Opinion

Felix Salmon

Why Apple’s cheap

Felix Salmon
Dec 5, 2011 22:17 UTC

I’m going to take one last bite at the Apple valuation question, since I’m happier now about why Apple’s trading where it’s trading than I was when I wrote my original post.

The first thing to note, as pointed out by Tadas Viskanta, is that Apple’s now a megacap, and that changes quite a few things. Consider, for instance, the iPod. It was a real game-changer in the history of Apple — the thing which moved the company out of providing expensive computers to people who wore a lot of black, and into a much bigger consumer space. The iPod changed the way the world listened to music, it helped to revolutionize the music industry, and it ultimately begat the iPhone.

The story of the iPod is now pretty much over, which means that we have a pretty good grasp of how much money has been spent on iPods over the course of their natural life. The answer is about $55 billion.

Now that’s an enormous number. If you reckon that 45% of that $55 billion is profit for Apple, then Apple has made about $25 billion in profit from the iPod in the ten years since it was launched — call it $2.5 billion per year on average. On the day the iPod was launched, Apple had a market capitalization of $6.3 billion — so it’s easy to see how a new product with $55 billion in sales and $25 billion in profits would do amazing things for the stock.

Today, however, Apple’s market capitalization is $362 billion. If the company invents a new product which is just as successful as the iPod, and which makes Apple just as much money, and which is completely unanticipated by the market, how much should the stock rise? The present value of $25 billion in future profits is still substantial — but even if you put it at $20 billion, that just gooses the share price by 5% or so. If you look at Apple today, the company’s cash in the bank — its liquid assets — is a significantly larger number than the total revenue it’s made from every iPod ever sold.

If you grow to 50 times your previous size, your new products don’t become 50 times more successful. Or even 10 times more successful. Apple, like all companies, has certain economies of scale, and it has millions of people devoted to its ecosystem. But the market isn’t going to give it credit for having a pipeline filled with unknown products that are going to be bigger than the iPod. The iPad will evolve; the Apple TV will get Siri voice control; the computers will get faster and thinner. All of these things will be profitable for Apple — the company’s not going away any time soon. As Horace Dediu puts it:

The consensus is that the value of future, unknown products is zero. Not only that but the probability that there will be any products at all is equally zero. Not only that but whatever Apple does to create new products is not perceptibly valuable. The company is simply the sum-of-the-product-parts and nothing more.

Dediu reckons this is silly — “like valuing Pixar on the box office revenues of its current movie”. But as his chart shows, it’s pretty much impossible to compete with iOS devices on a profitability basis. Look at the thin yellow line for music: Apple’s the biggest music merchant the world has ever known, and music sales barely register on its P&L.

Screen-Shot-2011-11-21-at-11-21-1.40.59-PM.png

More generally, the entire market for megacaps has been utterly miserable for the past decade, and Apple’s p/e has naturally shrunk as it has joined the ranks of the dinosaurs. If you picked a member of the S&P 500 at random on March 24, 2000, it has risen by 66% since then. While the index as a whole has fallen by 19%. That’s entirely a function of the megacaps performing atrociously, even as the rest of the index did reasonably well. On average, megacaps (the S&P 100) trade on a p/e of 18.6; right now, they’re at 12.1. I’m not going to hazard a guess as to why that should be the case, but it stands to reason that Apple is just as susceptible to the phenomenon as any other megacap.

And then there’s the question of what kind of asset Apple stock really is. Equity is permanent capital, of course, and the best stocks are the ones you buy and forget about and leave to your grandchildren. But it’s frankly hard to imagine that Apple is going to be one of the most valuable companies in the world in 50 years’ time. It has a lot of room to grow, to be sure, but it just doesn’t feel like the kind of company which lasts forever. On top of that, Apple doesn’t pay a dividend.

Put those two things together and you have a trading vehicle, rather than a long-term play. Buy now, and sell when it reaches X. But the problem here is that no one has a clue what X might be. And if Apple is fundamentally a stock for speculators, rather than a buy-and-hold investment, then at that point things like p/e ratios cease to matter: all anybody cares about is momentum, and whether it’s going up or going down.

Apple never made it as a computer company; its big resurgence took place when it became an iPod/iTunes company. And just when that revenue stream started looking tired, the iPhone came along to turbocharge everything. The iPhone and iPad will be around for a while, I’m sure. But then they’ll be gone. And that will be the end of Apple’s megacap days — unless the company can pull yet another new product out of its hat, and one which can bring in billions of dollars of profit every quarter, at that. I wouldn’t bet against it. But I can see why the market might be reluctant to bet on it, before anybody really knows what that product might be.

COMMENT

* an analysis. Please add an edit feature.

Posted by DrFuManchu | Report as abusive

American plutocracy

Felix Salmon
Dec 5, 2011 15:08 UTC

Michael Lewis puts his finger on something important:

Ordinary Greeks seldom harass their rich, for the simple reason that they have no idea where to find them. To a member of the Greek Lower 99 a Greek Upper One is as good as invisible.

He pays no taxes, lives no place and bears no relationship to his fellow citizens. As the public expects nothing of him, he always meets, and sometimes even exceeds, their expectations. As a result, the chief concern of the ordinary Greek about the rich Greek is that he will cease to pay the occasional visit.

That is the sort of relationship with the Lower 99 we must cultivate if we are to survive. We must inculcate, in ourselves as much as in them, the understanding that our relationship to each other is provisional, almost accidental and their claims on us nonexistent.

I can’t help but remember that George Papandreou was born in Saint Paul, Minnesota, grew up with Greek as a second language, and was schooled in Canada, the US, Sweden, and England. He’s part of the Greek social compact entirely by choice; he arrived when he wanted to, and can leave for a comfy sinecure in some English-speaking country any time he wants. Meanwhile, for every Papandreou who was born in the US and made his career in Greece, there are many more highly successful people — think Pete Peterson or Arianna Huffington — who moved the other way.

Indeed, the elite of most countries in the world is there by choice rather than by any kind of necessity. Chrystia Freeland — herself a Canadian who has lived and travelled widely in Russia and who cemented her reputation by working for the New York bureau of a London newspaper — wrote a great story about the “new global elite” earlier this year which made the point that the very rich are, these days, largely stateless:

They are becoming a transglobal community of peers who have more in common with one another than with their countrymen back home. Whether they maintain primary residences in New York or Hong Kong, Moscow or Mumbai, today’s super-rich are increasingly a nation unto themselves…

The business elite view themselves increasingly as a global community, distinguished by their unique talents and above such parochial concerns as national identity, or devoting “their” taxes to paying down “our” budget deficit.

Chrystia quotes Silver Lake’s Glenn Hutchins as saying of the super-elite that “we are much less place-based than we used to be”, which is true. But the US has, historically, been behind this particular curve. It tends to import talent rather than export it: I don’t have exact numbers, but I’m sure that there’s an order of magnitude more foreign-born billionaires living in the US than there are US-born billionaires living abroad. For all that hedge-fund managers, in particular, are constantly threatening to leave the country if they get taxed more, the fact is that the US is so big and so rich that it actually does an extremely good job of retaining its billionaires, roping them in to the social compact whether they like it or not.

This is why the Occupy movements are particularly American. The Russians can’t Occupy anything: all their billionaires are in London. And while there’s an enormous number of the global elite living in Switzerland, they’re not actually Swiss: they’ve already broken the bounds of national identity, and have basically created a stateless stratospheric sovereignty of their very own.

In a way it’s reassuring that America’s billionaires are still so civic-minded that they buy laws and political parties: it’s a sign that they’re invested in the country and are here for the foreseeable. And the one law they’re not going to repeal any time soon is the most important one — the one which says that US citizens have to pay US federal taxes on their global income, no matter where they live. (Or at least demonstrate that they’ve paid at least that much in taxes elsewhere.) American plutocrats, almost uniquely, are tied to their home country in a way that other members of the global elite can barely imagine.

If you live in London, you’re constantly aware of the contingency of residency: you know those multi-million-dollar Chelsea homes are occupied for maybe only a few weeks per year by their Saudi or African owners. In America, by contrast, the rich can buy their fourth or even tenth home without ever having bought property abroad. So while America’s rich might dream of a stateless existence, they don’t have it — not yet. And I don’t think it’s coming any time soon.

Update: Pete Peterson, the son of Greek immigrants, was actually born in Kearney, Nebraska.

COMMENT

The plutocrats are still here because America isn’t sucked dry yet. The money is all going in one direction. Everyone says it’s the top 1%(3M+people),the true power lies with the 0.1% how fast is their piece of the pie growing?

Posted by dinge61 | Report as abusive

When art galleries ratify forgeries

Felix Salmon
Dec 3, 2011 17:50 UTC

Patricia Cohen has uncovered the art-world scandal of the year: it seems as though Knoedler, the 164-year-old Upper East Side institution, closed abruptly on Wednesday in large part to protect itself against a $17 million lawsuit from Pierre Lagrange. Lagrange spent that sum on a Pollock which he then discovered contained two paints which had not been manufactured until after Pollock died. And now it seems that Knoedler regularly sold AbEx paintings procured by Glafira Rosales with the vaguest of provenance:

Neither Ms. Freedman nor Mr. Weissman can identify with precision the collector whom Ms. Rosales has said she represents. They acknowledged that they did not know of any paperwork that documented the provenance of those works. They have said they only know what Ms. Rosales has told them: that the works were bought by a unnamed collector in the 1950s directly from the artists.

In a letter written to Ms. Freedman in 2007, Ms. Rosales said the secret collector acquired the works on the advice of David Herbert, an art dealer who died in 1995. When the collector died, they were inherited by the owner’s son, whom she described as “a close family friend” who lives in Mexico and Switzerland and insists on remaining anonymous.

This “close family friend”, over the years, seems to have been able to come up with seven Diebenkorns, on top of dozens more works by the likes of Motherwell, Pollock, Rothko, Franz Kline, Clyfford Still and Willem de Kooning.

Given that these works had basically zero documented provenance, they were to a first approximation unsellable. Until — and this is key — they found their way to Knoedler, whose reputation was rock-solid.

Current and former Knoedler employees, including the above-mentioned Ann Freedman and Julian Weissman, would accept paintings from Rosales and sell them while quietly whispering all manner of unverifiable assertions about where they came from. This court document is quite a fun read: in the case of one Motherwell, it seems, Weissman first said that it belonged to Shaikha Paula al-Sabah, a princess in the Kuwaiti royal family, and then changed his tune:

By letter dated November 23, 2010, Weissman’s lawyer writes to Killala and reveals that the owner of the work when he had it consigned to him by Glafira Rosales was purportedly John Gerzso, the son of Mexican painter Gunther Gerzso. This is an entirely new twist in the story. Up until now, the owner was supposedly a rich Mexican closet homosexual very close to David Herbert whose family was in the sugar business.

The point here is that the art market, like the stock market, runs on a combination of trust and storytelling ability. The most expensive artists are nearly always those who can be credibly placed into central slot in the history of art; one of the main reasons that Abstract Expressionists in general are so expensive is because they have spent decades as the very heart of MoMA’s collection, which presented them as the pinnacle of 20th Century art, the artists standing on the shoulders of people like Picasso.

When gallerists sell paintings, they tell stories not only about the work, but also about the story behind the work, conjuring up romantic notions of dealings between Robert Motherwell and Mexican sugar magnates, brokered by “man named Alfonso Ossorio”. So long as the institution selling the work is trustworthy, potential buyers tend to take such stories at face value — and, of course, they have a vested financial interest in those stories being true, the minute they actually buy the piece.

Which is why it’s easy to see how Freedman personally owns a “Motherwell”, a “Pollock”, and a “Rothko”, all of which came from Rosales — like all the best salespeople, she probably truly believed what she was saying.

But Freedman would also have found it much harder to sell all those Motherwells if she hadn’t had the full institutional credibility of Knoedler behind her. That’s how galleries can be such lucrative businesses to be in: once you’re established, you can literally add hundreds of thousands or even millions of dollars to the value of a painting, just by hanging it on your wall. A fake Motherwell in a garage in Switzerland is worthless; in an Upper East Side gallery, it’s priceless.

Until the forgery is uncovered, of course.

COMMENT

ErnieD, the artistry is in the act of creation itself. An art market that is focused on dead works by dead artists stifles the new. This goes beyond the financial implications.

As MKCurious notes, plutocrats are attracted to art because it allows them to vicariously share in the greatness of others. They buy the story, the experience, the connection. Yet ironically this has nothing to do with the creation — the art — itself.

Posted by TFF | Report as abusive

Counterparties

Nick Rizzo
Dec 3, 2011 02:01 UTC

Soros: The global financial system is in a “self-reinforcing process of disintegration” — WSJ

US economy adds 120,000 jobs, unemployment rate falls to 8.6% — BLS

Brad Plumer: Why Americans are leaving the labor force in large numbers — Washington Post

Rogoff: 5 big problems with capitalism as we know it — Project Syndicate

Shiller: The best advice I ever got is to ignore celebrities — Fortune

Mentioning a company on CNBC raises its stock price (pdf) — UC Berkeley

90% of bachelor’s degree recipients graduate with less than $40,000 in debt — NYT Economix

And hedge funds are trailing the market to the tune of about 6% this year — The Economist

COMMENT

@minderbinder Good catch! It was on Klein’s wonkblog, and I stupidly didn’t see the byline. (Sort of the way people think Counterparties is written by Felix.) It’s fixed now. Thanks for noticing.

Posted by Nick Rizzo | Report as abusive

The art of Griftopia

Felix Salmon
Dec 2, 2011 16:43 UTC

I’m in Miami right now, for the annual bacchanal of conspicuous consumption that is Art Basel Miami Beach. There are two equally important things going on here (and by “important” I mean “not important at all”) — a tiny group of people spending huge sums of money on art; and a small group of people in extremely expensive shoes gossiping about who’s buying what.

But the money sloshing around the art world is, ultimately, small potatoes. Any one artwork might sell for an astonishing amount of money, and it’s hard to read quotes like this, on the front page of the Art Newspaper, with equanimity:

“It is easier to have ten Damien Hirsts than to have ten yachts… besides, your yacht becomes more interesting with a Damien Hirst on it,” says the Mexico-based collector César Cervantes.

But compared with the sums of money in finance, the entire contemporary-art circus is basically a rounding error.

That’s why I was very happy to see William Powhida’s Derivatives show at Postmasters. There has always been socially-engaged art, but right now, at a time when the art market is booming, almost no one in the art world is really engaging the much bigger world of finance. Art about art is common, as is art about gender or art about sexuality or art about war or art about the built or natural environment. Art about finance, on the other hand, is all but unheard-of.

The biggest piece in the show, by far, is Griftopia, a 5-foot-by-10-foot reworking of the Matt Taibbi book of the same name. Frankly, it’s more Powhida than Taibbi, but there’s a lot of both of them in there, and I love the way that it presents the connections between various key financial-world players in the most coruscating light possible.

But it’s also, as Blake Gopnik notes in the video above, a work of art about the way in which the entire financial crisis is utterly incomprehensible to anybody who doesn’t study it day in and day out for months. Everybody wants easy answers or villains, but in fact everybody was to blame, and Powhida’s piece is a great way of showing how difficult it really is to understand this stuff. The CFTC, for instance, has a prominent part in the work, and goes unexplained: if you don’t know what it is — and 95% of the people looking at the work will have no idea what it is — then you’ll begin to get a good idea of just how beyond your grasp the financial crisis lies.

Here at Art Basel, everybody is in their comfort zone — the art world knows how to buy and sell and backstab and gossip, and it does it very well. And wading into the belly of the beast, Postmasters has brought Powhida’s works down to Miami, the natural home for high-impact pieces for people with short attention spans. I doubt they’ll do very well. But you never know: if people are still feeling the pain on the condo they bought at the top of the market because they thought it would be nice way to make a profit while having a pied-à-terre down here, Powhida might just pique their interest.

Update: I’m now informed that anything of Powhida’s which Postmasters hadn’t sold in New York has now been sold in Miami. Except the Griftopia piece.

COMMENT

“….but in fact everybody was to blame…”

You truly believe that???

Posted by fresnodan | Report as abusive

Chart of the day, employment edition

Felix Salmon
Dec 2, 2011 15:08 UTC

gateway.jpg

Today’s employment report counts as a win for the White House. Markets care about payrolls; politicians care about unemployment. And so does the country as a whole: the severity with which the BLS website crashes on the first Friday of the month is a direct function of the change in the headline unemployment rate, which, wonderfully, fell to just 8.6% last month.

But while numbers matter in election campaigns, it’s people who vote. And they vote based on their own personal experiences, rather than on macroeconomic statistics. And the fact is that if you’re a person in America, the likelihood that you have a job was unchanged this month: the employment-to-population ratio ticked up just one tenth of one percentage point.

When employed people become unemployed, that’s bad news, and immediately visible in the unemployment rate. When unemployed people leave the labor force entirely, that’s equally bad news, but it’s a tougher measure for the public to connect with, since at that point they’re no longer counted in the unemployment rate. Everybody knows what “unemployment” is; the population which cares about the “employment-to-population ratio”, by contrast, is wholly comprised of wonks.

The plunge in the employment-to-population ratio over the course of the Great Recession is going to be its biggest and most lasting legacy. We’re now back to the levels last seen in the days before most women worked, but we live in a very different world now. In the late 1970s, a woman without a job was much less likely to consider herself unemployed than in the early 2010s. And when she casts her vote in November, the degree to which she’s happy or unhappy with the current administration is going to be much more connected to her actual employment status than it is to whether she’s officially showing up in the unemployment rolls.

Over the next few months, we’ll get a better sense of the signal-to-noise ratio in the 8.6% number. I’m hopeful that we’ve seen the last 9 handle in the headline unemployment data series, and if I’m right, then the optics of the unemployment rate are, at the margin, good for Ds and bad for Rs. But the unemployment rate is not a particularly good gauge of how well the economy is functioning, or how many people have jobs. And I’m very pessimistic that the employment-to-population ratio is going to get back above 60% even over the medium term. It’s certainly not going to get there before the election.

It’s no coincidence that after the employment-to-population ratio plunged, we saw the rise of first the Tea Party and then Occupy Wall Street. Social unrest will not go away so long as more than 40% of the US population is jobless. Some part of that 41.5% is too young to work; some part is too old; some part is in jail; and some minuscule part is simply too rich to care. But at heart, it’s a massive dead weight dragging down the hopes and prospects of hundreds of millions of Americans. And they’re not going to take it quietly.

COMMENT

saralonde, as best I can tell they are counting civilian non-institutional population age 16+.

FifthDecade, if you read their “technical notes” they explain that there are two separate reports — in the household survey, each individual is counted once. In the establishment survey, they will be double-counted.

Posted by TFF | Report as abusive

Walmart’s MoneyCard: Still nothing to celebrate

Felix Salmon
Dec 2, 2011 06:36 UTC

American Banker’s Maria Aspan has sent a love letter to Jane Thompson today, giving her the “banking innovator of the year award” for her achievements at Walmart:

Jane Thompson is not a banker. But during her nine years running Wal-Mart Stores Inc.’s financial services unit she did more than any single bank or banker in the country to develop and sell affordable financial products to low-income customers.

Annoyingly, Aspan doesn’t go into much detail about what exactly these “affordable financial products” are, or how they compare in price to the alternatives. But there’s one product in particular which she singles out for praise.

In 2007, Wal-Mart introduced the MoneyCard, a prepaid card that customers can fund with their paychecks or cash and use like a traditional debit card, without having an existing checking account. Thompson calls it her favorite product.

This comes as a surprise to me. When the MoneyCard was launched, in 2007, I called it a rip-off. And I’m sad that technical glitches have caused all the comments to be deleted from that post, because there were a lot of them, and they tended towards the very angry. As Stephen Vanderpool writes,

A quick perusal of relevant message boards will yield thousands of Green Dot and WalMart MoneyCard customer complaints. A good chunk of these complaints involve the complete loss of deposited money. People usually don’t respond well when their funds go missing. Another big complaint category is refunds gone wrong. With startling frequency, attempts to return merchandise seem to result in no refunds issued.

Contrast this the scarcity of complaints surrounding the Western Union MoneyWise card. Granted, there are a lot more MoneyCards and Green Dot cards floating around out there, but the difference is disproportionate. This may be due to the apparent absence of Green Dot customer service. People aren’t getting their questions answered or their issues resolved.

It’s worth noting that although Walmart is getting the credit from American Banker, the MoneyCard is actually operated by Green Dot, which was sued in May by Florida AG Pam Bondi for possible deceptive and unfair practices, including failure to disclose fees. And I can’t find much in the way of independent praise for the product. Vanderpool, for one, finds the MoneyWise card to be clearly superior to the MoneyCard, and writes:

The WalMart MoneyCard, developed by Green Dot, charges an activation fee, a monthly fee, and a deposit/reload fee that stand at $3 apiece (direct deposit is free). The ATM fee is $2, and it’s another $1 for a simple balance inquiry. Those are some pretty hefty charges, just for the privilege of carrying the card around.

These fees are also far from transparent: on the web page describing the MoneyCard, for instance, there’s no mention of fees at all. And finding the page with the fees is basically impossible, because there isn’t one. In order to find the fees, you have to bring up the 12,000-word cardholder agreement, which starts off not by listing the fees, but rather by entering into legalese defining the word “Agreement” to refer to “This Cardholder Agreement”.

My opinion hasn’t changed since 2007: I don’t like this card, even though I do like the idea of Walmart banking America’s poor. The company does a good job of banking in Mexico, and it’s sad that it can’t do the same here. But the MoneyCard is not a good alternative to a bank account, or even to other prepaid cards. (It’s significantly worse than, say, the prepaid cards which California uses to distribute its unemployment and disability benefits.) So I find this American Banker article rather odd.

COMMENT

I like many am a victim. I am looking to resolve this matter today because quite frankly, I have been a loyal customer for some time now. I refuse to accept the information I have been told by the “customer care” line. These people are not helpful in resolving my issue. I am owed a substantial amount of money that was deposited by the IRS. I do not understand how your company can offer such a service as direct deposit for tax returns…and then put a hold on my account. THIS MONEY WAS DEPOSITED BY THE IRS. I hope that someone can resolve my issue immediately otherwise I will have no choice but to alert the appropriate personel:

IRS
FBI
BBB
Legal Counsel
Local Police
Local News Station
Forums
Anyone who I feel is going to hear my voice

I do not want to go to these lengths to get the money that is owed to me by law. I would like for someone to call my at my direct line to resolve this issue. I do not appreciate the blatant disregard for my situation. I am not comfortable with the responses I have received from the “customer care”.

Brooke1324@gmail.com

Posted by bashley | Report as abusive

Counterparties

Nick Rizzo
Dec 1, 2011 23:49 UTC

The Euro debt crisis in 8 graphs — Washington Post

Mario Draghi: Time for the “Euro area design” to adapt — ECB

Why unlimited monetization and eurobonds are right around the corner — Credit Writedowns

Here’s the full Massachusetts AG’s foreclosure practices lawsuit — Mass.gov

Foreclosures are at an all-time high, but mortgage delinquencies are down — LPS

“The hacking scandal could be the best thing that ever happened to News Corp shareholders” — Bloomberg

Om Malik thinks Yahoo’s like “salmon farmed on carcinogens” — GigaOm

And Tom Glocer, my boss’s boss’s boss’s boss’s boss, is out — Reuters

COMMENT

Here’s something for ya on why households who can observe the same stock market data think differently about investment potential. http://bit.ly/uY1hzJ

Posted by dbunn | Report as abusive

Why rogue traders will never disappear

Felix Salmon
Dec 1, 2011 18:40 UTC

John Gapper’s new e-book, How To Be a Rogue Trader, is really good. Gapper’s been covering such things ever since he wrote a 1997 book about Nick Leeson which itself has just been reissued in Kindle form. And you might be surprised how many rogue-trading scandals there have been between then and now. Leeson was roughly contemporaneous with Joseph Jett, at Kidder Peabody; since then we’ve had Toshihide Iguchi at Daiwa, Yasuo Hamanaka at Sumitomo, John Rusnak at AIB, a team (!) of four rogue traderes at National Australia Bank, Jerome Kerviel at SocGen, and of course Kweku Adoboli at UBS.

Gapper’s book looks at the common pathologies here, and finds quite a few. The first is a trait common not only to rogue traders, but rather to all animals — it’s been seen in birds quite vividly. It’s the entirely rational decision which you see in any movie where somebody utters the line “it’s the only chance we’ve got” — no matter how improbable your chances of success, if the alternative is failure, then you take the gamble.

Some people are more likely to take those risks than others, of course — and those people are exactly the ones who end up getting hired on trading desks. As Gapper recalls, Christopher Heath, the former CEO of Barings, would ask potential recruits if they were “hungry” — much as Ace Greenberg and Jimmy Cayne did at Bear Stearns. And “hungry” is exactly the state that you need to put birds in before they start taking stupid risks.

Investment banks don’t just hire the kind of people who are more likely to go rogue, they also encourage exactly the kind of trading that rogue traders excel in. Risk-management operations are designed to reduce risk, rather than detect fraud. And rogue traders, if you believe their numbers, tend to be running extremely low levels of risk.

There’s an almost infinite number of strategies, on Wall Street, which work until they don’t. Many involve shorting volatility in one form or another, maybe by selling out-of-the-money options. That brings in lots of cash, and you can do it for a long time until you blow up. More desperate strategies involve doubling down in an attempt to make up bad bets — a strategy which Andrew Weisman has demonstrated is likely to work for more than seven years of outperformance until the inevitable conflagration. Or you can simply mark your illiquid assets to “market” rates which get further and further away from reality. If a rogue trader does this, says Gapper, he “appears to be doing everything right”.

And he’s also likely to be supported, at least implicitly, by the most senior executives at the bank. “There has never been a case of a rogue trader carrying on his fraud for months or years without the executives in charge having noticed at least some signs of trouble, and often having been bluntly advised to investigate,” writes Gapper. “They often react by ignoring what they see, and telling the whistleblowers to shut up.”

Of course we have no data on how many times executives are asked to investigate something suspicious and they say yes. But this kind of gut denial that anything could be amiss is far too common in executive ranks, especially in banks where the first job of every executive is always to manage risk.

Gapper does find one thing which the executives, as opposed to the rogue traders themselves, have in common: they, too, have excessive amounts of hunger. The banks worst hit by rogue trading, Gapper writes, are not generally found in Wall Street’s bulge bracket. Instead,

they are striving to get there… they are outsiders that are eager to make their mark and are willing to take short cuts. They tend to be retail and commercial banks seeking to transform themselves into investment banks. They have a case of what became known before the 2008 crisis as “Goldman envy”.

Just as rogue traders want to be successful traders, rogue banks want to be Goldman. These kind of blow-ups, in other words, are a natural byproduct of precisely the ambition which is so highly valued on Wall Street. And as a result, they’ll never go away.

COMMENT

for 20 years…. Should be easy for you no?

Posted by Danny_Black | Report as abusive
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