NI: A little credit for the rest of us

Heads I win, tails you lose. It’s a simple game we used to trick others when we are younger. Unfortunately, a large portion of Yalies now aspire to make a career of it. Worse, many of those who do so patronize the rest of us, telling us that just because we don’t understand what big banks do doesn’t mean that they don’t provide a valuable service.

Here’s what I do know. Regulators have stated in front of the Senate that they will not let the largest 11 banks fail. When several large banks should have gone bankrupt during the financial crisis, the federal government created a program to purchase hundreds of billions of dollars of toxic assets and bail the banks out. When the banks collapsed during the crisis, they also dragged AIG down with them. AIG is an insurance company that had insured toxic assets for the big banks without fully understanding the risks involved — because, let’s face it, the guys at AIG are not as smart as the guys at Goldman Sachs. AIG’s irresponsible policies forced the government to allocate over a hundred billion dollars to purchase those toxic assets AIG had bought or insured. While American citizens don’t see a penny when banks make money, we can somehow be on the hook when they lose it.

At this point, defenders of big banks will point to TARP (Troubled Assets Relief Program), the $700 billion facility created by the government to bail out the big banks, and say that banks have paid back the amount they borrowed — plus interest.

While this is true, it is also misleading. The reason banks could pay back these loans is that they were able to borrow money from the Federal Reserve at near zero interest rates. Then, instead of loaning it out to consumers and businesses, they turned around and lent this money right back to the federal government. Finally, they used the profits from this to pay back their TARP money. Other banks were more direct, simply borrowing money from another special lending facility to pay off the money owed to TARP. In what universe is this not simply using one government handout to pay back another?

So that explains tails you lose; how about heads I win? Well, banks make money when they advise companies on acquiring other companies, raising debt and initial public offerings. That much is true; however, banks also are in the business of buying and selling stocks, bonds and any number of financial derivatives of varying complexity. This accounts for the lion’s share of the revenue at most investment banks; indeed, roughly two thirds of Goldman Sachs’ revenue every year is derived from this shuffling around of money.

Those in finance would have you believe that they are in the business of providing access to functioning capital markets and providing liquidity — all fancy ways of saying that if one guy wants to buy Apple stock and one guy wants to sell Apple stock, the bank will match up these buyers and sellers and collect a small percentage.

I don’t think many people would argue that this matching of buyers and sellers isn’t a valuable service. However, banks also make many speculative bets that have nothing to do with matching buyers and sellers.

For example, if Morgan Stanley made a bet that inflation would go down, this would be a purely speculative bet. See how it does nothing in the way of matching buyers and sellers? These speculative bets have potential for huge gain or loss — almost like flipping a giant coin. For the record, Morgan Stanley lost tens of millions of dollars on this inflation bet this summer. As long as the banks know that the government will never let them fail, why wouldn’t they flip this coin? What’s the worst that could happen?

Look, to those of you going to work at big banks, it’s great that you can make $70,000 a year right out of college. It’s great that you get a $10,000 signing bonus on top of that. It’s even fine that you get another end of the year bonus on top of that. It’s great that you get to “take a lot of responsibility right out of the gate” and “meet with C-level executives.”

It just really sucks that you have trapped us into playing this high stakes game of “heads I win, tails you lose,” and that we can’t do anything about it other than chant in parks and parade in front of info sessions. But at least give the rest of us a little credit. At least concede that we know exactly what’s going on. We get it. You win. We lose.


  • ScalabrineFan

    Best article I’ve read in a long time.

  • RexMottram08

    Written as though a bunch of M&A first-years are taking huge prop bets… written like someone who has only watched Wall Street II.

    • ScalabrineFan

      What does this comment even mean? Are you saying banks don’t take these huge prop bets on their market making desks? Are all of the pro-finance trolls going to be reduced to making ad hominem attacks on the author? I can’t wait to see this.

      • RexMottram08

        The AUTHOR was the one who attacked first-year analysts… as though their compensation was undeserved or behavior dangerous

  • ScalabrineFan

    Where you at now River_Tam?

  • CrazyBus

    Well said, Dan. Great piece.

  • cottagefanatic

    Perhaps the best article I have ever read in the YDN. ever.

    Long live the occupation!

  • River_Tam

    Is this the same Daniel Ni who interned at DE Shaw?

  • ashe12

    “proprietary trading intern” at DE Shaw…. lolololol

    if linkedin is right, this article is laughable

  • btcl

    @ ScalabrineFan and cottagefanatic

    @ ScalabrineFan and cottagefanatic

    This is basically a worse-written version of what Paul Krugman writes about once a month (he even uses the same coin flip metaphor), except by someone who clearly doesn’t know as much as him, as Ni makes evident through his factual mistakes.
    1) The collapse of AIG did more to bring down the banks than the banks did to bring down AIG, as the bailouts of the banks followed the bailout of AIG.
    2) There never was any big government program to buy toxic assets from banks. TARP ultimately was used for direct capital infusions, for which the government received ownerships stakes in many of these institutions.
    3) Ni’s characterization of banks’ “buying and selling stocks, bonds and any number of financial derivatives of varying complexity” as an unmitigated societal wrong is completely uninformed. Stocks and bonds are how companies raise money—they either sell ownership stakes or debt to the public. As the public often entrusts its financial savings to financial institutions, it falls to them to choose where they should invest these savings: where they can earn the highest return with the lowest risk. This allows savers to earn retirement income and it allows companies and startups to access the capital they need to operate and expand. It is true that an implicit government guarantee for financial institutions means that their calculus might fall too much on the side of earning high returns and too little on the side of minimizing risk, but this does not mean that investing in stocks or bonds is bad.

    Furthermore, Ni ignores that the Dodd Frank act will put restrictions on bank’s ability to trade with on their own account with FDIC backed dollars. Banks like Morgan Stanley will have to choose between the taxpayer guarantee (for which they pay a fee) or the ability to invest their own money.

  • btcl

    3) Though the point that much of banks’ revenue comes from merely shifting money around is partially true, the example of Morgan Stanley’s inflation bet totally ignores the societal benefit of hedging risk. Ni’s characterization of it as “a purely speculative bet” which does “nothing in the way of matching buyers and sellers” shows a complete misunderstanding of how banks operate. Morgan Stanley, for instance, has probably lent out money to consumers or invested in company’s equity or debt. Such lending or investment (crucial for economic activity) contains risk for Morgan Stanley beyond the risk that a loan won’t be paid back. What if, for instance, inflation sky rockets, but the customer continues to pay the loan back at a fixed 5% interest rate. In real terms, Morgan Stanley would have lost money on such a loan even if it is paid back in full, and it will therefore be less likely to have lent out the money in the first place as it doesn’t know if inflation will take a bite out of its profits. If it can hedge against this risk, however, by placing a “purely speculative bet” that inflation will go up, it can avoid risk, and even if it loses a few million when the bet goes wrong, that means it probably would have made money on loans it would otherwise not have made. Of course, sometimes banks make outsized speculative bets that are not hedging other parts of their business, and that is why the Dodd Frank Act placed new regulations on such back which will be going into effect just as the Yalies Ni so condemns will be entering finance. One can make a case, however, that there is still a benefit to hedging like inflation bets even if you are not hedging against a particular part of your portfolio–as inflation starts to emerge, a firm with a lot of exposure might by the hedge from Morgan Stanley at a slightly marked up price but still be able to reduce its exposure.

  • ScalabrineFan

    1) Either btcl is of the opinion that Bear Stearns was not a bank, or that September 2008 came before March 2008. Either claim is tenuous at best.
    2) It is miraculous that without any big government program to buy toxic assets, 2 trillion dollars worth of toxic assets just magically appeared at the Federal Reserve.
    3) I love how Ni specifically says that market-making is fine, but proprietary trading under the guise of market making is not, yet you still make the same old tired “We’re just providing liquidity argument!” though clearly banks take large proprietary risks on almost all of their market making desks. The point is not that investing is bad, clearly nobody thinks that. The point is that the securities divisions of banks should be market makers and shy from taking large proprietary risks, which clearly (as Ni points out with his Morgan Stanley example) they do not.
    4) It is unbelievable to me that you would even try to pass this trade off as a hedge.
    This was clearly not a hedge on loans. Also, this was not an inflation hedge done by some sort of internal treasury department, this was a straight bet on inflation made by their rates desk. I would encourage you to do a little more research before you post.

    Finally, you continue to cite Dodd Frank when Ni’s entire point is that proprietary trading is being done under the guise of market making. I think you and I both know that it is nearly impossible to regulate proprietary risks being taken by market making desks, which I think is the overarching theme of this article.

  • Spider14

    1. The article said “the banks” brought down AIG. Bear Stearns aside, the chronology was that most banks didn’t seek support until after AIG collapsed. 2. If you actually read the blog post you linked to, you would realize that the $2 trillion figure refers to the Fed’s total balance sheet, most of which is invested in US Treasury bonds. Even $610 billion in mortgage backed securities (mostly purchased from Fannie and Freddie, not private banks) are not toxic assets–they are securities whose values are tied to the repayment on prime mortgages and that are considered likely to be paid back in full. The toxic assets to which Ni refers are the sub-prime mortgages that brought on the crisis. 3. The Reuters article you linked to did not address whether or not the bet was intended on a hedge (which might not be tied to any particular security, but rather designed to minimize the firm’s overall inflation risk)–that information is likely not public. However, as btcl pointed out, even bets not intended as hedges on your own portfolio may be used by other parties as such when they are traded.
    4. The point of the Volcker rule in Dodd Frank would be to identify what is in fact proprietary trading and ban that for firms that take FDIC guaranteed deposits. This rule has not been implemented yet but soon will be, and is likely to solve many of the issues Ni brings up. But even if the rule is insufficient, neither you nor Ni truly addresses how it is so.

  • ScalabrineFan

    The liquidity crisis suffered by AIG was a direct result of Lehman Brothers going down. Lehman went bankrupt on September 15th, AIG suffered a liquidity crisis on September 16th. You’re probably just trolling me, but I just wanted there to be no confusion to people who read your post. Your assertion that Morgan Stanley was hedging its own position is absurd, losing 50 million on a duration hedge? In addition this article says Morgan Stanley was forced to unwind some of its positions in the trade, which would not be the case if it were a hedge.
    Finally I have a question. Do you not believe that market making desks take large proprietary risks and that some so called market making desks in liquid products such as Spot FX tend to make a large majority of their PNL not in market making but in taking proprietary risks? Your fourth point seems to be that I don’t address how Dodd Frank is insufficient, but it seems to me that it is fairly obviously insufficient to anybody with any familiarity with the industry.

  • theterminator

    This article is hilarious. Looks like the author, who supposedly interned at PROP TRADING shop DE shaw, didn’t get a return offer for full time. Too bad Daniel, you can get your Rolex watches from Chinatown now….

    I smell a strong aroma of bitterness in this article. Occupy Wall Street ain’t about occupying anything but the streets.

  • River_Tam

    Scumbag Yalie:

    Claims banks don’t create value

    Works as a prop trader

  • ScalabrineFan

    Problem: Article attacks big banks in reasonable manner. Can’t find counterarguments.

    Solution: Shoot messenger.