Structural change in high finance

July 7, 2012 7:47 AM

What can be done to prevent another financial meltdown? While some cry for armed revolution, others are whispering for incremental changes that could have a substantial impact on how high finance works – or doesn't. John Coates, a former Wall Street derivatives trader and now a neuroscientist at the University of Cambridge, has done novel research on how testosterone skews the thinking – and thus the behavior – of traders, inspiring them to take on more risk than benefits society. His research is now available in a book. Would programs that encourage more women to enter – and/or climb the ranks of – trading groups make finance more responsible? (If this strikes you as biological determinism, there are other lines of inquiry that may be headed in the same direction: how managers exploit subordinates in ways that shape overall behavior and could be modified via both incentives and regulation; how cheating happens and the best ways to prevent it.)
posted by noway (45 comments total)

there were no bank failures in Canada and in Israel...Studyh those places and you will know how to prevent some of the mess we encountered.
posted by Postroad at 7:50 AM on July 7, 2012 [4 favorites]

What can be done to prevent another financial meltdown?

One source I've heard from tells me that cutting taxes on the wealthiest, removing all regulations from all industry, and slashing programs for the poor will do the trick.
posted by hippybear at 8:00 AM on July 7, 2012 [27 favorites]

Postroad, sure: here's a recent story on Canadian banking rules. Note, however, the final quote in this story. It may be that Canadian banks have not had as many opportunities to go out on a limb for that golden ring. Whether those regulations are sufficient to check the temptations they will now encounter… check back in 10 years. :-)
posted by noway at 8:01 AM on July 7, 2012

Would programs that encourage more women to enter – and/or climb the ranks of – trading groups make finance more responsible?

Iceland is having success with this approach, apparently.
posted by infini at 8:07 AM on July 7, 2012 [2 favorites]

I talked to several of my classmates who had obtained jobs in finance when we all graduated a few years ago and one of the main sentiments I heard was that they had no interest in a long-term career in that industry - basically, they wanted to get in, make a ton of money, get out after max ten or fifteen years, and spend the rest of their life comfortably pursuing their true interests. Anecdotal, sure, but from everything I've heard in the years afterwards the industry itself is so brutal that many of the young traders moving the money around have no interest in the long term health of their company, much less the world - they just want to get their own money and get out.

Even then, my classmates seemed somewhat optimistic - only the really good traders will make it to year ten.

Women, despite their sweet and delicate lack of testosterone, are fully capable of making the same "gonna get mine" decisions one makes in finance so, uh, maybe instead of making testosterone levels the main focus of our analysis here we can just look at the rational incentives and perhaps background conditioning these traders have for acting the way they do. Like, if you steep a bunch of 18-22 year-olds in the Milton Freedman rational-actor model for four years, they often don't seem to enter their finance jobs with a goal towards altruism.
posted by newg at 8:13 AM on July 7, 2012 [14 favorites]

Iceland is a good example of the testosterone risk taking leads to a crash. Michael Lewis wrote about it in this Vanity Fair article "Wall Street on the Tundra" (paywall). Summarized here: Economic Meltdown: It's a Guy Thing
posted by stbalbach at 8:17 AM on July 7, 2012

Wouldn't we first need to confirm that higher estrogen doesn't inspire more irrationality than benefits society? You know, for science.
posted by cheburashka at 8:20 AM on July 7, 2012 [3 favorites]

Well they say women shouldn't be
the president
Cause we go crazy from time to time
Well push my button baby here I come
Yeah look out baby
I'm at high tide
posted by seanmpuckett at 8:24 AM on July 7, 2012

If it were absolutely, without exception, true and deterministic that men take big selfish risks and women do not (despite being an industry known to attract and reward selfish risk-takers), then replacing 50% of the men with women honestly doesn't do very much. It doesn't take a quorum to screw things up for everyone, it only takes a few, and possibly just one.

Fix the regulations. Done.
posted by Foosnark at 8:25 AM on July 7, 2012 [5 favorites]

The instructions suggested I shouldn't break up my post into paragraphs but I fear the last part – about biological determinism – is easily missed.

Someone could make an argument about gender (whether from nature, nurture or both) and its impact on social organizations. This is not the argument I wanted to highlight.

Rather, I want to link to some of the interesting work being down to manage the behavior that leads to big problems. Because, I believe, big problems don't have simple solutions.
posted by noway at 8:36 AM on July 7, 2012 [1 favorite]

You guys are conflating what happened at the investment banks with what makes someone a good trader.

Absolutely unequivocally there should be more woman in finance, and specifically there should be more woman in risk taking roles, but Foosnark is correct - making it a 50/50 M/F or even 40/60 wouldn't have prevented the crisis. That was about a failure of regulation and poorly aligned incentives.
posted by JPD at 8:37 AM on July 7, 2012 [3 favorites]

I think there might be another “molecule of irrational exuberance”, besides testosterone, involved.
posted by StickyCarpet at 9:02 AM on July 7, 2012 [2 favorites]

One way to prevent another crash might be be some accountability for the last one; which was accurately predicted by Nouriel Roubini.
Where are the prosecutions and prison sentences for Freddie Mac and Fanny Mae CEOs.
Maybe some active criminal prosecutions in the present LIBOR scandle would help. The spineless politicians are equally to blame.
There’s No Recovery Because the Government Made it Official Policy Not to Prosecute Fraud.
posted by adamvasco at 9:09 AM on July 7, 2012 [6 favorites]

Fannie and Freddie are really weird candidates to put first against the wall no?
posted by JPD at 9:16 AM on July 7, 2012 [1 favorite]

Surprised nobody mentioned the hedge fund estrogen scandal.
posted by steinsaltz at 9:29 AM on July 7, 2012

From the testosterone link.

Coates sampled testosterone levels in traders in London and found that higher levels of the hormone in the morning correlated with beefier profits in the afternoon. Such profits came from taking higher risks, not greater skill.

So the solution is to try and get testosterone out of trading even though it's mere presence makes money? Try and sell that one to the investors. You can invest with Trader A who is bad for society but will make you a significant profit or Trader B who is better for society but will make you less money.

What will the investors choose?
posted by The Violet Cypher at 9:40 AM on July 7, 2012

Because with Trader A you eventually end up with Zero. An ROE of 20% with a +/- of 50% is less desirable than an ROE of 15% +/- of 5%.
posted by JPD at 9:45 AM on July 7, 2012 [2 favorites]

If testosterone correlates to higher profits, we should be seeing some serious steroidal trader beefcake soon. More steak for everyone.
posted by cheburashka at 9:47 AM on July 7, 2012

I came in here and I'm not seeing the words "guillotines," "pikes," or "torches" anywhere.
posted by entropicamericana at 9:48 AM on July 7, 2012 [3 favorites]

I think that the risk level only applies with a longer term commitment which has been shown to be not the focus of the current investor class. I mean they could invest in municipal bonds and have almost no risk but get very little payback. Yet the investors choose risk every time. That is the problem. It is the investors that need to show returns every quarter that force ever increasing risk taking until it suddenly stops working.
posted by The Violet Cypher at 9:54 AM on July 7, 2012

Yet the investors choose risk every time.

Wouldn't it be that investors choose to maximize profits every time? I don't think that's the same as choosing risk. And when or if the middlemen in those transactions engage in fraud or otherwise manipulate transactions so as to maximize their own personal gain without accountability as to what happens to either investors or anything else left in their wake, it seems to me the problem is with the middlemen, not the investors.
posted by cheburashka at 10:06 AM on July 7, 2012

I talked to several of my classmates who had obtained jobs in finance when we all graduated a few years ago and one of the main sentiments I heard was that they had no interest in a long-term career in that industry - basically, they wanted to get in, make a ton of money, get out after max ten or fifteen years, and spend the rest of their life comfortably pursuing their true interests. Anecdotal, sure, but from everything I've heard in the years afterwards the industry itself is so brutal that many of the young traders moving the money around have no interest in the long term health of their company, much less the world - they just want to get their own money and get out.

I much prefer this explanation, as it focusses on individual wants and needs to explain why folk working in finance act irrationally in the long run (their interests run counter to society's or investors' over a period longer than they work there). The solution would be to financially destroy those who make clear and avoidable mistakes or outright breach the rules. The threat of losing your entire career earnings rebalances their interests, although the punishments actually need to be enforced. However, it also chimes with the idea of testosterone and male dominance by making the regulator effectively "top dog" meting out punishments.

Doing nothing is not an option.
posted by Jehan at 10:17 AM on July 7, 2012 [5 favorites]

Bankers used to be pillars of the community, instead they're undermining it's foundations.

Regulations and penalties with teeth are the only things that will work in the long run. Not seeing the fruits of your labours (aka risky gambles with other peoples' money) and the loss of liberty for a couple of decades will have an impact - but only if it is routinely and universally applied.
posted by arcticseal at 10:57 AM on July 7, 2012

I'm curious as to how "trading" - as opposed to "investing", which bankers USED to do - is good for the economy at all. Shuffling money around doesn't creating any jobs in and of itself (except trading jobs).

Obviously some degree of trading is needed in order for people who have invested in a company to feel the negative and positive consequences of their chosen company's decisions. But that's just a byproduct of a market-driven economy. Treating trading itself as though it somehow stimulates the economy or propels the market seems like a huge fallacy.
posted by wolfdreams01 at 11:12 AM on July 7, 2012 [1 favorite]

I'm right there with you, wolfdreams01... If there's any market which should be most heavily regulated of all, it's derivatives and such ilk. People taking bets on the failure of a segment of the economy hoping to profit? That should be discouraged as much as possible. We don't need people cheerleading failure, we need people striving toward success.
posted by hippybear at 11:27 AM on July 7, 2012 [1 favorite]

Scott Patterson, author of The Quants and Dark Pools, just did an AMA on reddit

Hey Reddit, I’m Scott Patterson. I'm an author and staff reporter for the Wall Street Journal, covering the government's regulation of the financial industry. I also write extensively on advanced technology used by sophisticated firms to trade on the stock market—and sometimes manipulate it—such as high-frequency trading, high-powered algorithms, artificial intelligence and dark pools.

posted by the man of twists and turns at 11:33 AM on July 7, 2012

People taking bets on the failure of a segment of the economy hoping to profit? That should be discouraged as much as possible.

You don't think a trader should be able to short a stock they think is overpriced?
posted by monju_bosatsu at 11:54 AM on July 7, 2012

You don't think a trader should be able to short a stock they think is overpriced?

Derivaties. Significantly different from shorting a stock.
posted by hippybear at 11:58 AM on July 7, 2012 [1 favorite]

Women also secrete testosterone; some, more than others. The testosterone effect has also been studied in trial lawyers.

That said, it's not about testosterone; it's about cash! We need to get corporate money out of politics, because government policies that are bought and paid for by the financial sector make many of their abuses legal, until it's too late. All campaigns should be publicly financed (at local, state, and national levels) with strict penalties for cheating.
posted by Vibrissae at 12:09 PM on July 7, 2012 [2 favorites]

Mod note: A bunch of comments removed; maybe not so much with the castration jokes. Please see Metatalk thread if you need to talk about it.
posted by cortex (staff) at 12:18 PM on July 7, 2012

I just feel like they might be secreting testosterone because they're about to take a risk rather than vice-versa.

I also wonder if corporate culture is going to propagate the same types of behaviour regardless of gender.
posted by windykites at 12:23 PM on July 7, 2012

We don't need people cheerleading failure, we need people striving toward success.

That's a sure road to another asset bubble - trying to make it a matter of policy that a particular investment is always successful will just line the pockets of insiders for ten or twenty years before the inevitable collapse. That's the real problem with derivatives - they're not nearly as dangerous to the economy when used as speculative plays as they are when used as a way to try and eliminate risk.

Take for example that pillar of the derivatives market, credit default swaps. Say I'm a mortgage lender, so to hedge against the risk of my borrowers defaulting, I securitize the mortgages I write and I buy a bunch of CDSs against a default. I assume that I've mitigated my credit risk, so consequently I loosen my underwriting standards and start writing a bunch of interest-only and NINJA loans. The real estate market prospers, which oddly enough is what both I and my CDS counterparty and my borrowers are all betting on; isn't it wonderful what we can accomplish when everybody is striving for success?

But in reality, I've actually concentrated all of my risk in one scenario - a double default where both my borrowers default and so does the counterparty who sold me the CDS (we can call it, say, "Bear Stearns"). However, the risk of a double default is actually much higher than what I'm estimating, because I have no real idea of what my counterparty's full exposure is, and in fact the flood of easy credit has created an asset bubble in real estate, which, once it pops and everybody defaults all at once, leaves my counterparty as bankrupt as my borrowers. As a risk mitigation strategy, it falls into the same category as a martingale gambling strategy - it seems unbeatable right up to the point where it fails catastrophically and ruins you.

By contrast somebody buying CDSs against somebody else's mortgage-backed securities as a pure speculative play that the market will go bad seems almost benign. It's not a good thing in the sense that it's not actually a form of productive economic activity, and it always presents a risk of some kind of insider trading or double dealing by the bankers because of the opacity of the market. But it does provide at least a little bit of benefit in that it raised the price of CDSs for our mortgage lenders too, and made them less attractive as a substitute for underwriting.
posted by strangely stunted trees at 1:01 PM on July 7, 2012 [3 favorites]

Say I'm a mortgage lender, so to hedge against the risk of my borrowers defaulting, I securitize the mortgages I write and I buy a bunch of CDSs against a default.

I'd say the point in which this scenario has gone wrong is when you didn't do due diligence about who you were lending money to and stopped carrying the mortgage and its associated risk yourself.
posted by hippybear at 1:37 PM on July 7, 2012 [1 favorite]

I believe the first derivatives were created by... a woman. (saw this on some PBS show about the economic meltdown). So much for testosterone.

Explained on that show.... the basic concept of a derivative seemed sound, but gosh-darn if I can recall it enough to defend it here. Which to me is clear enough indication that all such synthesized financial instruments must be government approved and regulated.

This 'testosterone' and other such theories are interesting, but avoid the main truth that the financial market's interest is not completely synonymous with the peoples' interest, and the market cannot be trusted to regulate itself. The financial market must be regulated.
posted by Artful Codger at 1:39 PM on July 7, 2012

In my (amateur) opinion this thesis is 180 degrees wrong as wrong as you can possibly be. The guys doing this shit are corporate employees. (e.g. the Lehman Brothers guy who testified to Congress that he knew the bonds were shit but "we are not paid to rock the boat".) This is a social role which depresses, not stimulates, testosterone production.

90% of the guys I have met in the corporate world are complete sissies.

There was a famous comic circulating for years comparing them to sea squirts, the animal that has a brain until it finds a place to anchor and then it eats its brain because it doesn't need it any longer. Also: see 90% of the Dilbert cartoons ever. Not even Dogbert would ever challenge anyone to a fistfight.
posted by bukvich at 1:53 PM on July 7, 2012

I'd say the point in which this scenario has gone wrong is when you didn't do due diligence about who you were lending money to and stopped carrying the mortgage and its associated risk yourself.

Stop cheerleading failure! Strive towards success!

Or in seriousness: if there is a profit motive for someone pointing out that the Emperor has no clothes, then the fact that the Emperor has no clothes is more likely to come out sooner, which is good.

At least in theory. Then you get the last ten years, and I don't know...
posted by alasdair at 1:54 PM on July 7, 2012

Snark all you want, but my reasoning is sound. If financial institutions had not come up with this slice-and-dice way to theoretically "distribute risk" for mortgages, and then subsequently gone hog-wild giving mortgages to anyone who was breathing, and instead had been actually responsible for the risk associated with any mortgage they originated and thus had been more interested in giving out mortgages to people who could actually pay them and the loan would succeed as an investment...

That's pretty much striving toward success all around.

That there are entire sectors of the financial industry which are geared specifically toward profit-making when some other sector of the economy collapses, that's pretty much cheerleading failure.

Let's get rid of that second concept, and set right the first to how it ought to be, and run with that scenario for 20 years or so and see how things ends up.
posted by hippybear at 2:02 PM on July 7, 2012

Let's get rid of that second concept, and set right the first to how it ought to be, and run with that scenario for 20 years or so and see how things ends up.

It will be such a success that people in 20 years time will believe that the success is theirs, the result of their sophistication and the sweat of their brow, and that those old fuddy duddy regulations getting in the way were only needed for those morons of yesteryear who couldn't handle things properly, and it's time to free ourselves of their training wheels and get the full benefit of our brilliance.

And then history will repeat. Again.
posted by -harlequin- at 2:11 PM on July 7, 2012 [4 favorites]

(I agree with you hippybear)
posted by -harlequin- at 2:12 PM on July 7, 2012

I believe the first derivatives were created by... a woman. (saw this on some PBS show about the economic meltdown).

This one?
posted by homunculus at 5:48 PM on July 7, 2012

I believe the first derivatives were created by... a woman. (saw this on some PBS show about the economic meltdown). So much for testosterone.


Unlikely, given that option contracts were first employed by the Ancient Greeks.
posted by emergent at 9:13 PM on July 7, 2012

I can see why the castration option might be raised again:-
Just when you thought Wall Street couldn’t sink any lower.
posted by adamvasco at 4:04 PM on July 9, 2012

homunculous - YES! That was the show. Thanks.
posted by Artful Codger at 4:34 PM on July 9, 2012

Ex-Citi CEO calls for breaking up the banks
posted by the man of twists and turns at 9:50 PM on July 26, 2012

Reuters: Insight: Banks bristle at breakup call from Sandy Weill

NYTimes Editorial: The Big Banker’s Change of Heart.

At the tail, the Times indicates they have changed their minds as well...
posted by the man of twists and turns at 11:40 AM on July 27, 2012