The Wall Street Meltdown Part 3

[For context, please read Part 1 and Part 2 first]

The Dow Jones Industrial Average (DJIA) gains 936 points on a spectacular Monday. And then, like the proverbial monkey on the oily pole, drops 733 points on Wednesday, making it the second worst single day drop in Wall Street history.

The stock market has now entered a most dangerous period—-a time of high price volatility. As an investor, you say to yourself—“The market has gone the lowest it can go, equities are as cheap than they have ever been for a long time and I can start buying stocks now.” And the moment you think its safe to go into the water, the market goes into a free fall once again. Naturally, you panic even more and keep holding onto whatever investments you have. Unsure as to which direction the market will go and fearing for the worst, you start having a fire-sale of your holdings. Other people do the same thing. The market drops further. Then perhaps some little gains are made, market sentiment perks up and you again wade in. The shark however sneaks up once again and before you know it, you are holding a bloody stump where once your investment portfolio was.

Welcome to 2008. What the pundits are now saying is as close to the Great Depression as we have ever been. The very worst of times. The last time they used the word “depression”  was in the context of the 1929 economic cataclysm. Markets then took decades to recover—-General Electric, one of the leading corporations of the day, took almost twenty five years to recoup its losses in value.

Which means that if we accept the assessment that we are inside a depression (or something close to it), then what we are seeing is much more severe  than just a “market correction”, a “bear market” or a “recession”.

And the most disquieting thing of all.

Evidently, as the big brains tell us, matters are even now nowhere near the worst.

The only silver lining. The big financial gurus have been proven very wrong in the past. Maybe, after a spell of irrational over-exuberance in the last few years, they are now compensating for it by being over-pessimistic. Or perhaps, by the law of “a broken clock is right twice a day”, they are finally “on the money”.

The kind of disquiet and apprehension for the future that exists in the US today is almost unprecedented in recent memory. National debt is so high that the debt clock in New York city had to be taken down as it had run out of digits ! Unemployment figures are at historic highs, consumer confidence (very critical to the economy for the Christmas shopping season) low and real estate prices keep falling every month (Recently, a house sold on Ebay for $1.76)

People are angry. And angry people obsess about identifying the “guilty party”. Not that the act of identification serves any purpose other than to provide the mental satisfaction that the apportion of blame, even if it be as effective as shouting in a dark room, brings about .The verdict is unanimous —–“Wall Street” is the culprit but since there is no single person who can be lynched, all America’s anger has focused on the Republican administration, that is widely perceived to have let investment banks run loose. And the man who has suffered most as a result of this has been John McCain, who has seen his election lead being wiped out to be replaced with a significant lag behind Obama (Gallup) on the back of the economic collapse. So concentrated has the tide of public opinion been against him that he was found to be pleading with the nation in the third presidential debate— “I am not George Bush”.

This post is not about who is to blame for the credit crisis—I think that has been discussed in the previous posts on the subject. However I cannot go to the main course without telling you about something that has fascinated me—-in the same sense that Shibu Soren “fascinates” me, in the same sense that two cockroaches making love hold me enthralled.

And that is greed. Vulgarly arrogant displays of it. The kind that brings the world’s strongest economy at the doorstep of collapse.

Story 1: After the Paulson plan became law, many financial institutions (who had lobbied extensively for a government bail-out) were reported to be no longer as keen to avail of the provisions of the  plan because the politicians, in an acknowledgment of popular anger, had put a ceiling on executive compensation for any institute that wished to avail of the plan’s benefits. Instead, these financial fatcats were preparing to go it alone, at least for now, to see if they could solve the problem without taking a pay-cut. And if they can’t, they can always extend the begging bowl later on. For now, let’s empty out whatever we can.

Story 2: 70 of AIG executives, after (and I repeat after) they had been bailed out by the government, went on a pleasure trip to an exclusive resort and spent many thousands of dollars on spa treatments and the other corporeal pleasures of the Wall Street life. If that was not outrageous enough, what send me into fits of maniacal laughter  was when I saw one of the AIG bosses on TV justifying it by saying that perhaps the executives were stressed out by recent developments—-of course later on the story was changed to be: this trip had been planned “in advance” and surely once you tell kids about a planned excursion, it would be most unfair to “cancel it”.

Story 3: By the high standards of Wall Street compensation, 50 per cent of the total revenue of a financial institution is spent on executive salary, when times are “good”.  In the first nine months of 2008, when times were undisputedly bad, Merrill Lynch (now bankrupt) paid their execs 13 times their total revenue as salary —yes that means 1,300 per cent. So next time, one of your Wall Street friends tell you that that they earn more because of their astounding “performance” (and so jealous outsiders should “get over it”), kindly throw this figure in his/her face. And you do have the right to be a bit arrogant here. After all, its your tax dollars that’s providing the downpayment for his Porsche.

But greed is not what this post is about. Its about trying to answer whether the crash of 2008 is really as big as it is being made out to be or is all the hullabaloo just an extreme knee-jerk reaction to the inevitable bad times that follow periods of high Wall Street numbers?

After all, the Depression was more than 70 years ago. The science of managing economic crises has changed since then. Surely the same follies in 1929 that drove the US deeper into Depression will not be repeated. Steep declines in stock values and wiping out of investments have happened many times since, from single day bloodbaths like Black Monday to a period of free-fall like from 2000 to 2002 when the Dow Jones lost more than 50% of its value with $7.4 trillion dollars “vanishing”. Some would say that after prolonged periods of increase in stock prices (“`overheating”‘) [about a year ago, on October 9 2007 the Dow Jones Index had reached its highest ever number] such a crash is inevitable.

In passing, isn’t the state of the investor today, after the highs of 2007, somewhat like the hedonist party-goer who after a deliriously debauched night on town wakes up in a bathtub with a “You have one kidney left”‘ message scribbled on the mirror in red lipstick?

As to big and perceived-to-be-solid corporations, they have failed before. Penn Central Transportation Company, the biggest railroad in the United States, declared bankruptcy in 1970, shaking up the system and sending people into panic. This is also not the first time that major banks have gone bust—the 80s had quite a few major catastrophes in the banking sector. Inflation? Today’s inflation in the US is still nothing compared to the early 80s.

So what is it that has changed over the years? What is it that is so special about this economic downturn that has necessitated the biggest government intervention in modern history? Needless panic? Or is there something unprecedentedly wrong with the US economy?

First let us look at what has not changed. That is what has remained constant over the last 100 years.

The follies of the common investor.

People still make the same mistakes while investing their money in the stock market that their grandfathers did years ago. After all what is the stock market except a composite measure of a nation’s economic sentiments, reflecting both the fundamental irrationality as well as the capriciousness of the homo sapien ? It is these emotion-driven swings between hopeless optimism to debilitating pessimism in the blink of an eye, that has historically driven markets to heights unheard of and then brought it to the ground with earth-shaking violence.

So what are these follies, so eternal that they bind together the monocoled banker of the 30s to the rimless framed soccer mom of the 2000s?

Error Number 1: This is the big one. And by far the most common. Whereas in every business transaction, people believe in buying low and selling high, when it comes to the stock market, they end up doing exactly the opposite.

How many times have you heard something on these lines:” Did you hear how much money Rajesh has made on the stock market. He used to ride a bicycle. Now he has a Bajaj scooter. Everyone is making money on the market. Let’s take money out from your provident fund and buy some shares.”

I have. And this is, on the face of it, a rather persuasive argument for buying stocks. After all if Rajesh and Rukmini are making money playing stocks and riding a bicycle or buying a new fridge, why the hell should not I?

The problem is that if indeed Rajesh and Rukmini are making money off stocks and so is Riaz and Rahim, then the chances are that just like you, everyone else is making a beeline to buy stocks, pushing their values up way above their true worth as investments.  Hence if you “jump in” as soon as you hear Rajesh’s scooter vroom, the chances are that you are buying “high”. It stands to cold-hearted logic that the more the market does “good”, the greater is the risk that tomorrow it will do “bad”. And once that happens, you shall be forced to sell your stock “low” (the same stock you bought “high” in the hope of buying a scooter) in order to minimize your loss.

Smarter than that? Perhaps you are. But this error sneaks upon you, often in a very insidious, indirect way.

Consider Tandiya Bhai, who after capturing Gol Basti decides to do some investment. Having learnt a lesson from his old boss, Lukka who put all his money in risky investment and then lost it all (as Lukka said about his investments: the share certificates he holds are like cinema tickets for a show that has already taken place) Tandiya creates a portfolio where he puts 50% of his savings of $200 i.e. $100 in a company bond (paying 5% simple interest) and the remaining $100 in a high growth stock. Namely in Lucky Chikna’s Latakta Circus Limited (ticker symbol: LCLC).

A year later, based on bumper earnings of LCLC and a huge Bull(ah) market, Tandiya’s $100 stocks are now worth $150 netting him a 50% return on his stock investment. His $100 in the company bond gave him $5. Tandiya’s total worth is, at the end of 1st year, $255 ($105 of his original bond investment and $150 in stock).

Note that the 1:1 balance from the previous year is now tilted in favor of stocks. In other words, Tandiya’s exposure to the stock market (i.e. the chance that something “bad” in the stock market will affect him adversely) has increased because he has almost 60% of his assets in stock. As a result, the insurance against risk (the $105 holding in the bond account) is not as strong as it was before. This lack of “insurance” is even greater a problem than it appears because since the market is now higher than the level at which it was a year ago, the chance that the stock markets will subsequently fall and reduce the values of his investments has increased. In short, Tandiya has a bad risk management policy in place.

And as luck would have it, the stock markets  do go south. Lucky Chikna and business partner Haseena Tantan (duplicate of Raveena Tandon) fall out publicly and this adversely affects investor confidence in LCLC.  Result: LCLC stock falls by 50% i.e. Tandiya’s $150 in stocks now becomes $75. So now in comparison to two years ago, his total portfolio is now down to ($100 [bond principal from 1st year] + $5[ bond interest from 1st year] +  $ 5[bond interest from 2nd year]  + $75 [new value of stock portion of his portfolio])=$185 i.e. he has lost 7.5% of his principal in 2 years.

So how could Tandiya have done better risk management? By taking  $25 (half of $50 profit from 1st year) out of his stock account at the end of the first year and putting it into the low-yield but safe savings account. If he had done that (that is maintained the 1:1 ratio between his stocks and bond account) his total portfolio would have now been: ($100 [principal from 1st year] + $5[ interest from 1st year] + $25 [added principal to the bond in the 2nd year] + $6.25[interest from 2nd year]  + $62.50 [new value of stock portion of his portfolio]= $198.75 i.e. he would have almost recovered his principal.

Looking at it another way, if at the end of the 1st year, he had sold some of his stock (i.e. cashed in) when the market was high, he could have reduced his loss to a large extent.  However Tandiya did not. He told himself “The stock markets are doing so awesome. It would be a sin to take money out of it when the going is good” and did not balance his portfolio. However as pointed out, just because the market was doing well, the risk of it going down had become higher and Tandiya would have been better advised to take out a larger “insurance” to cover the increased risk (technically speaking, he should have made a better hedge).

Taking away money from a stock fund when things are doing well in a smart manner, as means of managing risk, is one of the toughest things to do. Which is why this is a folly that is made not only by small investors and tyros but also by the big boys and the market gurus.If one looks closely, one would see that the major losses on Wall Street sustained by the big players have come because of similarly improper risk management strategies where the potential of higher returns have made fund managers take more and more risk till the camel has buckled down and rolled over under the weight of one straw too many.

Error Number 2: The Nostradamus syndrome. When you hear people saying “Biotech is going to be the future. I am putting $10,000 on Toxic Pharma”, you know that they are making Error Number 2.

While you may definitely get lucky and choose a winner among companies perceived to have potential, putting an inordinate amount of your investments in so-called “growth stocks” (i.e. those companies that have shown healthy per share earnings in the past one or two years or are tipped to grow) has historically been extremely risky. As well as extremely popular.

It is indeed because of this popularity, that growth stocks are almost always “over-valued” and that is because everyone wants to buy them. It is worth remembering that an investment, even in a company that is “great” or may become “great”, may be bad if you paid too much for it.

Also the potential for growth of a sector does not necessarily mean that their share prices appreciate as much as expected. The classical example of this are “air-transport-stocks” which were considered to be the growth industry of choice in the early 50s. Mutual funds that invested in the airline industry (like Aeronautical Securities) have proven to be disastrous and despite the popularity of air-travel today, the airline industry has never performed as impressively as was believed.

In addition, just because a sector looks good to grow, does not mean that you will be lucky enough to separate the wheat from the chaff. For every IBM, there are hundreds of tech companies that have been brought to their knees. Amerindo Technnology Fund, a mutual fund that concentrated on dot coms, rose 249% in 1999–however if you had invested $10,000 in it, you would have about $1,200 left at the end of 2002.

Error Number 3: The stock tip. Whether it be your paanwala, the guy who sits in your cubicle, or the market expert on TV giving you a stock tip, people should treat such advise with more than a healthy dose of skepticism. Not surprisingly, they do not.

Unless the information is of the type that is not by nature publicly available (i.e. reliable “insider” information from a direct trusted source), stock tips are almost always misleading. If the stock tip is “good” (which is rarely the case), everyone knows it, and then acts upon it. This pushes the price of the tipped security up making it not as attractive an investment as it originally was.

In most cases however such insights into the future are misguided.

Remember that the most intelligent men of our times with great heads for figures have suffered humiliation in the stock market.  Case in point: a certain Isaac Newton who lost a lot of money thus.

And as to the so-called experts on TV and on the Internet, the lesser said about them the better.  James Cramer, a stock evangelist and expert, who comes on CNBC and is known for his animated sports-casterish way of analyzing markets, gave ten “hot tips” for the future in 2000 (read them here). Most of these companies have now gone bust and according to the “Intelligent Investor”, a $10,000 investment spread  equally across Cramer’s picks would have lost 94% of their value by 2002, leaving the hapless investor with a total of $597.44.

Coming back to the original question. So given that people still make the same mistakes and will continue to do so, what is it that makes the situation so bad in 2008?

First of all, and this is perhaps because stock investments have done fairly well over the years,  they are considered much less risky than they were considered to be in the 50s and into the 70s.  Which is why many people in the US think nothing of putting almost their entire life savings in the stock market.

Even more important has been the democratization of the investment landscape brought on by low-cost online brokerages. Traditionally, investment in the stock market was an opportunity reserved for a privileged few, that is those who had a significant corpus of assets that would make it economically feasible  for them to hire a money manager and to shell out large broker commissions (the money a broker takes from you as his payment for doing a stock transaction) and engage in sufficient volume of transactions that would make it worthwhile for the broker to service the customer.

However the last decade or so has seen the proliferation of online brokerages whose low fees and low limits  on volume of transactions has removed the entry barriers to the stock market in a way that is nothing less than revolutionary. Housewives, truck drivers, college students, grandpas—are now all “in the game” , connected by their cellphones and laptops at all times to the market, having real-time access to market data and an always available corpus of financial knowledge, things that even a few years ago were the prerogative of the professionals.

This increased involvement of all sections of the society in the market has increased, in general, society’s exposure to the vicissitudes of the stock market. Which means any slight perturbation in the markets affects people’s wealth to a far greater extent than they would two decades ago. This also works the other way—-people’s emotions (of panic as well as of optimism and of course collective follies) affect the market more significantly than they used to.

Add to it the fact that instantaneous online trades, automated trading and the availability of real-time quotes make shock waves propagate through the market faster than before, and one begins to understand why share markets are much more volatile and exert a greater, almost instant impact on the common man than ever before in their history.

The second reason why the crash of 2008 is different from previous collapses is that for the past few years, both individual investors as well as financial institutions have exposed themselves to almost obscene levels of risk through high leverage. This means that they have not been investing with just their own money but also with money borrowed from others, with this borrowing many many times greater than their own assets.

This borrowing of money to increase your returns is called investing on margin.

And why is it so attractive?

Consider aggressive investor Inderjit Chadda, the lawyer from “Damini”. He has $20,000 in assets and borrows another $180,00 from a lender, promising to pay him back the principal along with $10,000 as interest at the end of one year.  Seeing that the housing market is booming, he then buys a $200,000 house. In a year the price of the house becomes $230,000. Chadda sells the house, returns the money to the bank ($180,000) and pays them the interest ($10,00) and has $40,000 left for himself. Since his initial share was $20,000 he has now obtained $20,000 as return on his investment—in effect doubling his money in a year.

Consider passive investor Alok Nath. He waits for many years till he himself has saved $200,000 and in the process misses many opportunities for profiting from rising housing markets. Ultimately, he times his house buying at a time the housing market is going up and like Chadda manages to sell the house for $230,000. His profit is $30,000 but on an initial investment of $200,000 making it only a 15% gain per year. Good but nothing like Chadda’s returns however. Expect Chadda to do an exaggerated toss of his head,as a sign of victory, every time he sees Alok Nath

But what if Chadda made a miscalculation, like the time he dared to cross paths with Sunny Deol. What if instead, the market went down while he held the house. That is, at the end of the year, the house’s value had become $170,000. Now Chadda would still have to pay the bank their $180,000 + $10,000= $190,000. Which means he would need to get $20,000 ($190,000 – $170,000) from somewhere in order to prevent being in default of the bank. And his own investment of $20,000? That would have been wiped out. Chadda would now effectively have lost $40,000 in a year, $20,000 of which he himself never had.

In a similar situation, Alok Nath’s loss would be only down 15% i.e. he would still have 85% of his original investment. And he would not have to sell his kidney. At least for now.

If you think that Chadda was being excessively cavalier in his investments, you are mistaken. At $190,000 debt for $20,000 of assets, he was well within the leverage (i.e. debt to assets) ratio of 12:1, traditionally what has been considered, by US law, to be the upper limit to the amount of leverage a bank can carry. In 2004, under pressure from the sharks at Wall Street and from their greasy lobbyists, the federal government entity SEC (Securities and Exchange Commission) allowed 5 investment banks to carry leverages of, hold your breath, 30 and even 40 to 1.Which not only opened the doors to the potential of mind-boggling returns (mind you ‘potential’) but also unleashed the dogs of absolute financial ruin on five of the strongest pillars of the US economy.

And who indeed were the chosen 5?

Lehman Brothers, Bears and Sterns, Merril Lynch, Goldman Sachs and Morgan Stanley.

And we wonder why a firm like Lehman Brothers that survived a Great Depression and two World Wars could not survive 2008 !

Operating under dangerously high leverage ratios is not a prerogative of the Big Boys, even ordinary investors, seduced like Inderjit Chadda, have fallen prey to it like never before. Not only are they carrying higher risks by operating “on margin” (i.e. investing borrowed money), many Joe the plumbers and Jane the programmers are using the borrowed money to venture away from stocks into riskier, but higher pay-off financial instruments like options and futures(which are bets placed on the price of a financial commodity in the future).

In short, ordinary investors are not only more plugged into the markets than ever before, they are also carrying higher levels of risk. Which means that while billions will be made when the going is good, in times like 2008, the impact of a weak market on the country is like a rifle shot through the brain whereas in past decades it was perhaps like a slash with a long knife on the thigh.

And finally what makes 2008 so hellish, in comparison to the past, is that the main fuel for a vibrant economy—corporate growth has come to a standstill in the US. The cumulative effect of years of  steady flight of manufacturing jobs and investment capital away from the US, high oil prices that not only have led to the biggest transfer of wealth in human history but brought to its knees many of America’s most venerable automotive corporations and the three trillion cost of a needless war have all detrimentally affected the foundations of the market. So while money can still be made on Wall Street through well-placed bets and the markets will go up (and down) based on trading, the fundamental supply of oxygen that keeps earnings growing, the dividends coming and leads to overall economic prosperity have been severely constricted.

Which is perhaps the most worrying aspect of this whole affair.

101 thoughts on “The Wall Street Meltdown Part 3

  1. pehla comment kahan hai

  2. Put a “long post” warning!

  3. GB – with all due respect, you really should learn a little more finance before writing tomes about it.

    Your post is somewhat naive and factually incorrect in many ways. An easy one – ‘unemployment is at historic highs’ – here’s some history:
    Current rate (6.1%) is lower than June 2003.

    In case you did not pay attention, the economy grew at a health pace in Q1 and Q2. The problems have been heavily localized to the financial sector. Of course, the spate of bad news and resulting sentiment is going to hit everyone else pretty soon, but to suggest it has already happened is plain wrong.

  4. @Manu: The word “historic highs” does not necessarily mean something is at the highest. I hope someone with an ear for how the word is used would understand that.

    For instance, look at this article whose headline is: “Ohio jobless rate eases; still historically high

    The jobless rate improved from August, but it remained at its highest level in more than 15 years.

    The Ohio Department of Job and Family Services on Friday reported the jobless rate last month dipped to 7.2 percent from 7.4 percent in August. But the level was up from 5.7 percent a year earlier.

    I hope the context in which the phrase “historically high” is typically used is evident.

    Still not convinced? Look at this post dated Sept 23, 2008.

    But the other key point of our economic emergency is that too many people are losing their jobs based on financial decisions beyond their control. We have historically high job losses over the past few months. What could be more of an emergency than to address this now rather than wait another six months for Congress and a new president?

    The author is Hillary Rosen of CNN and an editor of Huffington Post.

    In conclusion, 6.1 is quite high in general if you look at the numbers you linked to. And coupled with other factors like debt and consumer confidence(yes thats very important) and the all-time high number of people who subsist on food stamps , it brings about a negative perception of the economy, “historically” one of the most pessimistic.

    And as to growth, looking at the article here, one sees that there are many things that affect economic growth, not all of which are beneficial to the common man. For instance here is something from someone who presumably knows finance better than me.

    Mark Zandi, chief economist at Moody’s, said expanding exports due to a weak dollar are “an important source of growth, but it doesn’t add a lot to jobs, it doesn’t mean very much for the average American household.

    In other words, economic growth caused due to attractiveness of US goods in foreign markets in turn due to the falling dollar, does not necessarily mean much to the common man.

    As to the Quarter 1 growth in 2008 being good, some people disagree.

    From here with the headline
    Economy grows by only 0.6 percent in 1st quarter of 2008.

    The bruised economy limped through the first quarter, growing at just a 0.6 percent pace as housing and credit problems forced people and businesses alike to hunker down.

    Limped through. Again not my words.

    Actually the stats on Q1 were revised to 0.9%. As to Q2 growth, the reason for the 2.8 number (from 0.9 in Q1) didnt look too great.

    The increase in real GDP in the second quarter primarily reflected positive contributions from
    exports, personal consumption expenditures (PCE), nonresidential structures, federal government
    spending, and state and local government spending that were partly offset by negative contributions
    from private inventory investment, residential fixed investment, and equipment and software.

    And as discussed before, positive contributions from exports comes, to a large extent, from a weak dollar.

    Again my point is that numbers like GDP growth do not translate into public perception of an improved economy. (3 in 4 Americans thought their country is in recession or on the verge of it in March) And it is on perception and on expectation that stock markets and consumer indexes move.

  5. Not your arena, leave it. You sound like the amateur investors, you mentioned in your post. I read all three posts and my comments are similar to this in all of ’em. Also, some of the content seems like a direct copy of “rich dad poor dad”. I am a huge fan, but this time I must act like a critic and ask you to not write post 4!

  6. @Prateek: Thanks for being so perceptive. I havent copied from Rich Dad Poor Dad mainly because I have never read it. I have read Intelligent Investor though, which is a book Warren-da recommends.

    Since you have accused me of “direct” copying, I would be obliged if you could back that up.

    I hope you do not think I am taking credit for espousing sound risk management principles that have existed for decades and written about in many books, most definitely in the Intelligent Investor.

  7. Just a few comments.

    1) Although you were never judgmental of the stories that you quoted, I think few things need to be clarified:
    * On Story 1: The failed companies HAD to keep the executive pay high and give golden handshakes. Failing to do so would lead to lost talent (if you accept they were talented in first place and the crisis was because of external factors) and adversely affect productivity throughout the organization. Read “Logic of Life” by Tim Harford for detailed analysis of this result.
    * On Story 2: After carefully reading the passage and linked news item, I could not find any mention that they did this on company money. If they did so, then it meant misplaced priorities of the companies (though there could be a deeper rationale why they NEEDED it). However, if they did it out of their own pockets, then we shouldn’t be judging them. How much money they get in pay and bonuses can be argued upon. But once they get the money, it becomes a personal decision to spend and it shouldn’t be our concern.
    2) What most people will miss here is that the economy is growing (howsoever slowly). This means that we are not in recession. Real GDP is rising and so there is progress.
    3) The unemployment rate, at 6.1%, is ‘historically high’. But ‘historically high’ is a misnomer as it doesn’t tell exactly the period it is referring to. It is 15 year high now (in Ohio) and 5 year high (all over US), but nothing compared to the Great Depression, when it was over 20%.
    4) The weakened dollar will lead to increased competitiveness of US goods in world market. Although it may not get as ‘good’ as during depression (US had a trade surplus in 9 out of 10 years following the Great Depression), increased competitiveness will mean improvement in US economy.
    5) The current panic has led to rapid decline of credit market, though it is still a long way before it can be said ‘frozen’.
    6) Things are improving. Oil has lost its flab (down to $70 a barrel from $140 not too long ago). And while, it may be a bad time to invest in equities, I am sure the world economies will improve faster than what most people are anticipating. Let’s not get the pessimistic bias already.

  8. @Ambuj,

    1.A) Please. In every other type of organization, if revenues decrease people get fired and proportion of salary to net revenues decrease. Companies do not “retain” talent which is partially responsible for getting them there in the first place. So according to you, the golden parachutes (when they are leaving) given to CEOS was necessary in order to “retain them” and increase “productivity”.

    Shame on you, Mr. Sullivan,” said Rep. Jackie Speier (D-Calif.), noting that Sullivan was not giving up any of his $5 million performance bonus.

    I don’t think I want to belabor this point further. Suffice to say, even the biggest apologists for Wall Street in the popular media wont air your views. At least not now.

    1 B) So you think they did it on their own money and I would be foolish enough to cite that as an example of corporate greed??? No they did not pay for it with their own money. They did it on company money. Was this seriously not apparent from the story? Do you think that AIG execs would be dragged over the coals by a House Committee for their personal spending habits?

    “Less than a week after the taxpayers rescued AIG, company executives could be found wining and dining at one of the most exclusive resorts in the nation,” Waxman said in kicking off an angry hearing of the House Committee on Oversight and Government Reform. “We will ask whether any of this makes sense.” “They were getting their manicures, their pedicures, massages, their facials while the American people were paying their bills,” thundered Rep. Elijah E. Cummings (D-Md.). ”

    2. Pity that 2/3rd of US economists dont agree with your assertion that the country is not in recession. One of Bush’s advisors is saying that parts of the country are in recession. Thats the official stance.

    3.I dont think I compared unemployment to Great Depression levels.

    4. I have no problems with that.

    5. That is your own assessment. Because you do not define what “frozen” is. Its sufficiently frozen for the government to spend $700 billion dollars to buy bad mortgages, sufficiently frozen to insure money market mutual funds. If that’s not frozen, then perhaps neither is the polar ice cap.

    6. Again I never said things wont improve. If you read my post again you will see that I have considered the POV that things are not as bad as they seem. However there are certain aspects of today’s investment climate that make the catastrophe in the stock markets so important to peoples lives that it is an issue that loses elections and causes world governments to act instantly and in coordination with each other.

  9. Well written. Is it going to be end of “Free Markets/Deregulation”. In India bureaucrats and politicians now have got a very strong case against privatization and opening up of the economy.

  10. @Sam: The Karats must be delirious with joy. The problem however is not with privatization/globalization/capitalism but unbridled, regulationless adventurism. And yes it is difficult to understand where the line is.

  11. “Even more important has been the democratization of the investment landscape….” There’s a point I’d like to add on this. You’d mentioned that more people from the bottom up have been able to play the market. But equally important in my view is that markets are more interconnected than ever before. The Depression took a year or more to reach Europe, and the Asian financial crisis, while it hit America quickly, did not noticeably (I may be wrong here, correct me if so) affect India and China. With markets connected worldwide the way they are, some dude in UK can put his money in a bank in Iceland which offers nice returns, which just happened to have invested in a security backed by subprime thingies. So, for no fault of theirs, the entire police force of a UK town can lose their savings!!! The story is here:

  12. Hi GB,
    I have been following your posts with vigor. Wall St part 3 is quite articulate and well read, but I must disagree with some parts.

    1. The US is not in a recession. Contrary to what Bush’s advisor says, the markets do not go by what the government or the Fed preaches. Rule of thumb is recession occurs only when there are two consecutive quarters of negative growth, something that is now de facto in UK, Ireland, Iceland and good ole Europe. Some parts of a country being in a recession does not quantify the whole country being in a recession. The US has in fact had positive GDP growth last quarter, somthing that one of your readers has posted before. Recession, however is not doomsday scenario. Japan is a prime example.

    2. The US dollar has always been on a historic roller coaster. The currency has been deliberately kept undervalued at 20-25% its actual value. There have been several economic reports on why this is the case. Simply put, a high dollar causes more harm to the US economy than a lower valued one. If Take India for example. When the Rupee was trading against the dollar for 38, the export sector of the country got badly hurt. IT, manufacturing, services reported lower revenues.

    3. In regards to your story 1. Many financial institutions are not keen to avail the Treasury’s package because of executive pay ceilings but simply because the treasury package was vague and did not offer specific details on what it proposed. The report when first created, was only 3 pages. It was presented to the house as a 3 page report when it was turned down. It expanded to 110 pages and became a 400 page report that turned into a law. Surely, if I were given a 3 page report that did not articulate on how it would help my business, I would say thanks but no thanks. The same financial institutions that balked off before are now coming back to avail of the package. I believe this section of yours needed some more research, but given your non finane background, I must say you have done a betterjob than others of the same calibre.

    4. Wall street always over reacts to booms and busts. Since it is a short term market, it follows the short term principles. You do good, yuo get paid good, you do bad, you are out on the streets. While the inflated salaries are now being looked down upon, they simply signify the true value of the job. I might say, why pay 100 million dollars to Tiger Woods when all you have to do is swing a stick at a ball and make it fall into a hole. Or Tom Brady, Ron Artest, Shaq, Steve Nash,Lance Armstrong, Michael Schummacher, Valentino Rossi..and the list goes on. These guys are good at what they do. The same applies to wall street. Now some may counter it by saying, whats the point paying these goons so much when they threw the economy down the crapper. There is no right or wrong answer to this. There are so many fingers to point at that there is no right way to even answer this.

    But what is happening to us in 2008 is not doomsday scenario. It is a market correction that was bound to happen. It has happened time and again and it will happen in the future.

    Greed and fear are what runs finance. The ones who can see greed through the fearful times are the ones who will start the next financial money making trend. After all the housing market started because of lower interest rates issued by the Feds after the 1987 crash.

  13. anonymous coward October 20, 2008 — 3:58 am

    parts of the post, esp. about the mistakes made by investors look straight out of the intelligent investor. but then, people never learn do they ?

  14. @Raapchikmaal: “I believe this section of yours needed some more research, but given your non finane background, I must say you have done a betterjob than others of the same calibre.”

    Please read this

    But Wall Street analysts, believe the addition of so many terms to the bill might deter potential participants.

    One of the least attractive elements is a section designed to curb executive pay at banks that participate in the bail-out package. These include limiting stock-related pay and banning ‘golden parachutes’ for executives.

    ‘I think this hodge-podge of regulations and rules will be enough to put many [chief executives] off participating,’ Caldwell said.

    This is the reason for Story 1.(The assumption about people’s intentions is something that this article makes). I didnt give this link because I had this link in Part 2 of my post. I have put it back in so that people dont think I didnt do my research here.

    @Anonymous Coward: True. That was the point is. People still make the same mistakes that they did when Graham wrote his seminal tome.

    @Akasuna No Sasuri: Agree.

  15. Arnabh – this is too complex for a commentary fight but let me just say a couple of things.

    First off, using Ohio data as a proxy for US, is like painting a picture of Indian economy based on Bihar’s economy. 2-3% growth rate is the most you expect in the US. So 2.8% in Q2 was up there.

    Why don’t you write something amusing about India – Australia series instead?

  16. @Manu:

    1. The reason I gave the Ohio example was to demonstrate to you what the phrase “historic high” means. I would think you would understand that this was not to extrapolate Ohio’s numbers to US.

    2. My name is not spelt “Arnabh”.

  17. Totally unrelated technically, but keeping with the spirit of the thing…. watch “Wall Street”. Specially the amazing “Greed is good” speech.

  18. Ehh got here too many wall street apologists.

  19. this is turning to be a can of worms.

    GB, the article you are using for your research is outdated (in finance, anything older than a day is prehistoric) and comes from mainstream media. Given the tumultous events, something that happened 2 weeks ago cannot be held in the same regard today. And mainstream media, even if reputable like Guardian does not comprehend the intricacies. There are several better articles that talk about the bailout and its effect on wall street on bloomberg, economist, or FT.

    The article quotes Wall Street Analysts. Who are these analysts? Are they investment analysts in a 2 year program at JP Morgan who do nothing other than filling coffee pots? Are these seasoned analysts who equity research in the derivatives market, FX, bonds.. yadda point is that you cannot rely on this material to justify your opinions.

    I think for a layman its very easy to make armchair analysis and point figures and believe in his or her convictions. Kudos to your thinking and your analysis of the subject, but you are basing your facts on what you have learned from the mainstream media and the current events.

    The issue is more complex than it appears. Keep up the good work, but I think you have opened a can of worms with your newest offering and you may have to face some heat.

  20. Yes Raapchikmaal I have made my analysis based on what I have learnt from “the mainstream media and current events” (your words). I never knew that was considered to be “opening a can of worms”. Nothing personal, I think I will continue to place my trust in mainstream media outlets like the Guardian and NY Times than on basically anonymous comments on a blog.

    “In finance, anything older than a day is prehistoric”.

    So what you are in essence saying is that historic data and analysis is “pre-historic” and hence wrong. I did not know that.

  21. GB,

    your opening a can of worms is not related to your analysis based on media but your whole article in general.

    Yes, historic data in finance is prehistoric. The markets work on speculation. That is why every pundit speculated on the housing market saying by historic trends the housing market is supposed to go up.. It didnt.

    Same goes for oil prices. Everyone speculated on high oil prices going by their analysis of commodities market. Russia and Iran are now the new economic calamities due to low oil prices. No one predicted that.

  22. @ raapchikmaal

    It seems to me that you are nothing more than those apologists who just got a finance degree from somewhere but lack the very basic of common sense. Just one comment that “Historic data in finance is prehistoric” is enough to even tell the naive that you are a hopeless apologist.

    as for your rant that this scenario is more complex that it seems, its the trademark of finance androids everywhere to speak in vague tersm when they don’t know what to say.

  23. abhishek,

    big words indeed. not having known me or what I do for a living, you make an assumption of me having a finance degree from somewhere and being an naive apologist clinging to my theories.

    your common sense should have warned you not to make self assumptions and go on a post bashing thread. However, you seem to have checked your common sense outside the door before stepping in. I dont know you, but I hope that before you start talking, you back your statements with some solid facts instead of name calling.

    when something is deemed complex, you term it complex. However, I am sure you are one of those non-androids who think its quite easy and you regularly provide counsel to Paulson and Bernanke.

  24. *Pro Click*
    This video explains why this isn’t just a financial crisis, as the media would try to limit it to.

  25. Raapchikmaal – are you serious?

    To say that any data beyond a day old is prehistoric – that may be true for a trading desk (isn’t even true for a trading desk, because, for example, they do look at historical levels of TED spreads, LIBOR rates, overnight rates, etc.), but there’s a whole universe of banking and finance beyond the trading desk.

    If this wasn’t true, then announcements of macroeconomic indicators wouldn’t matter one bit to any investment bank. And by the way, your objection is misplaced anyway, because all Arnab is doing is faithfully reporting what was indeed a fairly well-recorded objection to the Paulson Plan. Yes, things have changed, but that doesn’t mean we cannot report on what went on before.

    As for the Guardian article, here’s a quote from it:

    “There is a growing feeling that banks … might instead decide to tough it out,’ said Thomas Caldwell, chairman and CEO of Caldwell Financial, a $1bn-plus fund manager.”

    Does the fund manager of a $1 bn plus fund sound like someone from the JP Morgan analyst program?

    If you think Arnab’s analysis is flawed, why don’t you point out what are the specific things that you disagree with instead of dismissing his efforts offhand as armchair analysis?

  26. Yes..they are big words…And why do you think its required for me to know what you do for a living to pass a judgment on you. Your total rant is just that this process is not that simple and its a can of worms without any rebuttal to Arnab’s post. You never said whats your take on it or how Arnab is wrong. So, in the light of these acts of yours, you have been called what is apt. I may be wrong about your financial degree but for the apologists part, i am spot on. As for the counsel to Paulson, the day voices of us are heard and fiat money system thrown, it will be bliss.

  27. Arnab, I liked this one as much as the other two, but I do have a minor quibble with it.

    I think you are very correct in noting the tremendous increase in market participation by retail investors (many of who are also day traders) who actively trade through electronic trading platforms. However, the vast majority of retail investors channel their money into the stock market through their 401(k)s and pension funds.

    And these are managed by institutional money managers. On the whole, the institutional players like pension funds, mutual funds, hedge funds, and funds owned by investment banks still dominate the movements on the market. So, even if the retail investor is guilty of all the errors that you list, his clout in influencing the market is very limited.

    And this is precisely why rumblings in the credit market have such a profound impact on the stock prices. It’s not the retail investor who’s so over-leveraged, it’s all the hedge funds and investment banks who are the major institutional players and get affected with enhanced collateral requirements and margin calls.

  28. Well Rapchikmaal is correct as far as basing finanical events on the basis of ‘historicity’. Especially when you are betting against ‘low probability but very high consequence’ events. I think Nassim Taleb calls these ‘black swan’ events.

    His classic example is that a Turkey is fed increasing amount of food for a 1000 days. The Turkey’s statistics department after doing a time series analysis concludes that the humans are interested in the welfare of the Turkey. On the 1001st day the Turkey has a surprise 🙂

  29. Hi Thalasaa,
    no, I do not object to Arnab’s analysis. Instead, I admire it because I read his previous posts on the same topic and he was bang on the topic with this. I only disagreed with some of the parts in his writeup, which Arnab countered with valid points but I felt that some of his research is flawed.

    My point is that one cannot make valid conclusions simply relying on data or figures. Yet that is the mistake Wall Street continues to make and will make. And to a certain extent, the successful financers, or at least the saneful ones dont take these economic parameters into trend.

    Macroeconomic indicators or rather analysts using historic trends actually pointed to the beginning of an economic recovery by Q4 2008. This was in March 2008 when Bear Stearns went down the drain. Now the same analysts are saying it will be 2-3 years before any change happens. All based on your historic market trends and patterns.

    As for the fund manager part, I referred to the statement where the article says Wall Street analysts etc etc

    I already pointed out to the specific things I disagreed with Arnab’s view point in my first post.

    It would be redundant to keep on harping the same topic.

  30. @ Abhishek

    Please read through the whole post before blabbering away. I already mentioned what I felt could be disagreed with the owner’s post. Then you stepped in.

    Read before you speak. Not to mention you havent posted anything constructive other than random name calling. However, I am sure you havent exercised those gray cells of yours much either so I dont expect anything substantial. I forgive you for your superflous banter.

  31. I have never seen GB coming back with rebuttals so often in recent times.

    And of course the curious absence of RTDM frequent flyers! So I think I’m sticking my neck out here, but here I go.

    GB made it very clear that he does not have the training which the stalwarts like Manu, Prateek or Ambuj might have. Posts WSMD 1, 2 & 3 looked to me like a brilliant student’s project. Something where you understand the basics while you work on it. And I would give an A for putting a finger on it every time.

    Times are bad. And not just in the financial sector. Only two kinds of people still can say things like some of the comments above. One, people who have invested heavily and continue to hope that a miracle will save their ass. And two, ex-financial wizards who haven’t received their golden handshake cheques yet. Perhaps some of the comments were written from the calming environs of cool resorts.

    It’s okay GB. You never claimed to be a know-all of this game, in spite of the evident depth of your understanding. These posts have certainly made me very wise. And I never had time for ‘Intelligent Investor’.

    If there are tutorials like these you plan on politics, sociology and quantum physics, please count me in as a frontbencher.


  32. Thanks for the insight!!

    I was captivated by the “investing on margin” funda. I have had friends who invested on margin and made a killing. But then, their timing was impeccable and they were not so greedy as to hold on to their high performance investments after a certain limit. The same cannot be said for the big 5 though!!

    After digesting all this information, one just wonders “isint this all commonsense anyway?” Then I remember hearing “Common sense is the most un-common sense”….:D

  33. @Great bong Quote “In your latest comment, you have accused me of copying directly from a certain book, a book I have not read. Since you have made the accusation publicly, I would expect you to back up your accusation with specifics. I have not claimed any originality in the advice of value investing (which is originally an idea of Graham) but thats not your accusation. It is of direct plagiarism. Which I never do and do not condone. However you are free to doubt me.

    Having made that rather serious accusation, I think that you should support that.

    You should understand I am not reacting to the rest of your comment, why I should stop writing on my own blog and why I am wrong. This is only with respect to the charge of plagiarism.””

    The comment in question here is this “Not your arena, leave it. You sound like the amateur investors, you mentioned in your post. I read all three posts and my comments are similar to this in all of ‘em. Also, some of the content seems like a direct copy of “rich dad poor dad”. I am a huge fan, but this time I must act like a critic and ask you to not write post 4!”

    My sincere apology for your misunderstanding I was accusing you of plagiarism, like you explained to “manu” the relevance and clear meaning of word “historically high”, I think you know the meaning of the word “seems like”. It does not means that IT IS A COPY it merely looks like one.

  34. The above comment is from me, I forgot to add name.

  35. The above comment is from me, I forgot to add name.

  36. I know of one guy who (years back) purchased shares of a particular company after researching it and visitng its factory etc ..then use to distribute pamplets to make its share prices go up! He failed badly.

  37. This is nitpicking, but I’ll still point it out :
    In the Inderjit story, it should be “borrows another $180,000 from a lender” instead of “borrows another $180,00 from a lender”.

  38. @ Raapchikmaal (& Thalassa)

    -Historical data is pre-historic…may be true for a trading desk
    Untrue- I work for a trading desk and I use historical data all the time… to back-test my model & VAR numbers & stress-test (how my model behaves under extreme scenarios)

    Nothing-personal mate, but actually, it is one of those classic – smart sounding, but intellectually weak arguments…we all know future may look nothing like the past, but past is all we have to go by. That is why I think somebody like Buffet (almost an octogenarian) is so smart, he’s seen enough bubbles and busts to understand the patterns…

  39. Arnie – turkey the bird, not Turkey the country :). I was wondering what surprise is in store for the Turkish nation after 1000 days.

    Actually, I would like to disagree slightly on this interpretation of Taleb.

    I highly doubt Taleb ever said that historic data doesn’t matter and that any data beyond a day old has no value for finance professionals (if he did say so, I sincerely apologize and I’d be grateful if you could provide me a reference so I can look it up).

    I thought Taleb’s argument was to warn against over reliance on historical data and making decisions on the basis of poor risk assessment models formulated on an over-optimistic reading of historical data.

    I think he believes that outliers (six sigma events, ten sigma events, take your pick) in predictive models should be given more importance in risk assessment.

    I’m a little conflicted about this. I mean, on the whole I do believe that historic data is invaluable for us to understand how financial systems work – at least from a behavioural finance point of view, such data is invaluable.

    On the other hand, I think technical analysis and chart reading is basically nonsense and that past stock prices are poor predictors of future stock movements. We’d be better off thinking of it as a memoryless system.

  40. Hi GB,

    There might be many financial “GURUs” in your forum who is finding this analysis of your trivial… But to an engineer like me, it is perfect. I got your story a lot clearer than probably a financial analysts (of course with a tinge of humor).

    Some people just fail to see the premise and attack on every possible opportunity. They are free to read high end economic journals – no one is prohibiting them.

    Why don’t you talk about the working of iPhone is the next post..

  41. Great Bong,
    This is a very well explained post and funny too.
    All these half-baked desi Gordon Gekkos should come up with better arguments.
    Believe me, they would’nt be reading this post if they knew shit from shinola.
    I think there was a disclaimer in the beginning of this series that said the the author is not Warren Buffet.
    Also please get laid my fellow argumentative Indians, All that pent up libido is making you talk dirty to GB.

  42. @GB,

    Clarifying on the points again.

    When things go bad, many organizations layoff and cut salaries to cut costs. However, this is not indiscriminate result of drawing lotteries. The best people in the organization are retained. In the current situation many organizations are, in fact, believing this situation is due to external factors (like too much government intervention). Penalizing for people (who the organization believes did the right thing) will definitely be bad for business in the long term. Also, the obscene salaries and golden parachutes are aimed less at retaining people at top, but more throughout the heirarchy. If they cap the CEO pay, the VPs will go elsewhere because they know they can’t progress any further in the organization. Read “Logic of Life” for a detailed analysis.

    “[…]while the American people were paying their bills”. This sentence doesn’t quite say if the trip was directly funded by the company. Even if they did it on own money, using bonuses they got from “American people”, this statement would have been made. Again making clear, if they did it on company money, it was most likely wrong on part of companies to allow that. Of course there can be more to it, so I am not judging. For example, if it turned out that the trip was planned long back in a non-refundable booking, I wouldn’t hold the executives for any wrong-doings.

    A country is said to be in recession when the real GDP falls for two consecutive quarters. It doesn’t matter what the economists “feel” or “think”. That doesn’t change the truth. If you accept that the GDP grew for the last quarter, you can’t claim there is recession.

    You didn’t compare the unemployment rates to Great Depression, but using words like “historically high” leaves a lot to open interpretation. Who would have thought that the history you are talking about spans only 5 years (2008 vs 2003 unemployment levels in US).

    It is true that I haven’t defined “frozen”. In fact it can never be completely frozen, if you go by the rigorous definition. I agree that there is crisis situation in the credit market and there is tremendous shortage of credits to fuel the economy. However this doesn’t mean that credit market has dried up completely. It is still available, though not sufficient for every deserving person’s need.

    I never trust the government stand on economic policies because more often than not, they are because of political compulsions rather than economic common-sense. The only time I find that politicians are being truthful when they describe their relation with another political party as a “political alliance”.

  43. Arnab, another fantastic article. I love how some of the readers quibble at minor issues while totally miss the big picture. Those who are ranting that things are not so bad for the US economy should revisit their comments in another couple of quarters.

    The balloon has popped for sure, there is no place to go but down. The “rifle shot through the brain” (excellent analogy, Arnab) will bleed Uncle Sam out. Watch out for the global repurcussions of the falling giant. Remember Mahabharata? When Gatotkacha was lethally wounded, he magically blew himself up several times (I wonder whether that ratio was close to 30:1 or 40:1 like the leverage ratio) and fell upon the fighting Kauravas, crushing several thousands in the process.
    The most spectacular ramification of US crisis till date has been Iceland’s tragic collapse. Who would have thought that the Scandinavians were so much into bogus hedge funds?

    IMHO, the current picture of the economic crisis is only the tip of a mighty iceberg. How the US and the world will react remains to be seen. I pray that the short-term manic-depressive reaction subsides and a long-term reformative approach is initiated soon.

  44. @GB: A fitting end to a great trilogy! 😀 … This post was every bit as enthralling and informative as its predecessors! Keep expanding upon the subject from time to time. I think it is time that you begin to diversify from matters of frivolous national interest to matters of international significance. And you seem to have bridged that gap with the help of this series of posts.

    @GB wrt Venky: LOL!! I think I agree with Venky! I would readily sign up for a highly sarcastic, but deadpan online dissemination from you in everything from ‘The aesthetic appeal of the Kama Sutra’ to ‘Bose-Einstein Condensate’!! Am looking forward to your branching out into uncharted territories (for example: try out connecting quantum physics with prabhuji’s cinematic masterpieces!) 😀

    @Raapchikmaal & other critics: I do think that GB deserves some credit for presenting a crisp, lucid and entertaining picture of the entire financial meltdown. He has managed to capture the essence and gist of it in quite a wonderfully simple yet comprehensive manner. So for those of us who are not associated with a formal (or informal) education in finance and economics, it serves as a highly amusing and informative read on both the vagaries of the stock markets and the basics of what went wrong. I certainly found it immensely helpful in trying to figure out some of the details which I hadn’t grasped earlier. And with whatever sense of judgement I have (for what its worth) I do think that GB’s descriptions seem to be reasonably accurate and his conclusions entirely logical. I suppose that these posts were never aimed at a select ’sophisticated’ elitist crowd who seek to cover everything under a vague cloak of ‘complexities’. So to those who criticize this series as ’simplifying a complex issue’ or ‘reflecting historical and obsolete data’, etc. I can only say that this blog is too god-damned simplified for your psychological desire for complication! 😀

  45. Manu,
    Are you an I banker? I am getting a little curious!!!

  46. I am not smart enough to understand most of the stuff here but pray help me understand this:
    You wrote: “…he was well within the leverage (i.e. debt to assets) ratio of 12:1, traditionally what has been considered, by US law, to be the upper limit to the amount of leverage a bank can carry. In 2004, under pressure from the sharks at Wall Street and from their greasy lobbyists, the federal government entity SEC (Securities and Exchange Commission) allowed 5 investment banks to carry leverages of, hold your breath, 30 and even 40 to 1. … ”

    I do not understand why the government has to pass a law restricting the debts: assets ratio that banks should hold. Aren’t these banks privately owned ? Isn’t the risk they are exposing themselves to, their own business ? Am I not, as an investor in this bank, privy to this debt: asset ratio ? Do I not have the right to pull out my investment from these banks if I find the risk unacceptable ?
    I definitely must be missing something here…could you please help me out ?

  47. @Sridhar: With reply to your question SEC not only regulates banks but also imposes restrictions on day-traders. ( The principle behind this is to see that you do not hurt yourself and others in the pursuit of your investment goals. Now this might seem unduly constricting to people with libertarian POVs but as the current crisis demonstrates the effects of your risky investments, in today’s market, affect not only you but other “innocent bystanders”

  48. Hello GB.

    My second time commenting here with the first being on Part 1 of this post. Once again, an excellent and highly informed analysis which is totally correct. Simplified it is no doubt but that is the point of such posts and is its biggest positive. Through your series of posts you have explained some fairly fundamental concepts in a very lucid, unique and light-hearted way.

    I am commenting because having been in Wall Street for more than a decade, I can vouch for the authenticity of your post, particularly in the light of moderately nasty comments from people, some of whom have in the process of carping betrayed their own ignorance on the subject they think they know. Comments on the lines of “You are an amateur and should go back to writing your movie reviews” and “Everything about your post is wrong but I am too busy to contradict them” or misinformed assertions from people who do not know the contradiction between “golden parachute” and “retention” say more about the character of the commentors, than attest to their own knowledge and grasp of the subject. This however is inevitable in any online forum and not worth the time replying to.

    What strikes me as worth commenting on is the attitude which I think (and I am speculating here) that drives these commentors. Many of them think they know finance and some of them possibly do. They have learnt it the hard way and sometimes not the right way. When they see someone who claims to know nothing on the topic is writing lucid, though simplified, tracts of text about their subject displaying a level of understanding they think a layman should not be allowed to have, something snaps inside them. How dare he discuss with such authority on a topic I have spent years learning? He must have copied from a book. He must be wrong.

    I have seen the same attitude with physicists towards popular science books. “What? General theory of relativity explained in 30 pages? It’s wrong ! It’s an oversimplification ! It’s naive.” Well the news is that it is supposed to be. If the basic principles are illustrated in 30 pages so that lay people have some intuition of this topic, then the popular science book has served its purpose.

    The only dissenting commenter here who seems to have any degree of financial knowledge is Rapchik (RC). I speculate that RC is actually in the industry. This makes his comments even the more alarming.

    RC said:

    “GB, the article you are using for your research is outdated (in finance, anything older than a day is prehistoric) and comes from mainstream media. Given the tumultous events, something that happened 2 weeks ago cannot be held in the same regard today. And mainstream media, even if reputable like Guardian does not comprehend the intricacies. There are several better articles that talk about the bailout and its effect on wall street on bloomberg, economist, or FT.”

    First of all, the article that GB uses for his research is not financial “data” but a news report. Assuming your main argument that “anything older than a day in the finance world is prehistoric”, it still is not applicable to the linked piece. If your objective is to find some fault with GB’s reasoning, I only ask you to make a better effort.

    Second, when you say that the Guardian is MSM but Bloomberg and Economist are not, you either do not know the difference between mainstream and alternative media or do not know the differnece between financial publications or non-financial. In either way, your lack of knowledge of this distinction is rather suprising.

    Third, the piece that GB links to and his comments are 100% right. I can say that being a part of Wall Street myself. I should tell you I make coffee for myself and have been in this line of work for more than a decade. The need to say this upfront is to establish my credentials to talk on this topic. Incidentally, your dismissive remark about people possibly in a lower station of life than yours, smacks of arrogance and more than a little bit of smugness. I only hoped that the content of your comments would have made your arrogance look, at the very least, not without any merit.

    Coming back to the main discussion, the problem as you incorrectly pointed out is not that the Paulson Plan is vague. On the contrary, the problem Wall Street has is it is too concrete. In its original formulation, it was delightfully vague and was in essence a blanket safety net given by Paulson, a friend of the Street, who even put legal immunity as part of the Bill to protect himself from the charges of irregularities that would inevitably follow. The banks were very happy then and told the lobbyists to go hammer and tongs to get the Bill passed.

    However then the politicians added things like salary caps, and the potential for government to get returns on its investment through equity ownership, Wall Street got angry. Wall Street was expecting a donation, not a loan. It then asked itself—why take a loan from the government, let’s wait it out and take it from elsewhere. At least my salaries wont suffer.

    Fourth and most important. The very basis of your assertion that all data in the financial data beyond one day is useless is , forgive me for saying so, laughable. I sincerely hope you were trying to say “Past performance is no guarantee for future returns” and maybe it came out sounding different. Because otherwise what you said flies in the face of every predictive model for stock valuation in use. While past does not “guarantee” future, the past is the only way to predict the future. I do not think you need an MBA to understand that.

    For every cherry picked “Look the predictions are wrong” one can come up with tens of “Look the predictions are right”. That does not mean that that past data counts for nothing. I hope you know that wrong results may come from wrong data as well as from incorrect models, incorrect assumptions and incorrect intepretation of the results. But I digress.

    RC said:

    “The US is not in a recession. Contrary to what Bush’s advisor says, the markets do not go by what the government or the Fed preaches.”

    Neither does it go on textbook formulations of “recession”, which are not even universally accepted . While the person correcting your ICSE answer paper might be impressed by your knowledge of the rule of thumb of recession, the public couldnt care two hoots about successive quarters of negative growth before cutting back on spending or dumping stocks. The perception among 75% of Americans that we are in recession is dangerous enough. The point I think GB is making is that even the administration admits it is a recession.

    Sorry for the long comment but I just had to.

    My only advise to you GB would be to not be as humble with your disclaimers of knowing nothing of finance. While humility is an admirable trait, it is perhaps an unwise thing to practice when so many others interpret humility purely as an acceptance of ignorance and do not bother being humble themselves when there is often much in them to be humble about.

  49. Once again an excellent post. I read this post this morning and had decided to come back to draft a response in the afternoon once I got out of meetings. But thanks to the Anonymous above me I can now go back to doing the work my company pays me to do for he has expressed my thoughts(and more) with greater eloquence and authority than I could hope to.

  50. GB,
    Have found the current series of Wall Street posts to be really neat in terms of info and analysis. You mentioned reading the “Intelligent Investor”; was wondering if you have some other sources (other than the linked news items) of financial know-how for people who are interested in brushing up their economics.
    What can I say – you got me way more curious than I was before 🙂

  51. @kaushik
    The situation in Iceland in indeed serious, much worse than US. The reasons for it are similar to those in US in many ways (over-heated credit market, large consumer debt, etc.). However, per my understanding of the issue, it happened independently from the US credit collapse. Am I missing something? The only connection between the two that I have read (admittedly I haven’t read so much about the Icelandic crisis) is that Iceland had to ask for help from Russia because US couldn’t help owing to its own crisis. I will be glad if you can help me with a few links to relevant news items/articles. Also, I haven’t missed the ‘bigger picture’. The reason I have not written about it is that I agree with most of the things GB said. The reason I wrote about minor quibbles is that there is nothing to argue about the larger issue at hand. Take it easy.

    @Rajiv Iyer
    As I said before, even I liked GB way of putting things in a simplified and humorous way.

    I am glad you came to know so much about my character. But unfortunately it had been a useless learning and you will have to discard it because you totally misunderstood the point that I made. Yes, there is a big difference in “retention” and “golden parachute”. In fact, they are quite the opposite things. What I said was that in order to retain the executives and motivate those lower in the organization, they had to keep the pay high (and give big bonuses). However, giving golden parachutes is a sign that the company does not punish people for no fault of theirs. If an employee performs well, but because of external, uncontrollable factors the business does bad, punishing the good performers will send bad signals throughout the organization. So although companies often have to do across-the-board pay cuts and downsizing, those who still believe in their future prefer to retain the best talent and reward the performers, even if they are leaving the organization.
    And ya, GB is giving me a lot of inferiority complex. How can he, who hasn’t studied economics, write such good article about the current situation, while me, again having no formal education in economics and thus in the same boat as him, not do so. 🙂

  52. @Ambuj There are reams of academic papers and books written on the perverse nature of executive compensation in publicly held companies. Suffice to say that the concept of “moral hazard” figures prominently.

    In this specific case, these are some of the salient issues and my take on them:

    1. It is often argued that executives are compensated for maximizing shareholder value.Every major investment bank has suffered either a loss or a severe erosion of profits. And yet, before the compensation brouhaha, none of the banks seemed to be cutting back on bonuses to quit the same extent as decline in profits.

    2. The government actually plans to take equity stakes in the banks. As a significant shareholder, it has every right to push through its own agenda on what it believes appropriate compensation will be.

    3. Deutsche Bank CEO Josef Ackermann voluntarily agreed to forgo his bonus for the year (his base saiary is peanuts compared to his bonus). All of Deutsche Bank followed suit and agreed to forgo bonuses this year.

    Are they not afraid of executive flight? No, because they know as well as anyone that in this market, anyone in investment banking is grateful to hold on to the job they already have.

    What will they do if they don’t get their bonuses? Threaten to leave? To go where? Who’s hiring? (Well, the government is, but the government doesn’t give outlandish bonuses).

    As for Iceland, they basically ran away with their ambition of becoming global players in banking and in hindsight, made some rather foolhardy decisions along the way. Their currency had anyway been under attack from hedge funds before, and as a small nation, they are especially vulnerable.

  53. I guess being arrogant and smug is good, especially in these turbulent times. No wonder I am still managing to run my company very successfully while others are getting battered about.

    All I can say is that, I have had enough experience surviving in Wall Street and not listen to the quacks pretending they got the hang of the whole finance industry by listening to what the media blabbers about every morning and going by trends and data.

    and yes, I started as an analyst in one of the IBs many decades ago, where I did absolutely nothing other than photcopying pitch books and filling coffee pots. Probably while you guys were still in your diapers. So when people quote analysts, I know the verity of the statement.

    The crux is that I appreciated the author’s posts but felt that certain components of his story needed ramification. I expected a debate, not slavish appreciation towards the author and a mud slinging festival.

  54. Raapchikmaal,
    Are you in the pimping business?

  55. @sid

  56. Chandan – nope, I am not an investment banker but have read books about it.

    Arnab – sorry about the spelling of your name.

    Finance, unlike kitsch, is not suited to being adorned by flowery language. You are doing nothing better than the investment banks, their pitchbooks and mile long disclosures that only obfuscated reality.

  57. Ambuj Saxena said:
    “As I said before, even I liked GB way of putting things in a simplified and humorous way.”

    Raapchikmaal said
    “The crux is that I appreciated the author’s posts but felt that certain components of his story needed ramification”

    Thanks for looking down upon mere mortals once in a while. Thanks also for the insightful comments amidst us slaves & mudslingers.

    I come here in the midst of many harrowing days, to breathe easy. I have said this before, this blog has enlivened many a dreary day and I find the author’s humor as a succour to most monday morning blues. Laced with such sarcasm, if this blog also provides certain insights into certain happenings around the world, I can’t complain.

    If I really wanted complex explanations, presumed by some to be (hence) more authentic, I would have gone else where in the first place.

    I too have disagreed with GB on many occasions. Since it is his views on his blog, either I keep my learned opinions to myself or dissent with civility.

    If someone felt that a certain blogger should not write on certain subjects and if someone else has ‘had enough experience surviving in Wall Street and not listen to the quacks pretending they got the hang of the whole finance industry..’, please take your business elsewhere and let us slaves revel while we are here


  58. GB,

    Commenting after a long time… though I have been reading your posts regularly in the interim… dont think have missed any…

    Anyways coming back to my point… there is a reason why people like me keep coming back to your post… after a hard days work… your movie reviews are good, your take on bengal politics and the once-in-a-while NRI angst is awesome, your posts on icons like Mithun-da and Dada are must-preserves and the occasional stuff you dish out like the one on Andaman Cellular Jail are absolute gems…

    The one thing I don’t come back to this blog for is to read stuff which in any case the financial-planner-with-below-average-IQ bombards me with everyday in half a dozen newspapers across the country…

    of course you are fully within your rights to say you couldn’t care less whether I came back to this blog or not as it is your very own personal space… but I guess feedback never hurt anyone… especially from someone who is genuinely a huge fan…

    Also a caveat on the Investment Bank compensation issue… though at this point I must admit I am not entirely an unbiased commenter, being as I am, one of the privileged (!!!) lot…

    I think its important to remember two things…
    Firstly we lose our jobs a lot more quickly in any downturn… agreed this time the banks themselves screwed up… but last time when dotcom companies went bust or the time before that when the Asian Tigers went belly up… more I-Bankers lost their jobs than in any other profession… so its just the familiar concept of risk-return at work…
    Secondly most of us have a worklife span of at most 10-15 years compared to 30 for the average worker in any industry… so its not all pay and no work as people might want to believe…

  59. To all financial pundits and GB detractors…take a look at this!

    CEO — Chief Embezzlement Officer

    BULL MARKET — A random market movement causing an investor to mistake himself for a financial genius.

    BEAR MARKET — A 6 to 18 month period when the kids get no allowance, the wife gets no jewelry, and the husband gets no sex.

    VALUE INVESTING — The art of buying low and selling lower.

    P/E RATIO — The percentage of investors wetting their pants as the market keeps crashing.

    BROKER — What my broker has made me.

    STANDARD & POOR — Your life in a nutshell.

    STOCK ANALYST — Idiot who just downgraded your stock.

    STOCK SPLIT — When your ex-wife and her lawyer split your assets equally between themselves.

    FINANCIAL PLANNER — A guy whose phone has been disconnected.

    MARKET CORRECTION — The day after you buy stocks.

    CASH FLOW — The movement your money makes as it disappears down the toilet.

    YAHOO — What you yell after selling it to some poor sucker for $240 per share.

    WINDOWS — What you jump out of when you’re the sucker who bought Yahoo @ $240 per share.

    INSTITUTIONAL INVESTOR — Past year investor who’s now locked up in a nuthouse.

    PROFIT — An archaic word no longer in use

  60. The Economist has a simple principle — however complex the subject, any article should be understood by an intelligent layman. It’s worked pretty well for them for around 150 years, so I see no reason why Arnab can’t take the same approach. Go for it, champ!

    For those of you who were offended by Arnab’s insufficiently erudite version, here’s the Really Thick Version.

    Substitute the words ‘up shit creek’ for difficult words like ‘depression’ and ‘recession’ which us stupids don’t understand.

    The world’s biggest insurance company go boom
    The world’s biggest housing finance companies go boom
    2 of the world’s biggest banks go boom.
    Person in charge of bailout — him heap big friend of banks that go
    boom, because Big Chief — he put fox in every hen house.
    Country have big heap minus because of Iraq war and give away money to
    Big Chief’s friends — now give away even more money to banks.
    Big Chief — he have IQ of 2.

    Don’t know about the experts, that sure sounds like shit creek to me!
    But then again, what do we know?

  61. @kunal
    Dude you started off reasonably well, but somewhere down the line, it got really pathetic.

    You said “I must admit I am not entirely an unbiased commenter, being as I am, one of the privileged (!!!) lot…”

    Hey if you are pimping, you immediately lose your right to defend the profession of profitable pimping where others’ ass is being sold.

    Then you said

    “most of us have a worklife span of at most 10-15 years compared to 30 for the average worker in any industry… so its not all pay and no work as people might want to believe…”

    To me it looks that you want to work for 10-15 years & retire to Bahamas, unlike the “average worker”. And you complain. My god, the gumption!

    Take a hike buddy. Or go get a real job

  62. Good and relevant post at this turbulent time. Also visit my blog Logi-call at to give me some inspiration. Hope to see your footsteps on my blog.

  63. Dear Gb
    Great trilogy.

    @ Anonymous
    Post – Oct 20th, 2008 at 8:58 pm
    Name pl.
    Good work.

  64. Another fantastic post. You seem to grasp and interpret concepts at the click of a finger. And unlike what many people have posted saying “stick to mithunda” or “ur out of ur depth” etc., it would be good if you could carry this topic onward. It is probably the most serious issue we will have to face in our lifetimes. Civil unrest and war will eventuate from this.

    The problem is that the financial sector is run by predominately ivy league mba’s who are totally out of touch with reality – you go down to the “main street” level and people will see what a catastrophic mess a lot of people are in. There were waves of defaults beginning since 2006 in the western world (i am in australia btw), and its just getting bigger and bigger. And to say that to soften the crisis by adding more credit into the system is a joke. I have worked in a DJI financial services company for a few years “modelling” how much credit should be issued into the australian consumer market based on bank policy – I can tell everyone this much – ITS A JOKE AND EXECUTIVE BONUS DRIVEN.

    As for this fake gdp number that comes out of washington, for every dollar “made”, there has been 6 dollars of DEBT generated. And the biggest difference between say debt generated since the 1980s and before the 1980s is that in the last 20 years the usa have driven debt via consumption predominately and no real investment in domestic american industry (everything is offshore these days). Now we are getting to the stage that americans finally cant consume anymore, and the likes of GM, Ford are in serious danger of being bankrupt.

    The usd has recently been getting “stronger” because a lot of us investors (retail to ibs/hedge funds) are unwinding their positions in “foreign stakes”. eventually with the debt that has been accumulated, and the possibility of say China dumping their usd reserves the usd will b worth less than toilet paper.

    I recommend people to read/watch articles/interviews of Peter Schiff and Max Keiser. They sound doomsday, but they have got their predictions right so far (eg fannie freddie, iceland – they saw these scenarios happening 2-3 years back).

    final notes: hank paulson is a financial terrorist and should be tried as such – Goldman and JP Morgan r being made very rich from this, and the entire us congress should be impeeched (except Ron Paul). And if we switch back to Gold Standard, India will be the richest country in the world with half the world’s above ground gold (not held in central banks) held by its citizens, 13000 tonnes. fort knox only has 8000. Chak De.

  65. sorry one more thing: credit 101: PAY BACK WHAT YOU BORROW!

  66. If Gandhiji would have ever thought about stock market investors, then he would have definitely put a fourth monkey with its hands on its ASS!
    — an SMS joke doing the rounds

  67. Before I start out, something to Kunal. While being naive is not inherently bad, but being outright disingenous is. People in the financial industry are about as prone to job-loss as in any other private enterprise. For instance, the IT industry. Incidentally in any I-bank, it is usually the IT people, and not the financial brains, who are the first ones to be given pink slips because they are considered not as critical for core operations. Finance people, in general, have it as good or as bad as the assistant in a grocery store. They however do get paid a bit more. You came off sounded like a sullen, arrogant industry-person, with a dismissive air (for really no stated reason) on a first-rate piece , which of course, I accept, is nothing wrong in itself.

    Now on to Raapchik (RC)

    First of all, do realize that I have nothing against you and neither do I own stock in GB’s blog, profitable as it no doubt would be if it went public. So I do not see why reason why me, and others like me, have to be slavish if we find GB to be totally in the right.

    Its very ironic when you say you came looking for a debate and instead got mud slung at you. It is ironic you say so for several reasons:

    1. I clearly rebutted your main arguments. It was you who retorted with a “I run my own successful business and have done the I-bank thing, many years ago, the very thing which you people are doing now. Ergo I have amazing insights and you should believe what I say”.

    2. It is difficult to debate with someone whose central thesis is that all data is bull. Why? Because such a person has no obligation to back his assertions with data. The logic is circular here.

    Coming back to the “I run my own successful business and have done the I-bank thing which you people are doing now.” contention.

    This could mean either of two things:

    1. You were too smart for I-banks because, unlike you, they based their decisions on data and on reports by “mainstream media” (a term whose meaning, as I pointed out, you are ignorant of). The work done by people at I-banks is, in any case, trivial like “photocopying pitch books and filling coffee mugs” (which is why these are such sought-after jobs) and you revolted against it like Tagore revolted against conventional education. You then started your own business venture where you mint money from your unconventional theories and your aversion for “mainstream media”.

    2. While others in the I-bank world did challenging things that kept them at work for 14 hours daily, you were given the onerous duties of photocopying and coffee-mug filling. Thus was born your aversion for data, data like the temperature of the coffee mug or the amount of toner left in the photocopier. Soon management, unable to recognize your unique talents and disappointed with the temperature of their coffee and the color quality of the photocopies, slipped you something pink. Much more experienced and well-versed in the ways of the world, you now run a successful business of photocopying notes which if I recall from my IIM days was quite a money-making enterprise, one that allows insulation from the vagaries of the economic world.

    Based purely on the data you provided, either of these could be true and I have no reason to favor the one over the other.

    But then again, data counts for nothing.

    In conclusion, I myself was not looking for debate or a fight on GB’s comment space since I am too aware of their futility in such forums. But felt that your incorrect statements needed to be commented upon.


    Thank you. I prefer to stay anonymous online.

  68. A couple of more thoughts on the entire compensation issue…

    @ Anonymous…
    You mention in an earlier comment that you’ve been working 10 years on Wall St… I have spent far less and so am all-the-more surprised at your comments… I don’t know what you’ve been doing for the last 10 years but I’m quite sure that whatever it has been it has left you virtually unemployable in most (as Laborer would call it) ‘real’ jobs…
    So what you’ve been paid till date is essentially the NPV of a full career… if you dont believe me look around you… your IIM friends who probably made as much money in their first ten years as you did with your first bonus are suddenly starting to become CEOs while most traders around you are thinking of post-retirement plans…

    As an analogy… lets look at Indian cricketers… Ishant Sharma got $900k from KKR for IPL Season 1… should we grudge him the money… I think not… he has 15 years to make money (possibly lesser for a fast bowler)… at 35 he’ll be unemployable in a ‘real’ job… how many cricketers turn commentators… how many traders go on to become trading heads…
    To stretch the analogy…. Ishant Sharma has made a lot more money than say Akhil Kumar … does that make him a better sportsman… definitely not… should we then grudge him his money… again I think not… given the monies involved its only fair to assume that Ishant Sharma’s journey to the Indian team has been far tougher than Akhil Kumar’s journey to the Indian Olympic Boxing Team…
    for a more lucid discussion on this read Freakonomics… the chapter on the economics of being a drug dealer…

    As far as my comments to GB go, I am not sullen at his writing the piece… nor do I comment on its lucidity… it just that when I come to RTDM I do so with the expectations of reading up on Dada’s swansong or Mamata-di’s idiosyncracies… not on Benjamin Graham… though as I’ve already said… GB is well within his rights to ask me to take a hike…

    @ Laborer…

    the reply to Anonymous applies to you as well… the only addition is… Bahamas !!!… I wish…

  69. the post above was me…

  70. Kunal,

    First of all, you do not know anything about me, nor about my financial situation nor about my opportunities for career growth. Unless of course you share RC’s allergy to data before making statements, such speculations about me make no sense.

    Second of all, I am surprised at your comprehension skills. Nobody here, not me not GB, has grudged anybody their money. I-bankers make more money because in good times they bring in a lot of money as a result of their decisions, half-assed guesses they may be most of the time. How can I complain about that being myself one of them?

    The problem is when I-bankers take the same amount of money when they do not perform or when their bets go wrong. This is typically not seen in any other industry where dismal performance is punished just as good performance is rewarded. The day Ishant Sharma’s performance dips, he will be shown the door by Shahrukh Khan. He will then not have the luxury, if he has not saved his money, of having taxpayers pay for maintaining his locks of hair.

    If your objection is to content that is intelligent and introspective as opposed to purely entertaining, I get your point. The view from the front stalls is always exceptional.

  71. Kunal, I recently read that Freakonomics chapter on drug dealers, and I do believe that it offers insight on the nature of IB compensation, but not in the way you seem to imply.

    The chapter says that the only way to make drug dealing worth the risk is to climb up to the top of the organization hierarchy. In order to do this, the junior members have to be noticed by the gang leaders and they indulge in dangerous confrontation with other gang members to accomplish this.

    That explains why I Bankers take on the kinds of risk and leverage that they do. It still doesn’t explain, as Vijay pointed out, why they get paid bonuses in times of poor performance.

    You see:

    1. Many other industries have the same sort of job uncertainties and don’t get paid nearly as much (law, IT, consulting, R&D, PR, advertising, sales and marketing)

    2. Unless they are industry veterans, or financial engineers, they are not bringing any super-specialized skills to the table (unlike petroleum engineers for instance). Why exactly should you be paying a $50k bonus to retain a second year analyst who has a BA in History from Brown? (hypothetically speaking)

    I feel that the reason why I Banks end up paying bonuses even in times of poor performance are the following:

    1. There is very poor oversight of executive compensation in publicly held companies. The Board of Directors are supposed to represent shareholder interests, but unless they are hounded by an activist shareholder, they tend to be one big old boys’ club with the top management of the bank.

    2. Employees don’t matter much, but client lists and proprietary strategies and programs do. What banks fear the most is clients migrating with employees to rival banks (as they often do) and an employee taking a proprietary strategy with him (all he has to do is tweak it a bit and then use it somewhere else).

    All it takes is for one employee to lure away a billion dollar hedge fund who used you as prime brokerage to punch a hole in your profits. Wouldn’t you rather pay him a million dollars to stay?

  72. Though the banks seem to be taking all the blame, why isn’t anyone pointing fingers at the rating agencies? Arent they the ones who are supposed to asses the mortgage backed “securities” that the banks were offering?

    I dont know the ins and outs of the financial industry, so hoping that some one answers even if the question sounds naive.

  73. GBda, even in hindsight you fail to be clearheaded. E.g. in “Error 2” you fault investors for investing in growth stocks. What would you have them do? Buy stocks of companies that are not growing? You get 0/10 for this long and vacuous post.

    A general tip I would give you, if at the end of writing a post, it turns out to be this long, it is a sign you have nothing to say. Delete it and stick to insidious championing of the right wing cause; you write better on those topics.

  74. Good article GB..very informative with some good pointers for regular folk dabbling in shares..regardless of the hair splitting in the forum. the basic concepts are quite sound.

  75. @Bunty – do you have any idea what a “growth stock” is? Do you understand how problematic valuations of “growth stocks” are? At least Raapchikmaal knows what he’s talking about. You sir, are completely clueless.

  76. @Bunty:

    Here is my advice for you. With a name like Bunty and the gyan “growth stocks” refers to any stock that “grows”, it is better to stay silent. In other words, to totally zip it.

    Rule of thumb: If your name is Bunty and your head is stuck inside your ass, keep it there.

  77. Did the comment section of this blog break some records? GB please update us atleast wrt all your blogs

  78. Chandan, you must be new here. There are quite a few posts with more than 200 comments and one with more than 600.

  79. @ kaustav,
    The ratings agencies are a joke. They do not have the faintest idea how to rate complex derivatives. Most guys in the rating agencies are typical Joe Six Packers who are left holding valuations done by PhD quant jocks. I have seen some of these valuations and unraveling one valuation can take you a week just to understand what the fundamentals are. So why would anyone spend so much time poring over the details, when most of it is incomprehensible. So, rating agencies are a big part of the problem. However not much can be done to improve them since they do not retain talent. Its not a lucrative job and if not for SEC guidelines, the whole rating process would have been shipped offshore. I am sure someone in Wall Street will be eyeing this segment.


    If you were associated in any faintest way with IB, you would know how the industry works. No one sticks in IB for the length and breadth of their lives. The majority last 5-6 years to a decade. Hedge funds are the creations of IBers leaving work and starting their own shop.

    There are several books and even some online blogs of folks who describe their lives in IB. If photocopying and coffee pot filling does not constitute a significant part of their lives during entry level positions and even more then please do some more digging.

    14-15 hour work days are not the norm in IB. Only M&A works that long. S&T works 10-11 hours max, from open until close of market.

    And yes, going against the flow in IB is what makes you successful. I am not the only odd case here who does not care much for data. People get blinded by greed and the chance to make a quick buck. Spin reports offering a killing based on charts, graphs may look good but it takes foresight to understand the implications. Why JP Morgan escaped the crunch is because it chose not to read the data. Pretty common knowledge now especially when its rivals made financial killings. Jamie Dimon and gang got laughed in the face by other bankers. Guess whos laughing now. In finance, you need to use ur intution. The proverbial cliche, look beyond is what applies in IB.

    I welcome you to enter the industry and find out for yourself.

    One reason why there such huge bonuses – not coz you work hard, but what comes out of your work. The caveat is even if you work hard, you will lose out and end your career. I dont think this happens in other industries.

    IB jobs are not the most sought after. They rose in fame after 2005 due to the huge bonuses. And contrary to belief, the basic salary is very low compared to IT. most entry level analysts and associates make less than a good IT engineer in SF. Its only when the bonuses kick in that makes the package look extremely attractive. Now that the whole bonus situation has changed, I wonder how many people will enter this segment with pomp and ardor.

    IT in finance is on a contractual basis. Back office is in India or in USA. That where most of the IT action happens. The rest of the staff in front office, other than the quant jocks who will never get laid off are contractors. So yes, they will get the pink slip immediately during a downturn.

    So before you pass judgement on bankers and finance folk, put yourself in their shoes and see if you can last one week.

  80. Excellent Post GB 🙂
    Being a technical person myself, I kept on wondering what people meant when they talked about sub-prime crisis, market fall etc etc. Your 3 posts were excellent in giving an in site for a newbie like me 🙂

  81. By the way I am new to this blog [Followed only technical blogs most of the time].
    Now reading your previous posts 🙂
    One more person added to your fan list 🙂

  82. Hi,
    I have been reading this blog for about a year or so. By and large, I have liked what I read. Do you mind giving a link to the post which had 600 comments – i might well have missed it if it is more than a year old. And i ams ure it would be interesting.

    And re the comments on this post – I have a limited understanding of the credit crunch, don’t agree with everything you have written but still believe that it has been very well written and gives a very good flavour of what’s going on. So keep at it.

    Waiting to read your comments on the Mohali test


    > greatbong
    >Oct 22nd, 2008 at 10:56 pm
    >Chandan, you must be new here. There are quite a few posts >with more than 200 comments and one with more than 600.

  83. “If you were associated in any faintest way with IB, you would know how the industry works. No one sticks in IB for the length and breadth of their lives. The majority last 5-6 years to a decade. Hedge funds are the creations of IBers leaving work and starting their own shop.”

    Absolutely oh wise one. It just requires common sense to understand that senior management posts held in the IB sector are held by people who have spent a life-time in it. So every IB-leaving person joins hedge funds. Right ! Which if it was true would make hedge funds more common than Starbucks. Amazing insight. I now doubt whether you were filling coffee cups for the IB people or for the custodial staff.

    Oh wait. There is anothe howler. JP Morgan did not read the data ! Let me assure you that JP Morgan did read the data. It just made different choices based on it. However I agree that the cleaning crew possibly does think that JP Morgan’s analysts do not read market data but instead consult pre-cogs as in Minority Report.

    “IT in finance is on a contracts basis”. That is about as divorced from fact as I can imagine.

  84. Raapchikmaal,

    ‘IT in finance is on a contractual basis. Back office is in India or in USA. That where most of the IT action happens. The rest of the staff in front office, other than the quant jocks who will never get laid off are contractors. So yes, they will get the pink slip immediately during a downturn’

    When I was in school in the US, the main investment banks of Wall Street, the Citis and the Morgans and the Sachs and the Lehmans all thronged to my university to recruit Comp Sc and Electrical graduates and undergraduates as *permanent* employees. I know as I was one of those selected.

    I know this point is not germane to the central discussion but thought I should tell you that, unless I am unaware of the sense in which you mean “contractual”, you are totally wrong.

  85. @anonymous,

    Wow, I clearly see your brilliant insight into IB. Your common sense dictates that senior management posts are held only by long serving IB folks. Ya right!!! And hedge funds being as common place as Starbucks. Look up hedge funds and you will there are roughly 8000 of them in the world with NYC having the bulk. NYC is called the Hedge fund capital of the world. London is # 2. NYC alone has about 500-2000 hedge funds, probably more, definitely more than the area of Starbucks.

    Garner some education about IB.

    And senior management posts in IB are held by those who spend a lifetime in it. What a hoot! Your ignorance is on par with your verbal spiel. Hahahahah, I mean seriously, who gave you this idea? you must have overlooked the hundreds of people from Bain, BCG, ZS Associates, McKinsey, IFC, Propaco, DEG, World Bank garnering top positions in IB senior management. I guess that escaped your thought. Last time I checked, the head honcho of Asia Pac trading at one of the IBs was a financial treasurer from corporate banking and the equity research head at one of the NYC IBs is an auditor.

    and learn to read. I did not say every IBer leaves work to open a hedge fund. Also I did not say I do not read data, I clearly mentioned, I do not pay relevance to data. A big difference, which your lil mind could not fathom. Go get some education.


    I am not very familiar with the undergraduate hiring process at IBs, but my department had most college grads who worked in IT termed as contractors. They did not come through any contractual agency or anything of that sort. They were hired on campus. However, their pay classification, and HR and performance review processes were the only things different. And I am sorry to say, they were the ones who get hit the first when the proverbial s$%t hits the fan. Two of my ex-colleagues were as permanent as me, but were always labeled as contractors. They were the ones who got laid off during the crisis. Perhaps, you clarify on this contracts terminology. Never knew what purpose this classification served. I have never seen quant jocks (most of them are grad students, usually PhD) who worked as developers getting laid off. Usually they quit and move on with the senior traders or remain at their jobs.

  86. Raapchikmaal – I take it back. I was completely wrong. You have absolutely no clue what you’re talking about. I’m certain that you were only an IB associate in your dreams and your knowledge of the industry is mostly from poring over blog like LBO or Bankers’ Ball.

    Let’s address your comments now:

    1. So everyone at the entry level basically photocopies stuff and fills coffee pots? Unlike you, I actually know several folks who are IB analysts. No one is filling coffee pots except to make some for themselves.

    2. Open till close of markets is 7 hours (where in the world are you dealing with an 11 hour market?)

    3. “JP Morgan chose not to read the data”??? Right – they really didn’t have any accountants and lawyers poring over the Bear Stearns books over that frantic weekend before the takeover. Or didn’t check Wamu books before taking over their deposit base. Because you see, JP Morgan rolls like that. No data, no analysis, straight shooting from the hip.

    Have you ever stopped to consider that JPM is not an IB in the classic sense but a deposit taking commercial bank like Bank of America? That it is restricted by regulation from taking on unsustainable levels of leverage? But these institutional fine points seem beyond you.

    4. Who are these consulting industry refugees who are no in the top echelons of IBs? It is fairly common for folks who’ve put in a few years into consulting to go into business school and then get hired into associate programs at IBs.

    But I assure you that not one partner at McKinsey, Bain or BCG would be hired as the head of any division of an IB.

    “Last time I checked, the head honcho of Asia Pac trading at one of the IBs was a financial treasurer from corporate banking and the equity research head at one of the NYC IBs is an auditor.”

    Precisely – both of them life long finance professionals, not strategy consultants. Senior executives in IBs are lifelong bankers – there’s overwhelming evidence for this and anyone claiming otherwise is seriously deluded.

    Not only are you completely mistaken, but you are brazen enough to keep defending your half baked ideas and be rude and hostile to another commenter.

  87. @Rapchikmaal,

    One of your basic problems is you draw conclusions based on very limited observations, possibly as hinted by Anonymous, observations obtained from changing the toilet paper on the third floor. I understand you have a healthy disregard for figures and small things like “actual facts” but still bear with me here.

    The IT people i.e. programmers, system developers and maintainers are hired not on the basis of time-bound contracts, which is what the word contractor means but as permanent employees with all the benefits that an employee normally gets. This is standard practice today in almost all I-banks on Wall Street. In your defense, this may have been different when you were an young man. But then I suppose Lal Bahadur Shastri was the Prime Minister at that time and so kindly account for the fact that time has moved on and reduce your cocksureness about things you are clearly out of your depth talking about.

    [The source of this information is an HR employee at a major I-bank who is a very good friend and whom I called just to confirm the information I was going to type. I as you can see do believe in facts.]

    In this context, it should be clear that noone give’s an “f” as to what “you” labelled people: whether you labelled them “contractors” or “chamiyas”. What is important is what is written in their job description.

    IT permanent employees are the first to be laid off because they are not core assets to the company. It is as simple as that. There are always many more from where they came from.

    I do not know if you are Bangali. If you are, I would presume you have heard of Ghonada, Tadinikhuro and Tenida. If you are not Bengali, these are all fictional characters who tell tall tales of great heroism about themselves and pretend to know things they have no idea about. You Asscheekmaal-da are the latest addition to that august club.

  88. @Sancho: (

    There was a question as to what books I read. Well I read a bit of financial news and whenever I find a term I do not understand I google it and almost all the time, there is a nice explanation somewhere. Graham’s “Intelligent Investor” and Boglehead’s Guide to Investing are the only investment books I have ever read.

  89. @ Thalassa…

    The point I was mentioning was different… I try and paraphrase though its been a long time since I’ve read it… Why would someone spend his youth on a street-corner risking arrest by cops and death by other gang members…. picking up no transferable skills along the way… unless the pot at the end of the rainbow is reasonably large…

    >> Many other industries have the same sort of job uncertainties and don’t get paid nearly as much….
    The skills are transferable…

    >>Unless they are industry veterans, or financial engineers, they are not bringing any super-specialized skills to the table (unlike petroleum engineers for instance)…
    I am sceptical of this whole argument that you are paid for the skills you bring to the table … tho I am aware that in this commentlist itself there are a lot of people who like to believe they are paid for what your work is ‘worth’…
    My counter-logic is simple… you are compensated for what a job takes out of you… heck thats why they call it ‘compensation’ in the first place… and trust me no job takes more out of you than IB/Trading… with the possible exception of course of standing on a street corner pushing drugs or waiting to sell yourself to a deputy assistant movie director… which is why top drug-dealers and top actors are paid even more than top I-Bankers…

  90. @ rohan

    Kunal is now sounding almost like Bunty. Justifying the saying a rose by any name etc etc….
    He he he

  91. Such viciousness!

    Tab Pantoprazole 40 mg twice daily before food for a week followed by once daily for 3 weeks is certain to cure most recalcitrant stomach ulcers caused by the smoking gun in the hand. But it does nothing to the sores on furious-typing-finger tips and deep headache due to the contortions of the face while commenting acidly.

    This post looks now almost like ‘Was Jinnah secular’….even without Hara Hara Bom Bom! No offense to HHBB because I thought his rebuttals are well researched unlike here.

    PS (@GB): I have a license to prescribe & believe that no law was broken here

  92. GB,Thanks for your insight into this mess . I really enjoyed it, Kudos to you for putting so much time and effort into writing this trilogy

  93. Most informative blog i have come across..!
    The percentage increase in my knowledge of the financial world has increased many folds..after reading your blog..

  94. Venky: ‘Tab Pantoprazole 40 mg twice daily before food for a week followed by once daily for 3 weeks is certain to cure most recalcitrant stomach ulcers caused by the smoking gun in the hand. But it does nothing to the sores on furious-typing-finger tips and deep headache due to the contortions of the face while commenting acidly.’

    ROTFLMAO!! …. that is indeed quite nicely summed up …. Unfortunately, the discussion seems to have gone way too off-hand …. its deviated from a mature analysis into the merits and de-merits of the each other’s arguments and transcended into a mud-slinging spectacle of sorts …. hopefully, participants all around realize and restore the tone of the debates to a more civil and mature manner.

  95. @ Thalassa
    (Replying to your comment on 21st October. Sorry for being late.)
    On the salient issues:
    1. You accept that “Every major investment bank has suffered either a loss or a severe erosion of profits”. So are you implying that all the executives in all the companies were equally (in)competent or does it sound a systemic failure outside their control.
    2. I have no problems with that. In fact it is quite natural that the government will try to push its demands when it buys equity stake. My whole argument was trying to convince people that the stance of executives isn’t as absurd as most people would believe and there is a not-so-apparent reason why executives were reluctant on giving up their bonuses, and companies (as a whole) sided with them. In “The Logic of Life”, Tim Harford has dealt with the issue in great detail and wonderful insights.
    3. What the executives at DB did is right in their own regard, and it is their personal decision. This shouldn’t mean that everyone HAS to follow suit. If someone isn’t ‘afraid’ of being unable to find another job, they have every right to fight what they believe in.

    Lastly, thanks for agreeing with my viewpoint on Iceland crisis (that it was largely independent, though coincidental, with the US financial meltdown).

    If you would have read my comments completely, you would have realized that I have stated that I am as mortal as GB (if not more). There was no sarcasm.

  96. Only a few small bits to add here. As someone who knows a little something about the field.

    1. GB is pretty much right about everything he said. He overstates the role of individual stock-picking investors a bit — most individuals hold stocks through mutual funds & 401(k)s, & about 35% of stocks are held by institutions — but the intuition was dead-on.

    2. Raapchikmaal: the 2 quarters of negative growth definition of recession is dead. The NBER (National Bureau of Economic Research) defines recessions & uses a variety of factors like industrial production, unemployment rates, etc. The 2-quarters rule has not been used in decades. By current NBER rules, the fact that unemployment is rising & industrial production is falling is good reason to believe we are either headed for a recession or already in one.

    3. Thalassa: Taleb was right that outliers need to be given more importance, but his main points were: a. there are some outliers we simply cannot imagine, so we need to account for the worst possible cases, & b. the normal (Gaussian) distribution does not apply to financial markets, so all the risk models are simply wrong. Accounting for 10 sigma events is not useful when your definition of sigma is based on the wrong distribution.

    4. General point: Some 40% of corporate profits in the last few years have come from financial management rather than real production of goods/services. This is scary. This also accounts for rising inequality over the last few decades, & why the GDP growth of the last few years benefited only a rich few, while the median American household’s income (after adjusting for inflation) has actually fallen slightly since 2000. It’s all quite sad & scary.

  97. Hi
    Fair post if you like technicals you may like to visit this.:)

  98. GB,

    All the three posts were wonderful. It’d be great if you write a sequel to them, as to what the current economic situation is, what Obama plans etc. 🙂

  99. Hey, great post… i know its a little too late to be reading this but i was looking for humor when i came here …… i am in the financial sector and i believe you have done such a great job in explaining all the concepts and broken down the crisis into something which everyone can understand that all i can say is kudos to you my man….

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