The Eye of the Beholder - RnRF Reviews: The Big Short [movie]

I got to distract myself from this wretched referendum business tonight. Resurrecting the old “The Eye of the Beholder” review column seems like a good idea. 

So I watched “The Big Short” the other day. And I’m going to come right to the conclusion: it is funnier than it has any right to be and quite possibly more educational than one might expect. How so? Well, it manages to break down some of the more obscure and convoluted shenanigans of the world of banking into nice little bite-sized chunks that you can wrap your head around without getting all stressed about random terminology and auto-fellating acronyms. Nice! What’s more, those bite-sized chunks are presented in a way that is both shallow and endearing and totally captures your attention. Like when Margot Robbie explains the sub-prime bond market in bozo-language whilst sitting in her bubble bath, sipping champagne. Crude, but it works.

Dorks - Rockstars of Finance

Obviously just about all the characters are caricatures. The bankers are generally on the borderline between Slytherin-style group think and ‘greed-is-good’ Gordon Gekko infatuation (mind you, _that_ is pretty real). The wider industry is fully of has-beens, wannabes…generally sub-prime, really. The Hedge Fund guys are all really smart, oddball weirdos. With the smartest of them all basically displaying undiagnosed  Aspergers syndrome. But that doesn’t really matter, because it all works to propel the story forward. In an entertaining and understandable way. Which matters, because let’s face it, when did you last figure out you actually _wanted_ to spend two hours of your Saturday night trying to figure out how and why a fairly esoteric market for acronym-heavy derivatives contracts was essential to bring about the total and utter cluster-fucking meltdown of not only the US housing market, but basically the whole global financial world? Well, almost. But it was close. Anyway, the point is: this is fun and educational in one!! Also, for added bonus, the chief geek of them all - Neurologist turned hedge-fund manager Michael Burry - is a total metal-head and basically cranks Mastodon et al in his office while he is meditating on how the whole rotten edifice that is the sub-prime mortgage bond market will come crashing down. Forget the silly motion-picture soundtrack. Try to get a hold of the Michael-Burry-thinks-about-ARMs-resetting-as-trigger-for-the-financial-apocalypse playlist and you’ll do well with that. 

What you get is a funny - bordering on hilarious at times - ride through a world that is opaque, often maligned beyond sense and nonetheless crucial to the lives of gazillions of people without tooooo many figuring out how that is actually the case. At the end of it you might even walk away feeling a bit more enlightened about WTF went down in those crazily boring looking office buildings that financial institutions seem so fond of. And of course, the little guys win in the end. The smelly little secret you might forget by the end of the movie is that the rogues and outsiders, the little guys that ‘win’ against the banks by figuring out that the system is rotten and about to become unstuck aren’t that little to start with. These guys are all hedge fund managers. By all rational measures they are already at the top of the tree. They are worth tens of millions each where the story picks up. So be careful when you’re getting all excited about how they are taking on the man. They’re not exactly working in a coal mine. Fucked up? Yup!

That end note is a bit more depressing than I care for. How about we finish with that delightful segment where Margot Robbie Explains the mortgage bond market in a bubble bath:

See! Better already!!

KISS – Keep it simple, stupid! Or: Derivatives, Models, Academics… and Tazers

Sorry, I’ve been away for a while. Too much to do, not enough sleep, etc. Which is a shame; after all there is an embarrassment of riches or rather topics to bitch about out there! In fact, part of the reason why I have not been more prolific lately is that I just cannot seem to keep up with what going on out there. Too many crises, acts of muppetry or reasons to gawk incredulously to even begin to gather my thoughts before the next one is up on the agenda. It’s stressful! Anyway, enough prevarication let us move on.

The first thing I have to do is to make sure that you understand that I DO NOT regularly (or even occasionally) read The Guardian. I strictly limit myself to articles and columns recommended to me by concerned friends. Thus I was confronted with a piece on the pitfalls of mathematical modeling in finance that was on the face of it actually reasonably well thought out. Please find aforementioned piece here. Shame, however, that in the end the author managed to not only conflate about three or four different problems that plague the world of finance but also missed out a number of glaring problems with the thrust of his argument and then finally came up with the weirdest and most hackneyed remedy to the mess we are in that only a dyed-in-the-wool materialist dialectic type Marxist who sadly doesn’t really understand Marx (or possibly did not read him to the end).

Right, so what are my points of contention?

Number one: Black-Scholes is not the all there is to financial modeling – Despite the somewhat excessive use of big names, a historical narrative that goes back to the beginning of the 20^th century mathematics and features super numerate Frenchmen and cryptic terms such as “Brownian motion” the Black-Scholes model is not really all there is to quantitative finance. In fact, it’s used for a very specific purpose, namely valuing options. And granted, therein lies a challenge. And it is open to abuse. And it can, if misused, bring about all manner of financial ruin. However, it didn’t really bring about the credit crunch all by itself (granted the author indemnifies himself a bit by phrasing the thrust of his argument in such a manner as to avoid stating that B-S [yes, funny(ish) acronym] is directly responsible for the credit crunch and merely “opened” the field, but the implication is pretty blunt). For that one needs all manner of other mathematical chimeras that defy easy comprehension: Gaussian cupolas, mean reversion theorems, VAR, Monte Carlo simulations, the list goes on and on. Just burrowing into the history of one particular type of financial modeling technique doesn’t really make for a comprehensive argument about the use of mathematical models in finance. Especially if that history is bereft of it’s proper context and leaves out a cautionary tale that is known industry wide. Which leads me to my next point.

Number two: Long Term Capital Management … Kaboom! Rather gamely, the author informs us, that the brains that developed the B-S formula (or rather the surviving part, seeing that Mr. Black passed away a before it could come to pass) were awarded the Nobel prize for economics in 1997. What he fails to mention is that Myron Scholes and Robert Merton (who didn’t author the model but refined it) basically lost their shirts when the investment company they co-founded – not overly prophetically named Long Term Capital Management – demonstrated the limits of the usefulness of their theoretical acumen by imploding. The fact that LCTM peaked and then died in 1998, the year following the award of the Nobel prize, does actually make me think that whoever is in charge of the universe does have a wicked sense of irony. At any rate, that story has been and remains a constant reminder for any option trader to not rely on B-S derived option valuations too much. I bet you; even the most illiterate option desk in the city has a copy of this book lying around somewhere.

John Meriwhether, Robert C. Merton and Myron Scholes as seen by themselves.

John Meriwhether, Robert C. Merton and Myron Scholes as seen by the financial industry.

Number three: Derivatives are not simply bets on bets – Another thing that really annoys me about that article is the obtuseness with which derivatives are simply described as “investments in investments, bets about bets”. I’d expect that kind of definition from a dreadlocked tramp at the Occupy camp outside St Paul’s, not from a Emeritus Professor of Mathematics at Warwick University and a Fellow of the Royal Society who has written over 80 books, and has won three gold medals for his work on the public understanding of science. With this standard of work, I do wonder who awarded those gold medals? Derivatives do cover a humongous range of different financial products, which across all different types do share one – and only one – characteristic: Their value is determined not intrinsically, but through observation of another, underlying asset. It is derived; hence the name derivative. And yes, they can be bets upon bets. But they are not necessarily so. To say so is a bit like asserting that hammers are instruments of murder. They certainly can be, but I’m not so sure that really comprehensively captures the essence of what a derivative is. To be fair, derivatives are a bit more complex than hammers. They also can wreak havoc on a larger scale. But the analogy does work. Oh, and please spare me the Warren Buffet comment.

Number four: More models are NOT the answer!!! – The single most mind-boggling thing about the whole article really is the conclusion. Namely, that the answer to the travails of the world of modern finance lies in an increase in the reliance on mathematical models. I’m not quite clear how the factually somewhat compromised but still largely coherent rant about the inadequacy and misuse of mathematical models in the world of derivatives finance leads to the conclusion that more rather than less emphasis needs to be put on developing ever more complex models. I mean, he does get one thing right: model abuse is at the heart of a rotten system. How that model abuse is remedied by use of more intricate (and by implication less well understood) models is beyond me. I daresay trying to make it more academic is not the answer. But then again, Emeritus Professor of Mathematics at Warwick University tactfully failed to mention that his esteemed and academically minded colleagues’ venture into the world of finance did end with a bang and not a chest beating roar of triumph. Personally I think finance should be run more like Tazerball:

And I think next I’ll try and write something about pirates!

The Eye of the Beholder - RnRF-Reviews: Lulu

No, it doesn't get less depressing.

First: No, it's not Master of Puppets part two. If you are one of those dyed-in-the-wool-total-bonehead-let-it-be-1986-again die-hards who just cannot cope with Metallica not trying to record the same album for the 17th time, then this record is not for you. Stop reading this and go back to trying to fit into your black stretch jeans. Second: I'm not liable to give you a truly unbiased account of this. I love Metallica. I even managed to find something (very little) vaguely redeemable in the mess that was Garage Inc. So don't expect me to go all high-brow and read a yard of Brecht before I go and comment on the somewhat anxiously awaited collaboration between Metallica, the royalty of all things metal, and Lou Reed, erstwhile frontman of cutting edge art-rock wonder Velvet Underground and by now probably one of the gnarliest and moodiest bully-brains on stage.
Talking of anxiety: I had been anticipating the arrival of 'Lulu' with a barely contained sense of dread since from when I first learned about the collaboration effort between the (by now slightly ageing) gods of thunder and the (yet even older) undisputed king of sexually inspired misery poetry. What good could possibly come of that? I wasn't heartened after the first bunch of reviews. At best there seemed to be a sense of confusion and incredulity mounting in the open minded. Outright disbelief and scorn from traditionalists on both side of the marriage. And howls of incomprehension from the rest. Not exactly a good sign.

All in all, somewhat unexpected.

Strangely enough, however, I kind of like this album. Don't get me wrong, it's not exactly the kind of aural energy drink equivalent you listen to on the way to the office to get pumped up before a particularly beastly client meeting. It's more of a soundtrack to an evening with a bottle of wine, a gripe about political incompetence in the Eurozone or the inversion a CDS curve and the time to turn it into a blog post. It's not an entirely sane affair. It does name-check both Boris Karloff and Klaus Kinski in the first song. And it kind of relegates one of the world's most dominant and charismatic rockbands to a supporting ensemble to an expert in bitterness. Except that that supporting ensemble occasionally coalesces into a menacing snarl that reminds you that it  _is_ Metallica that is hanging back in the wings. What it does have is tension and latent violence that sometimes comes close to the surface. Like a fanged octopus-monster rising to the surface of a muddy lagoon...while some demented shaman is howling it's name in some Lovecraftian un-language. And a palpable sense of disappointment that is what the music is about. Not what it is!
So would this discerning critic recommend it to you? Not if you are looking to stuff something entertaining onto your iPod. To be honest, this is probably best listened to at home, on your own, when you are sufficiently misanthropic to start with. And bear in mind that I actually wanted to like this. I'm sure you can find plenty of reasons to find this underwhelming. But if you are ready to accept that jaded millionaire rockstars can sometime actually strike gold in their (often misguided) search for a new experience, rather than turn into Iron Maiden / a circus act, then this might actually work for you. Just don't expect to feel chipper afterwards.

Raining Blood - Greece, Mercs, Merkel and the EFSF

Raining blood

From a lacerated sky

Bleeding its horror

Feeding my structure

Now I shall reign in blood!

- Raining Blood by Slayer - 

"One more referendum and I will fuck him up."

Today something vaguely frightening/flattering happened: the inimitable, esteemed and often unflappable blogger and keen observer to the human condition RogerofSicily dared me to explain or - even worse - make sense of the Kabuki theater that is the European effort to bail out Greece. It’s not exactly like he’s asking me to unify quantum physics and Einstein’s view of the world but it still made me kind of gulp with trepidation. But then again, this is Rock’n’RollFinance! So there, here we go: Challenge accepted! ...Don’t blame me if this gets boring half way through!

Rather than go straight to the “why bother?” part of the bail-out question, it might be worthwhile to start with the “how did we end up in this mess?” end. To brighten things up I’ll be channeling a bit of Teutonic working class heroism in an effort to bring us closer to comprehension. I’ll be drawing heavily on the efforts of Superfritz. Hope you don’t mind, but do consider yourself referenced!

So let’s step away from the global super-macro perspective and have a look at the German micro perspective to understand why this is (politically) not exactly straightforward. The story goes as follows:

German worker goes to work and builds a great Mercedes.

German worker gets paid 2,500 Euros, pays 1,000 Euros taxes/social security and saves 250 Euros on his savings account at stupid German bank, because he wants to buy a great Mercedes sometime in the future.

Stupid German bank takes the 250 Euros and buys some funny paper from a stupid US bank for 100 Euros and some more funny papers from US government for 100 Euros, converted into 100 Dollars. For good measure it also buys some 50 Euros of funny paper from the Greek government.

The stupid US bank is happy. It found someone even more stupid to buy its mortgage risks.

US government is happy. It has a handful of wars to run and taxes to break. Wars and tax breaks are expensive.

Greek government is happy. It has a legion of civil service unions to buy off and needs to keep up with the neighbours in the “buying-Bundeswehr-surplus-tanks” competition. Doesn’t have to bother with tax collection either now!

Stupid US bank pays huge bonus to banker who sold funny paper. Stupid German bank pays huge bonus to banker who bought funny paper.

Stupid US bank takes the 100 Euros and grants another mortgage to US IT consultant.

US IT consultant takes out mortgage, uses the money (incl. the 100 Euros saved by the German worker) to buy himself a great Mercedes for 100,000 Euros. Why wait and save to buy it? That's so 1950s! US IT consultant is happy. His house has turned him into millionaire. He drives a great Mercedes.

Mercedes is happy. It now has money to pay 2,500 Euro to the German worker, 10,000 to the German government and 87,500 Euros to its shareholders in Kuwait.

Kuwait shareholders are happy.

German government takes 10,000 Euros, pays 5,000 to pensioners and unemployed, 1,000 to Eastern Germany, 3,000 for "other expenses" and 1,000 Euros for non-existent olive trees in Greece and great Spanish Autobahns.

Greek farmer is happy. Considers buying a Mercedes. Spanish construction worker is happy. Considers buying a Mercedes. German worker doesn't really understand what's going on. Goes to work to build Mercedes.

Scene at the Eurozone bail-out summit

Restart at top. Repeat 10 times. 

= Trade imbalance.

Turns out, US IT consultants house is worth half his mortgage. US IT consultant gives house and car keys back to bank. Pity. But what a great time he had with his great Mercedes!

Stupid US bank goes bankrupt.

Stupid German bank reads the funny paper it bought from stupid US bank for the first time (500 pages in English, hello?) and finds out it's bankrupt, too.

German government uses taxes of German worker to bail out stupid German bank's shareholders. German worker's kids Kindergarten is not refurbished. No money left. But German worker still has savings of 250 Euros at state owned stupid German bank. Phew!

Stupid US bank is bailed out by US state, using the 100 Euros saved by German worker given to it by stupid German bank.

US government is broke. Invents new term for inflating debt away. "Quantitative easing”, sounds funny. German worker doesn't get it. 

US government returns 100 USD to stupid German bank. Bank converts 100 USD into 10 EUR. Ooops, 90 Euros gone. Stupid German bank is bankrupt again.

German government uses German workers taxes to bail out stupid German bank again. German worker's street is not repaired. No money left. But German worker still has savings of 250 Euros at state owned stupid German bank. Phew!

German bank now no longer keen on buying funny Greek government paper. Stops that non-sense. 

Greek government figures out it is broke too. Didn’t bother with tax collection. Why bother when stupid German bank gives you money? 

Enter ECB.

ECB council decides that sticking to rules is for stupid Germans. Easier without rules. Much more fun. Cranky Germans don't get the joke. Typical. ECB buys lots of Italian and Greek debt at knock-down price.

THE FUTURE:

ECB decides that 2% inflation is too ambitious. The rules are only paper, after all. ECB decides 10% inflation is better for majority of countries in ECB council. Cranky German still doesn't get the joke. Ah, these Germans...

German worker goes to bank. Wants to buy Mercedes with money saved. Bank gives him 250 EUR back. Plus interest. German worker is happy.

German worker goes to buy Mercedes. Turns out, Mercedes now costs 123,890,571,238,457 Euros, instead of 100,000 Euros. German worker uses savings to buy himself a glass of Schnaps instead. German worker is a bit cranky. Now understands what "Quantitative Easing" means. Doesn't get the joke. Lack of humour, presumably.

US banker: got huge bonus
German banker: got huge bonus
US IT Consultant: got Mercedes and huge house (for a while)
Mercedes shareholder: got dividend
Greek farmer: got subsidies
Spanish construction worker: got subsidies
Bond holders: got bailed out.
German worker: got bill.

German worker feels so 1950s. Needs to catch up with rest of world. Should have borrowed money years ago to buy Mercedes. Honest work and sticking to rules makes no sense. Quantitative Easing makes alles kaputt. 

Greek and British papers tell German workers it's all his fault because his granddad invaded Poland.

Merkel after the post summit press-conference

Not sure this explains what's going on but then again I'm not sure any of this _really_ makes sense.

I'm not even going to try explain how the EFSF is supposed to work in all this. I'll need to drink a lot more to try that. 

Katy Perry, pink latex, death metal and Gordon Brown

I was going to write something about Gordon Brown topping out the league of the world's most devastating rogue traders but then I got side tracked. Sorry! I hope this is suitably weird recompense.

Goldman Sachs doing God's work. Or something like it.

This is just so deliciously fucked up, I don't have any further comment.

Rockstars and Banksters

The other day I woke up to yet another insipid debate about bankers’ excessive pay on Radio 4 (yes, I do listen to the radio station of the aspirational middle class  - get over it!). What struck me is that this by now seemingly endless debate (if you can call it that) no longer really relates to the altogether justifiable outcry over excessive pay for bankers whose institutions were saved by the taxpayer’s purse in times of financial stress. Instead, we seem to have moved on to a new type of complaint: The bankers simply earn too much money! It no longer seems to matter that, say Bob Diamond, CEO of Barclays bank never took his shop cap in hand to the treasury when the going got tough, but instead found private funds to shore up his bank. The gripe is now simply about him earning loads of money. And to be fair, it is a chunky bit of dosh coming his way. What isn’t so clear to me is why he (and his cohort of fellow bankers) is in the spotlight for this. It certainly isn’t the case that he earned more money than Robert Iger (who adds to humanities well being by running Walt Disney Co.). Or for that matter Jay-Z. Who I believe took home approximate six times as much as poor old Bobby Diamond last year. Now, don’t get me wrong, I’m hardly going to sing songs of lamentation for a CEO who walks home with a seven figure pay packet every year. I would, however, point at the strange blind spot that our friends at the Today program seem to have when it comes scrutinizing the pay of those not running banks these days. Why, I ask, is it okay for a reasonably foul mouthed rap-star to make a staggering amount of money by selling torrents of overproduced invectives and garish Chinese-made leisure wear but not for somebody running one of the world’s largest privately owned banks? I daresay it is not because some Rawlsian calculus of utility indicates the former to be more deserving than the latter. I reckon it is because for most people out there (be it the more degenerate rabble that features on various reality TV-programs or the somewhat terse crowd lamenting slow erosion of received pronunciation at the BBC) just cannot fathom what a banker really does. While we can all at least imagine how Bono manages to rack up his millions (and truth be told, think we probably could give it a decent try ourselves, given half a chance) public imagination seems unable to penetrate the smokescreen of nefarious plotting and dealing that no doubt fills the average banking executives Machiavellian diary. Let’s face it; most chaps out there don’t begrudge The Boss being a better singer guitarist than they ever could hope to be. At least they can understand what he does (let’s not bring Lady Gaga into this line of thinking, however). I guess it is just hard to accept that there are in fact some people out there that spend their days doing things that seem utterly tedious and quite possibly incomprehensible to most of humanity and yet get paid handsomely for it. Which is ironic, as one quick glance at the saddening sight of the average investment banker’s collection of incredibly beautiful yet woefully underused vintage guitars will immediately tell you that banks are full of failed rock stars.