Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

CHAPTER ONE
Financial WMDs – derivatives
demagoguery
In 2003 there was a debate about financial WMDs (weapons of mass
destruction) – derivatives. I have been around derivatives all my working
life and was unaware that I had been handling WMDs. The Indonesians
probably agreed with this description of derivatives: they should have worn
their hazardous materials suits when handling their trades. The debate was
between two giants of American capitalism – Warren Buffett and Alan
Greenspan. Warren Buffett is ostensibly the chairman of Berkshire
Hathaway, basically an investment company, and his fame relates primarily
to his legendary stock picking skills. But it is a tendency for folksy wisdom
that has turned Buffett into an iconic figure – an American ‘original’.
Buffett’s well-known statements include: ‘We eat what we cook’, ‘Only
when the tide goes out will we know who is swimming naked’, and ‘The
view through the rear window is much clearer than the one through the
windshield.’ Buffett groupies treat these statements reverentially. His
annual ‘Letter to Shareholders’ is regarded as a sacred text. Berkshire
Hathaway’s annual meeting, an immense religious jamboree attended by
adoring converts, is known as ‘Woodstock for Capitalists’. Buffett is the
‘Oracle of Omaha’.
In 2003 Buffett took aim at derivatives, calling them ‘financial weapons of
mass destruction’.1
 He was joined in this crusade by a few notable figures.
A significant fellow-traveller was Bill Gross, who managed PIMCO’s (one
of the world’s largest investment management companies) vast fixed
income fund. Their complaint seemed to be that derivative contracts had
hidden losses that would eventually emerge. This would affect the banks
and insurance companies who traded in these instruments. They were
concerned that derivatives allowed companies and investors to gamble with
other people’s money. I had naïvely assumed that gambling with other
people’s money was part and parcel of capitalism.
The catchy line and the fact that it was from Buffett ensured immediate
airplay. Buffett’s assault rattled the derivative dealers who feared that
others, especially regulators, would take notice. What if new regulations
were to be imposed on derivatives trading? The derivative lobby went into
overdrive but they needn’t have bothered.
The major defender of derivatives was Alan Greenspan, Chairman of the
Federal Reserve system, effectively America’s central bank. Its
responsibilities include ensuring the integrity of the financial system and
the stability of banks. The head of the central bank’s role as cheerleader for
the derivatives lobby was curious.
Greenspan had succeeded Paul Volcker in the late 1980s. Volcker had
embarked on an unpopular strategy of high interest rates that had ultimately
proved successful in beating inflation, although there had been collateral
damage. The entire US Savings and Loan Industry had ended up as roadkill.

But the high interest rates opened up la belle époque – an era of low
inflation, low interest rates and rising stock prices. Chairman Greenspan
found himself in command of the ship just as it sailed into calmer waters.
Woody Allen observed that 80% of success in life is just showing up at the
right time. The Maestro, Greenspan’s nickname, had immaculate timing.
The tennis-playing, jazz saxophone-loving Greenspan has presided over an
unparalleled period of prosperity, the bond market collapse of 1994 and
several asset price bubbles and collapses. Greenspan is famous for two
other things – lengthy sentence construction and an unfettered belief in new
technology.
Greenspan’s regular congressional testimony attracted financial analysts,
journalists and linguists in equal numbers. An industry in interpreting
Greenspan’s prognostications has developed. Without a hint of self-parody,
Greenspan himself provided guidance to interpreting his pronouncements.
‘I know you believe you understand what you think I said, but I am not sure
you realize that what you heard is not what I meant,’ the Maestro once

Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das