The Devil’s Dictionary of Post-Crisis Finance

October 16, 2015

The author is a guest columnist for Reuters Breakingviews. 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 two – for the letters L to Z – 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 one was published last week.

L

Laddering: A broker’s manipulation of the market following an IPO by promising to repurchase shares at a higher price. Prevalent during the dot-com era.

Lender of last resort: The traditional role of a central bank, providing funds to the markets at times of panic. Originally restricted to lending against high-quality collateral at penal rates of interest. More recently provided against toxic assets at subsidized rates.

Libor scandal: The illegal manipulation of short-term interest rates by traders to generate bankers’ bonuses. Not to be confused with the legal manipulation of interest rates by central banks to generate bankers’ bonuses.

Liquidity: Since the financial crisis, the oxygen of Wall Street, supplied on demand by the Fed. “Of the maxims of orthodox finance none, surely, is more antisocial than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of ‘liquid’ securities. It forgets that there is no such thing as liquidity of investment for the community as a whole” (Keynes).

M

MBA: A person with neither ethics nor business sense. See Business school.

Mean reversion: The touching belief of value investors that life will one day return to normal.

Mergers and acquisitions: An activity undertaken by CEOs whose pay is linked to a company’s turnover and market capitalisation. Debt-funded M&A is commonly used to enhance earnings per share.

Mine: “A hole in the ground with a liar standing next to it” (attributed to Mark Twain). See Commodity supercycle.

Money: A zero-coupon perpetual bond.

Money market fund: A mutual fund that behaves like a bank deposit but which is uninsured, opaque, liable to fall below its presumed value (known as “breaking the buck”), and able to impose gates on investors.

Moral hazard: Wall Street’s mentality of “heads I win, tails you lose”, fostered by Fed policy.

Muppet: See Client.

O

Occupy Wall Street: A traveling troupe which entertained Lower Manhattan in the aftermath of the financial crisis. Hoping for a rerun.

Off balance sheet: The hidden truth.

Oligarch: A member of an emerging-market elite, whose initial fortune, gained by ripping off locals, is enhanced by flogging dodgy shares to Western investors.

Options reset: The reissuing of corporate stock options at a lower price after the shares have fallen sharply. Often coincides with the arrival of a new CEO. SeeKitchen sink.

Other people’s money: A financier’s plaything. “The goose that lays golden eggs has been considered a most valuable possession. But even more profitable is the privilege of taking the golden eggs laid by somebody else’s goose. The investment bankers and their associates now enjoy that privilege. They control the people through the people’s own money.” (Louis Brandeis, U.S. Supreme Court justice.)

P

Pension plan: A collection of unpayable corporate promises backed by inadequate funds and managed on the assumption of unrealistic returns.

Pension consultant: Someone who cannot find employment with an investment firm.

People’s quantitative easing, or PQE: The printing of money to fund government spending. Long practiced throughout Africa. Lately, a “progressive” policy proposal for the UK. See QE.

Ponzi scheme: The operation of modern capitalism, from the United States to China, which requires ever-rising asset prices to sustain economic activity and validate ever-increasing debt levels. See Debt supercycle.

Principal-agent problem: The ancient danger of trusting your assets to another person’s care, especially pronounced on Wall Street: “The good shepherd giveth his life for the sheep. But he that is an hireling, and not the shepherd, whose own the sheep are not, seeth the wolf coming, and leaveth the sheep, and fleeth: and the wolf catcheth them, and scattereth the sheep.” (John 10.11-13, King James Version.)

Private equity industry: One of the most undeserving beneficiaries of the Fed’s easy money policy. Despite overpaying for and overleveraging buyouts prior to the global financial crisis, the industry has been able to refinance its deals with even cheaper money.

Profit: Currently, America’s biggest manufacturing industry.

Proprietary trading desk, or prop desk: A place where investment bank traders front-run trades placed by their clients. Recently rebranded as the “flow desk”.

Q

QE: Quantitative easing, exemplified by the Fed’s purchase of securities with newly printed money with the aim of defeating U.S. deflation and boosting economic growth. In practice, QE has resulted in asset price bubbles, over-investment in commodities and emerging-market credit bubbles, whose ongoing collapse is producing global deflation and lower world economic growth.

R

Rate rise: Wall Street’s Godot.

Red capitalism: The shell game of Chinese finance by which all losses are concealed and transferred between state-owned enterprises on Beijing’s orders. See State capitalism.

Regulatory capture: the process by which dumb and lazy public officials are got the better of by smart and hard-working bankers. See Revolving door.

Regulatory arbitrage: How Wall Street gets around financial regulations, thus preparing the ground for the next financial crisis.

Rehypothecation: An investment bank’s use of a client’s collateral to support its own debt. If the bank goes bust, as Lehman Brothers did, the client discovers his assets have vanished too.

Retail investor: An outsider on Wall Street who isn’t rich enough to be a fully fledged muppet and thus pays higher fees. See Principal-agent problem andBandwagon.

Rent seeking: The extraction of profit without creating value, the principal economic activity in emerging markets. Wall Street’s rent seeking is supported by lavish political donations and the largest lobby in Washington.

Revolving door: The process by which former government officials are rewarded by Wall Street with lucrative jobs (see Robert Rubin at Citigroup, Alan Greenspan at Paulson & Co, and Ben Bernanke at Citadel). Known in Japan as “amakudari”, which translates as “descent from heaven”.

Risk-free rate: The yield on U.S. Treasury bonds. Also known as “return-free risk” (Jim Grant, editor of Grant’s Interest Rate Observer).

Risk management: A cost centre for a bank. Next to compliance, the most futile activity in finance.

Risk parity: An asset-allocation strategy which involves buying large amounts of government bonds using leverage at a time when yields are at all-time lows. Popular with Endowments.

Risk-weighted assets: The outcome of a game of Regulatory arbitrage, used by banks to reduce reported leverage.

Rogue trader: An investment bank employee who couldn’t get a job on the prop desk.

S

Sage of Omaha: The name that value investors give to Warren Buffett, an investor of inconsistent principles. Publicly opposed to using debt in order to goose returns, the Sage has leveraged his own insurance company’s balance sheet for nearly half a century. An ardent tax avoider, he wants less wealthy persons to pay more taxes; and despite being a longstanding Wall Street critic, Buffett hops into bed with bankers if the price is right.

Savings glut: The mistaken notion, popularised by Bernanke, that interest rates have fallen due to excess Asian savings. The real cause of low rates has been a “banking glut”. (Claudio Borio, Bank for International Settlements).

Scapegoat: Someone or something other than their own fecklessness that the public and politicians can blame for the global financial crisis.

Securities and Exchange Commission: A U.S. regulator which sleeps during booms and prosecutes some small fry after busts.

Securitisation: A cause of financial insecurity.

Shareholder value: A cover for the transfer of wealth from shareholders to company managers.

Sharpe ratio: A distorted measure of investment returns based on the assumption that past volatility is a guide to the future and on the Bell curve. The Sharpe ratio conceals investors’ exposure to fat-tailed risks. A hedge funds can achieve a high Sharpe ratio and large performance fees by selling out-of-the-money put options – a trade which blows up when prices crash.

Short sellers: Investors who attempt to impose rationality on the market by betting against bubbles and exposing corporate frauds. Theirs is one of the least profitable activities on Wall Street.

Sovereign debt: “Countries don’t go bust.” (Walter Wriston, Citigroup). Instead, they default.

Spinning: An allocation of shares in a hot IPO to favoured clients. A common practice during the dot-com bubble.

State capitalism: A stage of economic development in which all rents are siphoned off by public officials and their cronies. When taken to excess, results in arrested development. See China.

State-owned enterprise: An emerging-markets business whose capital is misallocated for policy purposes and what remains is diverted into the pockets of public officials.

Swiss watches: A currency of corruption in emerging markets.

Survivorship bias: The systemic exaggeration of hedge fund returns by excluding the results of failed funds.

T

Target 2: The payment system for central banks within the euro zone which results in worthless IOUs from insolvent European countries accumulating on the ECB’s balance sheet.

Target redemption forwards: Complex derivatives originally designed to hedge foreign exchange exposure but lately used for leveraged bets on the “inevitable” appreciation of China’s currency. Remember the initials “TRF” – they are a source of enormous potential losses.

Tiger hunting: The periodic pursuit of corruption in China, the tigers in question being wealthy public officials. The aim of the hunt is not to purge corruption from the system – an impossible task – but to replace one set of rent seekers with another.

Time horizon: On Wall Street, one quarter.

Too big to fail: The notion that very large banks act irresponsibly in the knowledge that they will be bailed out by the state. In fact, banking crises are more likely to break out in places where many small banks compete with each other.

Tracking error: A mistake made by well-paid asset managers when they deviate from the benchmark whose returns they are supposed to outperform.

Trump: Also known as The Donald. A leveraged real-estate mogul and serial corporate defaulter, who has benefited from three decades of declining interest rates and rising property prices. In other words, a lucky fool.

V

Value investor: An old-fashioned type who buys stocks in the vain expectation that the future will resemble the past.

Value-at-risk: A self-serving risk-management metric used by investment banks to justify taking on too much risk and managing it ineffectively.

Veil of money: The mistaken idea held by modern economists that money is a veil over the “real” economy that can be safely ignored. In truth, the real economy distracts people from observing the all-important operations of finance.

Volatility: In modern finance theory, the mistaken notion that the market gyrations are equivalent to genuine risk, namely the prospect of permanent loss of capital.

Volcker, Paul: Former Fed chairman worshipped by Wall Street heretics.

W

Wall Street economist: A person who applies to the job of economic analysis the principles of hear no evil, see no evil and, above all, speak no evil.

Washington consensus: The policy recommendation of the IMF and other international organizations for less-developed countries to “stabilize, privatize, and liberalize” (Dani Rodrik, economist). This has resulted in rising inequality in the developed world, while providing a cover for public officials in emerging markets to plunder their economies.

Whale: A London-based trader for JPMorgan with enormous market positions. In 2012, the Whale lost over $6 billion. These losses were initially dismissed by Jamie Dimon, the giant U.S. bank’s CEO, as a “tempest in a teapot”.

Y

Yield curve: The difference between long- and short-term rates. After every financial downturn the Fed engineers a steep yield curve. This helps banks but also attracts global carry traders whose activities lead inexorably to the next crisis.

Yield hunger: “‘John Bull’, says someone, ‘can stand a great deal, but he cannot stand TWO per cent’ … Instead of that dreadful event, they invest their careful savings in something impossible – a canal to Kamchatka, a railway to Watchet, a plan for animating the Dead Sea, a corporation for shipping skates to the Torrid Zone.” (Walter Bagehot, British journalist and businessman). If our Victorian forefathers did dumb things when interest rates were so terribly low at 2 per cent, is it any surprise that people make even crazier investments with rates near zero? See Bitcoin.

Z

Zaitech: The Japanese term for financial engineering, which taken to excess turns corporations into Zombies*.

ZIRP: The policy of zero interest rates, which held in place for too long turns whole economies into Zombies*.

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

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The post-crisis re-definitions are fantastic. Thanks Breakingviews for putting the list together for the readers.

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