The Rich and The Dumb

Roger Lowenstein might not have know how oracular he was being when he wrote the following in his book When Genius Failed-

'The Bear CEO said, "We called this morning to tell people that we wouldn't be in." There was a deathly silence.'
'It was as if Bear were breaking a silent code; it would pay a price in the future, Allison vowed.'

How wrong the seeming intellectual traders, financial minds and fat bellied bankers can be is not a question anymore. The book is about the rise and fall of a Hedge-Fund (LTCM) run by the best minds in finance (JWM, Haghani, Rosenfeld, Hilibrand) and economics (including Nobel Prize winners and the most distinguished academic celebrities- Merton and Scholes). I don't intend to review the book (by all means, an interesting read) and it would suffice to say that the book is all the more relevant in current markets where it seems the financial giants have once again slipped. There has been already a lot of discussion on the prudence of so-called finance experts in the light of current credit crunch. Reading the book makes me feel that they were always as careless and speculative.

The brains that headed LTCM can be considered representative of most shrewd and brainy of financial fraternity. They knew the academics, models and had the best of practical experience. They were nothing less than the Fathers of Modern Finance. And yet, they speculated because no rationale can explain why they failed if everything was so logical. The fact is, you can not have a rational approach to markets because they have nothing sensible about them. Its like trying to get a driving license in New York City. You have to follow the rules to give the driving test but the authorities can not let you pass because the traffic in NYC does not follow the rules. You can not be easily certified to drive because others are not driving by rules. So, what it boils down in the end is that the traders are nothing but big gamblers. They bet like all of us do, the difference is the magnitude of stakes. They might consider themselves pretty intellectual to be doing that but their chance of making x% in market is no different than your or mine. The markets are not efficient, so what do you bet upon? If the traders were as highbrow as they like to think they are, we would not be in current mess.

One may like to think its a rare thing to happen but that again is a speculation. What LTCM failed on may seem like such a foolish mistake afterwards but many people in their place, and state of mind would have done the same. They took fat positions in the market and expected it to be efficient while their position themselves were enough to swing it. They betted on their models, which inspite of being logical, did not take all the factors in account. This explosive situation, intensified by the cut-throat greed of the Wall St giants towards the end led to the final washout of LTCM. But no lessons were learnt. Fed had intervened to rescue LTCM then and now it was Bear. Our geniuses have again nearly collapsed the markets and its we who suffer.

Don't they all suck?