Masters of the Universe, by Richard Lee

masters of the universe

Traders as Masters of the Universe – Comic Fantasy with Real Money?

I went straight from the military (served 6 years, 2 months and 15 days) to business school.  Turned in my dog tags and flak vest on Friday and was sitting in a quantitative analysis lecture on Monday.  So imagine the culture shock when my peers and professors started discussing CDOsmarket neutral hedging strategies, velocity of money, traders being the masters of the universe, etc…  After the initial WTF wore off, I recall thinking (despite my lack of market know-how) –

  • Collateralized debt obligations – if the underlying assets themselves are toxic, e.g. bad real-estate loan portfolio, how can re-packaging them into different segments and formats then selling them to third parties increase the inherent value of the asset?  Spread the risk maybe, but increase the value?
  • Market neutral trading strategies – if your risk is completely hedged (if there is such a thing in the first place) through buying and selling call and put options and other hedging instruments depending on the position you’ve taken in the market, how is it possible to come out on the top under any scenario?

Obviously we now know the CDO’s role in the United States real-estate collapse…   The recent debacle at JPMorgan illustrates how sometimes you can be too smart for your own good.  Simply put, JPM’s trader nicknamed “London Whale” sold too many CDS or credit default swaps, designed to hedge against a downturn when JPM thought European bank funding worries eased.  But when regional bond defaults flared up again, JPM’s position was so big that it could not unwind fast enough, resulting in 2BN+ losses so far.

Heads are rolling already at JPM – at least three senior officers are either resigning or retiring.  JPM’s defiant CEO Jamie Dimon stated that while the trades themselves did not violate the Volcker rule (designed to limit banks’ risk taking), it did violate Dimon principle.  I don’t get it…  Just what the heck is this Dimon principle?  Don’t let complex risk run wild and deny any potential for error until it was too late?  One thing is for sure, while its board is closing ranks to protect Dimon, JPM and its leadership will have rough time at the next shareholders meeting, and will face further scrutiny from the proponents of Dodd-Frank financial overhaul at the Capitol Hill (by the way, Senator Levin gives me nightmares – looks too much like my high school math teacher with his nose-tip spectacles and all).

Please don’t get me wrong – this post is not meant to endorse government regulations introduced since the near-death experience of our financial market back in ’08.  Being a free market economist at heart, I do believe less is more when it comes to government interventions.  Having said that, reading the details of complex web of trades tied to corporate debt at the center of JPM’s debacle made my head spin…   The current mess has yet again proved that the biggest dangers in finance are arrogance, group think and self-deception.  Masters of the Universe?  Please…   In case you were feeling sorry for Ina Drew who used to run JPM’s Chief Investment Office, I think she’ll be just fine having earned ~30MM in the past 2 years and ~15MM in additional equity awards due upon her departure.   She survived LTCM, she will survive JPM and resurface somewhere else.

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From Associated Press:

Dimon wins votes on pay, chairmanship

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About Richard Lee
Experienced finance and operations professional. Currently partner in five companies, adjunct professor of economics at Columbia College and executive contributor to a small business blog (www.SMBmatters.com); following corporate finance, M&A and management consulting tenures with Orbitz and Diamond Technology Partners; and six years of service with the United States Army.

One Response to Masters of the Universe, by Richard Lee

  1. Pingback: Masters of the Universe #2 – Volcker : They Shouldn’t Be a Bank… « SMB Matters – Small and Mid-Sized Business Blog

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