When Satyajit Das introduced trainees to his colleagues in the bank, this is how he described them: “There are salespeople—they lie to clients. Traders lie to sales and to risk managers. Risk managers? They lie to the people who run the place—correction, think they run the place. The people who run the place lie to shareholders and regulators.” That little citadel of mendacity is the world of derivatives trading, excellently caricatured by Das in Traders, Guns and Money, a rambunctious romp through dealing rooms.
In the zero-sum world of derivatives dealing, the only skill that counts is the ability to con your client, fool your boss, trample over your competitors, and bamboozle your clients. Das has been in the derivatives business for the past 25 years and he knows every nook and cranny of that world. He rips the mask off all the sanctimonious claptrap about risk diversification, quantitative models and financial engineering to expose what lies beneath—naked greed.
Traders, Guns and Money: Pearson Power, 334 pages, Rs399.
At one level, this is a book of spicy stories, gathered over decades of first-hand experience in derivatives. The anecdotes range from that of a Japanese pension fund manger who liked long-legged, blue-eyed, blonde women to the sexist jokes of the dealing room—“She’s as good as a guy; she can piss standing up”—to a Korean who didn’t know English and who was the most popular guy among a group attending a seminar on derivatives, thanks to his ability to drink all night.
But while these are entertaining enough, there’s an entirely different side to the book. The reader is led, through the eyes of an insider in the business, into the birth and development of the fascinating world of derivatives. Das starts with the early years, when swaps and options were the hot new things, and he describes the evolution of risk management from the early asset liability management committees (Alcos) to statistical techniques such as Value at Risk before going on to “structured products” and to the current alphabet soup of CDO, CLO, CDS, and so on. Here too, anecdotes abound, such as that of the Alco at his bank, which was known for betting on interest rates and was hence affectionately called Puntco.
But the anecdotes are incidental. Das also takes his readers down a tour of recent financial history. The celebrated disasters of Orange County in California, which lost more than $1.5 billion (about Rs5,000 crore then) in derivatives trading in structured products, the catastrophe of Long-Term Capital Management, the derivatives firm run by Nobel laureates that had to be rescued by the US Federal Reserve, the bizarre world of Japanese zaiteku or financial engineering, and numerous lesser fiascos are chronicled here. Did you know, for instance, that when General Motors (GM) debt was downgraded to junk, it was suddenly found that the volume of credit default swaps outstanding on GM was around four times the value of the underlying GM debt?
Market graph: Das explains why defaults increased when the US slipped into recession in 2001.
And just in case all this talk of swaps and interest rate arbitrage and collateralized debt obligations is way above your head, Das obligingly explains every single detail in plain English. He demystifies financial products and debunks financial jargon, pointing out time and again how weird some of the so-called structured products are and how their sole aim is to generate fees and bonuses for their creators. In fact, this book, despite its sly swipe at the culture of derivatives trading, could easily have been called “A dummy’s guide to derivatives”. Don’t forget that Das is the author of a number of standard reference books on the subject.
Also, in spite of its breezy tour guide attitude to its subject, this is actually a very serious book. Das points out, for example, what happened to collateralized debt obligations when the recession of 2001 set in.
Writes Das, “Defaults increased sharply as the US slipped into recession and creative accounting compounded the losses.” He also says that “CDO litigation reached pandemic status”. With a recession casting its shadow over the US economy, the probability of a recurrence of that carnage in today’s derivatives markets is very real.
I recently caught up with Das when he came to Mumbai from Sydney, where he is based. Wasn’t it true, I asked him, that derivatives reduced risks by diversifying them and spreading them out among a multitude of investors, each matching his investment to his risk profile, as we had been taught by our professors?” Das laughed out loud. “Only the regulators believe that,” he said.