5 October 2009

Still The Masters of the Universe ~ Satyajit Das

Tom Wolfe writing in Bonfire of the Vanities created the term – ‘Masters of the Universe’: “He considered himself part of the new era and the new breed, a Wall Street egalitarian, a Master of the Universe, who was only a respecter of performance.” Wall Street bond trader Sherman McCoy, the original Master of the Universe, came to personify the avariciousness and self-aggrandisement of financiers.

Human history is a sequence of “ations” – civilisation, industrialisation, urbanisation, globalisation interspersed with actual or threatened “annihilation”. The most recent “ation” is “financialisation” - the conversion of everything into monetary form (also known as another “ation” – “monetisation”).

New paper economies emerged directly from the demise of the gold standard that removed restrictions on the ability to create money, especially debt. Finance inexorably displaced industry with trading and speculation becoming major activities as financial engineering replaced real engineering. In an earlier age, Heinrich Heine, the German poet, too had identified the change: “Money is the God of our time….” The rise of financiers is intimately linked to this financialisation of the global economy.

Financial innovations such as securitisation (the packaging up and sale of loans) and derivatives (effectively risk insurance) enabled banks to extend more credit. Banks could literally by increasing throughput, making more loans and selling them off to eager investors, magically increase returns to their investors. Bankers had invented a ‘money machine’.

Bank also began to trade more actively with their shareholders money, following the advice of Fear of Flying author Erica Jong: “If you don’t risk anything then you risk even more”.

All of this, of course, meant increased earnings for the bank and its star performers. As people who work in financial institutions know, it is primarily an enterprise that is run for the employees with an afterthought for shareholders.

Sherman McCoy could with a single phone call make $50,000 and, even better, a share of that was his and his alone. At the height of the boom, top hedge fund and private managers could make more in 10 minutes than the average worker earned in an entire year. In 2007, James Simons of Renaissance Technologies earned $1.5 billion and David Rubinstein of The Carlyle Group earned $260 million in the ethereal “economic stratosphere.” In Australia, Macquarie Bank employees rejoiced in the sobriquet – the ‘Millionaires factory”.

The ability to earn high rewards only becomes a problem where the promise of a share of profits encourages excessive risk taking and a focus on short-term earnings. It also becomes a problem where the basic measure of performance is ambiguous and can be systematically manipulated. Unfortunately, ‘earnings’ proved to be the result of wildly inaccurate models, accounting tricks and risks that had not been accurately captured.

Finance is also problematic when it comes to dominate the economy. In the U.S.A., financial services’ share of total corporate profits increased from 10% in the early 1980s to 40% in 2007. The combined stock market value of these firms grew from 6% to 23% over the same period.

It is now conventional wisdom to accept the central role of financial services. Gordon Brown, the Chancellor of the Exchequer under Tony Blair and then Prime Minister, harboured secret dreams of a Scandinavian-style social welfare state with low taxes funded by the growth of the City. In 2007, he told bankers: “What you have achieved for the financial services we … now aspire to achieve for the whole of the British economy.” Alistair Darling, Gordon Brown successor as Chancellor, was no less loquacious describing financial services as “absolutely critical” to the economy.

The golden age seemed to come to an end with the GFC. Initially, the world viewed the destruction of storied financial institutions in Global Financial Crisis as an entertaining blood sport.

Some bankers lost their jobs by the thousands. Others lived with the psychological fear of firing by text message.

In New York, bankers confessed it was hard to live on less than $500,000 – after all, the children’s private school fees, the maid, the Pilates lessons etc all cost money. They economised by buying cheaper cuts of meat. In London, families deferred moves to more expensive suburbs. The latest Gordon Ramsay restaurant was no longer a must have.

The effects of belt-tightening were seen in a fall in bookings at luxury hotels, holiday resorts and sales of super yachts – some of the plutocrats were down to their last billion. Once rich hedge fund managers were back in court trying to renegotiate the terms of their divorce pleading ‘poverty’.

For some women, the aphrodisiac quality of a young unattached male purring “I’m an investment banker” in a certain type of bar lost its allure. Some professions – personal trainers, dog walkers, personal dressers, children's party organisers – were in danger of extinction.

There was a sense of Schadenfreude as the Masters of the Universe received their comeuppance. Unfortunately, the “financial” crisis quickly spread to the “real” economy – jobs, consumption, and investment- becoming everybody’s problem. “Too large to fail” financial institutions had to be bailed out by governments, that is the ordinary taxpayer. In a perverse piece of income redistribution, the less fortunate now were subsidising the masters of universe because it was in their best interest.

Commentators briefly dared hope that the power and influences of finance and financiers would be reduced. Finance would revert to being a facilitator rather than the central driver of the economy.

The Economist wrote: “Over the past 35 years it has seemed as if everyone in finance has wanted to be someone else. Hedge funds and private equity wanted to be as cool as a dot.com. Goldman Sachs wanted to be as smart as a hedge fund. The other investment banks wanted to be as profitable as Goldman Sachs. America's retail banks wanted to be as cutting-edge as investment banks. And European banks wanted to be as aggressive as American banks. They all ended up wishing they could be back precisely where they started.”

Unfortunately, those hopes are misplaced. Low or zero interest rates, heavily managed markets, reduced competition and state underwriting of solvency has helped surviving banks prosper.

Bank risk levels have increased to and in some cases beyond pre-crisis levels. The higher levels of risk taking reflect increasing comfort in central bank support of financial institution’s liquidity and their ability and willingness to intervene to limit price risks.

In 2008 in Canary Wharf, the financial district in London’s docklands, I meet two affable recruiters from the English Teachers Union who explained that there was “a bit of financial crisis”. Well-educated and highly motivated bankers who were losing their jobs by the thousands might like to consider a new career teaching. I questioned the adjustment in salaries that the change in careers would necessitate. One recruiter’s responded: “If you haven’t got a job then it’s not relevant is it? It was never real money and it wasn’t going to ever last was it?”

Over the last 30 years, talent has increasingly been lured from productive profession into finance and the speculative economy. The rewards available mean that the brain drain into these professions is unlikely to stop. The excesses of the financial economy are also unlikely to be easily tamed.

The Masters of the Universe that survived the carnage are back to their old tricks. The ‘fight for talent’ means that bonuses and remuneration guarantees for new employees are all back in vogue.

Government attempts to deal with the problems of the financial system, especially in the U.S.A., Great Britain and other countries, illustrate Mancur Olson’s thesis - small distributional coalitions tend to form over time in developed nations and influence policies in their favor through intensive, well funded lobbying. The resulting policies benefit the coalitions and its members but large costs borne by the rest of population.

The “finance government complex” (dubbed “Government Sachs” by its critics) and financiers have proved exquisite masters of the game of privatisation of profits and socialisation of losses. Many countries now practice Chinese socialism with Western characteristics.

A year after the collapse of Lehman, the near collapse of AIG and the grande mal seizure in financial markets, the Masters of the Universe are still firmly in charge. As Giuseppe di Lampedusa, author of The Leopard knew: “everything must change so that everything can stay the same.”

© 2009 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).


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