The Devil’s Dictionary of Post-Crisis Finance

October 9, 2015

The author is a Reuters Breakingviews guest columnist. The opinions expressed are his own.

American writer Ambrose Bierce published “The Devil’s Dictionary” in 1911. Bierce’s acerbic definitions ranged from government to commerce and life in general. He displayed a profound understanding of finance, for example defining “riches” as “the savings of many in the hands of one”.

Breakingviews published a pioneering appropriation of his form in 2007, when the global financial crisis was barely beginning. Call it “The Original Devil’s Dictionary of Finance”. But it no longer seems adequate for the post-crisis task. Herewith part one – for the letters A to K – of the sequel, updated and enlarged for the world of hedge funds, private equity, structured finance, subprime equity and the like: “The Devil’s Dictionary of Post-Crisis Finance.”

Part two will be published next week.

A

Activist: One who makes importunate demands for financial engineering*.

Alpha: An investment return above that of a benchmark index, usually achieved by luck or by “gaming” the index.

Analyst: A stock puffer whose purpose is to generate brokerage commissions. See Chinese walls.

Arbitrage: The time-consuming and risky activity of buying an underpriced asset whilst simultaneously selling an equivalent overpriced asset. Eschewed by Wall Street, which instead profits from regulatory arbitrage, accounting arbitrage, jurisdictional arbitrage and fiscal arbitrage.

Asset price bubble: The most noticeable consequence of the U.S. Federal Reserve’s easy money policy. See ZIRP.

Auction house: A place where Wall Street high-flyers blow their windfall gains. See Contemporary art.

Austerity: Also known as “sado-fiscalism”. A forlorn attempt to stave off government bankruptcy.

B

Bandwagon: That which every investor jumps upon. “If you see a bandwagon, it’s too late.” (James Goldsmith, financier.)

Bank: An institution which, by applying leverage and mismatching assets and liabilities, earns short-term profit and generates long run losses.

Bankrupt: A person who has run out of liquidity. Also, the intellectual state of modern economics.

Basel: The Swiss home of the Bank for International Settlements, an institution which creates global banking rules thus setting the stage for regulatory arbitrage and, thereby, precipitating crises at regular intervals.

Behavioural finance: The field of study resting on the notion that an asset price bubble is the result of “irrational exuberance” (see Greenspan*) rather than the inevitable consequence of bad monetary policy and conflicts of interest on Wall Street.

Bell curve: A visual representation of the false assumption, baked into most financial models, that outcomes are what statisticians call “normally distributed”.

Bernanke, Ben: Former Fed chairman who failed to spot the housing bubble before it burst and in 2007 claimed that U.S. subprime mortgage problems were “contained”. After the Lehman Brothers bust, Bernanke succeeded in re-inflating the Greenspan* superbubble. Soon after leaving the Fed, he was rewarded with a job at Citadel, a hedge fund, which presumably didn’t hire Bernanke for his market insights. See Revolving door.

Biotech: A pharmaceutical Ponzi scheme of a company. See Burn rate.

Bitcoin: A digital tulip bulb.

Black swan: A common bird on Wall Street, renowned for its fat tail.

Bonus: In banks, a large payment out of short-term profit to retain “talent”. While a bank’s profit is generally illusory, bonuses endure.

BRIC: A “Bloody Ridiculous Investment Concept” (Peter Tasker, fund manager and author). An emerging bull market acronym comprising the first letters of Brazil, Russia, India and China coined by Jim O’Neill, a former member of theGoldman Sachs marketing department.

Burn rate: The alarming pace at which technology and biotechnology companies run through their cash piles.

Business school: Networking hotspot where young people pay large sums of money to have their scruples expensively removed. See MBA.

Buybacks: Debt-funded purchases of a company’s own shares in order to enhance growth in earnings per share. A tool to maximize the value of a chief executive’s stock options.

C

Capex: The splurging of shareholder funds on the latest investment fad (see Mine). Sensible CEOs prefer financial engineering*.

Capital controls: A futile attempt to evade the global carry trade. Chinese capital controls are circumvented through gaming in Macau, faking exports, offshore borrowing and the age-old expedient of carrying suitcases of cash abroad.

Capital flight: The last act of the global carry trade. Currently under way in China.

Career risk: The near inevitability that a fund manager will be sacked if he or she refuses to participate in an asset price bubble or exhibits more than a hint of tracking error.

Carried interest: The “performance” fee extracted by private equity firms for leveraging assets. Proposals to remove the advantageous tax rate on carried interest were compared by Stephen Schwarzman, co-founder of private equity firm Blackstone, to the Nazi invasion of Poland.

Carve-out: A seemingly profitable Chinese business freshly separated from a larger loss-making state-owned enterprise, which retains control, in preparation for an initial public offering.

Chief executive officer: A corporate boss who extracts any surplus value created by the business he or she runs for his or her own benefit. SeeShareholder value.

China: Since GDP growth started slowing, a country suffering from 3,000 years of bureaucratic despotism and corruption.

China dream: The age-old business vision of selling a toothbrush to everyone in China. Until recently, a useful way of pushing stocks. Now Wall Street’s worst nightmare.

Chinese credit guarantees: The provision of credit insurance, unregulated and without adequate reserves, which supports China’s non-bank, or shadow, financial system.

Chinese economic growth: “Unstable, unbalanced, uncoordinated, and unsustainable” (Wen Jiabao, Chinese premier, in 2007).

Chinese GDP: A “man-made” figure (Li Keqiang, future Chinese premier, in 2007).

Chinese infrastructure: The construction of bridges to nowhere, ghost cities and the like, which has driven recent economic growth. “In China you don’t rob a bank, you rob infrastructure” (Minxin Pei, expert on Chinese corruption).

Chinese public debt: Beijing’s vastly understated liabilities, which are mostly hidden off balance sheet – in local government funding vehicles, asset-management companies, policy banks, and so forth.

Chinese real estate: Jerry-built apartment buildings standing empty on the outskirts of second-tier cities and providing the collateral for China’s broken credit system.

Client: See Muppet.

Commodity supercycle: A term coined in 2004 so that investment banks could extract fees from selling commodity index funds and arranging mining-related IPOs, mergers and debt issuance.

Company accounts: A misrepresentation of a firm’s profitability and financial state. See Off balance sheet and Kitchen sink.

Compensation committee: A group of people, often the chief executives of other companies, tasked with ratcheting up the CEO’s pay. See Executive pay consultants.

Compliance officer: A box-ticking functionary charged with ensuring the letter – but not the spirit – of the law is observed on Wall Street.

Contemporary art: A bubble asset class, which combines conspicuous consumption with tradability whilst making no demands on taste.

Corporate governance: A set of rules intended to preserve the fiction that executives are working on behalf of shareholders. See Shareholder value.

Corporate psychopaths: Clive Boddy, who studies company leadership, maintains the recent financial crisis was the consequence of Wall Street being run by mentally unstable types. A plausible hypothesis.

Correlation: A spurious statistical relationship between the prices of different assets, used in risk models.

Credit cycle: The ebb and flow of finance determined by the actions of central bankers, who are blissfully unaware of its existence. See Bernanke, Ben.

D

Debt supercycle: The apparently endless accumulation of financial obligations by people and governments around the world. The road to perdition.

Default: “A thorough and complete deception of the creditor by the debtor” (Max Winkler, 1933). See Greece.

Deflation: A benign fall in the price level due to productivity improvements and the expansion of global trade. Not to be confused with debt deflation, the consequence of the Fed’s easy money policies.

Derivatives: “Financial weapons of mass destruction” was the definition once used by Warren Buffett, but that hasn’t stopped the Berkshire Hathaway chairman from dabbling in them himself. See Sage of Omaha.

Dollar: A worthless token conjured up by an entry in the Fed’s balance sheet. The lynchpin of the global financial system, which results in low U.S. interest rates wreaking havoc in all corners of the globe.

Dollar-weighted return: The investment industry’s dirty little secret. The average return on every dollar invested in a fund over its lifetime. Invariably lower than the published return of a fund since inception, and sometimes negative.

Dot-com 2.0: The second coming of the internet bubble. See Burn rate.

E

Earnings per share: A corporate performance metric, published quarterly, which says little about a company’s true profitability and is easily manipulated. Often set as a target for executive compensation schemes.

Economist: A person who failed to anticipate the global financial crisis; generally, an undistinguished mathematician with a poor understanding of finance. See Bernanke, Ben.

Efficient market hypothesis: The discredited notion that market prices reflect all available information and that asset price bubbles cannot be identified in advance.

Elon Musk: A company promoter who may one day be seen to have taken investors for a ride (in electric cars, spaceships, and so on).

Emerging markets: A collection of relatively poor countries with little in common save a history of economic mismanagement, widespread corruption and the absence of the rule of law. See BRIC.

Endowment: A speculative investment fund, which embraces illiquidity and leverage in an attempt to emulate Yale University’s past success.

Eurodollar market: A $5 trillion unregulated offshore financial market in which banks fund the global carry trade and enable emerging market countries to borrow cheap dollars. Such asset-liability mismatches lie at the heart of most emerging market crises.

European Central Bank: An institution which holds the euro zone together by providing limitless credit to insolvent members. See Target 2.

Exchange-traded fund: An investment vehicle which trades like shares, providing retail investors with exposure to illiquid assets and the latest investment fads, for example the ALPS U.S. Equity High Volatility Put Write Index Fund.

Euro zone: Europe’s “permanent” currency union. A doomsday machine which generates debt deflation, economic sclerosis and sovereign bankruptcy.

Evergreening: the practice of rolling over a bank’s bad debts in order to avoid reporting losses and to support corporate zombies*. A Japanese invention of the early 1990s, more recently adopted by China and the euro zone.

Executive pay consultants: Advisers who justify one CEO’s proposed pay increase by reference to another client’s recent pay increase.

F

Finance: The work of the devil, sometimes known on Wall Street as “God’s work” (Lloyd Blankfein, CEO of Goldman Sachs).

Financial innovation: New ways conceived by Wall Street to extract fees, conceal risks, and evade financial regulation.

Financial liberalization: The loss of control by a government of its domestic financial system, antecedent to the system’s collapse.

Financial regulation: A Maginot Line constructed around Wall Street after the last bust. See Regulatory arbitrage.

Financial repression: The Fed’s mechanism for transferring wealth from savers to bankers by keeping interest rates below the rate of inflation.

Fine: A punishment inflicted on a bank’s shareholders after its employees have abused their trust.

Flack: A purveyor of financial propaganda and public relations pabulum, normally an ex-journalist, who ensures a favourable news flow by feeding pet journalists with “scoops”.

Flash Crash: A brief but large dip in the stock markets on a May afternoon in 2010, resulting from the antics of high-frequency traders. The authorities have found an unlikely scapegoat for this event in the Hound of Hounslow.

Forecast: An inaccurate prediction, invariably optimistic, produced by brokers to generate turnover and by pension plan sponsors to mask insolvency.

Fund management: An industry built on the “illusion of skill” (Daniel Kahneman, Nobel laureate). Although it takes several decades to distinguish luck from skill in the investment world, successful fund managers are inclined to believe in their own skill. See Lucky fool*.

G

Gate: That which slams on investors in hedge funds and money market funds during periods of market turmoil, preventing them from redeeming their investments.

Gaussian copula: A quantitative tool used to measure securitization risk based on faulty assumptions of correlation and normal distributions. Sometimes known as “the formula which killed Wall Street”, this invention of rocket scientists was one of the biggest causes of the global financial crisis.

German banker: The patsy of global finance.

Global carry trade: The flooding of the global financial system with cheap dollars. This trade normally comes to a sudden stop when U.S. rates rise, ushering forth the inevitable emerging-market crisis.

Global financial crisis: An event which, before the Fed came to the rescue, threatened to bring to an end Wall Street’s well-oiled fee-extraction machine.

Globalisation: The opening up of the world economy to the global carry trade.

Gold: “A pet rock” (Wall Street Journal).

Goldman Sachs: “A great vampire squid wrapped around the face of humanity” (Matt Taibbi). Wall Street firm that specializes in “handling” conflicts of interest.

Goldman Sachs alumni: Former employees who infest central banks and finance ministries around the world, ensuring that the authorities bail out the bank whenever it is about to go belly up.

Goodwill: An accounting entry quantifying how much a firm has overpaid for past acquisitions. Written off by incoming CEOs. See Kitchen sink.

Greece: A country which has spent half its time since independence in default. Qualified to join the euro zone after taking off-balance-sheet financial advice from Goldman Sachs.

Greenspan put: The Fed’s practice of using monetary policy to prevent asset price bubbles from bursting. A cause of even bigger bubbles. See Moral hazard.

Gunning the fund: The practice of marketing investment funds with good initial track records. Funds with poor initial returns are either dropped or merged with better performing funds. See Survivorship bias.

H

High-frequency trading: A zero-sum game played by computer nerds.

High-water mark: The high point of a hedge fund’s value, below which it cannot charge extra fees. Falling below this level indicates that it is time to start a new fund.

Hot money: Short-term debt used to finance the global carry trade. Runs for the door at the first sign of trouble.

Hound of Hounslow: A trader operating from his parents’ sitting room underneath the Heathrow flight path, blamed by the authorities for the Flash Crash.

I

Inequality: The social consequence of Fed policies that inflate Wall Street fees and CEO pay while simultaneously reducing returns on the public’s savings.

Initial public offering: An opportunity for insiders to sell overpriced shares to outsiders and for Wall Street to extract exorbitant fees, manipulate markets and distribute favours. See Spinning and Laddering.

Interest: A reward for saving enjoyed in distant memory by our forefathers. SeeZIRP.

Interest rate: The price of money over time, which balances saving and investment. In the hands of the Fed, a dangerous policy tool.

Internal rate of return: A distorted measure of performance used by private equity firms to boost reported returns. A high IRR can be achieved by selling their best investments early whilst hanging on to the dogs.

Investment conference: A place where asset managers meet to discuss the latest investment fad. Investment strategist: A person who always recommends buying equities regardless of price.

K

Keynesians: Economists “who hear voices in the air (and) are distilling their frenzy from some academic scribbler of a few years back” (John Maynard Keynes).

Kitchen sink: Excessively large writedowns whose subsequent reversal becomes a source of future profit. Usually announced by an incoming CEO. Also known as “cookie-jar accounting”.

*These cross-references refer to the previous Breakingviews publication, The Devil’s Dictionary of Finance, from 2007.

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