Felix Salmon

The truth about Blackstone and Codere

Felix Salmon
Dec 6, 2013 23:19 UTC

I’ve always felt that the Daily Show should do more financial stuff, and there’s no doubt that Wednesday’s piece on Blackstone was funny. But it was also extremely credulous about a single Bloomberg article from October.

Jon Stewart — a man who, according to the NYT, might be “the most trusted man in America” — said that the Bloomberg piece was “unbelievable story” of how Blackstone engaged in “incredibly egregious behavior” which “should be illegal” — strong words, which elicited smart reactions from both Matt Levine and Dan Primack.

In a sign of the degree to which Bloomberg is implicitly trusted, however, all concerned — Bloomberg View, the Daily Show, Fortune — take at face value the core assertion made by Bloomberg News: that Blackstone made a profit of “from 11.4 million euros to as much as 13.7 million” on its Codere trade.

The article attributes those numbers simply to “data compiled by Bloomberg”, but in fact it’s quite easy to see where they came from. Blackstone, according to Bloomberg, “held 25 million to 30 million euros” of credit default swaps on Codere. It then forced Codere into a technical default (repaying a loan two days late) — which triggered those swaps and forced a payout at 45.5 cents on the dollar. Therefore, the amount that Blackstone received on its CDS position was somewhere between €11.375 million and €13.65 million.

But that number is gross revenue, not profit. The profit on Blackstone’s CDS position can be looked at as being the difference between that payout, on the one hand, and the amount that it spent buying the CDS in the first place, on the other. (Although in fact, as we’ll see, it’s more complicated than that.) Unless we have some idea of Blackstone’s cost basis on this trade, we have no idea what its profit was. Bloomberg, however, seems to simply assume that Blackstone’s cost basis for the CDS was zero — that it managed to accumulate all that insurance without paying anything for it whatsoever.

To be sure, Blackstone are smart operators, and I don’t doubt that they’re making a profit on this trade. But we really have no idea how big that profit was.

And in any case the whole thing was part of a much bigger trade, which has yet to be unwound. Primack explains that “in the first half of 2013, Blackstone affiliate GSO Capital Partners purchased debt and credit default swaps in Codere” — in other words, it entered into a basis trade, where it bought debt in a troubled company and also bought insurance on that debt. But Codere was already a deeply troubled company in the first half of 2013, which means that Blackstone would have had to pay some nontrivial amount of money to buy its CDS position in the first place.

So before we take Levine’s lead and admire the “majestic beauty” of the Blackstone deal, let’s wait and see just how profitable it was. We’re not going to know that for a while, since Blackstone is now a major creditor of Codere, which is (still) at very high risk of defaulting on its debt: when the original Bloomberg article was published in October, Codere’s bonds were trading at a mere 53 cents on the dollar.

The way that Blackstone made some unknown amount of money on the CDS leg of its trade, then, was to take a huge direct exposure to Codere on the other side of its trade. It’s still entirely plausible that Blackstone’s current exposure to Codere could be written down sharply, and could even end up being bigger than the profits on its CDS trade.

Two other points are worth making, here. The first is, as Primack points out, that absent new money from Blackstone, Codere was pretty certain to default in any event. As a result, Blackstone can credibly be painted as the white knight here — as the company which managed to find a way to funnel money from the CDS market back into Codere, thereby avoiding a bankruptcy filing. That’s certainly Blackstone’s view: spokesman Pete Rose says that the trade saved jobs at Codere, as well as lots of money for Codere’s supplier-creditors.

What’s more, it’s worth stopping to ask who Blackstone bought the CDS from, in the first place. Not many people are in the business of writing single-name CDS on a troubled company like Codere, and the people who do engage in such transactions tend to be highly sophisticated investors — and indeed are probably engaging in some kind of relative-value trade of their own.

Add it all up, and I really don’t think that what Blackstone did was particularly egregious; there’s certainly no reason to believe that it should be illegal. The Daily Show basically accuses Blackstone of setting fire to Codere so that it could collect the insurance proceeds — but in fact Blackstone’s actions were a large part of the reason why Codere managed to survive. Far from being a pile of ashes, Codere now has a real chance of avoiding liquidation. For a piece of clever financial engineering, that’s an uncommonly positive societal outcome.


Every contract, in the US at least, includes an implied covenant of good faith and fair dealing. Blackstone’s actions as described appear to violate that covenant. Moreover, I wouldn’t be surprised if a motivated prosecutor could find a criminal violation here. It’s disturbing that the article focused on the amount of profit Blackstone made, and not the allegation that the company created the default it collected on. If that is business as usual in the derivative markets, something has to change. Get your moral compass fixed, Felix! Then ask the counter-party how it feels about paying off after Blackstone’s manipulation.

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The $5 trillion dilemma facing banking regulators

Felix Salmon
Dec 3, 2013 17:16 UTC

Last month, I wrote about bond-market illiquidity — the problem that it’s incredibly difficult to buy and sell bonds in any kind of volume, especially if they’re not Treasuries. That’s a big issue — but it turns out there’s an even bigger issue hiding in the same vicinity.

The problem is that there’s only a certain amount of liquidity to go around — and under Dodd-Frank rules, a huge proportion of that liquidity has to be available to exchanges and clearinghouses, the hubs which sit in the middle of the derivatives market and act as an insulating buffer, making sure that the failure of one entity doesn’t cascade through the entire system.

Craig Pirrong has a good overview of what’s going on, and I’m glad to say that Thomson Reuters is leading the charge in terms of reporting about all this: see, for instance, recent pieces by Karen Brettell, Christopher Whittall, and Helen Bartholomew. The problem is that it’s not an easy subject to understand, and most of the coverage of the issue tends to assume a lot of background knowledge. So, let me try to (over)simplify a little.

During the financial crisis, everybody became familiar with the idea that a bank could be “too interconnected to fail”. The problem arises from the way that derivatives tend to accumulate: if you have a certain position with a certain counterparty, and you want to unwind that position, then you can try to negotiate with your original counterparty — but they might not be particularly inclined to give you the best price. So instead you enter into an offsetting position with a different counterparty. You now have two derivatives positions, rather than one. The profits on one should offset any losses on the other — but your counterparty risk has doubled. As a result, total counterparty risk only ever goes up, and when a bank like Lehman Brothers fails, the entire financial system gets put at risk.

There are two solutions to this problem. One is bilateral netting — a system whereby banks look at the various contracts they have outstanding with each of their counterparties, and simply tear them up where they offset each other. That can be quite effective, especially in credit derivatives. The second solution is to force banks to move more of their derivatives business to centralized exchanges. If there’s a single central counterparty who faces everyone, then the problem of ever-growing derivatives books goes away naturally.

Of course, if everybody faces a central counterparty, then it’s of paramount importance to ensure that the clearinghouse in question will itself never fail. Naturally, the clearinghouse doesn’t own any positions, but on top of that it has to be able to cope with its own counterparties failing. Typically, the way it does that — and we saw this during MF Global’s collapse — is to demand ever-increasing amounts of collateral whenever there’s a sign of trouble.

Such demands have two effects of their own. The first, and most important, effect is that they really do protect the central clearinghouse from going bust. But the secondary effect is that they increase the amount of stress everywhere else in the system. (MF Global might have ended up going bust anyway, but all those extra collateral demands certainly served to accelerate its downfall.) Pirrong calls this “the levee effect”:

Just as making the levee higher at one point does not reduce flooding risk throughout a river system, but redistributes it, strengthening a central counterparty (CCP) can redistribute shocks elsewhere in the system in a highly destabilizing way. CCP managers focus on CCP survival, not on the survival of the entire system, and this is quite dangerous when as is almost certainly the case, their decisions have external effects. Indeed, greater reliance on CCPs increases the tightness of the coupling of the financial system, which can be highly problematic under stressed conditions.

Essentially, when markets start getting stressed, liquidity and collateral will start flowing in very large quantities from banks to clearinghouses. Indeed, to be on the safe side, central clearinghouses are likely to demand very large amounts of collateral — as much as $5 trillion, according to some estimates — even during relatively benign market conditions. That is good for the clearinghouses, and bad for the banks. And while it’s important that the clearinghouses don’t go bust, it’s equally important that the banks don’t all end up forced into a massive liquidity crunch as a result of the clearinghouses’ attempts at self-preservation.

The banks, of course, will look after themselves first — especially as the new Basel III liquidity requirements start to bite. If they need to retain a lot of liquid assets for themselves, and they also need to ship a lot of liquid assets over to clearinghouses, then there won’t be anything left for their clients. Historically, when clients have needed to post collateral, they’ve been able to get it from the banks. But under Basel III, the banks are likely to be unable or unwilling to provide that collateral.

So where will clients turn? These are truly enormous businesses which might need to be replaced: Barclays has cleared some $26.5 trillion of client trades, while JP Morgan sees an extra half a billion dollars a year in revenue from clearing and collateral management.

Just as in the bond markets, one option is that the clients — the buy-side investors — will turn to each other for collateral, instead of always turning to intermediary banks. That’s already beginning to happen: some 10% to 15% of collateral trades already involve non-banking counterparties. But it’s still very unclear how far this trend can be pushed:

While corporates and buysiders might be comfortable sharing confidential information with their banking counterparties, shifting to a customer-to-customer model is a big step.

“The problem is that buyside firms have to open up their credit credentials to each other to get a credit line in place. I always felt that was an impediment to customer-to-customer business, but the combined impact of new rules changed that,” said Osborne.

Osborne, here, is Newedge’s Angela Osborne; her job is to start replacing banks in the collateral-management business. Once you adjust for Osborne talking her own book, it’s clear that there’s still a very long way to go before the banks will realistically be able to step back from this market.

After all, it’s not as though the banks’ buy-side clients themselves have unlimited amounts of collateral which they can happily post at a moment’s notice. It’s true that they aren’t as leveraged as the banks are. But they themselves have investors, who can generally ask for their money back at any time — normally, when doing so is most inconvenient for the fund in question. If they tie up assets posting collateral for themselves or others, that makes it much harder for them to meet potential redemption requests.

All of which means that as we move to a system of central clearinghouses, a new systemic risk is emerging: “fire sale risk” is the term of art. If a market becomes stressed, and the clearinghouses raise their margin requirements, then the consequences can be huge. In the bond market, the death spiral is all too well known: a sovereign starts looking risky, the margin on its bonds is hiked, which in turn triggers a sell-off in that country’s bonds, which makes them seem even riskier, which triggers another margin hike, and so on. This can happen in any asset class, but derivatives are in many ways the most dangerous, just because they’re inherently leveraged, and the amount of leverage that the clearinghouses allow can be changed at a moment’s notice.

Do the world’s macroprudential regulators have a clear plan to stop this from happening? Do they have any plan to resolve the inherent tension involved in demanding that banks retain large amounts of ready liquidity, even as they also allow clearinghouses to demand unlimited amounts of liquidity from the very same banks? The answers to those questions are — at least for the time being — very unclear. But the risk is very real, and it makes sense that regulators should do something to try to mitigate it.


Maybe I am missing something but this pretty much seems to be a made up risk to me. It would make sense for the banks to push this story so they can keep screwing over their costumers with OTC derivatives.

Is there any example in history of a clearing house causing a financial crisis? Collateral calls add stability to the system by lowering leverage before it gets to levels where systematic default is a danger. If a collateral shortage leads to the credit derivative market shrinking that is a positive in my book.

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The Deutsche allegations

Felix Salmon
Dec 6, 2012 09:27 UTC

Tom Braithwaite, Michael Mackenzie and Kara Scannell of the FT have one of the wonkiest articles I can ever remember reading in any newspaper, trying to explain the mechanics behind the complaints that various former Deutsche Bank employees have taken to the SEC. Matthew Goldstein first reported on the whistleblower complaints last year, in pretty vague terms; the FT has now added a huge amount of detail.

I have sympathy with all three of the sides in this story: Deutsche Bank, the SEC, and the whistleblowers. The main whistleblower in the FT story is Eric Ben-Artzi, who joined Deutsche in 2010, when the actions in question were already in the past. An alumnus of Goldman Sachs, he was assiduous about finding and defining all the various exotic risks that can crop up in derivatives portfolios, and he ultimately came to the conclusion that during the crisis, Deutsche hadn’t been marking those risks properly to market.

Ben-Artzi, along with at least two other Deutsche whistleblowers, took his complaints to the SEC, which in turn heard them out but has not (as yet) accused the bank of any wrongdoing in the matter. These things are highly complex, and very hard to get a prosecution on, and frankly the SEC probably has more important things to do. Here’s how the FT story concludes:

By 2012, many of the trades have matured or have been unwound. With credit markets back to more normal levels, Deutsche’s dalliance with exotic derivatives is no longer life-threatening. A person familiar with the matter says that for all the sturm und drang over gap risk, at no time was the collateral jeopardised.

But the three former employees told the SEC that this outcome does not mean the allegations should be forgotten. “If Lehman Brothers didn’t have to mark its books for six months it might still be in business,” says one of the men. “And if Deutsche had marked its books it might have been in the same position as Lehman.”

The “gap risk” here needs a little bit of explanation. Simplifying a bit, let’s say that Deutsche Bank bought $130 billion of protection from some Canadians, but the Canadians, in turn, only put up $1.3 billion of collateral. Deutsche never actually called on that collateral — but there was a risk that something catastrophic would happen, and that it would demand much more than $100 million. In that event, the Canadians would probably have just walked away, leaving their $1.3 billion behind, but also leaving Deutsche on the hook for potentially enormous losses.

The question then becomes: what is the value of the protection that Deutsche bought from the Canadians? And the answer depends in part on what Deutsche did to hedge the risk that the Canadians would walk away. Deutsche hedged that risk — the “gap risk” in various ways at various times — first it applied a “haircut” to the valuation of the trades, then it used a reserve account, and finally it bought put options from Warren Buffett.

None of these hedges was remotely perfect, however, and Ben-Artzi, who came from a bank which was notoriously aggressive in such matters, came to the conclusion that the $130 billion of protection had actually been worth roughly $10 billion less than that, if you marked its value to, um, “market”. One problem with this, of course, is that at the height of the financial crisis, the ability of Deutsche Bank to sell $130 billion of leveraged super-senior derivatives was exactly zero. There was no real liquid market to mark to, and what Ben-Artzi was really doing here was “marking to model”.

In the end, what the whistleblowers seem to be complaining about here was that Deutsche didn’t aggressively write down its assets so far that “it might have been in the same position as Lehman.” And why on earth should it have done such a thing? Well, an equally aggressive SEC could surely try to make the case that US GAAP required them to. But let’s take a step back here.

The whole point of banks is that they lend money for the long term, “through the cycle”, and make money over the long terms as well. Sometimes defaults spike, but if you can get through those tough periods, then banking can be a profitable business overall. Now that’s not the way that Goldman Sachs thinks. At Goldman, everything is marked to market every day, and the bank competes on fighting as hard as it can for daily profits. There’s no delusional marking-to-par at Goldman: it’s far more disciplined than that.

But if everybody behaved like Goldman, the result would be a disaster. Specifically, it’s fair to say that if you have a broad economic crisis and there’s not much liquidity in the credit market, then if you assiduously marked every asset to market, the entire banking system would be insolvent. Indeed, a common-or-garden cyclical recession can sometimes come close to having the same effect. If one or two investment banks mark their balance sheets to market every day, that’s fine. But if every bank in the system were to do such a thing, there would never be a bank in the country more than a decade or two old. After all, as even some Goldman executives will now quietly admit, no amount of clever counterparty hedging can protect a bank against the risk that the global financial system collapses.

Deutsche was not selling its super-senior portfolio during the crisis, it was holding on to it. Should it have marked the value of that portfolio down by $12 billion, on the grounds that mark-to-market rules required it to do so? I have no idea: the whistleblowers think it should have, while Deutsche Bank is adamant that it has investigated the allegations and found no particular cause for concern.

But here’s a certainty: seeing Deutsche Bank take a $12 billion writedown at the height of the crisis would have been almost as bad for the system as a whole as seeing Lehman go bankrupt. The time for kitchen-sink writedowns is when you can afford them, not when you can’t. And while there’s a convenient fiction that quarterly accounts are simply the product of following clear and simple rules, no one really believes it — especially not in the ultra-complex world of derivatives accounting.

It’s pretty clear that the world is a better place for Deutsche Bank not having taken a gratuitous writedown on the grounds that even though it had billions of dollars of collateral from the Canadians, that might not be enough to cover what they owed if the crisis got even worse. I remember those crisis days vividly; they were characterized by policymakers on every continent doing everything they possibly could to boost the liquidity and confidence in the financial system. (Well, except for maybe Sheila Bair.)

The whistleblowers say that when Deutsche Bank reported record profits at the end of the first quarter of 2009, it was reporting fiction, because there should have been enormous charges related to derivatives valuation. But I’m happy that Deutsche managed to find a way to keep its accounts in shape during those most dreadful months. Here’s the FT again, talking about early 2009:

In an investor call that February, Mr Ackermann said he would provide “as much clarity as we can on all the positions” to refute the suggestion that banks such as his had “hidden losses, and one day that will pop up, and then . . . we need more capital.”

Ackerman’s performance paid off: his share price rallied, and soon the worst of the crisis was behind us. If he had taken an eleven-figure charge in the first quarter of 2009, that would have been the absolutely worst possible time to do so, both for his bank and for the financial system as a whole. Deutsche Bank survived, the positions turned out to be healthy, and when you see situations as unique and exceptional as this one, there’s a strong case to say “no harm, no foul”.

No good would have come of Deutsche doing what the whistleblowers say it should have done; instead, its profits helped to restore badly-needed confidence in the system as a whole. It’s not exactly a shining precedent. But given how unique and terrible this crisis was, I’m inclined to give Deutsche a pass.


What DB did deserves no sympathy and is outrageous. The author clearly is very superficial and does not understand the difference between retail bank and derivative speculating Investment Bank. When retail bank issues a mortgage at 5% that it thinks it can finance at 4% DOES NOT recognise ALL THE PROFIT EXPECTED TO ACCRUE FROM THIS OVER THE YEARS on the very first day of the mortgage. It does it over the life of the mortgage. Investment Bank WILL recognise it all on DAY ONE – it is called Fair Value Accounting. BUT WHAT IT MEANS IF MARKET CONDITIONS CHANGE AND NOW THE MORTGAGE IS PERCEIVED LESS VALUABLE BY THE MARKET IT MUST, ABSOLUTELY MUST, recognise the losses. If allegations are true (and I am quite sure they are) then DB will have recognised all potential profit during the good times and just sat quiet during bad. LEHMAN was honest – and hence failed. If it is proved that DB were at wrong and it enabled the to survive – they should be fined sufficient amount that will force them to go bust – otherwise it is just not fair!

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Mining the Australian CPDO decision

Felix Salmon
Nov 9, 2012 07:58 UTC

Now that the election is over, there’s a bit of time to revisit that very important CPDO decision I wrote about on Monday. There’s a lot of material to be mined here, and the Internet is slowly delving its way into it: I particularly love, for instance, the way that Daniel Davies started tweeting out noteworthy paragraphs.

But first there’s Paul Davies, who does a great job of explaining the revolving-door aspect to the case. You know how banks will hire regulators, at multiples of their former salary, and turn the former gamekeepers into poachers? Well, exactly the same thing happens to S&P: it pays better than the US government, but not nearly as well as the structured-credit department at ABN Amro. And thus a whole slew of S&P alumni ended up at the Dutch bank, putting together deals precisely designed to be the absolutely worst possible product in the world which could still, somehow, get a triple-A rating. In order to do that, you need people who know how the ratings sausage is made — and the easiest way to do that is to simply hire them.

S&P was well aware of what ABN Amro was doing, of course, but they had no incentive to frown on its behavior. For one thing it was good news for staffers that there was a healthy bid out there for their services; for another, ABN Amro paid S&P itself huge amounts of money to rate these deals. Everybody won — except the credulous investors who thought that ratings were honest, arm’s-length things.

Matt Levine points out that conceptually, the CPDO is “the perfect ratings arbitrage”, because the rating just tries to calculate the probability of default, without regard to the recovery value given default. As a result, the CPDO was specifically designed to have a recovery given default of very near zero, since that would increase the yield on the instrument without increasing the default rate. (This is exactly the same reason why it was S&P, rather than Moody’s, which downgraded the US from triple-A last year.)

Louise Bowman, meanwhile, finds this email exchange, between a couple of S&P quants:

Mr Venus: I am done with the whole CPDO – wish I was never involved in that whole mess that was made.

Mr Ding: What a wuss.

Mr Venus: That thing is done by 3 people: Cian, Sriram and you. I am not responsible, I just helped build an internal model. You are the wuss for bending over in front of bankers and taking it.

Mr Ding: primarily me and the banker…so what? I would not mind if they put my name on that article, grow up kid.

Mr Venus: You rate something AAA, when it is really A-? You proud of that little mistake? It’s nothing to do with growing up, it’s about doing your job to a high standard. If you want to talk about growing up, you should admit to Perry [Inglis] that you made a mistake with your analysis.

But the smartest lines, still, come from the judge, Jayne Jagot. For instance, she spends a lot of time demolishing the S&P argument that the investors didn’t understand what they were buying, and therefore that it was the investors’ fault, not S&P’s fault, that the investors lost money. Jagot demonstrates clearly that the investors knew full well that they didn’t understand the CPDOs, and that it wasn’t necessarily stupid of them to invest anyway:

The notion that it was necessarily imprudent of the councils to invest in a product they did not understand, on analysis, is specious. It is a superficially attractive catchphrase which does not withstand scrutiny. An investor who obtains expert advice and relies on an expert rating is not imprudent merely because the investor does not understand the investment. So in this case the councils’ lack of understanding and their knowledge of their own lack of capacity to understand was the reason for relying on the expert advice and recommendations of LGFS and the expert opinion of S&P embodied in the rating.

The fact is that in the fixed-income world, investors almost never understand what they are buying. A bond is a set of predictable cashflows, with a sting in the tail: it has some unknowable probability of default. Different analysts can try to calculate that probability by different means, but in reality bond investors simply don’t have the time or the expertise to do that for every bond they buy. That’s where ratings come in handy: they’re a way for bond investors to outsource a lot of the hard work they don’t have the time or the human capital to do themselves. And the ratings agencies know it: as Jagot says, “S&P is paid to assign a rating for a structured financial product for one purpose only.”

And then there’s the bigger picture: the fact that Jagot was able to deliver this magnum opus of an opinion at all. It’s clearly the product of vast amounts of work, and a positively enormous amount of lawyering on both sides. The victims, in this case, were relatively small Australian municipalities: how did they manage to afford to fight this court case this far?

The answer is, they didn’t: all of the legal fees were paid by a litigation funder called IMF (Australia), which will take a cut of any proceeds. They write:

Litigation finance is a critical mechanism to enable cases to be brought and litigated against large corporations, banks and other powerful institutions, often by small and mid-sized companies and entities.

The Australian Federal Court’s finding yesterday — in favor of local municipalities — that S&P’s AAA ratings were “misleading and deceptive” could never have been achieved without litigation funding support from IMF (Australia), Bentham’s parent.

I have no problem at all with companies like IMF funding these lawsuits. It’s incredibly hard for investors to successfully sue big financial-services companies like S&P, and litigation funders help to level the playing field. Even if they end up getting paid no money at all, they have at least caused Jagot’s wonderful opinion to see the light of day. And that alone is a massive public service.


An idea I’ve been rolling around my head for a while, which would require some implementation details that I’m missing, is that rather than use ratings for whatever regulatory purposes we currently use them for, we cap the returns on assets, taxing the overage at 100%. If you’re holding assets in a bucket that is currently required to be investment grade, you’re allowed to decide whether they are investment grade yourself, without relying on a ratings agency, but once you have made that declaration to your regulator, your regulator can tell you what kind of current return one can expect on investment grade assets; if it’s 6%, and you get an 8% return, 2% of the asset goes to the IRS.

The idea here is that, when you say they are trying to construct “the worst possible” instrument with a particular rating, you’re assuming a degree of market efficiency; what they’re really trying to get isn’t the product most likely to implode, but the product with the highest yield, and the markets are efficient enough that these are reasonably close. I want to use that for regulatory purposes. Indeed, once you get your investment-grade bucket to 6%, you have no incentive to increase yield (which you lose), but you do have an incentive to decrease risk (which you keep); to the extent market inefficiencies can be found, your incentive is to use them to reduce risk rather than chase yield.

If someone develops a security that generates 18% returns and gets S&P to stick a AA- label on it, I’m not betting on S&P.

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Debating financial speculation with speculators

Felix Salmon
Jun 23, 2011 18:31 UTC

On Tuesday I moderated a panel at the New York Forum which featured, inter alia, Duncan Niederauer, the CEO of the New York Stock Exchange, and Richard Robb, the CEO of Christofferson Robb, a money management firm which does its fair share of speculation.

My question at the beginning of this clip, for Niederauer, didn’t come entirely out of the blue. Amar Bhidé had previously talked about the casino aspect of markets, and Andrew Ross Sorkin had talked about the distinction between speculation and investment. But Niederauer was not happy when I pushed him on these concepts. Wall Street is increasingly a game of speculation rather than investment, I said, and asked how a casino operator pushing people to make bets over the course of a millisecond was not part of the problem. Rather than engaging with the question, he simply shut me down: “I thought my job description was quite different than what you just described,” he said. “So you must be talking to someone else.”

Niederauer then used all his media training to pivot and give a mini-speech instead about how self-regulation was better than Dodd-Frank. But Richard Robb, to his credit, engaged, even if what he said doesn’t stand up to scrutiny. “I don’t know what the difference between investing and speculation looks like,” he said, throwing up a straw man of everybody working at peoples’ tractor collectives. Robb’s prescription was essentially to do nothing but ban a few of his competitors: stop big banks from doing what he does, leave him alone to do anything he wants, and “let innovation find its own way, and if it’s parasitic and unproductive, it will not be rewarded by the capitalist system.”

That’s clearly false, of course: we can all think of parasitic and unproductive Wall Street innovations which have made millions of dollars for bankers and traders and money managers. Richard Robb himself gave a good example earlier on in the panel: structured investment vehicles.

And so Sorkin jumped in, making the good and obvious point that “it’s actually very easy to see what speculation is and what investing is.” Here’s one simple distinction: speculation is where you buy something in the expectation that it will rise in price, where investment is where you put money into something so that over the long term you can make a profit from the resulting cashflows, be they coupon payments or dividends. And as Sorkin said, if you make an investment for two seconds, that’s clearly speculation.

Robb’s response to Sorkin I think was one of the most telling points of the panel. “How about two days?” he asked. “Two weeks? Two months? Where would you draw the line?”

I could barely believe what I was hearing — was Robb really suggesting that holding a position for two days might be considered investment rather than speculation? Or even two months? All of them are speculation — and the fact that the likes of Niederauer and Robb can’t see that is I think a big part of the problem.

The subject of the panel was financial innovation, and Robb genuinely believes that he’s something of a centrist on the issue: he makes great play of agreeing with his friend Bhidé, for instance. But the fact is that if you’re talking to alumni of Goldman Sachs (Niederauer) or the University of Chicago (Robb), or someone who used to run the derivatives desk at a too-big-to-fail bank (Robb, again), then their idea of what’s good for the world is always going to be pretty skewed. They’ve made millions of dollars in the Wall Street casino, and they’re precisely the people being put on panels to ask whether the casino is a good thing. It’s reasonably easy to predict what they’re going to say — and to discount it heavily.


Without reading all the comments, I will say the “investment is good and speculation is bad” construct is fatally flawed. I’m a big supporter of more regulation of the finance industry, but I think pure, greedy speculation can have a lot of upside, particularly through increasing liquidity in certain instruments.

In the commodity markets, for example, it would be tough to see a market for hedges for airlines, farmers or food producers without traders constantly trying to make a buck. The old-fashioned market-makers on the NYSE floor also do the same thing, doing nothing except trying to buy low and sell high. I read once that most guys still on the floor read the New York Post rather than the WSJ. They couldn’t really care less about the long-term fundamentals of a company, but they still help grease the wheels for investment.

The real issue is how speculators could take systematically dangerous risks. Do you remember all the CME traders threatening the downfall of the international markets? Neither do I. On the shadow market, on the other hand, counterparty risk can be extremely unpredictable and subject markets to bank runs. The real way to help make financial markets robust is not to demonize “speculation,” but the system robust to too much speculation.

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