength is that his knowledge of structured finance means he could talk at some length about its evolution, its use, and misuse.

The weakness is that when one is reading about technical stuff, the incomprehensible descriptions and diagrams all eventually meld into the same eye glaze inducing block of text that is read multiple times without being understood. There was a time, about 10 years ago, when I understood the things (in theory). I could price options (which are not available in my country), design swaps (which are only useful for really big and rich companies who preferred to use foreign IBs), and could avidly discuss derivatives. It was a time when I read the self-congratulatory hagiographies of the top banks and knew who their CEOs were. Being that money is a global deity, IBs are among its temples and their CEOs are high priests. Now, I just can't be bothered. Another weakness is that IB is much more than structured finance, and even though the book did not make such a claim, its dim view of that segment of the industry could tar the rest of it.

The book is written in a cynical tone, which is understandable for anyone who has worked in the industry regardless of whether the person was a success or not. It doesn't seem the author was a star. Objectively, that's not much of a failing. Except that, despicable as investment bankers often are, the high esteem in which the industry is held and the high entry requirements can make it seem that success in it makes the person equal to the best in a society. The cynical tone presents many structured products (the work of the core investment bankers - the sell siders) as little more than elaborate scams designed to fleece clients, I thought that was an extreme view, despite structured products being the cause of 2008 financial crisis and many previous ones as well as massive losses. However, it's like the saying - guns don't kill people, someone has to use the gun to do so. Thus with structured products, their use or misuse (based on slick marketing by the banker) cause losses, but on their own, they are just tools. The book also presented the trading activities (the buy side focus), especially if done for the firm's own account, known as proprietary trading; as little more than gambling. I agree with that view. I once attended a training program on pricing and trading derivatives when it seemed like the regulators would allow their introduction. The trainer was a trader from the Intercontinental Exchange (better known by its cool acronym - ICE) who kept talking about placing a bet on global shipping rates even though the bettor had neither ships nor goods to ship. I piped up and said this is gambling, he tried hard to prove that it wasn't; I think his explanations brought a few people to my view.

I think the title of the book was misleading. While it talked at length about traders and money, there was precious little about guns in it other than a few references to Donald Rumsfeld whose closest connection to guns was being US Secretary of Defense (or maybe his being American and republican, and thus probably a gun nut), and to some nameless traders who allegedly had combat experience. Alternatively, since investment bankers have a high opinion of themselves, they might think their MS Excel models and PowerPoint presentations are guns.

This book is not recommended because while interesting in some parts, it had too much information which was too technical to be interesting. It was also too cynical. The only people that might want to read it are younger versions of me, because they would find the cynicism amusing and talking about the technical stuff among peers might create the impression that one is smart.