The problem with smart bankers

By Felix Salmon
October 14, 2009
Calvin Trillin, in his own inimitable way, has now weighed in on the causes of the financial crisis. It's great stuff:

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Calvin Trillin, in his own inimitable way, has now weighed in on the causes of the financial crisis. It’s great stuff:

“Don’t get me wrong: the guys from the lower third of the class who went to Wall Street had a lot of nice qualities. Most of them were pleasant enough. They made a good impression. And now we realize that by the standards that came later, they weren’t really greedy. They just wanted a nice house in Greenwich and maybe a sailboat. A lot of them were from families that had always been on Wall Street, so they were accustomed to nice houses in Greenwich. They didn’t feel the need to leverage the entire business so they could make the sort of money that easily supports the second oceangoing yacht.”

“So what happened?”

“I told you what happened. Smart guys started going to Wall Street.”

Trillin’s right. Bankers have made money for centuries, by doing essentially what their fathers and grandfathers did before them. (They’ve lost money, too, but nearly always in the same way: by lending money to people who can’t or won’t pay it back.)

Then Wall Street went go-go in the 1980s, and lots of smart, hungry, and highly self-regarding MBA types started flooding into big investment banks. When they started making money, they credited themselves, and their own intelligence. Which led to an obvious conclusion: if you did something even cleverer, you’d make more money still. Which, like most things in finance, is a strategy which works until it doesn’t.

Trillin’s also right that a large part of the problem is that senior management had no idea what was going on:

“When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness.”

In fact, even the bankers from the upper third of the class — the likes of Bob Rubin, who famously had no idea what liquidity puts were until a bunch of them exploded right underneath him — fell into this trap: in his case, he was both the smart and scrappy arbitrageur who thought that he could turn brainpower into billions, and the baffled senior risk manager who gave his underlings far too much ability to blow up his bank.

Banking isn’t for outright dummies — conscientious underwriting, for one, is a difficult and highly-skilled job which requires good, well-paid professionals. But far too many bankers thought of that kind of income as boring money, and were much more excited by the higher rewards and sophisticated risk management being shown them by the rocket scientists on the structured-products desk. Maybe in future they’ll be more suspicious of things they don’t really understand, but I’m not holding my breath. That’s what regulators are for.


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In the long run, regulation is needed because greed and self-interest trump social responsibility and moral behavior. IF you get rich enough, it MUST be the right thing to do, right? We’re famously capable of deluding ourselves that anything that makes money must be good.

-bob D.

Posted by Bob D | Report as abusive

Nicely put.

It’s not to late to recognize what has happened and punish those who allowed this catastrophe to unfold. I am very disappointed with Obama – I guess aI expected miracles – becasue he followed the advice of Geithner and Summers.

It’s not to late to ensure this does not happen again.

From Trillin: “That’s when you started reading about these geniuses from M.I.T. and Caltech who instead of going to graduate school in physics went to Wall Street to calculate arbitrage odds.”

We also started hearing the money argument: they were earning more money in finance than they could in science, so finance must be the better use of their skills. Which reduces to saying that writing glorified spreadsheets is better than, say, developing fusion power, but who are we to argue with the market?

Posted by Ken | Report as abusive

Correction: That’s what regulators SHOULD be for.

Posted by Tiny Tim | Report as abusive

The market perfectly allocates resources for the benefit of the market. Just not for the benefit of most people.

Posted by Rockfish | Report as abusive

so JP Morgan was neither greedy nor smart?

Posted by q | Report as abusive

“Bob Rubin, who famously had no idea what liquidity puts were until a bunch of them exploded right underneath him”

Huh? We believe him because this is what he told us? There was a whole lotta “geez, this stuff was so complex and I really didn’t understand it” goin’ on.

The entire system is just not for most people. As you so eloquently put it, one needs to be part of the “smart” crew. Clearly even the regulators don’t seem to understand what these guys are up to. I mean really, how did the SEC fail to catch Madoff for so long?

Don’t act like it was only rocket scientists going for too much green that started all of this. In the end all of these structured products have a wondrous document called a prospectus that even on those dirty subprime securitizations clearly showed that these borrowers would flounder if home prices did not keep rising as they had. Everyone (Including financial journalists, and noted economists on both sides of the political spectrum) got that wrong.

Posted by Structured Products Guy | Report as abusive

I believe it’s simpler and more general than that. It’s the same process of modernization/professionalization/optimi zation that has being going on everywhere.

Look at the evolution of tennis players for instance. Compare tennis players from the 60ies, 70ies to the guys we have now. Those from old times look like undisciplined amateurs while players such as Federer or Nadal are like hyper-lean intense killer machines.

Ultimately the force that drives all this is competition. You might think: it’s all good, competition will ensure the most capable will fill the highest positions.

I’m not so sure. I suspect there’s a law of diminishing returns in competition. It probably worked well at the beginning. Smart young guys from average/modest background who might not have attended universities in old times started showing up. This process was beneficial.

However it seems to me that the situation has now evolved into a new equilibrium. The new achievers are no longer necessarily the smartest or most talented. They look to me like the most brutishly methodical or those who know best how to work the system. For instance, in engineering firms, those who obtain high managerial positions are typically not the most technically competent or creative but those who are the most ruthless at office politics.

Posted by EmilianoZ | Report as abusive

I liken it to modern sports. The short term rewards of cheating are so high, that uppers, and eventually HGH and steroids make their way into the game. None of these things hurt anyone else, right? Well, unfortunately, not true for Baseball, nor for Wall Street. Now everyone must participate in order to compete. For Wall Street, the individual risk was modest as it was mostly carried by other people. The guy who risks the company (especially if he’s expected to do it) has no real risk except losing his job, but there are plenty more jobs out there (or were, at least.) He probably won’t even get the blame. However, when it does finally blow up, all his coworkers, his bosses, and all the company investors and creditors pay big time. In many cases, U.S. Taxpayers also. Problem is, how do you change the incentive structure? Is there an appropriate (I won’t say ‘fair’) way to force innovators to carry the risk? Conversely, do we really want to force people to avoid stupid investments? Meaning anything they don’t really understand? Despite the many good things they can be used to accomplish, Derivatives are inherently dangerous, to a greater or lesser degree. Derivatives can be compared to a loaded gun: Derivatives don’t kill economies, people kill economies. As if that half-truth makes the results acceptable.

Posted by American_Fool | Report as abusive

Pretty compelling stuff by Trillin. Wrong, but compelling. More here:  /the_eggheads_did_it.php

What is Obama doing? Just sitting at the Whitehouse and waiting for Nobel prize. Back in March, it was the best and only moment to nationalize the banking system and eliminate the fat cats but dear Obama chose to pump more blood to the banking system and let them alive. Now we all see the result. Nobel committee should award the economy prize to Obama instead!

To save the bankers, we stack up the national debt and accelerate the bankruptcy of this country. Now again, they got billion dollars of bonus again, on the expense of the national debt! Great Obama! Shameful on you!

Posted by Rose Eli | Report as abusive

Not only did the smart guys get involved, but they were making so much money that they figured they must be geniuses instead of lucky. I’m reminded of Microsoft during its heyday, when everyone there would claim “of course we’re doing everything right, look how profitable we are.” It never occurred to them that they were profitable because they had a monopoly, and the wheels might just fall off. Sometimes being too successful blinds people to the real causes of that success.

The big change underpinning everything was cheaper and cheaper computing power, beginning in roughly the late ’70′s. Without that technology, none of the new breed of products could be analyzed, and the application of quant skills to financial markets was limited by an inability to crunch the underlying data.

Posted by Dave | Report as abusive

These people really are smart but not for the reasons the article attributes. Their ability to come up with cleverly named sham assets like credit default swaps and bundled securities was a real stroke of genuis. But really now anyone with any financial or accounting education had to see what purpose all these engineered instruments served. The ability to create some thing out of nothing had been reserved for magicians, and honest bankers and businessmen use to be content with a fair profit for a fair service. When the political reality of total control of government by the FED was realized with the help of Bush, the need for continued deception to draw in investors was over, the time to cash in had arrived. The fact that the scam is obvious and the players are well known is of no concern since there are no honest people left in government who can do anything about it. And we the people are left with the political reality that democracy is dead. We are left with the FED, long live the KING!

Posted by freefall | Report as abusive