Thursday, May 29, 2008

Bearish on Risk Taking...

...or, "The Socialization of Capitalism, continued."

Anyone who’s ever been quoted by any of what we used to call “the media” quickly learns that the way one's words are perceived is mostly a function of context (or more correctly, the absence or distortion of it), in so many cases.

With a respectful acknowledgement of that fact, I print here a quote from the Bloomberg News website of one Charles Geisst, professor of Finance at Manhattan College. Well, out of deference to context, let me cite a few lines from the article:

The risk-taking culture that Bear Stearns represented is probably now gone for good, said Charles Geisst, a finance professor at Manhattan College in New York and author of ``100 Years on Wall Street.''

"Hopefully the surviving firms will manage their risks better and won't leave it to individual traders," he said. "As they sink into the sunset, as I suspect they will, that model they embody will as well."

Now I’m going to take issue with Mr. Geisst’s sentiments, as I read them in the context of the article (or absence or distortion thereof).

Mr. Geisst doesn’t approve of “the risk-taking culture” of Bear Stearns, which is legendary in the industry. He advocates that firms will eliminate “individual traders” from the risk management process, in favor of some “model” that is unspecified, but is suggested by the context to be a “risk czar” – either human or machine – that holds veto over any trade or position. This is an aggregated, top-down, if you will, socialistic, and flawed model. But it was aggregated risk-management algorithms that were at the very heart of the models of the structured securities that blew up in Bear's face.

As the author of a book entitled “100 Years on Wall Street” (which sounds like a good read), he ought to know that both individuals and risk-taking on Wall Street, are Wall Street. At least, they were, until the cash cow got so big that the institutional, mechanized approach to management began to take over, finally asserting itself into trading rooms.

In the recent Wall Street Journal series about the Bear disintegration (recommended), we read – not surprisingly – that it was three individual traders – including the legendary Wall Street individual trader and risk-taker Mr. Ace Greenberg – who insisted that Bear cut its risk in mortgages by hedging and liquidating prudently.

But it was the bureaucrats – the managers and executives -- who advocated what in hindsight appears to be the classic “don’t do anything until it’s too late” approach; acting like deer in the headlights of a bad trade until someone came along from outside and took control of the situation far too late to be of any benefit whatsoever to the Bear Stearns that was built (into the 5th largest securities firm in the US and an acknowledged innovator) by individuals who were risk takers.

Mr. Geisst's prescription for the aversion of (an isolated episode of) bad risk management is to replace risk-takers with some...entity, the nature of which cannot be reduced to specifics but must certainly be better than 86 years of Bear Stearns' home runs followed by one very mismanaged portfolio event. Manage risk by replacing traders means, not taking risk. A bearish stance on reality, indeed.

I rather hope for the opposite of what Mr. Geisst hopes for, and presumably inculcates into his students: I hope for individuals who know how to take risks – and in case the reader doesn’t know, on Wall Street – the one that was built by individual risk-takers – “taking risk” implies “laying off risk.” Every individual trader who lives long enough to be Mr. Greenberg’s age has learned that lesson at the beginning of his career.

I counter sentiments from the Ivory Tower with observations from the street, in my favorite way, by pointing out what is obvious: it took a trader to see a trade-gone-bad and insist on the risk-managing course of action. Had the Ace trader been closer to the action all along, I'd wager the decline of Bear Stearns would be as nearly unthinkable now as it was a mere week or two before it did.

The further away the risk manager is from the trade – the further away the trader is from the trade – the less skin he has in the game, the less effective his judgment of the trade will be. Now, every trader knows that an objective opinion is an edge in risk management. All big-money-machines need to managed. Even Alex Rodriguez – an individual and a risk taker – needs to be managed. But once he’s in the box, it’s his game, not his manager's. Accountability is not being denigrated here. The denigration of individuals, risk-takers, and specifically of individual risk-takers is.

Perhaps Mr. Geisst would prefer that individual batters “sink into the sunset,” as well. The effect on baseball will about on par with the socialization of capitalism that the removal of individual risk takers will naturally (and has naturally) cause(d) in the marketplace. It will flatten it.

Even as Wall Street is converted into condominiums right before our eyes, as the industry is hard-coded into black boxes and outsourced, I say, "No. Bring back the individual. Bring back the risk taker. Or lose the crowning jewel of America: the heart of capitalism."


It wasn't PsD's that brought down Bear. PhD's, maybe.

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