proprietary trading

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The Greed Merchants: How the Investment Banks Exploited the System by Philip Augar

Alan Greenspan, Andy Kessler, AOL-Time Warner, barriers to entry, Bear Stearns, Berlin Wall, Big bang: deregulation of the City of London, Bonfire of the Vanities, business cycle, buttonwood tree, buy and hold, capital asset pricing model, Carl Icahn, commoditize, corporate governance, corporate raider, crony capitalism, cross-subsidies, deal flow, equity risk premium, financial deregulation, financial engineering, financial innovation, fixed income, Glass-Steagall Act, Gordon Gekko, high net worth, information retrieval, interest rate derivative, invisible hand, John Meriwether, junk bonds, Long Term Capital Management, low interest rates, Martin Wolf, Michael Milken, new economy, Nick Leeson, offshore financial centre, pensions crisis, proprietary trading, regulatory arbitrage, risk free rate, Sand Hill Road, shareholder value, short selling, Silicon Valley, South Sea Bubble, statistical model, systematic bias, Telecommunications Act of 1996, The Chicago School, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, tulip mania, value at risk, yield curve

A survey of a group of banks operating in London in 2003 found that several made no distinction in their management accounts between client and proprietary trading.18 It was either an unimportant distinction or, more likely, it was just too difficult to separate out. One side effect of the closure of the specialist arbitrage desks in the late nineties was to give shareholders the impression that proprietary trading had gone away. Investors like to hear this, for they regard it as a high risk and unreliable business. They would not give the investment banks a high share price if they thought that too much profit came from proprietary trading. The investment banks disclose that they do proprietary trading and admit that it is managed alongside client business, but they tuck such news away in quiet corners of the financial statements.

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In the absence of profit numbers, qualitative comments are made about proprietary trading and, like Lehman’s in 2002, annual reports tend to play down the activity: ‘Instead of using a high percentage of the firm’s capital for proprietary trading, we held strong to our well-defined risk appetite and remained committed to our customer flow business model.’22 Other firms liked to under-emphasize this business: ‘To a lesser degree, Merrill Lynch also maintains proprietary trading inventory in seeking to profit from existing or projected market opportunities.’23 Because most proprietary trading actually occurs as an integral part of customer trading, Goldman Sachs, believed to be the most aggressive proprietary traders amongst the large investment banks, is able to state truthfully that equities arbitrage ‘is the only purely proprietary business we are in’.24 However, a former member of the management committee at one of these firms told me: ‘The investment banks have made a fortune from proprietary trading, especially in fixed income and mortgage-backed securities.

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While sales and trading activities are generated by client order flow, the Company also takes proprietary positions based on expectations of future market movements’.19 However, you have to look pretty hard to find this and other references to proprietary trading in Morgan Stanley’s Form 10-K, a technical document that is heavy reading even for financial specialists. There was no explicit mention of proprietary trading in the glossy, more commonly used version of the annual report.20 Morgan Stanley is not untypical. Every other large investment bank carries out proprietary trading, and every one gives a full disclosure, but rarely, if ever, in a prominent place in the financial reports. Numbers are few and far between.

Quantitative Trading: How to Build Your Own Algorithmic Trading Business by Ernie Chan

algorithmic trading, asset allocation, automated trading system, backtesting, Bear Stearns, Black Monday: stock market crash in 1987, Black Swan, book value, Brownian motion, business continuity plan, buy and hold, classic study, compound rate of return, Edward Thorp, Elliott wave, endowment effect, financial engineering, fixed income, general-purpose programming language, index fund, Jim Simons, John Markoff, Long Term Capital Management, loss aversion, p-value, paper trading, price discovery process, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Ray Kurzweil, Renaissance Technologies, risk free rate, risk-adjusted returns, Sharpe ratio, short selling, statistical arbitrage, statistical model, survivorship bias, systematic trading, transaction costs

I have covered the pros and cons of retail trading versus proprietary trading and the issues to consider in choosing a brokerage or proprietary trading firm. In a nutshell, retail brokerages give you complete freedom and better capital protection but smaller leverage, while proprietary trading firms give you less freedom and less capital protection but much high leverage. Finding a suitable retail brokerage is relatively easy. It took me less than a month to research and settle on one and I have not found a reason to switch yet. Finding a suitable proprietary trading firm is much more involved, since there are contracts to sign and an exam (Series 7) to pass.

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You do not need to negotiate with a banker or a venture capitalist to borrow more capital for your business. The brokerages stand ready and willing to do that. If you are a member of a proprietary trading firm (more on this later in Chapter 4 on setting up a business), you may even be able to obtain a leverage far exceeding that allowed by Securities and Exchange Commission (SEC) Regulation T. It is not unheard of for a proprietary trading firm to let you trade a portfolio worth $2 million intraday even if you have only $50,000 equity in your account (a ×40 leverage). At the same time, quantitative trading is definitely not a get-rich-quick scheme.

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For example, if you have low capital but opened an account at a proprietary trading firm, then you will be free of many of the considerations above (though not expenditure on infrastructure). I started my life as an independent quantitative trader with $100,000 at a retail brokerage account (I chose Interactive Brokers), and I traded only directional, intraday stock strategies at first. But when I developed a strategy that sometimes requires much more leverage in order to be profitable, I signed up as a member of a proprietary trading firm as well. (Yes, you can have both, or more, accounts simultaneously.

What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences by Steven G. Mandis

activist fund / activist shareholder / activist investor, algorithmic trading, Bear Stearns, Berlin Wall, Bob Litterman, bonus culture, book value, BRICs, business process, buy and hold, Carl Icahn, collapse of Lehman Brothers, collateralized debt obligation, commoditize, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, diversification, eat what you kill, Emanuel Derman, financial innovation, fixed income, friendly fire, Glass-Steagall Act, Goldman Sachs: Vampire Squid, high net worth, housing crisis, junk bonds, London Whale, Long Term Capital Management, merger arbitrage, Myron Scholes, new economy, passive investing, performance metric, proprietary trading, radical decentralization, risk tolerance, Ronald Reagan, Saturday Night Live, Satyajit Das, shareholder value, short selling, sovereign wealth fund, subprime mortgage crisis, systems thinking, The Nature of the Firm, too big to fail, value at risk

The firm also played multiple roles, including proprietary investing and investing with clients, before he became CEO. His rise in the firm reflected the pressures and changes. Proprietary Trading Becomes a Larger Percentage of Revenues When one looks at the business principles that John Whitehead wrote in 1979, it is a particular challenge to reconcile the goals of proprietary trading with putting clients’ interests first, or the goal of being the leading adviser. Proprietary trading has one client: Goldman. As proprietary traders, we were walled off from client activity. We were not there to provide liquidity to clients, manage funds for clients, or advise clients.

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From time to time, we were also approached by banking or trading to help finance a transaction or buy something from a client or coinvest with a client—actions that, most of the time, raised all types of potential conflicts and died because we were too busy to have long conference calls to discuss it. But generally we were in our own silo. Proprietary trading at Goldman did not start in the 1990s. Bob Rubin joined the risk arbitrage proprietary trading area in the equities division in 1966, and by the 1980s it was considered one of the most profitable and powerful areas in the firm. When Rubin and Steve Friedman took over as senior partners in the 1990s, Goldman accelerated its additional role of risking its own capital versus being a mere “market maker.” It was the size of the losses from proprietary trading in 1994 that caused many observers to think the firm would not survive.

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It was the size of the losses from proprietary trading in 1994 that caused many observers to think the firm would not survive. How big and important are proprietary trading and principal investing activities at Goldman? Glenn Schorr, a Nomura Securities equity research analyst covering Goldman stock, estimated that the Volcker Rule, which is intended to restrict proprietary trading and principal investing at investment banks, would impact 48 percent of Goldman’s total consolidated revenue. To put this into context, he estimated the impact at 27 percent, 9 percent, and 8 percent of total consolidated revenues of Morgan Stanley, Bank of America, and J.P. Morgan, respectively. Certain Goldman client-oriented sales and trading desks had “proprietary trading” operations.

A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

affirmative action, Albert Einstein, asset allocation, backtesting, beat the dealer, behavioural economics, Black Swan, Black-Scholes formula, Bonfire of the Vanities, book value, butterfly effect, commoditize, commodity trading advisor, computer age, computerized trading, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, Edward Thorp, family office, financial engineering, financial innovation, fixed income, frictionless, frictionless market, Future Shock, George Akerlof, global macro, implied volatility, index arbitrage, intangible asset, Jeff Bezos, Jim Simons, John Meriwether, junk bonds, London Interbank Offered Rate, Long Term Capital Management, loose coupling, managed futures, margin call, market bubble, market design, Mary Meeker, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shock, Paul Samuelson, Pierre-Simon Laplace, proprietary trading, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Solow, rolodex, Saturday Night Live, selection bias, shareholder value, short selling, Silicon Valley, statistical arbitrage, tail risk, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, UUNET, William Langewiesche, yield curve, zero-coupon bond, zero-sum game

I would learn more over time about his remarkable appetite for detail and his penchant for condensing things onto one sheet of paper, as we would construct a risk report with an almost unreadably tiny type size to compress all the relevant risks of the firm onto one 8 1/2 by 11 inch page. 77 ccc_demon_077-096_ch05.qxd 2/13/07 A DEMON 1:45 PM OF Page 78 OUR OWN DESIGN Despite his assurances to the contrary, Sandy Weill was not enamored with the high-stakes proprietary trading embodied by this group. That antipathy did not stop him from buying Salomon, the biggest trading house in the world—a firm that, even after many attempts to broaden its revenue base, still made all of its earnings through proprietary trading. To try to control the unit, he first pushed to have both the head of U.S. fixed income arb, Rob Stavis, and his European counterpart, Costas Kaplanis, report to his son, Mark Weill.

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This was not the first time the sights of the firm had been drawn to the proprietary trading unit. Warren Buffett had occasional thoughts of getting rid of the arb unit, depicting the proprietary/client setup at Salomon as “a casino with a restaurant out front.” But he could never seriously 87 ccc_demon_077-096_ch05.qxd 2/13/07 A DEMON 1:45 PM OF Page 88 OUR OWN DESIGN consider doing so because the arb unit made half the firm’s revenue and pretty much all of its earnings. Travelers, however, could take such thoughts more seriously, because proprietary trading represented only about 10 percent of its revenues.

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Indeed, it often looked good—and almost free of risk—precisely because LTCM was in it. Both Goldman Sachs and Salomon had large positions that mirrored those of LTCM. For Salomon, this was understandable, because all of the LTCM principals came from Salomon’s proprietary trading group. Losses mounted for hedge funds, brokers, and banks across the world. While other proprietary trading desks found themselves with market losses, the implications for LTCM’s major creditors were disastrous. Some of the most stalwart institutions shook to their foundations. They lost not only from market positions but also from the possible default on loans to LTCM.

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

affirmative action, Alan Greenspan, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bear Stearns, Bernie Madoff, Black-Scholes formula, Bob Litterman, business cycle, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, Glass-Steagall Act, global macro, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, John Meriwether, Kickstarter, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low interest rates, low skilled workers, managed futures, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, Mitch Kapor, money market fund, moral hazard, mortgage debt, Myron Scholes, National best bid and offer, negative equity, Northern Rock, Occupy movement, oil shock, price stability, proprietary trading, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Ronald Reagan, Sam Peltzman, Savings and loan crisis, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, survivorship bias, systematic trading, tail risk, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

That is, people have believed for years that Goldman, as well as other banks, use their client trading desks as information sources for their own proprietary trading activities and thus have an unfair advantage. From this perspective, the rule might make some sense. However, there are potential problems with the separation of proprietary trading. First, short-term proprietary trading has become a particular target, which was not a central problem with investment banks. Many sovereign nations are also worried that restricting investment banks might also cause excessive volatility, less liquidity, and higher costs for governments issuing debt. Maybe the rule should restrict its scope to just not allowing proprietary trading from traditional banks that take customer deposits.

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One of the most controversial new rules on banking is the rule commonly known as the Volcker rule. There are two separate rules known as the Volcker rule. The first rule prohibits the banking entity from engaging in proprietary trading. The second rule places a limit on a bank’s involvement in hedge funds and private equity. Proprietary trading provides a large amount of profits for investment banks. Proprietary trading means that the bank is buying and selling securities with its own capital to make profits for itself.6 This rule applies to all “banking entities,” which includes banks, thrifts, BHCs, Savings and Loan Holding Companies (SLHCs), and their affiliates.

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Some Thoughts The purpose of the Volker rule is to prevent banks that are protected by the public sector safety net from having risks due to investments in hedge funds and/or proprietary trading desks which can increase their risk substantially. For example, take MF Global, which was a successful broker-dealer. The firm went bankrupt because of proprietary trades on Greece. Banks, like Citibank, that were ultimately protected by the umbrella of the government, took proprietary bets and when the bets went well, they kept the profits, and when they went poorly, they were bailed out. It might also be that assessing the risk of companies that engage in proprietary trading is harder for outsiders. For the most part, these proprietary activities played a small role in the financial crisis.

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, banking crisis, banks create money, Bear Stearns, book value, break the buck, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial engineering, financial innovation, fixed income, friendly fire, full employment, Glass-Steagall Act, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, junk bonds, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low interest rates, market bubble, market clearing, market fundamentalism, McMansion, Minsky moment, money market fund, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, Paul Volcker talking about ATMs, price mechanism, proprietary trading, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, vertical integration, working-age population, yield curve, Yogi Berra

But it was predictable that, as the fear factor dissipated, banks were going to dislike higher capital and liquidity requirements intensely. PROPRIETARY TRADING AND THE VOLCKER RULE There is a strong, though not necessarily accurate, belief that proprietary trading by commercial banks was among the root causes of the financial crisis. Was it? That’s a matter of definition. If we use the conventional definition of proprietary trading—actively buying and selling assets for the banks’ own accounts—there is relatively little evidence that proprietary trading got big commercial banks into the soup, and small banks never did much of it, anyway. If, on the other hand, we classify as proprietary trading the fateful decisions to retain significant volumes of their own MBS and CDOs on their balance sheets (“eating their own cooking”), there is little doubt that proprietary trading led them down the primrose path.

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If, on the other hand, we classify as proprietary trading the fateful decisions to retain significant volumes of their own MBS and CDOs on their balance sheets (“eating their own cooking”), there is little doubt that proprietary trading led them down the primrose path. Critics like the estimable former Fed chairman Paul Volcker argued in 2009 and after that banks that benefit from the protective umbrella of FDIC insurance have no business using depositors’ money to fund gambling operations that may foist bills onto taxpayers. Hence, the Volcker Rule: Commercial banks, which are insured by the FDIC, should stay out of proprietary trading. Conversely, financial institutions such as investment banks and hedge funds, which do lots of proprietary trading, should not be eligible for government bailouts.

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We are only about halfway through the table 11.1 list, but this is where we move from issues that were moderately controversial—leaving bipartisan agreement at least conceivable, to issues that were supercontroversial—making bipartisan agreement hard to imagine. Starting with: Proprietary Trading by Banks Risk taking had obviously been excessive in the run-up to the financial crisis. Some observers, including the formidable Paul Volcker and the prestigious Group of 30, a private group of international financial experts which he headed, claimed that proprietary trading was among the key causes of the meltdown. Others disputed this claim vehemently. As noted, much of the debate turned on how to define proprietary trading. Sadly, this case often fails the Potter Stewart test: You don’t know it when you see it.

Madoff Talks: Uncovering the Untold Story Behind the Most Notorious Ponzi Scheme in History by Jim Campbell

algorithmic trading, Bear Stearns, Bernie Madoff, currency risk, delta neutral, family office, fear of failure, financial thriller, fixed income, forensic accounting, full employment, Gordon Gekko, high net worth, index fund, Jim Simons, margin call, merger arbitrage, money market fund, mutually assured destruction, offshore financial centre, payment for order flow, Ponzi scheme, proprietary trading, Renaissance Technologies, risk free rate, riskless arbitrage, Robinhood: mobile stock trading app, Sharpe ratio, short selling, sovereign wealth fund, time value of money, two and twenty, walking around money

Madoff maintained to me he was a fanatic in his belief in “Chinese walls,” information barriers between separate units within a brokerage firm to prevent inside information from, say, investment bankers working on transactions, from leaking in advance to the firm’s traders who could then illegally make money on the inside information. When BLMIS made a move into proprietary trading, Bernie said he walled it off from the market-making business to the extent that the proprietary trading desk was not allowed to trade through the market-making side of the house, though they sat adjacent to each other on the nineteenth floor. He also claimed the seventeenth-floor IA business was walled off from the market-making side as well, meaning the Ponzi side didn’t trade through the market-making platform.

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At the time, it was still largely unknown that Madoff was even in the hedge fund business, much less that he was running one of the biggest operations in the world behind locked doors on the seventeenth floor of the distinctive, oval-shaped “Lipstick Building” in midtown Manhattan, home to Bernard L. Madoff Investment Securities (BLMIS). The secrecy and security on the seventeenth floor was so extensive that even Madoff’s sons, Mark and Andrew, who ran the big market-making and proprietary trading operation up on the nineteenth floor—where Madoff made his name as a market maker executing trades for the likes of Charles Schwab & Company—lacked electronic keycard access. Frank Casey’s Boston-based hedge fund, Rampart Investment Management, was, without his knowledge, a competitor of Madoff’s invisible investment advisory (IA) business.

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Dubinsky uncovered the staggering and still relatively unknown amount of money Madoff stole from his investment advisory (IA) clients to launder into his leading market-making business to keep it afloat. Madoff always denied obsessively to me that he ever took a dime from the IA side of his business to prop up his beloved and onetime legitimate market-making and proprietary trading business (MM&PT). Hot on the money trail, FBI Special Agent Paul Roberts was part of the small FBI team assigned to the Madoff criminal enterprise. His weapon of choice: a spreadsheet. He had only recently joined the Bureau. He ended up moving into Madoff’s seventeenth-floor offices for three years, and on the case for six years.

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

Alan Greenspan, American ideology, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, Bonfire of the Vanities, bonus culture, book value, break the buck, business cycle, business logic, buy and hold, capital controls, Carmen Reinhart, central bank independence, Charles Lindbergh, collapse of Lehman Brothers, collateralized debt obligation, commoditize, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency risk, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Glass-Steagall Act, Gordon Gekko, greed is good, Greenspan put, Home mortgage interest deduction, Hyman Minsky, income per capita, information asymmetry, interest rate derivative, interest rate swap, junk bonds, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, low interest rates, market bubble, market fundamentalism, Martin Wolf, Michael Milken, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, proprietary trading, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, Savings and loan crisis, sovereign wealth fund, Tax Reform Act of 1986, The Myth of the Rational Market, too big to fail, transaction costs, Tyler Cowen, value at risk, yield curve

In any case, under ordinary market conditions, arbitrage opportunities are close to free money—at least until the number of competitors mimicking a particular strategy drives its profitability down to zero—a far cry from the traditional business of lending money and taking the risk that it might not be paid back. Although Salomon pioneered quantitative arbitrage trading, the practice soon spread to other investment banks, causing a huge flow of talent into Wall Street (significantly driving up the mathematical aptitude shown on the Philippon-Reshef skill curve) and leading to vast growth in banks’ proprietary trading activities (trading on their own account, rather than executing trades for clients).* Its popularity also fueled the rapid growth of hedge funds (lightly regulated investment funds open only to institutions and rich individuals), which grew collectively from less than $30 billion in assets under management in 1990 to over $1.2 trillion in 2005,69 with estimates over $2 trillion by 2008.70 Arbitrage became a staple trading strategy of many hedge funds.

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Because hedge funds are largely unregulated, large risk exposures were building up outside the view of the financial regulators. And because arbitrage spreads are typically very thin—pricing inefficiencies tend to vanish as traders take advantage of them—making significant profits required large amounts of borrowed money. This leverage was the reason why some proprietary trading operations lost large amounts of money during the 1997–1998 emerging markets crises when prices failed to converge as expected—leading even Salomon Brothers to largely disband its arbitrage team.71 The fourth money machine of modern finance—after high-yield debt, securitization, and arbitrage trading—was the modern derivatives market.

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These large banks also had the scale required to build full-service derivatives operations that could assemble complex transactions and hedge their component parts. These new businesses helped blur the traditional line between commercial and investment banks, replacing it with a divide between small banks, which continued taking deposits and making loans, and big banks, which could branch out into securitization, proprietary trading, and derivatives. BIGGER BANKING At the same time, large banks were also growing by invading each other’s territories and acquiring smaller rivals. Banks had been trying to get around the restrictions on interstate banking and the constraints of the Glass-Steagall Act for decades. Congress responded repeatedly with legislation limiting bank activities, including the Bank Holding Company Act of 1956, the Savings and Loan Holding Company Act of 1967, and the Bank Holding Company Act Amendments of 1970.

Inside the House of Money: Top Hedge Fund Traders on Profiting in a Global Market by Steven Drobny

Abraham Maslow, Alan Greenspan, Albert Einstein, asset allocation, Berlin Wall, Bonfire of the Vanities, Bretton Woods, business cycle, buy and hold, buy low sell high, capital controls, central bank independence, commoditize, commodity trading advisor, corporate governance, correlation coefficient, Credit Default Swap, currency risk, diversification, diversified portfolio, family office, financial engineering, fixed income, glass ceiling, Glass-Steagall Act, global macro, Greenspan put, high batting average, implied volatility, index fund, inflation targeting, interest rate derivative, inventory management, inverted yield curve, John Meriwether, junk bonds, land bank, Long Term Capital Management, low interest rates, managed futures, margin call, market bubble, Market Wizards by Jack D. Schwager, Maui Hawaii, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, Nixon triggered the end of the Bretton Woods system, oil shale / tar sands, oil shock, out of africa, panic early, paper trading, Paul Samuelson, Peter Thiel, price anchoring, proprietary trading, purchasing power parity, Reminiscences of a Stock Operator, reserve currency, risk free rate, risk tolerance, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, tail risk, The Wisdom of Crowds, too big to fail, transaction costs, value at risk, Vision Fund, yield curve, zero-coupon bond, zero-sum game

I actually ended up making about 35 percent of my loss back being short fixed income. After 1994, they dramatically changed the proprietary trading structure of the firm. A lot of people left, and a lot of people were let go.The prop group went from 20-plus pure prop traders down to 3 by mid 1995.They asked me to run the European proprietary trading group and rebuild it but with a very different risk mandate. That was the birth of what I call the “new proprietary trading group.” What lessons did you learn from the sterling/yen loss? Confidence is a very, very dangerous thing. Simply because you’ve had a good run doesn’t mean it will continue.

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CHAPTER 5 The Prop Trader Christian Siva-Jothy Former Head of Proprietary Trading, Goldman Sachs SemperMacro London hat began as a means to get free drinks turned into quite a career for Christian Siva-Jothy. Formerly one of the biggest proprietary traders on the Street, Siva-Jothy admittedly got into the business because going to bank presentations while at university was an inexpensive way to finance a social life. More interestingly, his first job on a foreign exchange desk at Citibank was the day of the stock market crash in 1987. Rather than taking it as an inauspicious sign, Siva-Jothy immediately knew proprietary trading was what he was meant to do.

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He moved to Goldman Sachs (GS) a few years later, where he eventually became the partner in charge of fixed income and currency proprietary trading. Goldman Sachs in the early 1990s hardly lived up to its century-old image as a staid investment bank making money through old-line relationships. Rather, it turned into one of the biggest proprietary risk takers among the investment banks, with its traders making huge bets with firm capital in global fixed income, foreign exchange (FX), commodities, and derivatives. I first met Siva-Jothy when he was still head of proprietary trading at W 71 72 INSIDE THE HOUSE OF MONEY Goldman Sachs. A friend suggested I contact him, after dubbing him “the man.”

Rogue Trader by Nick Leeson

corporate governance, margin call, Nick Leeson, price anchoring, proprietary trading, the market place

Of course, a big investor like Warren Buffet makes all his money on long-term investments, and any fund manager will always point to ten-year performance charts, but then a lot of other big investors, like George Soros, make most of their money on a two- or three-day punt: and the beauty of it is that it’s instant profit. Plus – if you’re a dealer – it all goes into the pot for your bonus. When you make your own decisions about when to buy and sell, it’s called ‘proprietary trading’. I wanted to move into proprietary trading, but for the first year I was content to be an order-filler for Fernando in Tokyo and our Singapore clients. It is a stressful job, since you have to balance all the trades and ensure that you do not take any risk on to your own book, but you do not have the stress of running a large position, of taking a gamble.

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Each day we put a request over to London for a cash transfer to meet our clients’ daily margin payments and any proprietary positions held. We didn’t officially do proprietary trading, since Mike Killian thought it might scare some clients away (specifically, clients who suspected we might put ourselves in front of their orders and gain from the subsequent market move, a practice known as ‘front running’). However, Barings had been very active in proprietary trading from the day that I arrived in 1989. Most of this trading was booked through Fernando’s books in Japan, but we kept it quiet, and in fact there never was any front running.

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My trouble with Kim’s contracts was that they were just too big to hide, and everyone had gone home by the time I’d found them. My dabble in Error Account 88888 had been a useful way to buy time. But my main preoccupation then was not the forty contracts, but how best to help Su Khoo, a Malaysian trader who was the options dealer and Head of Proprietary Trading for Baring Securities in Tokyo. The crucial significance of this was that Su Khoo was a proprietary trader: she bought and sold large numbers of Nikkei contracts. The deals I did were all booked to her account in Tokyo, and she would check them – and if they looked out of balance she would cut the position.

Electronic and Algorithmic Trading Technology: The Complete Guide by Kendall Kim

algorithmic trading, automated trading system, backtesting, Bear Stearns, business logic, commoditize, computerized trading, corporate governance, Credit Default Swap, diversification, en.wikipedia.org, family office, financial engineering, financial innovation, fixed income, index arbitrage, index fund, interest rate swap, linked data, market fragmentation, money market fund, natural language processing, proprietary trading, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, short selling, statistical arbitrage, Steven Levy, transaction costs, yield curve

Humans make the final trading decisions and the parameters behind implementing them, but computers may calculate algorithms that route the order flow efficiently and in many cases, computers help the breakdown of trades to each individual stock within the program. 1.2 The Emergence of Electronic Trading Networks Algorithmic trading has become another method for large brokerage firms to grasp an advantage over their competitors for lower-cost executions; however, smaller players such as agency brokers also see algorithms as a way to level the playing field and infringe on the bigger bulge-bracket firms. Algorithmic trading originated on proprietary trading desks of investment banking firms. It began to expand executing client orders because of new markets and the need to remain in line with new players in the brokerage industry. This has created a more competitive environment for traditional dealers with services such as direct market access through the Internet.

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They will also use statistics and trade data based on internal algorithmic flows to determine transaction costs and market impact costs. Smaller niche brokers may go with vendor solutions that charge a flat fee. Agency brokers feel they have an advantage in providing nonproprietary services that service the customer alone. A bulge-bracket firm may utilize client flow analyzing the data for their own proprietary trading desk. The large broker-dealers still dominate the algorithm market, but agency brokers are gaining momentum due to their neutral stance.7 7 Daniel Safarik, ‘‘Algorithmic Trading: Somehow, It All Adds Up,’’ Wall Street & Technology, August 7, 2006. Chapter 6 Algorithmic Feasibility and Limitations 6.1 Introduction Algorithms are most effective and feasible for trades too small to focus on, or too liquid for a human trader to add impact or add significant value.

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Electronic blue sheets must be reported within 10 business days of a request regarding data going back up to two prior years. The types of securities that can potentially be requested include stocks and stock options. All exchanges and markets in an equity or option include domestic exchanges, OTC, or international exchanges. Both proprietary trades and customer trades must be reported. The types of transactions include buy, sell, sell short for cash trades, and open, close, long/short positions for options. Cancels must be recorded for both cash trades and options. Daily Program Trading Report (DPTR) Members and member firms are required by the NYSE to submit transactions that would qualify as a ‘‘program trade.’’

Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street Are Destroying Investor Confidence and Your Portfolio by Sal Arnuk, Joseph Saluzzi

algorithmic trading, automated trading system, Bernie Madoff, buttonwood tree, buy and hold, commoditize, computerized trading, corporate governance, cuban missile crisis, financial engineering, financial innovation, Flash crash, Gordon Gekko, High speed trading, latency arbitrage, locking in a profit, machine readable, Mark Zuckerberg, market fragmentation, National best bid and offer, payment for order flow, Ponzi scheme, price discovery process, price mechanism, price stability, proprietary trading, Sergey Aleynikov, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, stocks for the long run, stocks for the long term, transaction costs, two-sided market, uptick rule, zero-sum game

Their business model and short-term, day-trading focus seeded the market structure we have today. Maschler headed Datek Securities, a proprietary trading firm. With the help of two boy wonders, Jeff Citron and Josh Levine, Maschler in 1989 created Watcher. Watcher was a software program that enabled day traders to take advantage of a weakness in the SOES system—relatively slow updating of price quotes. While SOES was intended for small client orders, Datek used SOES, in combination with Watcher, to execute larger, proprietary trades, buying stocks and then selling them within seconds. Datek was very successful. By 1996, it had 500 traders, many of them fresh out of Ivy League schools, making as much as $750,000 a year each.4 Datek gurus Citron and Levine developed the Island electronic communication network (ECN) in 1997 to complement their usage of SOES.

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• If you are a professional investor, there’s a reason why your brokerage firm charges you only a half a penny a share if you use a volume weighted average price (VWAP) or percentage of volume (POV) algorithm to execute your trades. (Algos slice a large order into hundreds of smaller orders and feed them into the market.) It’s because your orders are fed to proprietary trading engines that make money off of you. Their algo figures out how your algo works, forcing you to pay more for buys and receive less for sells. • And if you are an agency broker, like we are, there’s a reason why some big brokerage firm salesmen offer their VWAP algo for free! It’s because their firm has a way to make money by disadvantaging your orders all day long.

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While Instinet charged a flat commission rate for all executions, Island paid traders for adding limit orders to its order book and charged traders only if they crossed the spread and executed against another limit order. For the first time, traders were paid just to bring their orders to a market center. Island grabbed 15% market share of NASDAQ trades by 1998 and was later bought by NASDAQ.5 Harvey Houtkin’s brokerage firm, All-Tech, another proprietary trading firm, in 1998 created an ECN called Attain, for the same reason Datek created Island. In 2005, Attain was sold to Knight Trading, which renamed it Direct Edge. Knight then sold stakes in Direct Edge to Goldman Sachs, Citadel Investments, and the International Securities Exchange (ISE). Today, Direct Edge is one of the four major exchange families in the United States.

Why I Left Goldman Sachs: A Wall Street Story by Greg Smith

Alan Greenspan, always be closing, asset allocation, Bear Stearns, Black Swan, bonus culture, break the buck, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, delayed gratification, East Village, fear index, financial engineering, fixed income, Flash crash, glass ceiling, Glass-Steagall Act, Goldman Sachs: Vampire Squid, high net worth, information asymmetry, London Interbank Offered Rate, mega-rich, money market fund, new economy, Nick Leeson, proprietary trading, quantitative hedge fund, Renaissance Technologies, short selling, short squeeze, Silicon Valley, Skype, sovereign wealth fund, Stanford marshmallow experiment, statistical model, technology bubble, too big to fail

The reforms Wall Street is pushing back the hardest against are in the areas it knows are the most profitable: opaque derivatives and proprietary trading. But these also happen to be the areas that are most dangerous to the stability of the financial system. The Wall Street lobby has already spent more than $300 million trying to kill measures to regulate derivatives (so that they are brought into the light of day and become transparent on exchanges), and to eliminate proprietary trading so banks can no longer bet against their customers using their information advantage as prescribed by the Volcker Rule. Wall Street hates transparency and will fight as hard as possible to prevent it from coming.

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Principal: The person or entity who takes the other side of a client’s trade—i.e., commits the firm’s own capital to facilitate the trade. Also see: AGENT. Proprietary trading: Engaging, as an investment bank, in trading securities for one’s own account with one’s own money to make a profit much like a hedge fund. This is opposed to facilitating trading for one’s customers. The Volcker Rule in the Dodd-Frank Act seeks to outlaw proprietary trading because of the role it played in the lead-up to the financial crisis in 2008 and because of the inherent conflict of interest with client trading. Put option: A type of derivative that gives the purchaser the right to sell an underlying security at a stipulated price in the future.

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You’re done/you’re filled: Your trade has been executed; your price will follow shortly. * In a continuing war against the Volcker Rule, which seeks to end proprietary trading, the investment banks defend principal trading, saying they need to hedge themselves after they’ve facilitated a client trade as a market maker. In fact, what often happens is banks use the cover of this “hedging” to then express their views via proprietary trades. ** A credit-default swap is a type of derivative that acts like an insurance policy against the default of a company or sovereign nation. About the Author GREG SMITH resigned in the spring of 2012 as the head of Goldman Sachs’s U.S.

The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis by Tim Lee, Jamie Lee, Kevin Coldiron

active measures, Alan Greenspan, Asian financial crisis, asset-backed security, backtesting, bank run, Bear Stearns, Bernie Madoff, Bretton Woods, business cycle, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, currency risk, debt deflation, disinformation, distributed ledger, diversification, financial engineering, financial intermediation, Flash crash, global reserve currency, implied volatility, income inequality, inflation targeting, junk bonds, labor-force participation, Long Term Capital Management, low interest rates, Lyft, margin call, market bubble, Money creation, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, negative equity, Network effects, Ponzi scheme, proprietary trading, public intellectual, purchasing power parity, quantitative easing, random walk, rent-seeking, reserve currency, rising living standards, risk free rate, risk/return, sharing economy, short selling, short squeeze, sovereign wealth fund, stock buybacks, tail risk, TikTok, Uber and Lyft, uber lyft, yield curve

Once again, this is a generalization; undoubtedly some of the larger funds, particularly those with in-house investment staff, do engage in carry. However, we do not believe that they are an important structural source of the secular growth in carry strategies. The Agents of Carry 77 Global Investment Banks’ Proprietary Trading Highlights the Power of the Compensation Incentive Prior to the implementation of the Volcker Rule in 2014, which required banks to close most proprietary trading operations, investment banks2 operated very large proprietary trading desks. Of course, there was a vast array of compensation arrangements, but the broad structure was an annual bonus linked to profit and loss with no “giveback” for subsequent losses.

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As it turned out, 2008 was a terrible year for carry strategies and coincided with a run on investment bank liabilities, with the result being the welldocumented global financial crisis. That these institutions still engaged in carry strategies despite having liabilities ill-suited to them speaks to the power of the compensation incentive in driving investment strategy. Since 2014, the scale of investment bank proprietary trading has been reduced. Anecdotal evidence suggests that many proprietary trading groups have simply joined hedge funds. Others suggest that “prop” positions are still present but better hidden within other allowable parts of banks’ books. These claims are not easily verified. Given the Volcker Rule and the increased regulatory focus on systemic risk, it seems unlikely that banks have been a meaningful source of carry growth in the last several years, and this is not likely to change. 2.

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See also currency carry trades bailouts of, 197, 198 central bank balance sheets as, 216–217 in commodities, 128–129 credit growth and, 37–42 in dollars, 14–23, 15f, 16f Euro-funded, 31 exchange rate stability and returns from, 52 INDEX by Federal Reserve, 103 government policies and returns from, 48 by hedge funds, 73–75 leverage in, 33–35 leveraged buyouts as, 78–80 as liquidity-providing trades, 35–36 measuring flow of, 41 non-currency forms of, 34 oil, 128–133 profit explanation attempts for, 48 sovereign wealth funds and, 75–76 S&P 500 as, 160–162 carry trades characteristics of, 3–5 defining, 2 risk of, 3, 5 sawtooth return pattern of, 4 short volatility of, 4 types of, 4 cash yields, 204 CBOE (Chicago Board Options Exchange), 57 CDOs (collateralized debt obligations), 36–37, 95, 135 CDS (credit default swap), 34, 36, 135 celebrity, 186, 187 central banks balance sheets of, as carry trades, 216–217 carry and, 5–8 carry regime and policies of, 86–89, 107, 208, 210 carry regime and power of, 123 carry regime collapses and, 215–216 carry regime weakening, 7 credit demand and, 13 deflationary pressures and, 115 foreign exchange markets and, 11, 13, 20 interventionist policies of, 201–202 liquidity and, 110–111 market stabilization by, 5–6 moral hazard and, 195, 200 volatility selling by, 101–105 Chicago Board Options Exchange (CBOE), benchmark indexes by, 57 China, 19 circular flow of dollars, 18–19, 18f classical equilibrium model of economy, 142 currency carry trade returns and, 10 223 collateralized debt obligations (CDOs), 36–37, 95, 135 Columbia MusicLab, 181–182, 184, 188 commodities, carry trade in, 128–129 compensation incentives hedge fund strategies and, 73 proprietary trading and, 77 constant leverage, 93 consumer price index, Turkey, 44 consumption utility, 100 corporations carry strategies by, 80–83 debt issuance by, 81–83, 82f, 83f share buybacks by, 82, 83f covered interest parity principle, 21, 22 credit Australia growth of, 40f, 41 availability of, 4 carry bubbles and demand for, 114 carry trades and growth of, 37–42 central bank influence on demand for, 13 debt levels and demand for, 114 interest rates and demand for, 110 moral hazard issues and, 199 credit booms, currency carry trades contributing to, 13 credit bubbles carry bubbles and, 37–38, 41 mid-2000s, 36 credit carry trades, risk mispricing and, 35–37 credit default swap (CDS), 34, 36, 135 credit demand, 13 credit derivatives, 135 cross-currency basis, 22 cryptocurrencies, 211, 212 cumulative advantage carry as, 181–184 evolution and, 188–190 self-perpetuation and, 186–188 currency carry trades, 9, 129 academic interest in, 47–49 covered interest parity principle and, 21–22 credit bubbles and, 36 credit creation by, 20 current account deficits and, 17 emerging markets and returns from, 55 equity carry correlation with, 56–59, 58f 224 currency carry trades (continued) equity volatility and returns from, 59 exchange rate risks of, 17 exchange rate stability and returns from, 52 expected returns, 10 global financial crisis of 2007-2009 and, 28–29 historical returns, 50–52, 50f, 51f, 53f history of, 23–31, 24f identifying, 11–12 interest rate differentials and returns from, 60–62 Japan and, 17–18 liquidity provision and, 88 liquidity swaps and, 104–105 market pricing efficiency and, 11 money supply effects of, 20–21 net claims as proxy for measuring, 41 portfolio for analyzing, 49–50 real economy links with, 56 United States and, 17–20 volatility signs of collapse in, 215 currency markets, 10 currency risk, 12 currency risk aversion, 13 currency volatility, 62 current account deficit of Thailand, 25 of United States, 17 debt.

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Irene Aldridge

algorithmic trading, asset allocation, asset-backed security, automated trading system, backtesting, Black Swan, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, computerized trading, diversification, equity premium, fault tolerance, financial engineering, financial intermediation, fixed income, global macro, high net worth, implied volatility, index arbitrage, information asymmetry, interest rate swap, inventory management, Jim Simons, law of one price, Long Term Capital Management, Louis Bachelier, machine readable, margin call, market friction, market microstructure, martingale, Myron Scholes, New Journalism, p-value, paper trading, performance metric, Performance of Mutual Funds in the Period, pneumatic tube, profit motive, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic trading, tail risk, trade route, transaction costs, value at risk, yield curve, zero-sum game

MARKET PARTICIPANTS Competitors High-frequency trading firms compete with other investment management firms for quick access to market inefficiencies, for access to trading and operations capital, and for recruiting of talented trading strategists. Competitive investment management firms may be proprietary trading divisions of investment banks, hedge funds, and independent proprietary trading operations. The largest independent firms deploying high-frequency strategies are DE Shaw, Tower Research Capital, and Renaissance Technologies. Investors Investors in high-frequency trading include fund of funds aiming to diversify their portfolios, hedge funds eager to add new strategies to their existing mix, and private equity firms seeing a sustainable opportunity to create wealth.

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Most of the highfrequency firms are hedge funds or other proprietary investment vehicles 4 HIGH-FREQUENCY TRADING TABLE 1.1 Classification of High-Frequency Strategies Typical Holding Period Strategy Description Automated liquidity provision Quantitative algorithms for optimal pricing and execution of market-making positions <1 minute Market microstructure trading Identifying trading party order flow through reverse engineering of observed quotes <10 minutes Event trading Short-term trading on macro events <1 hour Deviations arbitrage Statistical arbitrage of deviations from equilibrium: triangle trades, basis trades, and the like <1 day that fly under the radar of many market participants. Proprietary trading desks of major banks, too, dabble in high-frequency products, but often get spun out into hedge fund structures once they are successful. Currently, four classes of trading strategies are most popular in the high-frequency category: automated liquidity provision, market microstructure trading, event trading, and deviations arbitrage.

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In decentralized foreign exchange markets, inter-dealer networks consist of inter-dealer brokers, which, like exchanges, are organizations that ensure liquidity in the markets and deal between their peers and broker-dealers. Broker-dealers perform two functions—trading for their own accounts (known as “proprietary trading” or “prop trading”) and transacting and clearing trades for their customers. Broker-dealers use inter-dealer brokers to quickly find the best price for a particular security among the network of other broker-dealers. Occasionally, broker-dealers also deal directly with other broker-dealers, particularly for less liquid instruments such as customized option contracts.

Broken Markets: A User's Guide to the Post-Finance Economy by Kevin Mellyn

Alan Greenspan, banking crisis, banks create money, Basel III, Bear Stearns, Bernie Madoff, Big bang: deregulation of the City of London, bond market vigilante , Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, business cycle, buy and hold, call centre, Carmen Reinhart, central bank independence, centre right, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, compensation consultant, corporate governance, corporate raider, creative destruction, credit crunch, crony capitalism, currency manipulation / currency intervention, currency risk, disintermediation, eurozone crisis, fiat currency, financial innovation, financial repression, floating exchange rates, Fractional reserve banking, Glass-Steagall Act, global reserve currency, global supply chain, Home mortgage interest deduction, index fund, information asymmetry, joint-stock company, Joseph Schumpeter, junk bonds, labor-force participation, light touch regulation, liquidity trap, London Interbank Offered Rate, low interest rates, market bubble, market clearing, Martin Wolf, means of production, Michael Milken, mobile money, Money creation, money market fund, moral hazard, mortgage debt, mortgage tax deduction, negative equity, Nixon triggered the end of the Bretton Woods system, Paul Volcker talking about ATMs, Ponzi scheme, profit motive, proprietary trading, prudent man rule, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, rising living standards, Ronald Coase, Savings and loan crisis, seigniorage, shareholder value, Silicon Valley, SoftBank, Solyndra, statistical model, Steve Jobs, The Great Moderation, the payments system, Tobin tax, too big to fail, transaction costs, underbanked, Works Progress Administration, yield curve, Yogi Berra, zero-sum game

The largest single source of interbank payments is foreign exchange trading. While obtaining foreign exchange is necessary for persons and firms engaged cross-border business and travel, such transactions are a small percentage of turnover, perhaps as little as 1 percent. What accounts for the other $1,000 trillion? The answer is called professional or proprietary trading if you are a banker, but raw speculation or gambling if you are almost anyone else. Going back to our movie, remember that this vast disparity between the financial economy and the real economy is essentially new—a product of financial innovation on one hand and the severing of the last constraints on money creation on the other.

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What was new was its sheer scale and its sources.The financialized wealth of the 1982–2007 boom was concentrated in two types of people: the beneficiaries of stock-based compensation granted by public companies—itself a result of efforts to curb the cash compensation of executives—and participants in the financial services industry itself, especially investment bankers. This wealth, unlike the finance capital of Marx’s day that built the industries of America and railroads around the world, got recycled into more financial trading and risk taking to an extraordinary extent. Partners’ funds accumulated in investment banks fed ever more sophisticated proprietary trading operations. Hedge funds—essentially private investment clubs betting on the skills or connections of a stock manager—became real forces in the capital markets. Even conservative long-term investors such as pension funds, insurance companies, and university endowments put money into these vehicles, despite the utter lack of transparency and the high fees charged by their managers at the height of the bubble.

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Interbank trading of foreign exchange became one of the largest markets in the world, and remains such, with trillions turning over every day. Again, a new profit center for the largest banks was born. Although the real commercial needs of customers were at the bottom of all this activity, most bank trading desks were mainly engaged in proprietary trading, betting the bank’s own capital. As time went on, this expanded into other markets, such as financial futures, bonds, and even commodities. On the whole, the general public, politicians, and regulators tend to think that a bank is a bank, and though few understand how a bank really works, they assume that it makes its living taking deposits and making loans.

The Cost of Inequality: Why Economic Equality Is Essential for Recovery by Stewart Lansley

"World Economic Forum" Davos, Adam Curtis, air traffic controllers' union, Alan Greenspan, AOL-Time Warner, banking crisis, Basel III, Big bang: deregulation of the City of London, Bonfire of the Vanities, borderless world, Branko Milanovic, Bretton Woods, British Empire, business cycle, business process, call centre, capital controls, collective bargaining, corporate governance, corporate raider, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, deindustrialization, Edward Glaeser, Everybody Ought to Be Rich, falling living standards, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, Goldman Sachs: Vampire Squid, high net worth, hiring and firing, Hyman Minsky, income inequality, James Dyson, Jeff Bezos, job automation, job polarisation, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, laissez-faire capitalism, Larry Ellison, light touch regulation, Londongrad, Long Term Capital Management, low interest rates, low skilled workers, manufacturing employment, market bubble, Martin Wolf, Mary Meeker, mittelstand, mobile money, Mont Pelerin Society, Myron Scholes, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, proprietary trading, Right to Buy, rising living standards, Robert Shiller, Robert Solow, Ronald Reagan, savings glut, shareholder value, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, Tyler Cowen, Tyler Cowen: Great Stagnation, Washington Consensus, Winter of Discontent, working-age population

From the middle to the end of the 1990s, a number of banks—from Salomon Brothers and Goldman Sachs to Merrill Lynch and Drexel Burnham, Lambert—started to operate their own proprietary trading arms using the firm’s own rather than their customers’ money and investing mostly at the high risk end of the market. In this way profits were siphoned off to finance takeovers, invest in hedge funds or bet on commodities and currency movements. Such activity undoubtedly added considerable risk to the system as a whole. Nick Leeson, for example, was a key member of Barings proprietary trading team and at least some of the money he was investing came from the proprietary trading budget. As the investment banks were very lightly regulated, the authorities mostly had little idea about the scale or character of such activity.

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vlnk=993. 326 Don Young, ‘FTSE 100—the largest companies’, 2007. 327 D Young and P Scott, Having Their Cake, How the City and Top Managers are consuming British Industry, Kogan Page, London, 2004. 328 Andrew Tylecote and Paulina Ramirez, UK Corporate Governance and Innovation, Sheffield University Business School, Discussion Paper, 2004. 329 Ozgur Orhanguzi, ‘Financialisation and capital accumulation in the non-financial sector’, Cambridge Journal of Economics, 2008. 330 H Williams, Britain’s Power Elites, Constable, 2006, p 169. 331 T Dolphin, Financial Sector Taxes, IPPR, 2010, p 14. 332 Ibid. p 15. 333 J G Palma, ‘The Revenge of the Markets on the Rentiers’, Cambridge Journal of Economics, vol 333 issue 4, 2009. 334 Absolute Return, April 2010. 335 J Chapman, Phasing Out Hedge Funds, Public Policy Research, March-May, 2010. 336 A Hilton, ‘Hedge Funds’ Market Spoiler, Evening Standard, 12 May 2004. 337 Mansion House Speech March 2010 Available at http://archive.bis.gov.uk/newsarchive/nds/clientmicrosite/content/Detail.aspx-ReleaseID=411720&-NewsAreaID=2&ClientID=431.html. 338 Henry Hu and Barnard Black, Hedge Funds, ‘Insiders and Empty Voting’, Finance Working Paper, No xx/2006, European Governance Institute, p 12. 339 J Crotty, G Epstein and I Levin, ‘Proprietary Trading Is A Bigger Deal Than Many Bankers and Pundits Claim’, Policy Note No 15, February, 2010, Political Economy Research Institute, University of Masschusetts. 340 M Lewis, Liar’s Poker, Coronet, 1991, p 141. 341 Cowen, op. cit. 342 Sir John Gieve, The City’s Growth: The Crest of a Wave or Swimming with the Stream?

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Many of these companies started to handle only clients offering substantial sums. In the UK, for example, the wealth management firms Fleming Family and Partners, JO Hambro and Sarasin only handle a group known in the industry as ‘ultra high net worth’: those with assets to spare of at least £10 million. Some of the money supported proprietary trading desks in investment banks. Yet using the banks’ own capital in this way loaded additional risk and potential conflict. ‘Not only do they risk putting their own interests before those of their clients’, as the Economist magazine argued in 2007, ‘they are also increasingly exposing themselves to the dangers of an abrupt turn in the credit cycle.

Risk Management in Trading by Davis Edwards

Abraham Maslow, asset allocation, asset-backed security, backtesting, Bear Stearns, Black-Scholes formula, Brownian motion, business cycle, computerized trading, correlation coefficient, Credit Default Swap, discrete time, diversified portfolio, financial engineering, fixed income, Glass-Steagall Act, global macro, implied volatility, intangible asset, interest rate swap, iterative process, John Meriwether, junk bonds, London Whale, Long Term Capital Management, low interest rates, margin call, Myron Scholes, Nick Leeson, p-value, paper trading, pattern recognition, proprietary trading, random walk, risk free rate, risk tolerance, risk/return, selection bias, shareholder value, Sharpe ratio, short selling, statistical arbitrage, statistical model, stochastic process, systematic trading, time value of money, transaction costs, value at risk, Wiener process, zero-coupon bond

However, a couple types of trading desks are operated as their own line of business. The most prominent of these are mutual funds, hedge funds, and proprietary trading desks at banks. Trading and Hedge Funds 3 Some organizations whose focus is on trading for profit are: ■ ■ ■ Mutual Funds. Mutual funds are a pooled‐investment fund where the leadership of the fund manages investments on behalf of investors. These funds are restricted from many investment strategies deemed too speculative or risky for uninformed investors. Proprietary Trading Desks. A trading desk found in many investment banks that operates like an internal hedge fund to invest the firm’s capital.

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Over time, that most risk management is focused on analysis rather than making decisions. In most risk management texts, there is very little discussion on what decisions are made as the result of analysis. My first exposure to risk management came when I worked as a programmer on JP Morgan’s proprietary trading desk in the early 1990s. Just before I’d taken that job, I’d left my job at a computer game company and needed a short‐term job to pay the bills. At the time, I intended it to be temporary and lasting long enough for me to raise enough capital to start my own company. My life would have taken a different turn had I ever managed to get that IPO completed.

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Acceptance involves taking on risks and establishing a budget that will cover potential losses. This book focuses on techniques that professional traders use to assist in making decisions. The first three chapters establish the building blocks that are used in the rest of the text. The first chapter introduces trading and two major types of professional traders (hedge funds and proprietary trading desks). The second chapter discusses the major financial markets, and the third describes some of the terminology used by professional traders. The final six chapters of the book describe decisions that are made by traders. Risk avoidance and acceptance are discussed in Chapter 4: Backtesting and Trade Forensics.

Crapshoot Investing: How Tech-Savvy Traders and Clueless Regulators Turned the Stock Market Into a Casino by Jim McTague

Alan Greenspan, algorithmic trading, automated trading system, Bear Stearns, Bernie Madoff, Bernie Sanders, Black Monday: stock market crash in 1987, Bretton Woods, buttonwood tree, buy and hold, computerized trading, corporate raider, creative destruction, credit crunch, Credit Default Swap, financial innovation, fixed income, Flash crash, High speed trading, housing crisis, index arbitrage, junk bonds, locking in a profit, Long Term Capital Management, machine readable, margin call, market bubble, market fragmentation, market fundamentalism, Myron Scholes, naked short selling, Nixon triggered the end of the Bretton Woods system, pattern recognition, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, Renaissance Technologies, Ronald Reagan, Sergey Aleynikov, short selling, Small Order Execution System, statistical arbitrage, technology bubble, transaction costs, uptick rule, Vanguard fund, Y2K

Clearly, a lot of people thought high-frequency trading (HFT) was a path to quick and easy profits. The general investment public had no idea that this market version of the Invasion of the Body Snatchers was under way. Some of the biggest players in the high-frequency trading sector were not household names: They were proprietary trading firms such as Getco and Tradebot and hedge funds such as Millennium, DE Shaw, WorldQuant, and Renaissance Technologies. Others were household names, but investors hadn’t paid much attention to their forays into mechanized trading because it was a relatively small portion of their earnings and they did not break out the numbers in their annual reports.

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The scrutiny became so intense that a segment on HFT even ran on Comedy Central’s Daily Show, with make-believe news correspondent Samantha Bee, dressed as a “cash cow,” urging investors to try some HFT before it was banned by the regulators. The segment featured Irene Aldridge, who had written a book on the subject. In short order, HFT became a derisive term. Comically, the industry tried to change its label. One practitioner told journalists that he preferred his firm to be called an “automated proprietary trading firm.” “There have been automated trading firms around since at least the early 1990s. They traded as much as possible with automation, but they also had traders on the floor with handheld computer terminals,” he said. In the midst of the journalistic feeding frenzy, it wasn’t long before reporters discovered Arnuk and Saluzzi’s white paper and launched the pair into the limelight.

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There was nothing particularly flashy about high-frequency traders. A typical proprietary shop consisted of computer jocks, some math and physics wonks, and a handful of old-fashioned traders, many who had cut their teeth either in the push and shove and throat-scraping roar of the commodities and options trading pits in Chicago or on the proprietary trading desks of big New York banks. One thing that high-frequency traders had in common was a preference for the covert life. They preferred life in the shadows as opposed to life in the limelight because they guarded their trading secrets as carefully as anglers protect their favorite fishing holes.

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

Alan Greenspan, Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Bear Stearns, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, book value, Bretton Woods, business cycle, buy and hold, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, deal flow, do well by doing good, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, Jim Simons, John Bogle, John Meriwether, junk bonds, Kenneth Rogoff, Kickstarter, Long Term Capital Management, low interest rates, machine translation, margin call, market bubble, market clearing, market fundamentalism, Market Wizards by Jack D. Schwager, Mary Meeker, merger arbitrage, Michael Milken, money market fund, moral hazard, Myron Scholes, natural language processing, Network effects, new economy, Nikolai Kondratiev, operational security, pattern recognition, Paul Samuelson, pre–internet, proprietary trading, public intellectual, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Mercer, rolodex, Savings and loan crisis, Sharpe ratio, short selling, short squeeze, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, tail risk, technology bubble, The Great Moderation, The Myth of the Rational Market, the new new thing, too big to fail, transaction costs, two and twenty, uptick rule

Much like the Simons team, he pursued numerical precision with a zealous intensity: His staff soon discovered that it was no good telling him that a programming task might take three to eight weeks; you had to say that it would take 5.25, but with an error of two weeks.7 Yet for all these similarities, there were differences between Shaw and Simons too. These proved to be significant. Shaw got into finance via Morgan Stanley’s proprietary trading desk, which hired him to create a computer system to support its quantitative trading. It was 1986, and big things were stirring at Morgan. The firm’s secretive Analytical Proprietary Trading unit ran a computerized effort to profit from short-run liquidity effects in stock markets. As Michael Steinhardt had discovered in the 1970s, a big sell order from a pension fund could push a stock’s price out of line; provided that there was no information behind the sale—that is, provided that the pension fund was selling because it needed cash rather than because it was reacting to bad news—Steinhardt could profit by buying and holding the stock until it rose back to its previous level.

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But in the aftermath of the yen shock, traders’ logic asserted itself once again. Europe’s long-term interest rates spiked up: In the space of a fortnight, the yield on the German government’s ten-year bonds rose by thirty-seven basis points, Italy’s rose by fifty-eight basis points, and Spain’s rose by sixty-two.17 Hedge funds and banks’ proprietary trading desks had lost money on U.S. Treasuries and the yen. They were responding by dumping European bonds, never mind the continent’s economic fundamentals. Once hedge funds began to flee Europe, the stampede built on its own momentum. Brokers that had been willing to lend freely to the shadowbankers suddenly reversed themselves now that their trades were going wrong: Rather than accepting $1 million of collateral, or “margin,” to back every $100 million of bonds, the brokers demanded $3 million or $5 million to protect themselves from the danger that a hedge fund might prove unable to repay them.

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Paul Tudor Jones, whose great strength was to sense how other traders were positioned, failed to spot the danger in Europe, and in the spring of 1994 his fund was down sharply. The same went for the other members of the Commodities Corporation trio, Bruce Kovner and Louis Bacon. David Gerstenhaber, the macro trader whom Julian Robertson had hired in 1991, was by now running his own hot fund; he blew up spectacularly. Proprietary trading desks did badly too; in 1994, Goldman Sachs experienced its worst year in a decade. The insurance industry was reckoned to have lost as much money on its bond holdings as it had paid out for damages following the recent Hurricane Andrew; “I’m starting to call this Hurricane Greenspan,” quipped one insurance analyst.19 For a few hours on March 2, no less a firm than Bankers Trust teetered on the brink of bankruptcy.

Ethics in Investment Banking by John N. Reynolds, Edmund Newell

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, banking crisis, Bear Stearns, collapse of Lehman Brothers, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, discounted cash flows, financial independence, Glass-Steagall Act, index fund, invisible hand, junk bonds, light touch regulation, margin call, Michael Milken, moral hazard, Nick Leeson, Northern Rock, proprietary trading, quantitative easing, shareholder value, short selling, South Sea Bubble, stem cell, the market place, The Wealth of Nations by Adam Smith, too big to fail, two and twenty, zero-sum game

In addition, many investment banks take principal positions (that is, they make investments) either as a specific investment strategy for themselves or to facilitate client business. This is also a major driver for profitability – and for some investment banks it has become the major source of profits. The opportunity to benefit from market presence and understanding has helped many investment banks grow significantly, and some have groups, engaged in proprietary trading, that are remunerated and behave in a very similar way to hedge funds. This activity is not in any way novel for investment banks, although the balance of activities has changed considerably over time. From an ethical perspective, capital market activities and fulfilling market demands for services can be seen as potentially beneficial: facilitating commerce, encouraging market efficiency and providing essential services on more or less competitive terms.

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The Dodd–Frank Act specifically aims to end “too big to fail” by a combination of measures, including regulation and supervision, a levy to be paid by major financial institutions to create an Orderly Liquidation Fund and provisions for orderly liquidation. The Act does not, however, set a limit on the size of financial institutions, including investment banks. The Volcker Rule, also part of the Dodd–Frank Act (and named after its proponent, Paul Volcker, the former Chairman of the US Federal Reserve), restricts proprietary trading activities of banks (deposit-taking institutions), aimed at reducing risk-taking from deposit-taking. This rule has certain limitations, for example when determining hedging activities and when market-making. The likely impact of these limitations is currently unclear. The UK’s approach to legislative reform has been slower than in the US.

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At times, it may hold them for significantly longer, but this is likely to be very much when it is taking an 66 Ethics in Investment Banking investment view on the securities concerned, and thus goes beyond “pure” market-making. In some jurisdictions, there may be tax advantages to holding shares as a market maker, even if in reality a shareholding may be part of a proprietary trading position. The question of how an investment bank is viewed – as one of a number of market participants or alternatively as an orchestrator of the market – will influence how investment banks are expected to deal ethically with trading counterparties, whether fee-paying clients or non-fee-paying customers.

Crisis Economics: A Crash Course in the Future of Finance by Nouriel Roubini, Stephen Mihm

Alan Greenspan, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, bond market vigilante , bonus culture, Bretton Woods, BRICs, British Empire, business cycle, call centre, capital controls, Carmen Reinhart, central bank independence, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, dark matter, David Ricardo: comparative advantage, debt deflation, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, Glass-Steagall Act, global pandemic, global reserve currency, Gordon Gekko, Greenspan put, Growth in a Time of Debt, housing crisis, Hyman Minsky, information asymmetry, interest rate swap, invisible hand, Joseph Schumpeter, junk bonds, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market bubble, market fundamentalism, Martin Wolf, means of production, Minsky moment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, Northern Rock, offshore financial centre, oil shock, Paradox of Choice, paradox of thrift, Paul Samuelson, Ponzi scheme, price stability, principal–agent problem, private sector deleveraging, proprietary trading, pushing on a string, quantitative easing, quantitative trading / quantitative finance, race to the bottom, random walk, regulatory arbitrage, reserve currency, risk tolerance, Robert Shiller, Satyajit Das, Savings and loan crisis, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, subprime mortgage crisis, Suez crisis 1956, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, too big to fail, tulip mania, Tyler Cowen, unorthodox policies, value at risk, We are all Keynesians now, Works Progress Administration, yield curve, Yom Kippur War

This reform would make the financial system less interconnected, and therefore less prone to the kind of systemic chain reactions that lead to widespread failures. In order to stabilize the system even further, all banks—including investment banks—should be forbidden to practice any kind of risky proprietary trading. Nor should they be permitted to act like hedge funds and private equity firms. Instead, they should confine themselves to doing what they’ve done historically: raising capital and underwriting offerings of securities. The kind of proprietary trading that many investment banks now do, never mind hedge fund operations, should be the franchise of hedge funds alone. But like the investment banks, hedge funds would not be permitted to engage in large-scale short-term borrowing from banks and other financial institutions.

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These firms are understandably reluctant to see these instruments’ trading moved from dealers’ markets onto exchanges: doing so would deprive them of the ability to extract the kind of profits that come with having access to information their clients lack. Under the current system, firms can very easily charge high bid-ask spreads because there is no price transparency; they can effectively “front run” their clients, meaning that they can use information about their clients’ investments to make money in other departments, such as in proprietary trading or even in the actual market-making and market-dealing activities. Greater transparency will frustrate those sorts of behaviors. Skeptics might reasonably point out that if investors want to pay through the nose for the privilege of alpha—or schmalpha—returns, that’s their business. But the rise of a small coterie of incredibly powerful, opaque financial firms has generated a far more unsettling problem.

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We are now in the worst of all worlds, where many TBTF institutions have been bailed out and expect to be bailed out in any number of future crises. They have as yet faced no sustained regulatory scrutiny, and no system is in place to put them into insolvency should the need arise. Even worse, many of these institutions—starting with Goldman Sachs and JPMorgan Chase—are starting to engage once more in “proprietary trading strategies,” which are complicated bets on stocks, bonds, commodities, and derivatives driven by algorithms devised by the firm’s traders. Some of these “prop trading” strategies are risky, yet firms have resumed them while remaining under the protective umbrella of a dozen different government support programs.

When Free Markets Fail: Saving the Market When It Can't Save Itself (Wiley Corporate F&A) by Scott McCleskey

Alan Greenspan, Asian financial crisis, asset-backed security, bank run, barriers to entry, Bear Stearns, Bernie Madoff, break the buck, call centre, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, financial engineering, financial innovation, fixed income, Glass-Steagall Act, information asymmetry, invisible hand, Isaac Newton, iterative process, junk bonds, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, place-making, Ponzi scheme, prediction markets, proprietary trading, risk tolerance, Savings and loan crisis, shareholder value, statistical model, The Wealth of Nations by Adam Smith, time value of money, too big to fail, web of trust

Chief among these is the proposed prohibition against ‘‘proprietary trading’’ by commercial banks. Proprietary trading is generally the activity in which a firm bets its own money rather than that of its client. But laws have to be precisely written, and proprietary trading is a lot more difficult to define when looked at with a regulatory microscope. For example, some firms use proprietary trading to acquire stock which they will later sell to their clients, or will buy from a client when there isn’t sufficient demand to sell the client’s stock at a good price. Proprietary trading, it turns out, is another one of those ‘‘know-it-when-I-see-it’’ things.

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See also Troubled Asset Relief Program (TARP) accountability of senior management and boards, 22 Anti-Trust Division of Justice and phone market, 17–18 anti-trust powers/legislation, 18 assets weighted by level of risk, 16 banks, keep them small, 17–18 bonds, arbitrage between prices of, 16 capital cushion requirements, 17 capital requirements, increase, 19–20 commercial vs. investment banking activities, 18 conclusion, 22–23 do nothing, 22 financial disclosures, mandatory, 19 Glass-Steagall Act, bring back, 18–19 government intervention vs. free market principles, 17, 21 government support is swiftest, 23 hedge funds, 16, 19, 102, 105, 157–58 highly leveraged firm, 16 Long Term Capital Management, 16 market capitalization, 16 moral hazard encourages inordinate risks, 22 pay limits for officers, 20 n 191 Plan B, 10, 20, 22, 30, 81, 144 policy options, 17–22 proprietary trading by commercial banks, 19 Resolution Authority, 20–22 risk of unknown loss, 21 Sherman Anti-Trust Act, 18 systemic risk, identify, 22 too-big-to-fail concept, 15–17 Volcker, Fed Chairman Paul, 18–19 Volcker Rule, 19 Insurance Core Principles, 140 International Association of Insurance Supervisors (IAIS), 140–41 International Organization of Securities Commissioners (IOSCO), 140 international regulations Asia, regulatory initiatives in, 136 Basel Committee for Banking Supervision (BCBS), 140 Code of Conduct Fundamentals for Credit Rating Agencies, 140 conclusion, 141 EU privacy laws, 137, 141 Europe, stock exchanges in, 135 The European Union, 136–38 Financial Stability Board (FSB), 54, 139– 40, 184–85 FSA’s Handbook of regulations, 138 global markets, interconnectedness of, 134 herd mentality (short-term market movements), 134 Insurance Core Principles, 140 International Association of Insurance Supervisors (IAIS), 140–41 International Organization of Securities Commissioners (IOSCO), 140 international organizations, 139–41 Markets in Financial Instruments Directive (MiFID), 136 overseas regulators, 135–39 privacy laws, 134–35, 137, 141 Prospectus Directive governs filing requirements, 137 regulation, principles based vs. rulesbased, 138–39 SEC and shift toward principles-based regulation, 138 Sunday is the new Monday, 133–35 U.S.

Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

"World Economic Forum" Davos, accounting loophole / creative accounting, Alan Greenspan, Andrei Shleifer, Asian financial crisis, asset-backed security, assortative mating, bank run, barriers to entry, Bear Stearns, behavioural economics, Bernie Madoff, Bretton Woods, business climate, business cycle, carbon tax, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency risk, diversification, Edward Glaeser, financial innovation, fixed income, floating exchange rates, full employment, Glass-Steagall Act, global supply chain, Goldman Sachs: Vampire Squid, Greenspan put, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kaizen: continuous improvement, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, longitudinal study, low interest rates, machine readable, market bubble, Martin Wolf, medical malpractice, microcredit, money market fund, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, Phillips curve, price stability, profit motive, proprietary trading, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Ronald Reagan, Savings and loan crisis, school vouchers, seminal paper, short selling, sovereign wealth fund, tail risk, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

For instance, banks should not attempt to use client assets that are pledged to them in their prime brokerage units (units that lend securities, offer loans, and undertake asset-management functions for clients, typically hedge funds) in further transactions.11 The commingling of client assets with the bank’s own funding activities reduces transparency, increases risk, and was an important reason why many investment banks experienced runs in the current crisis, as clients tried to withdraw their assets before they got entangled in the bank’s bankruptcy. Of course, such a separation would increase a bank’s cost of borrowing, but the benefits here might outweigh the costs. Proprietary trading—in which the bank uses its balance sheet, partly funded by government-insured deposits, to take speculative positions—is another activity that has come in for censure. The reason critics want to ban it is, in my view, wrong, but there is another reason to consider limiting it. Critics argue that proprietary trading is risky. It is hard to see this as an important cause of the crisis: banks did not get into trouble because of large losses made on trading positions.

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Nevertheless, there is another reason for considering ways to limit proprietary trading. Banks that are involved in many businesses obtain an enormous amount of private information from them. This information should be used to help clients, not to trade against them.12 Banks effectively have an unfair informational advantage over the rest of us in trading: they can use inside information, despite the presence of firewalls within a bank that are meant to prevent sensitive client or market information from being shared with traders. This advantage should be reduced by limiting proprietary trading. I say limiting because some legitimate activities, including hedging and market making, could be hard to distinguish from proprietary trading.

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I say limiting because some legitimate activities, including hedging and market making, could be hard to distinguish from proprietary trading. A crude overall limit on a bank’s trading for its own account, no matter what the purpose, is one possibility, but it suffers from the same problems as any crude limit has. Perhaps an initial crude limit, refined over time with experience, as was the case with capital requirements, may be the way to go. The best way to keep institutions from becoming systemically important might not be through crude prohibitions on size or activity but through the collecting and monitoring by regulators of information about interinstitution exposures as well as risk concentrations in the system.

The Bank That Lived a Little: Barclays in the Age of the Very Free Market by Philip Augar

"Friedman doctrine" OR "shareholder theory", activist fund / activist shareholder / activist investor, Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, Bear Stearns, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, Bonfire of the Vanities, bonus culture, book value, break the buck, business logic, call centre, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, family office, financial deregulation, financial innovation, fixed income, foreign exchange controls, Glass-Steagall Act, high net worth, hiring and firing, index card, index fund, interest rate derivative, light touch regulation, loadsamoney, Long Term Capital Management, long term incentive plan, low interest rates, Martin Wolf, money market fund, moral hazard, Nick Leeson, Northern Rock, offshore financial centre, old-boy network, out of africa, prediction markets, proprietary trading, quantitative easing, risk free rate, Ronald Reagan, shareholder value, short selling, Sloane Ranger, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, too big to fail, vertical integration, wikimedia commons, yield curve

Barclays Capital had swung round from a quarter of a billion pounds profit in 1997 into a quarter of a billion pounds loss in 1998, and for several months its chief executive was a chastened man. When they met, Diamond told Middleton he had learned the lessons of the Russian losses. With Taylor, he had made a distinction between using the bank’s own money in proprietary trading, and trading to execute client orders. He had closed proprietary trading straightaway and was committed to building a great business. Taylor had barely trusted Diamond but Middleton took a different line. He had come across plenty of brash Americans in his time but Diamond was different. He decided Diamond owed the bank one and would repay straight dealing with straight dealing.

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Obviously Diamond was financially incentivized to stay at Barclays. A nagging voice inside Taylor warned: ‘Well, he would say that, wouldn’t he?’ It was another existential moment for Barclays and as before the investment bank was the cause of it. In the end Taylor decided to believe Diamond, but emerging markets activity would have to be curtailed, proprietary trading groups disbanded and credit limits cut.3 He told him that it was his responsibility to ensure that people in his division stuck to the rules. One more instance of Barclays Capital breaching its limits or breaking the rules in any other way would be the end of Diamond’s career at Barclays. ‘And probably mine too,’ he thought.

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This was the world of derivatives, the business that was still in its infancy when Camoys founded BZW but that now underpinned Barclays’ profits. Effectively bets on the future movements of stocks, currencies, interest rates, commodities and other assets, derivatives were used to hedge the bank’s own risk, to create complex packages for clients and for proprietary trading. The sums involved were enormous: Barclays’ derivatives based on the future movement of interest rates were, for example, £4 trillion. The real exposure was reduced by offsetting equal and opposite positions but the numbers were so large that any error could be fatal. Ten pages of the accounts were devoted to summarizing the derivatives book, but they were just headings and numbers on the page.

Why Aren't They Shouting?: A Banker’s Tale of Change, Computers and Perpetual Crisis by Kevin Rodgers

Alan Greenspan, algorithmic trading, bank run, banking crisis, Basel III, Bear Stearns, Berlin Wall, Big bang: deregulation of the City of London, bitcoin, Black Monday: stock market crash in 1987, Black-Scholes formula, buy and hold, buy low sell high, call centre, capital asset pricing model, collapse of Lehman Brothers, Credit Default Swap, currency peg, currency risk, diversification, Fall of the Berlin Wall, financial innovation, Financial Instability Hypothesis, fixed income, Flash crash, Francis Fukuyama: the end of history, Glass-Steagall Act, Hyman Minsky, implied volatility, index fund, interest rate derivative, interest rate swap, invisible hand, John Meriwether, latency arbitrage, law of one price, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, Minsky moment, money market fund, Myron Scholes, Northern Rock, Panopticon Jeremy Bentham, Ponzi scheme, prisoner's dilemma, proprietary trading, quantitative easing, race to the bottom, risk tolerance, risk-adjusted returns, Silicon Valley, systems thinking, technology bubble, The Myth of the Rational Market, The Wisdom of Crowds, Tobin tax, too big to fail, value at risk, vertical integration, Y2K, zero-coupon bond, zero-sum game

Maybe we should formally team up with small regional banks in Asia to provide FX prices to their customers? They would provide the sales force and would deal directly with their clients before passing on the risk to Deutsche Bank, which would, in effect, become a wholesaler. Maybe we should increase profitability by doing more proprietary trading? So much flow was passing through the books that, if it were properly analysed, we should be able to glean sufficient clues to enable Deutsche to trade at a profit on its own account. But it was the electronic strategy that won out – partly of course because this was what Hal had planned from the first.

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The introduction of the Troubled Asset Relief Program (TARP) halted the panic by effectively guaranteeing US banks, but the damage had been done. Although it did not need direct support from any government and by so doing joined the ranks of the world’s best-run banks, Deutsche Bank lost €8.5 billion in its trading businesses in 2008 having ‘recorded significant losses in credit trading, equity derivatives, and equities proprietary trading’ despite ‘strong results in more liquid, “flow” trading businesses including foreign exchange, money markets and commodities’.39 The performance of the businesses I was associated with gave me some sense of pride, but it was not a lot of comfort. Deutsche Bank’s stock price, which had been as high as €89.80 earlier in 2008, plummeted to a low of €18.59.40 The scale of the losses was in sharp contrast to the bank’s still reasonable-looking VaR (the loss figure that should only be exceeded one day in a hundred, remember), which averaged €122 million during the year.41 I asked one senior risk manager if his department was still going to calculate VaR despite its obvious and complete failure.

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Ultimately success or failure seems to have come down to managerial competence or plain luck rather than the banks’ business models. Regardless, regulators have made a somewhat half-hearted attempt to mandate more separation of investment and retail banking without resorting to a 21st-century version of Glass–Steagall. Within the Dodd–Frank bill in the US the ‘Volker rule’ bans proprietary trading by deposit-taking banks. In the UK, the Vickers report recommended that banks’ retail activities be ‘ring-fenced’ from any investment banking. Similar proposals are included in the 2012 Liikanen report into EU banking. My own view is that a full separation would be a good thing and that banks should be smaller.

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again by Nicholas Dunbar

Alan Greenspan, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, Black Swan, Black-Scholes formula, bonus culture, book value, break the buck, buy and hold, capital asset pricing model, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, delayed gratification, diversification, Edmond Halley, facts on the ground, fear index, financial innovation, fixed income, George Akerlof, Glass-Steagall Act, Greenspan put, implied volatility, index fund, interest rate derivative, interest rate swap, Isaac Newton, John Meriwether, junk bonds, Kenneth Rogoff, Kickstarter, Long Term Capital Management, margin call, market bubble, money market fund, Myron Scholes, Nick Leeson, Northern Rock, offshore financial centre, Paul Samuelson, price mechanism, proprietary trading, regulatory arbitrage, rent-seeking, Richard Thaler, risk free rate, risk tolerance, risk/return, Ronald Reagan, Salesforce, Savings and loan crisis, seminal paper, shareholder value, short selling, statistical model, subprime mortgage crisis, The Chicago School, Thomas Bayes, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, yield curve, zero-sum game

Over the following twenty-five years, the outside world would catch up with the eggheads in the ivory tower. Finance academics who had clustered around Merton at MIT (and elsewhere) moved to Wall Street. Trained to spot and replicate mispriced options across all financial markets, they became trading superstars. By the time Meriwether left Salomon in 1992, its proprietary trading group was bringing in revenues of over $1 billion a year. He set up his own highly lucrative hedge fund, LTCM, which made $5 billion from 1994 to 1997, earning annual returns of over 40 percent. By April 1998, Merton and Scholes were partners at LTCM and making millions of dollars per year, a nice bump from a professor’s salary.

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They essentially told him, “Get in line, we’re so busy, you’re a trader, not a banker—why don’t you suck up to us?” Usi was enraged; he felt his prized CDO rating was being delayed for petty reasons. If that wasn’t bad enough, he was getting pounded by his boss for not having kept up with the innovations of their competitors. The idea of running the CDO money machine like a proprietary trading desk was being implemented at UBS. “Why are they making all this money?” Diamond railed. “Why can’t you do the same thing? Everyone tells me you’re smart, but maybe you’re not.” Fortunately for Usi, the commercial pressure he was under to close deals was now being felt in the ratings agency world, and a new player was going to give him some game.

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Perhaps by buying some of the structured products Barclays was peddling, LB Kiel could get some instant diversification. The only drawback was that the $15 billion portfolio that Usi managed on Barclays’ behalf was mostly speculative grade, ranging from double- to triple-B in quality. That earned his proprietary trading desk a nice yield of around 2 or 3 percent above government bonds, but it was too risky for the Germans. However, if they could get access to Barclays’ assets but have them “sanctified” with a Fitch investment-grade rating, that would be just right. And so, in the summer of 2000, the LB Kiel board listened to a presentation by Barclays, offering a structured product with a lifetime of thirty years.

The Quants by Scott Patterson

Alan Greenspan, Albert Einstein, AOL-Time Warner, asset allocation, automated trading system, Bear Stearns, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Monday: stock market crash in 1987, Black Swan, Black-Scholes formula, Blythe Masters, Bonfire of the Vanities, book value, Brownian motion, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, Carl Icahn, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Dr. Strangelove, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial engineering, Financial Modelers Manifesto, fixed income, Glass-Steagall Act, global macro, Gordon Gekko, greed is good, Haight Ashbury, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, index fund, invention of the telegraph, invisible hand, Isaac Newton, Jim Simons, job automation, John Meriwether, John Nash: game theory, junk bonds, Kickstarter, law of one price, Long Term Capital Management, Louis Bachelier, low interest rates, mandelbrot fractal, margin call, Mark Spitznagel, merger arbitrage, Michael Milken, military-industrial complex, money market fund, Myron Scholes, NetJets, new economy, offshore financial centre, old-boy network, Paul Lévy, Paul Samuelson, Ponzi scheme, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Robert Mercer, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Savings and loan crisis, Sergey Aleynikov, short selling, short squeeze, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

After five years, he left the seminary to earn a Ph.D. in astrophysics from the University of Pittsburgh. By the early 1970s, Tartaglia found himself working on Wall Street as a retail broker at Merrill Lynch. After Merrill, the peripatetic Tartaglia went to five other firms before landing at Morgan in 1984. He renamed the group he’d taken over Automated Proprietary Trading, or APT, and moved it to a single forty-foot-long room on the nineteenth floor in Morgan’s Exxon Building headquarters in mid-town Manhattan. Tartaglia added more automation to the system, linking the desk to the New York Stock Exchange’s Super Designated Order Turnaround System, or SuperDOT, which facilitated computerized trades.

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PDT’s quants had largely discovered how to implement the strategy on their own, but there’s little question that by the time Midas was up and running, the idea of stat arb was in the air. Doyne Farmer’s Prediction Company was running a stat arb book in Sante Fe, as were D. E. Shaw, Renaissance, and a number of other funds. Over the years, however, few stat arb funds would do nearly as well as PDT, which in time became the most successful proprietary trading desk on Wall Street in terms of consistency, longevity, and profitability. Midas focused on specific industries: oil drillers such as Exxon and Chevron, or airline stocks such as American Airlines and United. If four airline companies were going up and three were going down, Midas would short the stocks going up and buy the stocks going down, exiting the position in a matter of days or even hours.

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The market couldn’t avoid the Truth. Or so he thought. By the early 2000s, the hedge fund industry was poised for a phenomenal run that would radically change the investment landscape around the world. Pension funds and endowments were diving in, and investment banks were expanding their proprietary trading operations such as Global Alpha at Goldman Sachs, PDT at Morgan Stanley, and Boaz Weinstein’s credit-trading shop at Deutsche Bank. Hundreds of billions poured into the gunslinging trading operations that benefited from an age of easy money, globally interconnected markets on the Money Grid, and the complex quantitative strategies that had first been deployed by innovators such as Ed Thorp more than three decades before.

Trading and Exchanges: Market Microstructure for Practitioners by Larry Harris

active measures, Andrei Shleifer, AOL-Time Warner, asset allocation, automated trading system, barriers to entry, Bernie Madoff, Bob Litterman, book value, business cycle, buttonwood tree, buy and hold, compound rate of return, computerized trading, corporate governance, correlation coefficient, data acquisition, diversified portfolio, equity risk premium, fault tolerance, financial engineering, financial innovation, financial intermediation, fixed income, floating exchange rates, High speed trading, index arbitrage, index fund, information asymmetry, information retrieval, information security, interest rate swap, invention of the telegraph, job automation, junk bonds, law of one price, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market clearing, market design, market fragmentation, market friction, market microstructure, money market fund, Myron Scholes, National best bid and offer, Nick Leeson, open economy, passive investing, pattern recognition, payment for order flow, Ponzi scheme, post-materialism, price discovery process, price discrimination, principal–agent problem, profit motive, proprietary trading, race to the bottom, random walk, Reminiscences of a Stock Operator, rent-seeking, risk free rate, risk tolerance, risk-adjusted returns, search costs, selection bias, shareholder value, short selling, short squeeze, Small Order Execution System, speech recognition, statistical arbitrage, statistical model, survivorship bias, the market place, transaction costs, two-sided market, vertical integration, winner-take-all economy, yield curve, zero-coupon bond, zero-sum game

The mission of the organization is “to improve the global trading process by defining, managing, and promoting an open protocol for real-time, electronic communication between industry participants, while complementing industry standards.” ◀ Source: www.fixprotocol.org. * * * 7.2.3 Proprietary Operations The proprietary trading operations of a brokerage firm include all trading activities that the firm conducts for its house account. For pure brokers, these activities primarily include cash management and the borrowing and lending of securities. If the firm also engages in principal trading as a dealer, speculator, or arbitrageur, the proprietary trading operations of the firm include these activities. * * * ▶ Graduated College and Thought You’d Never Have to Take an Exam Again?

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• How do you solve the settlement credit problem when you want to buy a used computer advertised by an individual in an eBay Internet auction? • What is the difference, if any, between proprietary trading and dealing? Should we allow brokers or dealers to sell information about their order flows and their limit order books to proprietary traders? Should we allow dealers to use computers to process this information for their own benefit? • What obligations do brokers have to their clients when they send orders to dealers who have large proprietary trading operations? • Most people obtain advice about investments and about financial planning from brokers. The brokers usually do not charge them specific fees for these services.

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They may arrange their own trades, they may have others arrange trades for them, or they may arrange trades for others. Proprietary traders trade for their own accounts, and brokers arrange trades as agents for their clients. Brokers are also called agency traders, commission traders, or commission merchants. Proprietary traders engage in proprietary trading, and brokers engage in agency trading. Traders have long positions when they own something. Traders with long positions profit when prices rise. They try to buy low and sell high. Traders have short positions when they have sold something that they do not own. Traders with short positions hope that prices will fall so they can repurchase at a lower price.

Getting a Job in Hedge Funds: An Inside Look at How Funds Hire by Adam Zoia, Aaron Finkel

backtesting, barriers to entry, Bear Stearns, collateralized debt obligation, commodity trading advisor, Credit Default Swap, credit default swaps / collateralized debt obligations, deal flow, discounted cash flows, family office, financial engineering, fixed income, global macro, high net worth, interest rate derivative, interest rate swap, Long Term Capital Management, managed futures, merger arbitrage, offshore financial centre, proprietary trading, random walk, Renaissance Technologies, risk-adjusted returns, rolodex, short selling, side project, statistical arbitrage, stock buybacks, stocks for the long run, systematic trading, two and twenty, unpaid internship, value at risk, yield curve, yield management

TRADERS As we’ve stated earlier, one of the misconceptions about hedge funds is that they are all the same—namely, active trading firms that take short-term positions in a variety of securities. Most hedge funds are in fact long-term equity investors, and, while they have in-house traders, they do not have much of a need for day traders who have worked at proprietary trading firms. Those individuals are used to moving in and out c03.indd 26 1/10/08 11:03:19 AM Pre-MBA 27 of positions at a furious pace and making their own decisions. Most hedge funds have portfolio managers and investment professionals who are making those decisions and are therefore not looking for traders to do the investing.

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As you will see in Case Study 6 later in the chapter, the sales and trading programs (be it fixed income or equity) are good training grounds for traders. Equity or debt capital markets also provide exposure to the markets and can be good feeders into a trading position. At a more senior level, traders who have worked on the proprietary trading desks at investment banks would be desirable, as these desks function in a very similar way to hedge funds. Although many traders are content-executing trades, we have seen junior traders groomed into more value-added traders. For the more trading-oriented hedge funds there may be more opportunities for sell-side traders, as they have experience trading based on information flow and momentum.

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Even when I lost money it was a great learning experience and it convinced me that I wanted to trade and manage money. I began to think hard about a change about a year into my program. At the time I was in the equity-linked origination group and knew that I preferred trading to structuring products. I spoke to the proprietary trading desk at my bank, but they couldn’t commit to me so I ventured outside. My first strategy was to contact headhunters. Then I contacted hedge funds directly. In some cases I was able to go on the web sites, find the job postings, and write an e-mail to the head of human resources. I focused on styles that would suit my background—equity, quant, and derivatives.

Dark Towers: Deutsche Bank, Donald Trump, and an Epic Trail of Destruction by David Enrich

"World Economic Forum" Davos, Affordable Care Act / Obamacare, Alan Greenspan, anti-globalists, Asian financial crisis, banking crisis, Bear Stearns, Berlin Wall, buy low sell high, collateralized debt obligation, commoditize, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Donald Trump, East Village, estate planning, Fall of the Berlin Wall, financial innovation, forensic accounting, high net worth, housing crisis, interest rate derivative, interest rate swap, Jeffrey Epstein, junk bonds, London Interbank Offered Rate, low interest rates, Lyft, Mikhail Gorbachev, NetJets, obamacare, offshore financial centre, post-materialism, proprietary trading, Quicken Loans, Ralph Waldo Emerson, Renaissance Technologies, risk tolerance, Robert Mercer, rolodex, SoftBank, sovereign wealth fund, Steve Bannon, too big to fail, transcontinental railway, Vision Fund, yield curve

Bill acknowledged to Edson that he missed Wall Street’s adrenaline, but said he didn’t feel ready to return. Edson, however, let it be known just how much money Bill could expect to make. It was a very large seven-figure number per year, considerably more than he’d been earning at Merrill. Bill soon agreed to take the job. He would be the bank’s co-head of proprietary trading—in other words, of making wagers with the bank’s own money—with a focus on derivatives, reporting to Mitchell. Even after signing on, Broeksmit wasn’t sure the effort to rocket Deutsche to the top of Wall Street would actually work. “I thought it would be an adventure,” he told a colleague years later.

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After all, Rajeev and Anshu had been pals for basically their entire lives—and for that matter, Ackermann was also known for tampering with the smoke detectors. Boaz Weinstein was another of Jain’s anointed. He was a brilliant, intense man—a chess master and poker partner to Warren Buffett—who would be polite or nasty depending on his level of respect for you. Boaz, in his early thirties, had a two-headed role. He was overseeing a proprietary trading group—making bets with the bank’s own money—and also managing relationships with a bunch of clients. Deutsche managers and compliance officers had signed off on the setup, but it was a glaring conflict of interest, the type of arrangement that wouldn’t have been acceptable at more established Wall Street firms and that even at Deutsche provoked considerable grumbling.

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The implication was that Ferron—and others in risk management, accounting, technology, and operations—was inferior to the revenue producers, a marginal employee who only sucked money away from the all-important bottom line. During these flush years, Deutsche executives and traders reveled in their cleverness. They had concocted intricate structures designed to throw off big profits, and the structures were working as intended. Alarm bells didn’t go off when proprietary trading went from representing 5 percent to 17 percent of the investment bank’s profits, or when the amount of money at risk on a daily basis spiked higher. The vorstand certainly didn’t try to rein things in. But this success didn’t reflect the bankers’ genius. Banks at the time were able to borrow virtually unlimited amounts of money from a variety of sources—central banks, depositors, the bond markets—at rock-bottom prices.

Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

Alan Greenspan, Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, bitcoin, Bob Litterman, Bonfire of the Vanities, bonus culture, break the buck, Brexit referendum, Brownian motion, business cycle, business process, butterfly effect, buy and hold, capital asset pricing model, Captain Sullenberger Hudson, carbon tax, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, confounding variable, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, democratizing finance, Diane Coyle, diversification, diversified portfolio, do well by doing good, double helix, easy for humans, difficult for computers, equity risk premium, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Glass-Steagall Act, global macro, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, information security, interest rate derivative, invention of the telegraph, Isaac Newton, it's over 9,000, James Watt: steam engine, Jeff Hawkins, Jim Simons, job satisfaction, John Bogle, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, language acquisition, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, megaproject, merger arbitrage, meta-analysis, Milgram experiment, mirror neurons, money market fund, moral hazard, Myron Scholes, Neil Armstrong, Nick Leeson, old-boy network, One Laptop per Child (OLPC), out of africa, p-value, PalmPilot, paper trading, passive investing, Paul Lévy, Paul Samuelson, Paul Volcker talking about ATMs, Phillips curve, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, proprietary trading, public intellectual, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Solow, Sam Peltzman, Savings and loan crisis, seminal paper, Shai Danziger, short selling, sovereign wealth fund, Stanford marshmallow experiment, Stanford prison experiment, statistical arbitrage, Steven Pinker, stochastic process, stocks for the long run, subprime mortgage crisis, survivorship bias, systematic bias, Thales and the olive presses, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, uptick rule, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

If the hedge fund’s bet goes wrong—maybe the Apricard technology has a flaw that allows hackers to steal millions of credit card numbers—and Apricot suffers a 10 percent loss while BlueBerry benefits from its competitor’s woes and enjoys a 10 percent gain, the hedge fund will lose $6 million, wiping out 60 percent of the fund. The power of leverage and short selling cuts both ways. There are currently over nine thousand hedge funds worldwide, managing more than $2 trillion in assets, and an unknown number of hedge fund–like entities at proprietary trading desks and the like. In fact, the hedge fund industry is more like twenty to thirty cottage industries, each with its own particular specialty. The mix of this industry clearly is adaptive to market conditions: new funds are started to take advantage of emerging opportunities from one strategy, while other funds close down after experiencing losses from another strategy.

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Bamberger’s pairs trading strategy was hugely profitable.20 Two years later, Morgan Stanley moved Bamberger’s successful group into the hands of a longtime trader, Nunzio Tartaglia, a Brooklyn-born former Jesuit seminarian with a Ph.D. in astrophysics. (Bamberger left Morgan Stanley acrimoniously as a result of this replacement.) Under Tartaglia, the group—rechristened Automated Proprietary Trading (APT)—increased its bets, and linked itself directly to the New York Stock Exchange through the early SuperDot electronic trading system, making windfall profits. APT’s secrecy became legendary on Wall Street, adding to its mystique. But perhaps its greatest achievement was in 1986, when it hired a young computer science professor from Columbia University named David E.

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The things they were doing in the APT group seemed like a lot of fun—and the salary was about six times as much as I was making as a professor. Until then, I’d never even thought about working on Wall Street, but I wound up saying yes.” Shaw moved to Morgan Stanley as vice-president for automated proprietary trading technology, or as he describes his role in APT, “the guy who did the technology there.” What interested him most, though, was the idea that quantitative and computational methods could be used to beat the market. He was impressed that APT had found even a single profitable trading strategy.

Stress Test: Reflections on Financial Crises by Timothy F. Geithner

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, Atul Gawande, bank run, banking crisis, Basel III, Bear Stearns, Bernie Madoff, Bernie Sanders, Black Monday: stock market crash in 1987, break the buck, Buckminster Fuller, Carmen Reinhart, central bank independence, collateralized debt obligation, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency risk, David Brooks, Doomsday Book, eurozone crisis, fear index, financial engineering, financial innovation, Flash crash, Goldman Sachs: Vampire Squid, Greenspan put, housing crisis, Hyman Minsky, illegal immigration, implied volatility, Kickstarter, London Interbank Offered Rate, Long Term Capital Management, low interest rates, margin call, market fundamentalism, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, Nate Silver, negative equity, Northern Rock, obamacare, paradox of thrift, pets.com, price stability, profit maximization, proprietary trading, pushing on a string, quantitative easing, race to the bottom, RAND corporation, regulatory arbitrage, reserve currency, Saturday Night Live, Savings and loan crisis, savings glut, selection bias, Sheryl Sandberg, short selling, sovereign wealth fund, stock buybacks, tail risk, The Great Moderation, The Signal and the Noise by Nate Silver, Tobin tax, too big to fail, working poor

He believed that the high-flying investment bank culture, fueled by surreal compensation packages that in some ways rewarded short-term risk-taking, had infected traditional banks that now competed for their business. He sketched out a proprietary trading ban on a single page, and pitched it as a simple way to rein in the speculation that he thought had turned Wall Street into a casino. It would be a partial substitute for the old Glass-Steagall restrictions on banks engaging in nonbanking financial activities, an effort to restore the conservative ethos that Volcker recalled from his days as a commercial banker. Larry and I were skeptical. Proprietary trading by banks played no meaningful role in the crisis. For traditional banks that failed, the main problem was traditional loans, mostly mortgage loans.

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On May 10, for example, Senator Levin and fellow progressive Jeff Merkley of Oregon released an amendment they described as a tougher version of the Volcker Rule, along with a supportive statement from Paul Volcker himself. This proved to be a much shinier object than our version, and it became a new litmus test for the left. And our discomfort with Merkley-Levin’s approach to proprietary trading became the latest evidence that we were soft on Wall Street. Merkley-Levin did broaden the definition of proprietary trading beyond what we had proposed, but we didn’t think it was better or in fact tougher than our approach. Its sweeping restrictions would be offset by all kinds of loopholes, making the amendment vastly more complicated than Volcker’s one-page synopsis and much more difficult to implement.

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President Obama never pushed me to support bad policy for political reasons, but he did ask us to try to avoid gratuitous attacks on Democrats when we fought bad proposals with popular appeal. And he did keep asking me whether we were being tough enough on the major banks. He was particularly interested in a proposal by Paul Volcker to prohibit traditional banks from engaging in “proprietary trading,” from speculating on their own account while enjoying access to cheaper capital as a result of their access to the government safety net. Volcker made the case in multiple meetings that banks shouldn’t be able to behave like hedge funds, taking trading risks that could force the Fed or the FDIC to ride to their rescue if the bets went bad.

Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America by Matt Taibbi

addicted to oil, affirmative action, Affordable Care Act / Obamacare, Alan Greenspan, Bear Stearns, Bernie Sanders, Bretton Woods, buy and hold, carried interest, classic study, clean water, collateralized debt obligation, collective bargaining, computerized trading, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, desegregation, diversification, diversified portfolio, Donald Trump, financial innovation, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Greenspan put, illegal immigration, interest rate swap, laissez-faire capitalism, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, medical malpractice, military-industrial complex, money market fund, moral hazard, mortgage debt, Nixon triggered the end of the Bretton Woods system, obamacare, passive investing, Ponzi scheme, prediction markets, proprietary trading, prudent man rule, quantitative easing, reserve currency, Ronald Reagan, Savings and loan crisis, Sergey Aleynikov, short selling, sovereign wealth fund, too big to fail, trickle-down economics, Y2K, Yom Kippur War

On the very last page of the newsletter, in tiny print, Goldman wrote, under the heading “General Disclosures,” the following: Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions reflected in this research. Our asset management area, our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research. We and our affiliates, officers, directors, and employees, excluding equity and credit analysts, will from time to time have long or short positions in, act as principal in, and buy and sell, the securities or derivatives, if any, referred to in this research.

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Miklos starts hearing that the other party is one of the top five investment banks on Wall Street. And the rumor is that the money behind the deals is “partner money”—that the higher-ups in the Wall Street colossus had caught on to this amazing deal and were buying it all up for themselves, with their personal money, via the firm’s proprietary trading desk. “They started tagging AIG with all of this stuff,” he recalls. “And we got squeezed out.” So here’s the question: why would AIG do this? Andy, though not involved with that deal, has a theory. “The question is, were they stupid—or were they just never intending to pay?” he asks. Before we get to the final part of the story—the part that involves a meeting of the very highest officials in government and heads of the most powerful financial companies in the world colluding on one final, unprecedented, grand-scale heist—we have to back up just a little and talk about another continent of Wall Street scams.

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And here at home, bodies like the CFTC and the Treasury will be slowly, agonizingly making supertechnical decisions on regulatory questions like “Who exactly will be subject to the new Consumer Financial Protection Bureau?” and “What kinds of activities will be covered by the partial ban on proprietary trading?” On these real meat-and-potatoes questions about how to set the rules for modern business, most ordinary people won’t have a voice at all; they won’t even be aware that these decisions are being made. But industry lobbyists are already positioning themselves to have a behind-the-scenes impact on the new rules.

The Big Short: Inside the Doomsday Machine by Michael Lewis

Alan Greenspan, An Inconvenient Truth, Asperger Syndrome, asset-backed security, Bear Stearns, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, facts on the ground, financial engineering, financial innovation, fixed income, forensic accounting, Gordon Gekko, high net worth, housing crisis, illegal immigration, income inequality, index fund, interest rate swap, John Meriwether, junk bonds, London Interbank Offered Rate, Long Term Capital Management, low interest rates, medical residency, Michael Milken, money market fund, moral hazard, mortgage debt, pets.com, Ponzi scheme, Potemkin village, proprietary trading, quantitative trading / quantitative finance, Quicken Loans, risk free rate, Robert Bork, short selling, Silicon Valley, tail risk, the new new thing, too big to fail, value at risk, Vanguard fund, zero-sum game

"* Hubler could make hundreds of millions facilitating the idiocy of Morgan Stanley's customers. He could make billions by using the firm's capital to bet against them. Morgan Stanley management, for its part, always feared that Hubler and his small team of traders might quit and create their own hedge fund. To keep them, they offered Hubler a special deal: his own proprietary trading group, with its own grandiose name: GPCG, or the Global Proprietary Credit Group. In his new arrangement, Hubler would keep for himself some of the profits this group generated. "The idea," says a member of the group, "was for us to go from making one billion dollars a year to two billion dollars a year, right away."

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He was smart enough to be cynical about his market but not smart enough to realize how cynical he needed to be. Inside Morgan Stanley, there was apparently never much question whether the company's elite risk takers should be allowed to buy $16 billion in subprime mortgage bonds. Howie Hubler's proprietary trading group was of course required to supply information about its trades to both upper management and risk management, but the information the traders supplied disguised the nature of their risk. The $16 billion in subprime risk Hubler had taken on showed up in Morgan Stanley's risk reports inside a bucket marked "triple A"--which is to say, they might as well have been U.S.

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Amazingly, it had nothing to do with the wisdom of owning $16 billion in complex securities whose value ultimately turned on the ability of a Las Vegas stripper with five investment properties, or a Mexican strawberry picker with a single $750,000 home, to make rapidly rising interest payments. The dispute was over Morgan Stanley's failure to deliver on its promise to spin Hubler's proprietary trading group off into its own money management firm, of which he would own 50 percent. Outraged by Morgan Stanley's foot-dragging, Howie Hubler threatened to quit. To keep him, Morgan Stanley promised to pay him, and his traders, an even bigger chunk of GPCG's profits. In 2006, Hubler had been paid $25 million; in 2007, it was understood, he would make far more.

High-Frequency Trading by David Easley, Marcos López de Prado, Maureen O'Hara

algorithmic trading, asset allocation, backtesting, Bear Stearns, Brownian motion, capital asset pricing model, computer vision, continuous double auction, dark matter, discrete time, finite state, fixed income, Flash crash, High speed trading, index arbitrage, information asymmetry, interest rate swap, Large Hadron Collider, latency arbitrage, margin call, market design, market fragmentation, market fundamentalism, market microstructure, martingale, National best bid and offer, natural language processing, offshore financial centre, pattern recognition, power law, price discovery process, price discrimination, price stability, proprietary trading, quantitative trading / quantitative finance, random walk, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, Tobin tax, transaction costs, two-sided market, yield curve

Gomber et al suggest criteria that only AT fulfil: agent trading; minimising market impact (for large orders); achievement of a particular benchmark; holding periods of possibly days, weeks or months; working an order through time and across markets. Finally, we list criteria that only HFT satisfy: very high number of orders; rapid order cancellation; proprietary trading; profit from buying and selling; no significant positions at the end of day; very short holding periods; very low margins extracted per trade; low latency requirement; use of co-location/proximity services and individual data feeds; a focus on highly liquid instruments. Indeed, as pointed out by Gomber et al (2011), HFT is not a trading strategy as such.

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In contrast to these studies, the following sections provide anecdotal evidence of the behaviour of computerised traders in times of severe stress in foreign exchange markets: • the JPY carry trade collapse in August 2007; • the May 6, 2010, Flash Crash; • JPY appreciation following the Fukushima disaster; • the Bank of Japan intervention in August 2011 and Swiss National Bank intervention in September 2011. 76 i i i i i i “Easley” — 2013/10/8 — 11:31 — page 77 — #97 i i HIGH-FREQUENCY TRADING IN FX MARKETS While each of these episodes is unique in terms of the specific details and they occurred at different stages of the evolution of highfrequency traders, these events provide valuable insight into how computerised traders behave in periods of large price moves. August 2007 yen appreciation The August 16, 2007, USD/JPY price rise was the result of the unwinding large yen carry-trade positions; many hedge funds and banks with proprietary trading desks had large positions at risk and decided to buy back yen to pay back low-interest loans. Chaboud et al (2012) provide details of this event, and report that the event had one of the highest realised volatilities and the highest absolute value of serial correlation in five-second returns.

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Nanex (2010) reported that quote saturation and NYSE Consolidated Quotation System (CQS) delays, combined with negative news from Greece together with the sale of E-mini S&P 500 futures 77 i i i i i i “Easley” — 2013/10/8 — 11:31 — page 78 — #98 i i HIGH-FREQUENCY TRADING “was the beginning of the freak sell-off which became known as the Flash Crash”. Menkveld and Yueshen (2013) analysed the May 6, 2010, Flash Crash using public and proprietary trade data on E-mini S&P 500 futures and S&P 500 Exchange Traded Fund (ETF) and found that the large mutual fund, whose E-mini trading reportedly contributed to the crash, was relatively inactive during the period of the crash, as its net selling volume was only 4% of the total E-mini net sells. Sharp price movement was also witnessed in the FX market.

Money and Power: How Goldman Sachs Came to Rule the World by William D. Cohan

"Friedman doctrine" OR "shareholder theory", "RICO laws" OR "Racketeer Influenced and Corrupt Organizations", Alan Greenspan, asset-backed security, Bear Stearns, Bernie Madoff, Bob Litterman, book value, business cycle, buttonwood tree, buy and hold, collateralized debt obligation, Cornelius Vanderbilt, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, deal flow, diversified portfolio, do well by doing good, fear of failure, financial engineering, financial innovation, fixed income, Ford paid five dollars a day, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Gordon Gekko, high net worth, hiring and firing, hive mind, Hyman Minsky, interest rate swap, John Meriwether, junk bonds, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, managed futures, margin call, market bubble, mega-rich, merger arbitrage, Michael Milken, moral hazard, mortgage debt, Myron Scholes, paper trading, passive investing, Paul Samuelson, Ponzi scheme, price stability, profit maximization, proprietary trading, risk tolerance, Ronald Reagan, Saturday Night Live, short squeeze, South Sea Bubble, tail risk, time value of money, too big to fail, traveling salesman, two and twenty, value at risk, work culture , yield curve, Yogi Berra, zero-sum game

Not only would having more capital help the firm absorb these outsize trading losses—until they could be stanched—but a group of older Goldman partners were looking to take as much as $150 million of their capital out of the firm and then retire. Then there was Goldman’s evolving business plan, which required more capital to increase Goldman’s principal investments in proprietary trading, private equity, and real estate. Upon hearing Rubin and Friedman’s pitch, the Management Committee—comprising partners nearing the end of their reigns—could see the wisdom of cashing out with an IPO. The consensus on the committee was that the firm should go public sooner rather than later.

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Many members of the committee spoke up in support of the IPO, but everyone paid particular interest when Friedman and Rubin got up together to speak in favor. Weinberg had positioned them, after all, to lead the firm after he retired. They made the case that with even more capital, Goldman could soon be a rival to Salomon Brothers in trading and could also become a leader in proprietary trading (for its own account) as well as in private equity and other forms of principal investing. Then they touched on the issue of partner liability. As a partnership, each of them individually was responsible for absorbing the losses the firm incurred in an amount equal to his entire net worth. This was no small worry, given the recent trading losses and such existential threats as the lawsuits that had hit the firm in the wake of the Penn Central bankruptcy.

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He recalled a moment during Goldman’s 1993 bonanza when one trader went on the internal squawk box and said, “Buy Bunds,” a reference to German federal government bonds. When a broker wanted to know how many Bunds he should be buying, the reply came: “I said buy Bunds. I’ll tell you when to stop.” Another time, Goldman’s chief economist in London, Gavyn Davies, came by the proprietary trading desk to offer his macroeconomic view of the world. One trader cut Davies off and “with his boots up on the desk,” told him, “With all due respect, Gavyn, I do my own research. I was in quite a few bars in Spain last weekend and let me tell you something—they were empty.” He followed this bit of trenchant analysis with another: “I’ve got another rule that I live by: ‘If you can’t drink the water, sell the currency.’ ” Siva-Jothy said he found the Goldman approach “incredibly powerful” and a “wonderful environment in which to work” but also “it was to have its downside as we discovered in 1994.”

All the Devils Are Here by Bethany McLean

Alan Greenspan, Asian financial crisis, asset-backed security, bank run, Bear Stearns, behavioural economics, Black-Scholes formula, Blythe Masters, break the buck, buy and hold, call centre, Carl Icahn, collateralized debt obligation, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, diversification, Dr. Strangelove, Exxon Valdez, fear of failure, financial innovation, fixed income, Glass-Steagall Act, high net worth, Home mortgage interest deduction, interest rate swap, junk bonds, Ken Thompson, laissez-faire capitalism, Long Term Capital Management, low interest rates, margin call, market bubble, market fundamentalism, Maui Hawaii, Michael Milken, money market fund, moral hazard, mortgage debt, Northern Rock, Own Your Own Home, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, race to the bottom, risk/return, Ronald Reagan, Rosa Parks, Savings and loan crisis, shareholder value, short selling, South Sea Bubble, statistical model, stock buybacks, tail risk, Tax Reform Act of 1986, telemarketer, the long tail, too big to fail, value at risk, zero-sum game

Sometimes it bought or shorted mortgage-related securities because it couldn’t get the deal done without committing its own capital. Other times, it did so because it had its own “view” about which way the securities were headed and it was trading for its own account. In any case, the line between client-related trading and proprietary trading was very blurry: if Goldman hedged a position that was a result of facilitating a client trade, did that count as a client trade or a proprietary trade? Goldman’s chief risk officer, Craig Broderick, would later say that “our client base is extremely aware and clear about what function we are performing.” But contemporaneous e-mails—and complaints after the fact—would paint a messier picture.

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One partner described it as a bit of a “sun god phenomenon.” As Blankfein rose, he pushed hard to complete the transformation that had begun under Rubin and had accelerated under Paulson. What this meant, broadly speaking, was that Goldman no longer sat on the sidelines dispensing advice. The new Goldman was at the center of the action. It had a proprietary trading operation and a large private equity business. It used its money to invest alongside clients, to get trades done—and, sometimes, to compete with clients or trade against them. In the trading business, Goldman wasn’t just hedging its risk, but actively seeking to profit for its own account. In other words, instead of trying to avoid conflicts of interest with clients, Goldman embraced them—and made money from them.

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Hedge fund managers and private equity executives alike complained that while they no longer trusted the firm, they did business with Goldman because they had to—the firm was so dominant and so much better at everything than everyone else that you pretty much had no choice. By 2004, trading accounted for 75 percent of Goldman’s profits, while investment banking had shrunk to about 6 percent. Soon there was a widespread cliché: Goldman was just a giant hedge fund that was engaged in proprietary trading and investing for its own account. Goldman always insisted that it had something no hedge fund had: customers. And that was true. As Goldman’s chief financial officer, David Viniar, explained it on a 2003 call, “There is a small percentage of our trading that is purely proprietary and there is a small percentage that is purely customer driven.

No One Would Listen: A True Financial Thriller by Harry Markopolos

Alan Greenspan, backtesting, barriers to entry, Bernie Madoff, buy and hold, call centre, centralized clearinghouse, correlation coefficient, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, family office, financial engineering, financial thriller, fixed income, forensic accounting, high net worth, index card, Long Term Capital Management, Louis Bachelier, low interest rates, Market Wizards by Jack D. Schwager, offshore financial centre, payment for order flow, Ponzi scheme, price mechanism, proprietary trading, quantitative trading / quantitative finance, regulatory arbitrage, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, statistical arbitrage, too big to fail, transaction costs, two and twenty, your tax dollars at work

Similarly, he adds, another firm could duplicate the strategy in an attempt to get similar results, but its returns would likely be unmatched because “you need the physical plant and a large operation” to do it with equal success. However, many Wall Street firms, he says, do use the strategy in their proprietary trading activities, but they don’t devote more capital to such operations because their return on capital is better used in other operations. Setting up a proprietary trading operation strictly for the strategy, or a separate asset management division in order to collect the incentive fees, says Madoff, would conflict with his firm’s primary business of market making. Commissions Suffice “We’re perfectly happy making the commissions” by trading for the funds, he says, which industry observers note also gives the firm the entirely legitimate opportunity to “piggyback” with proprietary trading that is given an advantage by knowing when and where orders are being placed.

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Even though I was busy with a dozen active cases, I dropped everything and started writing just a few thoughts. And then a few more. Eventually I had three pages of questions, more than 80 of them, although, as I wrote, “Gee, I could write questions all night. Somehow I think they’re not going to answer many of these questions in great detail in order to protect their proprietary trading methodology.” The questions covered all of the red flags we’d been waving for so long: If two stocks with a total portfolio weight of 4 percent drop 50 percent due to company-specific risk (say subprime exposure), how are you protected against a 2 percent portfolio loss? What are your total assets under management?

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Commissions Suffice “We’re perfectly happy making the commissions” by trading for the funds, he says, which industry observers note also gives the firm the entirely legitimate opportunity to “piggyback” with proprietary trading that is given an advantage by knowing when and where orders are being placed. Setting up a division to offer funds directly, says Madoff, is not an attractive proposition simply because he and the firm have no desire to get involved in the administration and marketing required for the effort, nor to deal with investors. Many parts of the firm’s operations could be similarly leveraged, he notes, but the firm generally believes in concentrating on its core strengths and not overextending itself.

Stocks for the Long Run 5/E: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies by Jeremy Siegel

Alan Greenspan, AOL-Time Warner, Asian financial crisis, asset allocation, backtesting, banking crisis, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, Black-Scholes formula, book value, break the buck, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, carried interest, central bank independence, cognitive dissonance, compound rate of return, computer age, computerized trading, corporate governance, correlation coefficient, Credit Default Swap, currency risk, Daniel Kahneman / Amos Tversky, Deng Xiaoping, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Financial Instability Hypothesis, fixed income, Flash crash, forward guidance, fundamental attribution error, Glass-Steagall Act, housing crisis, Hyman Minsky, implied volatility, income inequality, index arbitrage, index fund, indoor plumbing, inflation targeting, invention of the printing press, Isaac Newton, it's over 9,000, John Bogle, joint-stock company, London Interbank Offered Rate, Long Term Capital Management, loss aversion, machine readable, market bubble, mental accounting, Minsky moment, Money creation, money market fund, mortgage debt, Myron Scholes, new economy, Northern Rock, oil shock, passive investing, Paul Samuelson, Peter Thiel, Ponzi scheme, prediction markets, price anchoring, price stability, proprietary trading, purchasing power parity, quantitative easing, random walk, Richard Thaler, risk free rate, risk tolerance, risk/return, Robert Gordon, Robert Shiller, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, the payments system, The Wisdom of Crowds, transaction costs, tulip mania, Tyler Cowen, Tyler Cowen: Great Stagnation, uptick rule, Vanguard fund

Such a provision was not in the original bill submitted to Congress but inserted later. Originally the Volcker proposal specifically prohibited a bank or an institution that owns a bank from engaging in proprietary trading that is not at the behest of its clients and from owning or investing in a hedge fund or private equity fund. However, this proposal was later modified to allow up to 3 percent of the capital of banks to go into proprietary trading and exempts hedging operations as well as trading in U.S. Treasury debt. The Volker rule was designed to restore the separation between investment banks and commercial banks that was first mandated by the Glass-Steagall Act of 1933 but was effectively repealed by Congress in 1999 in the Gramm-Leach-Bliley Act.

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The act’s powers range from establishing the fees for debit cards, to setting the regulations of hedge funds, restricting “predatory lending,” addressing compensation of CEOs and other employees, and formulating measures designed to stabilize the economy and financial system. The act comprises 16 titles and requires that regulators create 243 rules, conduct 67 studies, and issue 22 periodic reports.25 The three most important parts of the law that impact the overall economy are (1) the “Volcker rule,” which limits the proprietary trading of commercial banks, (2) Title II, which provides for the liquidation of large financial firms not under the purview of the Federal Deposit Insurance Corporation, and (3) Title XI, which adds responsibilities but also places new restrictions on the Federal Reserve. The Volcker rule was named after Paul Volcker, former chairman of the Federal Reserve and chair of President Obama’s President’s Economic Recovery Advisory Board, who argued that financial stability required that Congress sharply limit the ability of banks to trade for their own accounts.

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Nor would it have applied to the insurance giant AIG, which the Fed chose to save after seeing the turmoil unleashed by the Lehman bankruptcy. Furthermore, banks that obtained loans from the Fed, specifically Citibank and Bank of America, ran into trouble because of bad real estate loans, not proprietary trading. Given this history, it is dubious that the Volcker amendment, had it been in effect in 2007, would have changed the course of the financial crisis. Title II of the Dodd-Frank Act permits the government to dismantle expeditiously financial firms that become a threat to the stability of the financial system in order to minimize the risk of a financial crisis.

Keeping at It: The Quest for Sound Money and Good Government by Paul Volcker, Christine Harper

Alan Greenspan, anti-communist, Ayatollah Khomeini, banking crisis, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, Bretton Woods, business cycle, central bank independence, corporate governance, Credit Default Swap, Donald Trump, fiat currency, financial engineering, financial innovation, fixed income, floating exchange rates, forensic accounting, full employment, Glass-Steagall Act, global reserve currency, income per capita, inflation targeting, liquidationism / Banker’s doctrine / the Treasury view, low interest rates, margin call, money market fund, Nixon shock, oil-for-food scandal, Paul Samuelson, price stability, proprietary trading, quantitative easing, reserve currency, Right to Buy, risk-adjusted returns, Ronald Reagan, Rosa Parks, Savings and loan crisis, secular stagnation, Sharpe ratio, Silicon Valley, special drawing rights, too big to fail, traveling salesman, urban planning

Stephen Thieke, our hard-working project director with both high-level central banking and commercial bank risk-management expertise, succeeded in getting the report published in January 2009, early enough so that it had some influence in shaping financial reform after the crisis. The report’s recommendations included consolidating supervision and regulation of the largest, most complex financial institutions under a single regulator, strong capital standards and risk controls (including on proprietary trading by institutions benefiting from the protection of deposit insurance and access to Federal Reserve financing), and emphasis on the effective oversight of all financial markets. I carried the message into discussions with the new Obama administration, as I will describe in a later chapter. In taking a public position in these and other areas, the G-30, like other self-appointed expert groups, needs to take care that these reports do not lose truly independent stature, free of pleading for the particular interests of its members.

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All too likely, it will be set aside until the next crisis again fully exposes the weaknesses.* Another controversial and well-publicized rule amid the complexities of Dodd-Frank bears my name. It aims to ameliorate some of the conflicts of interest and inappropriate incentives inherent in proprietary trading and the ownership and management of private equity and hedge funds by commercial banks. The mind-bending complexities of the new financial technology combined with the modern practice of incentive payments that reward employees for particular deals practically invites malpractice, whatever the pious institutional statements about the priority placed on client relationships and an ethical culture.

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My view, widely shared, is that it is inappropriate for an institution that benefits from the federal “safety net” (for example, access to Federal Reserve liquidity, FDIC insurance, and less tangible comforts) to engage in risk taking unrelated to the essential banking functions of deposit taking, lending, and serving customers while sharing in operating a safe, efficient, and necessary payments system. For months, my proposal that proprietary trading be banned from commercial banks seemed to attract little attention inside or outside of the Obama administration. In the absence of administration backing, Tony Dowd spent the summer and fall meeting with members of Congress and their staffs, winning some support on the Senate Banking Committee.

Statistical Arbitrage: Algorithmic Trading Insights and Techniques by Andrew Pole

algorithmic trading, Benoit Mandelbrot, constrained optimization, Dava Sobel, deal flow, financial engineering, George Santayana, Long Term Capital Management, Louis Pasteur, low interest rates, mandelbrot fractal, market clearing, market fundamentalism, merger arbitrage, pattern recognition, price discrimination, profit maximization, proprietary trading, quantitative trading / quantitative finance, risk tolerance, Sharpe ratio, statistical arbitrage, statistical model, stochastic volatility, systematic trading, transaction costs

That is difficult and, hence, there is much uncertainty, confusion, and an unavoidable scramble to the conservative ‘‘Statistical arbitrage is dead.’’ How is the Resurrection viewed, I wonder? The competition argument deserves serious attention. Though there are no publicly available figures recording the amount of capital devoted by hedge funds and proprietary trading desks of investment banks to systematic equity trading strategies, it can be deduced from the remarks of clearing brokers; investors; listings in Barron’s, Altvest, and so forth that both the number of funds and the amount of money devoted to the discipline increased greatly before 2000. An immediate counter to this observation as evidence supporting the competition hypothesis is that the increase in assets and number of managers has been taking place for two decades yet only with performance drought is a link to asset-class performance being made.

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—Virgil 10.1 INTRODUCTION invented the pairs trading business two decades ago, H aving Morgan Stanley was at the forefront of the creation of a new business in the early 2000s; a less risky, more sustainable business, which, in a wonderful example of commercial parricide, has systematically destroyed opportunities for old-line pairs trading. Algorithmic trading was born. Huge order flow from institutions and hedge funds, much of which is electronically matched in house, provided multiple opportunities for bounty beyond the expected brokerage fees. Combining the insight and knowledge learned from proprietary trading (beginning with the classic pairs trading business) with analysis of a warehouse of order flow data, Morgan Stanley and other brokers built trading tools that incorporate models for forecasting market impact as a function of order size and time of day, moderated by specific daily trading volume stock by stock.

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With the ability to gauge how much a client would be willing to pay for a fill, and estimates of how long it would take to get the trade at much lower market impact, the many possibilities fairly screamed themselves to researchers, echoing and amplifying the old-line pairs trade screams heard by a previous generation two decades earlier. Arise Black Boxes 185 All of this opportunity offered itself for reaping without requirement of capital commitment. The risk of proprietary trading was eliminated and the ‘‘new’’ business became infinitely scalable. Morgan Stanley has competitors, of course. Algorithmic trading tools have been developed and marketed by Goldman Sachs, Credit Suisse First Boston, Lehman Brothers, Bank of America, and others. 10.2 MODELING EXPECTED TRANSACTION VOLUME AND MARKET IMPACT The place to begin is the data mine.

The Payoff by Jeff Connaughton

Alan Greenspan, algorithmic trading, bank run, banking crisis, Bear Stearns, Bernie Madoff, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cuban missile crisis, desegregation, Flash crash, Glass-Steagall Act, locking in a profit, London Interbank Offered Rate, London Whale, Long Term Capital Management, naked short selling, Neil Kinnock, plutocrats, Ponzi scheme, proprietary trading, risk tolerance, Robert Bork, Savings and loan crisis, short selling, Silicon Valley, TED Talk, too big to fail, two-sided market, uptick rule, young professional

Volcker began, “You know, just about whatever anyone proposes, no matter what it is, the banks will come out and claim that it will restrict credit and harm the economy . . .” He took a long pause while Ted and I leaned in closer to hear what he’d say next. “It’s all bullshit.” Ted and I laughed. We were relieved . . . and emboldened. Volcker outlined his idea for banning banks from engaging in high-risk proprietary trading. After 1999, when Congress repealed Glass-Steagall (the 1933 Depression-era law that separated commercial banks with their federally insured deposits from investment houses), banks with federally insured deposits had started trading for their own accounts, using excessive leverage and making risky bets, implicitly relying on a federal safety net to catch them if they failed.

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I wanted it to read like a long-form essay, because I knew few people would hear it when Ted delivered it to an empty Senate chamber (unless casting a vote, senators are rarely on the Senate floor, usually leaving any speaker to talk solely to the presiding officer and C-SPAN cameras). Finally, Ted and I were comfortable with our magnum opus. And so on March 11, 2010, just a day after he signed onto the Merkley-Levin bill to restrict proprietary trading, Ted delivered his longest speech yet: “Wall Street Reform that Will Prevent the Next Financial Crisis.” It weighed in at 3,391 words (and that’s the shorter version Ted read on the floor; the longer version, at 6,572 words, was placed into the Congressional Record). It was, as Simon put it that morning in a HuffPo “splash” above Ted’s picture, which filled my computer screen, “The Speech for Which We Have All Been Waiting.”

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Bank of America made a huge miscalculation both in buying Countrywide and in acquiring Merrill Lynch (two very different kinds of transactions); and, like Citigroup, it would’ve failed without TARP and direct assistance from the Fed. Glass-Steagall is the inspiration for the Volcker Rule (on proprietary trading), Ted said, and President Obama and presumably the Treasury Department support the Volcker Rule. A cap on non-deposit liabilities, Ted argued, might be a simpler and better approach than the Volcker Rule, which could quickly get complicated. After Geithner left, Ted and I chewed it over further.

Day One Trader: A Liffe Story by John Sussex

algorithmic trading, Boris Johnson, credit crunch, fixed income, John Meriwether, Long Term Capital Management, Neil Kinnock, Nick Leeson, offshore financial centre, proprietary trading, Reminiscences of a Stock Operator, statistical arbitrage

Trading was the only job these dealers knew how to do, despite being illequipped to succeed in the new electronic age. Another £ 10,000 would be deposited with a broker to set up an account, only for the money to vanish a few months later. Some locals would keep coming back to have another go at trading until a savings pot was emptied and they were forced to look for work elsewhere or find a proprietary trading and clearing firm which would sponsor them to trade. These firms would be able to claw the money back from a sponsored trader through fees and commission charges. Some of the ex-Liffe dealers that did become successful day traders are still plying their trade in the City, renting desks at independent dealing firms known as trading arcades.

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Floor brokers at major investment banks who had enjoyed annual salaries of £ 100,000 made the mistake of starting new lives as day traders when the pits closed. A £ 40,000 redundancy payment would be used to set up a trading account at a brokerage firm. These day traders had a good understanding of the fundamentals of the market. Floor brokers would speak at length with dealers from investment funds and bank proprietary trading desks about the ebb and flow of the markets. This gave them an intimate knowledge of the behaviour of various financial instruments and the impact of economic and geopolitical events on dealing at major exchanges. But these dealers were still novices when it came to trading with their own money.

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A top trader at a US investment bank who retired as a multi-millionaire at the age of 37 opened a £ 50,000 trading account with a brokerage firm. He made just £ 3,000 in six months. While he would think nothing of buying 1,000 lots of futures contracts in his previous incarnation at the US investment bank’s proprietary trading desk even he found himself unable to pull the trigger. This was what separated bank traders from the best locals who would be unflinching in their conviction of where the market was heading and risk large sums of their own money to back up their belief. The ex-Liffe workers that failed as professional traders often ended up looking for work outside the industry.

Investment: A History by Norton Reamer, Jesse Downing

activist fund / activist shareholder / activist investor, Alan Greenspan, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, book value, break the buck, Brownian motion, business cycle, buttonwood tree, buy and hold, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, Cornelius Vanderbilt, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, dogs of the Dow, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, flying shuttle, Glass-Steagall Act, Gordon Gekko, Henri Poincaré, Henry Singleton, high net worth, impact investing, index fund, information asymmetry, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, John Bogle, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, managed futures, margin call, means of production, Menlo Park, merger arbitrage, Michael Milken, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Network effects, new economy, Nick Leeson, Own Your Own Home, Paul Samuelson, pension reform, Performance of Mutual Funds in the Period, Ponzi scheme, Post-Keynesian economics, price mechanism, principal–agent problem, profit maximization, proprietary trading, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Sand Hill Road, Savings and loan crisis, seminal paper, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, survivorship bias, tail risk, technology bubble, Teledyne, The Wealth of Nations by Adam Smith, time value of money, tontine, too big to fail, transaction costs, two and twenty, underbanked, Vanguard fund, working poor, yield curve

It is not that speculation should be banned in the financial markets more generally, of course, but that the speculation should be the domain of individuals, hedge funds, private equity firms, and other investors that can experience losses without inducing the seizure of the credit markets. The rule’s implementation took two years to clarify in the face of stark opposition. After all, proprietary trading is generally a profitable business for many investment banks. It is profitable, of course, until it is not. The original idea of the rule was threatened for some time, and Paul Volcker himself has stated, “I’d write a much simpler bill. I’d love to see a four-page bill that bans proprietary trading and makes the board and chief executive responsible for compliance.” The final version, by contrast, was some 900 pages.49 222 Investment: A History The difficulty in designing the optimal legislation for financial regulation is that crisis is what prompts the appetite for change.

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Simon Johnson, former chief economist at the IMF, makes the point that the experience of many banks in the crisis was, in fact, an issue of solvency but that many hoped that asset prices would rise again to reverse the issue.47 As such, regulators will be forced to think through the question of solvency based on liquidation value as well as potentially transitory insolvency for banks that have slightly negative equity but have a chance of becoming positive in an improved fiscal environment. One of the most promising ways of providing more stability to the banking system was the Volcker Rule, named after Paul Volcker, a previous chairman of the Federal Reserve. The goal of the original rule was to minimize or eliminate proprietary trading, or the trading of financial instruments with the firm’s own capital.48 It is a sound proposal, given that banking, in its most successful form, should be a rather mundane business. It should involve simple maturity transformation from short-dated depositors to longer-dated borrowers with sound asset coverage, the establishment of the appropriate collateral and covenants, and a close monitoring of borrower creditworthiness.

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This human frailty does not seem to have changed, and the tendency for the system to become more permissive over periods of prosperity has not changed either. This proclivity shows in both legislation and regulation, with rules often pared back as the boom is underway. Given both of these facts, the Dodd-Frank Act may be progress, but more could have been done to limit proprietary trading, enhance the accountability of top corporate officers, and design even tighter oversight controls. After all, we may not have another chance until the depths of the next crisis. And indeed, in the end only time will tell how successful this legislation is in enhancing the stability of the system.

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

"World Economic Forum" Davos, AI winter, Alan Greenspan, algorithmic trading, AOL-Time Warner, Apollo 11, asset allocation, banking crisis, barriers to entry, Bear Stearns, Big bang: deregulation of the City of London, Bob Litterman, book value, business cycle, butter production in bangladesh, butterfly effect, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, Charles Babbage, citizen journalism, collateralized debt obligation, Cornelius Vanderbilt, corporate governance, Craig Reynolds: boids flock, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, electricity market, Emanuel Derman, en.wikipedia.org, experimental economics, fake news, financial engineering, financial innovation, fixed income, Ford Model T, Gordon Gekko, Hans Moravec, Herman Kahn, implied volatility, index arbitrage, index fund, information retrieval, intangible asset, Internet Archive, Ivan Sutherland, Jim Simons, John Bogle, John Nash: game theory, Kenneth Arrow, load shedding, Long Term Capital Management, machine readable, machine translation, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, Metcalfe’s law, military-industrial complex, moral hazard, mutually assured destruction, Myron Scholes, natural language processing, negative equity, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Reminiscences of a Stock Operator, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Metcalfe, Ronald Reagan, Rubik’s Cube, Savings and loan crisis, semantic web, Sharpe ratio, short selling, short squeeze, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, stock buybacks, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, tontine, too big to fail, transaction costs, Turing machine, two and twenty, Upton Sinclair, value at risk, value engineering, Vernor Vinge, Wayback Machine, yield curve, Yogi Berra, your tax dollars at work

The Defense Advanced Research Projects Agency (DARPA) paid for the development of the Internet, which was called the ARPANET in the early days. Many additional millions have gone into programs with names like “Machine Understanding and Classification” and “Text Retrieval and Categorization.” A great deal of this research has now found its way into tools and products for mining the deep Web. Advanced proprietary trading firms have added these techniques to the sophisticated quantitative analytics in their technological arsenals. 1.1 1.2 1.4 1.5 1.7 1.8 2.0 2.3 2.6 33.0 Average Board Member Concentration as of April 2003 Figure 2.15 Cumulative Abnormal Return (CAR) Over 2002. Board member concentration deciles and return relative to S&P 1500 index, 2002.

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Under the 2-and-20 plan the firm would get to keep 20 percent of that, another $5 million on top of the $2 million in asset-based fees. The client keeps $18 million, substantially more than the meager few percent the client would have gotten in Treasuries. A $100 million portfolio is small as hedge funds go. It costs money to do the research or proprietary trading to produce that 25 percent alpha, so by the time all the bills are paid, that $7 million the manager takes is seriously pared down. But when the fund gets larger, the economies of scale kick in in a major way. Investment strategies don’t scale to the sky, but it is (approximately) true that the cost to run a $1 billion portfolio is not that much more than for $100 million.

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Traders can watch the same portfolio in any number of ways, watch multiple portfolios in the same way, or run completely unrelated strategies simultaneously. This paradigm has proven to be a good fit for a wide set of real investment and trading applications. It is used for market surveillance, market making, options trading, equity transaction cost control, and proprietary trading. Integration with Real-Time Feeds and Historical Databases Trading analytics often involve many measurements made over many days. An example is a measurement of past volatility over 100 trading days as an input to an option valuation function. Without access to historical data, filling up this analytic would take 100 days, which is clearly unacceptable.

The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja, Myron Scholes, Mohamed El-Erian

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Alan Greenspan, Asian financial crisis, asset allocation, asset-backed security, backtesting, Bear Stearns, Bernie Madoff, book value, Bretton Woods, business process, call centre, Carl Icahn, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, en.wikipedia.org, family office, financial engineering, fixed income, global macro, high net worth, high-speed rail, impact investing, interest rate derivative, Isaac Newton, Jim Simons, junk bonds, Long Term Capital Management, managed futures, Marc Andreessen, Mark Zuckerberg, merger arbitrage, Michael Milken, Myron Scholes, NetJets, oil shock, pattern recognition, Pershing Square Capital Management, Ponzi scheme, proprietary trading, quantitative easing, quantitative trading / quantitative finance, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, Savings and loan crisis, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, stock buybacks, systematic bias, systematic trading, tail risk, two and twenty, zero-sum game

He realized that financial institutions, in earning their way out of the mess they were in, would have to look forward to the future cash-generating ability of the institutions—thus cleaning up their balance sheets by getting rid of toxic assets and drastically slashing the size of risky businesses, like proprietary trading arms, essentially internal “hedge funds,” and credit restructuring divisions. A lifetime of recognizing patterns also paid off as Loeb realized that the much-discussed Citi trade at the end of February represented a kind of “blueprint” for the banks to solve their capital inadequacies with implicit Treasury permission.

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Though he wasn’t exactly shot at during the financial crisis of 2008, he was at the vortex of the conflict. Then 35 years old and the youngest managing director in the history of Deutsche Bank, Weinstein helped manage the bank’s affairs at that perilous time, when banks were suffering significant losses. Weinstein was also running a proprietary trading group within Deutsche called Saba, which itself was hit with losses of $1.8 billion, or 18 percent, on capital of $10 billion, a sudden turn of events after 10 profitable years. Moreover, Weinstein had long championed credit default swaps (CDSs), the still poorly understood instruments that were widely blamed for accelerating the collapse.

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Highly reluctant to lose Weinstein, they gave him wider authority and responsibility within the bank. By 2006, Weinstein was running junk bonds, corporate bonds, convertible bonds, and credit derivatives globally. At the same time, Deutsche encouraged his entrepreneurial ambitions within the bank structure, and in a significant concession, allowed him to brand his proprietary trading group, to facilitate an eventual lift-out from the bank. And why not? Weinstein’s earnings were certainly extraordinary. In 2006 the proprietary unit alone was managing $3 billion and earned $900 million for the bank. The following year, it managed $5 billion, and earned $600 million for the bank.

Automate This: How Algorithms Came to Rule Our World by Christopher Steiner

23andMe, Ada Lovelace, airport security, Al Roth, algorithmic trading, Apollo 13, backtesting, Bear Stearns, big-box store, Black Monday: stock market crash in 1987, Black-Scholes formula, call centre, Charles Babbage, cloud computing, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, Donald Trump, Douglas Hofstadter, dumpster diving, financial engineering, Flash crash, G4S, Gödel, Escher, Bach, Hacker News, High speed trading, Howard Rheingold, index fund, Isaac Newton, Jim Simons, John Markoff, John Maynard Keynes: technological unemployment, knowledge economy, late fees, machine translation, Marc Andreessen, Mark Zuckerberg, market bubble, Max Levchin, medical residency, money market fund, Myron Scholes, Narrative Science, PageRank, pattern recognition, Paul Graham, Pierre-Simon Laplace, prediction markets, proprietary trading, quantitative hedge fund, Renaissance Technologies, ride hailing / ride sharing, risk tolerance, Robert Mercer, Sergey Aleynikov, side project, Silicon Valley, Skype, speech recognition, Spread Networks laid a new fibre optics cable between New York and Chicago, transaction costs, upwardly mobile, Watson beat the top human players on Jeopardy!, Y Combinator

Spivey and Barksdale had them drilling, digging, and dredging through all manner of terrain and materials: mountain schist, valley shale, earthy mud, and Pennsylvania granite. Exasperated with the pace, Spivey and Barksdale kept an ear to the ground for rivals who could usurp them. They feared that one of the large proprietary trading houses would find out about their dig and pull the trick off first. Even though the project’s scope was huge, expensive, and almost unfathomable for a trading firm, players like Chicago’s Getco had the cash and would gladly have paid to gain the advantage. Spread’s fears diminished as their crews became better in difficult terrain and the project’s velocity increased without a competitor emerging.

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Conway had run right up against the Wall Street quant machine. 8 WALL STREET VERSUS SILICON VALLEY A COLLECTION OF EVENTS, ALL coalescing right around 2001, led to the fattening of trading houses’ income statements and the pools of adroit programmers they kept on staff. The expansion of the financial sector beginning in this period was unprecedented and fueled by two things: the booming housing sector (which Wall Street helped create) and the rise of algorithmic proprietary trading. In 2000, bots accounted for less than 10 percent of all trading on U.S. stock markets. Big Wall Street players knew well of their existence, but the algorithms back then weren’t moving the market. The thought of them co-opting the entire works and sparking an event like that of the Flash Crash was inconceivable.

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., 140, 165 Nobel Prize, 23, 106 North Carolina, 48, 204 Northwestern University, 145, 186 Kellogg School of Management at, 10 Novak, Ben, 77–79, 83, 85, 86 NSA, 137 NuclearPhynance, 124 nuclear power, 139 nuclear weapons, in Iran, 137, 138–39 number theory, 65 numerals: Arabic-Indian, 56 Roman, 56 NYSE composite index, 40, 41 Oakland Athletics, 141 Obama, Barack, 46, 218–19 Occupy Wall Street, 210 O’Connor & Associates, 40, 46 OEX, see S&P 100 index Ohio, 91 oil prices, 54 OkCupid, 144–45 Olivetti home computers, 27 opera, 92, 93, 95 Operation Match, 144 opinions-driven people, 173, 174, 175 OptionMonster, 119 option prices, probability and statistics in, 27 options: Black-Scholes formula and, 23 call, 21–22 commodities, 22 definition of, 21 pricing of, 22 put, 22 options contracts, 30 options trading, 36 algorithms in, 22–23, 24, 114–15 Oregon, University of, 96–97 organ donor networks: algorithms in, 149–51, 152, 214 game theory in, 147–49 oscilloscopes, 32 Outkast, 102 outliers, 63 musical, 102 outputs, algorithmic, 54 Pacific Exchange, 40 Page, Larry, 213 PageRank, 213–14 pairs matching, 148–51 pairs trading, 31 Pakistan, 191 Pandora, 6–7, 83 Papanikolaou, Georgios, 153 Pap tests, 152, 153–54 Parham, Peter, 161 Paris, 56, 59, 121 Paris Stock Exchange, 122 Parse.ly, 201 partial differential equations, 23 Pascal, Blaise, 59, 66–67 pathologists, 153 patient data, real-time, 158–59 patterns, in music, 89, 93, 96 Patterson, Nick, 160–61 PayPal, 188 PCs, Quotron data for, 33, 37, 39 pecking orders, social, 212–14 Pennsylvania, 115, 116 Pennsylvania, University of, 49 pension funds, 202 Pentagon, 168 Perfectmatch.com, 144 Perry, Katy, 89 Persia, 54 Peru, 91 Peterffy, Thomas: ambitions of, 27 on AMEX, 28–38 automated trading by, 41–42, 47–48, 113, 116 background and early career of, 18–20 Correlator algorithm of, 42–45 early handheld computers developed by, 36–39, 41, 44–45 earnings of, 17, 37, 46, 48, 51 fear that algorithms have gone too far by, 51 hackers hired by, 24–27 independence retained by, 46–47 on index funds, 41–46 at Interactive Brokers, 47–48 as market maker, 31, 35–36, 38, 51 at Mocatta, 20–28, 31 Nasdaq and, 11–18, 32, 42, 47–48, 185 new technology innovated by, 15–16 options trading algorithm of, 22–23, 24 as outsider, 31–32 profit guidelines of, 29 as programmer, 12, 15–16, 17, 20–21, 26–27, 38, 48, 62 Quotron hack of, 32–35 stock options algorithm as goal of, 27 Timber Hill trading operation of, see Timber Hill traders eliminated by, 12–18 trading floor methods of, 28–34 trading instincts of, 18, 26 World Trade Center offices of, 11, 39, 42, 43, 44 Petty, Tom, 84 pharmaceutical companies, 146, 155, 186 pharmacists, automation and, 154–56 Philips, 159 philosophy, Leibniz on, 57 phone lines: cross-country, 41 dedicated, 39, 42 phones, cell, 124–25 phosphate levels, 162 Physicians’ Desk Reference (PDR), 146 physicists, 62, 157 algorithms and, 6 on Wall Street, 14, 37, 119, 185, 190, 207 pianos, 108–9 Pincus, Mark, 206 Pisa, 56 pitch, 82, 93, 106 Pittsburgh International Airport, security algorithm at, 136 Pittsburgh Pirates, 141 Pius II, Pope, 69 Plimpton, George, 141–42 pneumonia, 158 poetry, composed by algorithm, 100–101 poker, 127–28 algorithms for, 129–35, 147, 150 Poland, 69, 91 Polyphonic HMI, 77–79, 82–83, 85 predictive algorithms, 54, 61, 62–65 prescriptions, mistakes with, 151, 155–56 present value, of future money streams, 57 pressure, thriving under, 169–70 prime numbers, general distribution pattern of, 65 probability theory, 66–68 in option prices, 27 problem solving, cooperative, 145 Procter & Gamble, 3 programmers: Cope as, 92–93 at eLoyalty, 182–83 Peterffy as, 12, 15–16, 17, 20–21, 26–27, 38, 48, 62 on Wall Street, 13, 14, 24, 46, 47, 53, 188, 191, 203, 207 programming, 188 education for, 218–20 learning, 9–10 simple algorithms in, 54 Progress Energy, 48 Project TACT (Technical Automated Compatibility Testing), 144 proprietary code, 190 proprietary trading, algorithmic, 184 Prussia, 69, 121 PSE, 40 pseudocholinesterase deficiency, 160 psychiatry, 163, 171 psychology, 178 Pu, Yihao, 190 Pulitzer Prize, 97 Purdue University, 170, 172 put options, 22, 43–45 Pythagorean algorithm, 64 quadratic equations, 63, 65 quants (quantitative analysts), 6, 46, 124, 133, 198, 200, 202–3, 204, 205 Leibniz as, 60 Wall Street’s monopoly on, 183, 190, 191, 192 Queen’s College, 72 quizzes, and OkCupid’s algorithms, 145 Quotron machine, 32–35, 37 Rachmaninoff, Sergei, 91, 96 Radiohead, 86 radiologists, 154 radio transmitters, in trading, 39, 41 railroad rights-of-way, 115–17 reactions-based people, 173–74, 195 ReadyForZero, 207 real estate, 192 on Redfin, 207 recruitment, of math and engineering students, 24 Redfin, 192, 206–7, 210 reflections-driven people, 173, 174, 182 refraction, indexes of, 15 regression analysis, 62 Relativity Technologies, 189 Renaissance Technologies, 160, 179–80, 207–8 Medallion Fund of, 207–8 retirement, 50, 214 Reuter, Paul Julius, 122 Rhode Island hold ‘em poker, 131 rhythms, 82, 86, 87, 89 Richmond, Va., 95 Richmond Times-Dispatch, 95 rickets, 162 ride sharing, algorithm for, 130 riffs, 86 Riker, William H., 136 Ritchie, Joe, 40, 46 Rochester, N.Y., 154 Rolling Stones, 86 Rondo, Rajon, 143 Ross, Robert, 143–44 Roth, Al, 147–49 Rothschild, Nathan, 121–22 Royal Society, London, 59 RSB40, 143 runners, 39, 122 Russia, 69, 193 intelligence of, 136 Russian debt default of 1998, 64 Rutgers University, 144 Ryan, Lee, 79 Saint Petersburg Academy of Sciences, 69 Sam Goody, 83 Sandberg, Martin (Max Martin), 88–89 Sandholm, Tuomas: organ donor matching algorithm of, 147–51 poker algorithm of, 128–33, 147, 150 S&P 100 index, 40–41 S&P 500 index, 40–41, 51, 114–15, 218 Santa Cruz, Calif., 90, 95, 99 satellites, 60 Savage Beast, 83 Saverin, Eduardo, 199 Scholes, Myron, 23, 62, 105–6 schools, matching algorithm for, 147–48 Schubert, Franz, 98 Schwartz, Pepper, 144 science, education in, 139–40, 218–20 scientists, on Wall Street, 46, 186 Scott, Riley, 9 scripts, algorithms for writing, 76 Seattle, Wash., 192, 207 securities, 113, 114–15 mortgage-backed, 203 options on, 21 Securities and Exchange Commission (SEC), 185 semiconductors, 60, 186 sentence structure, 62 Sequoia Capital, 158 Seven Bridges of Königsberg, 69, 111 Shannon, Claude, 73–74 Shuruppak, 55 Silicon Valley, 53, 81, 90, 116, 188, 189, 215 hackers in, 8 resurgence of, 198–211, 216 Y Combinator program in, 9, 207 silver, 27 Simons, James, 179–80, 208, 219 Simpson, O.

Young Money: Inside the Hidden World of Wall Street's Post-Crash Recruits by Kevin Roose

activist fund / activist shareholder / activist investor, Basel III, Bear Stearns, Carl Icahn, cognitive dissonance, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, deal flow, discounted cash flows, Donald Trump, East Village, eat what you kill, eurozone crisis, financial engineering, fixed income, forward guidance, glass ceiling, Goldman Sachs: Vampire Squid, hedonic treadmill, information security, Jane Street, jitney, junk bonds, Kevin Roose, knowledge worker, Michael Milken, new economy, Occupy movement, off-the-grid, plutocrats, proprietary trading, Robert Shiller, selection bias, shareholder value, side project, Silicon Valley, Skype, Steve Jobs, tail risk, The Predators' Ball, too big to fail, two and twenty, urban planning, We are the 99%, work culture , young professional

A group called Goldman Sachs Principal Strategies had popped up to focus on proprietary trading, but there had been others, including prop-focused commodities and mortgage traders, and an elite team of investors known throughout the bank as SSG—the Special Situations Group. Jeremy had heard these groups spoken of in reverent tones, but he had also heard that they were on the way out of vogue. The Volcker Rule (named after former Federal Reserve chairman Paul Volcker), a much-heralded piece of the Dodd-Frank financial reform act that cracked down on proprietary trading, was moving toward implementation, and the days of glory for prop desks all across Wall Street seemed numbered.

…

Banks were still taking on huge, leveraged positions in opaque and little-regulated markets. The junk bond market, which deals in high-yield corporate debt that is often issued by volatile and risky companies, was having its strongest year since the crisis. And although the Dodd-Frank act had effectively shut down the most obvious forms of proprietary trading at Wall Street firms, that work lived on under the guise of “market-making” trading desks, which were often functionally similar to their predecessors. Three years after Lehman Brothers, it was still far better to be the guy pushing the button on a billion-dollar trade than the guy hovering just behind him, warning about what could go wrong.

Trading at the Speed of Light: How Ultrafast Algorithms Are Transforming Financial Markets by Donald MacKenzie

algorithmic trading, automated trading system, banking crisis, barriers to entry, bitcoin, blockchain, Bonfire of the Vanities, Bretton Woods, Cambridge Analytica, centralized clearinghouse, Claude Shannon: information theory, coronavirus, COVID-19, cryptocurrency, disintermediation, diversification, en.wikipedia.org, Ethereum, ethereum blockchain, family office, financial intermediation, fixed income, Flash crash, Google Earth, Hacker Ethic, Hibernia Atlantic: Project Express, interest rate derivative, interest rate swap, inventory management, Jim Simons, level 1 cache, light touch regulation, linked data, lockdown, low earth orbit, machine readable, market design, market microstructure, Martin Wolf, proprietary trading, Renaissance Technologies, Satoshi Nakamoto, Small Order Execution System, Spread Networks laid a new fibre optics cable between New York and Chicago, statistical arbitrage, statistical model, Steven Levy, The Great Moderation, transaction costs, UUNET, zero-sum game

The practice emerged before the name did; as far as I can tell, the term first came into use at the Chicago hedge fund Citadel in the early 2000s. HFT is “proprietary” automated trading that takes place at speeds far faster than an unaided human can trade and in which trading’s profitability is inherently dependent on its speed.4 (The goal of proprietary trading is direct trading profit, rather than, for example, earning fees by executing trades on behalf of others.) Although the human beings employed by HFT firms to design and supervise trading algorithms often refer to themselves as traders, the trading itself is actually done by those computer algorithms.

…

Banks are still engaged in market-making in some classes of financial instrument (such as those discussed in chapter 4: foreign exchange and governments’ sovereign bonds), albeit often using systems that are slow by HFT standards, but large-scale use of other HFT strategies by banks was effectively ended by the curbs on banks’ proprietary trading that followed the 2008 banking crisis. The HFT firms I have visited differ widely. Some had offices in unremarkable or even scruffy buildings; others had spectacular views over Lake Michigan, Manhattan, or Greater London. The décor is generally bland, although as I sat waiting for an interviewee in one HFT firm’s new offices, some of the owner’s art collection was ready to be hung.

…

He praised “market-makers formerly known as prop[rietary] traders or high-frequency traders,” arguing that “trading on a trading venue is only possible because of market-makers,” and launching a thinly veiled attack on his French counterparts, who, coming from a country whose big banks are still active in trading but which does not have HFT firms like those in the Netherlands, were seeking to impose bank-style capital requirements on proprietary trading firms. Just the previous day, however, I had sat in a café with an experienced Amsterdam trader, interviewee CS, who had told me how arbitrage (which involves exploiting fleeting price discrepancies by buying and selling as close as possible to simultaneously, and thus typically involves “taking”) was interwoven with market-making, both in what he individually did and in the wider trading of the city’s HFT firms.

Unknown Market Wizards by Jack D. Schwager

3D printing, algorithmic trading, automated trading system, backtesting, barriers to entry, Black Monday: stock market crash in 1987, Brexit referendum, buy and hold, commodity trading advisor, computerized trading, COVID-19, cryptocurrency, diversification, Donald Trump, eurozone crisis, family office, financial deregulation, fixed income, forward guidance, index fund, Jim Simons, litecoin, Long Term Capital Management, margin call, market bubble, Market Wizards by Jack D. Schwager, Nick Leeson, performance metric, placebo effect, proprietary trading, quantitative easing, Reminiscences of a Stock Operator, risk tolerance, risk-adjusted returns, Sharpe ratio, short squeeze, side project, systematic trading, tail risk, transaction costs

What did you do then? At that point, I thought I might as well try to apply for as many trading positions as I could anyway. I felt if I could just get an interview, then maybe I could sell myself. I applied to about 30 different places, mostly banks, but also proprietary trading firms. I was rejected by all of them except for one proprietary trading firm that gave me an interview. Tell me about that interview. I was interviewed by the risk manager who had been a floor trader before he decided to switch from trading to management. I had just finished my final exams, and it was the only interview I had.

…

I bet 10%–15% of my account on long Swiss franc and Deutsche mark positions, and it turned into a giant profit instead of killing me. I can’t take credit for any of that. None of that is due to my own intelligence or abilities. None of that is due to who I am. That’s cosmic sovereignty. How did you get to manage money for Commodities Corporation? [Commodities Corporation was a proprietary trading firm in Princeton, New Jersey. The firm gained legendary status because some of the traders it seeded would go on to become among the world’s best traders, probably first and foremost being Michael Marcus and Bruce Kovner who were featured in the original Market Wizards book.4] I don’t recall how it started, but they reached out to me.

…

I appreciate the platform more than any other client. Do you get paid for being a consultant? I get a free subscription to TickerTags, which is a very expensive platform. The subscriptions are only available to hedge funds and banks. Aren’t you concerned that having this tool available to hedge funds and proprietary trading operations will compromise its effectiveness? No, because I think it will be a very long time before hedge funds are going to have the confidence in this tool that I have. In fact, while we were developing TickerTags, I would often share my trade ideas with hedge funds. Did you share the ideas after you put on the trades?

Bernie Madoff, the Wizard of Lies: Inside the Infamous $65 Billion Swindle by Diana B. Henriques

accounting loophole / creative accounting, airport security, Albert Einstein, AOL-Time Warner, banking crisis, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, break the buck, British Empire, buy and hold, centralized clearinghouse, collapse of Lehman Brothers, computerized trading, corporate raider, diversified portfolio, Donald Trump, dumpster diving, Edward Thorp, financial deregulation, financial engineering, financial thriller, fixed income, forensic accounting, Gordon Gekko, index fund, locking in a profit, low interest rates, mail merge, merger arbitrage, messenger bag, money market fund, payment for order flow, plutocrats, Ponzi scheme, Potemkin village, proprietary trading, random walk, Renaissance Technologies, riskless arbitrage, Ronald Reagan, Savings and loan crisis, short selling, short squeeze, Small Order Execution System, source of truth, sovereign wealth fund, too big to fail, transaction costs, traveling salesman

The “investment earnings” credited to their accounts might actually just be “compensation for the use of their money,” he suggested in a note to Ivy’s founders in May 1997. In short, Madoff might be lying about how he was making money for his investors—paying them a share of his firm’s legitimate proprietary trading profits, rather than investing in his arcane hedged strategy—but at least he was actually making money for them, the Ivy executive evidently surmised. This thesis—that Madoff’s investors were actually lenders who were unwittingly financing his own trading activity and getting paid for it with some of his firm’s profits—gained substance two years later when the Ivy executive talked with a prominent hedge fund manager, who was not identified in court records.

…

But the price of that bailout was that the border between Madoff’s fraud and his legitimate Wall Street business—his greatest pride, the lifelong occupation of his brother and sons—was blurred beyond repair. While the Ponzi scheme was nearly out of money, the Madoff brokerage firm wasn’t. Its bank accounts were healthy, its credit was good, and its business looked strong, at least from the outside. Indeed, under the direction of Madoff’s sons, the firm’s proprietary trading desk was generating profits for the firm and consistently outperforming the overall market. And it still handled an impressive share of the market’s trading volume. So, as a stopgap measure, Madoff moved some of his legitimate firm’s money into his Ponzi scheme’s bank account on November 3, 2005, to cover its outstanding cheques.

…

But he did attend the benefit and, at some point during the evening, approached Hofstra’s president and chatted about pledging $1 million to the school. Madoff’s family also enjoyed the surging wealth, of course; why wouldn’t they expect to share in Bernie’s obvious success? Peter Madoff and Madoff’s sons may have known that the market-making business was down to tissue-thin profit margins. The proprietary trading desk’s profits were good but fluctuated with the markets. But, increasingly, those sources of revenue were dwarfed by the money supposedly being generated by Madoff’s hedge fund business. As they all knew, this was true at many Wall Street firms these days. For years, as Madoff’s hedge fund business had grown, the firm had supported the family’s lifestyle in an ever-grander fashion.

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

activist fund / activist shareholder / activist investor, Alan Greenspan, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, Black-Scholes formula, book value, Brownian motion, business cycle, buy and hold, buy low sell high, buy the rumour, sell the news, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, currency risk, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, financial engineering, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, global macro, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, junk bonds, late capitalism, law of one price, Long Term Capital Management, low interest rates, managed futures, margin call, market clearing, market design, market friction, Market Wizards by Jack D. Schwager, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, Phillips curve, price discovery process, price stability, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Reminiscences of a Stock Operator, Renaissance Technologies, Richard Thaler, risk free rate, risk-adjusted returns, risk/return, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, short squeeze, SoftBank, sovereign wealth fund, statistical arbitrage, statistical model, stocks for the long run, stocks for the long term, survivorship bias, systematic trading, tail risk, technology bubble, time dilation, time value of money, total factor productivity, transaction costs, two and twenty, value at risk, Vanguard fund, yield curve, zero-coupon bond

PART I Active Investment CHAPTER 1 Understanding Hedge Funds and Other Smart Money There are many types of active investors who make markets efficiently inefficient. These investors include large sophisticated pension funds with in-house trading operations, endowments, dealers and proprietary traders at investment banks, trading arms at commodity producing firms, mutual funds, proprietary trading firms, and hedge funds. In each case, the traders have slightly different contracts or profit-sharing agreements and face different political and firm-specific pressures and concerns. Since the focus of this book is the trading strategies, not the players, it would take us too far astray to discuss each of these trading set-ups in detail.

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Hedge funds try to assess transaction costs before they trade, trading off the cost of trading against the benefits. To do this, they also look at market conditions such as the current bid–ask spread and the depth of the limit order book. Whereas the largest hedge funds often use their own proprietary trading systems and transaction cost estimates, a number of investment banks and specialized trading firms offer to execute trades efficiently using their trading systems and offer advice regarding expected transaction costs. Let’s try to get a sense for the magnitude of transaction costs for professional traders.

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These losses led some firms to start reducing risk and raise cash by selling liquid instruments such as their stock positions, hurting the returns of common stock-selection strategies. The money markets started breaking down, and some banks strapped for cash closed down some of their trading desks, including quant equity proprietary trading operations. Simultaneously, some hedge funds were experiencing redemptions. For instance, some funds of funds (hedge funds investing in other hedge funds) hit loss triggers and were forced to redeem from the hedge funds they were invested in, including quants. While the subprime credit crisis had little to do with the stocks held by quants, quant liquidation meant that high-expected-return stocks were being sold and, to close short positions, low-expected-return stocks were being bought.

The Great Divergence: America's Growing Inequality Crisis and What We Can Do About It by Timothy Noah

air traffic controllers' union, Alan Greenspan, assortative mating, autonomous vehicles, Bear Stearns, blue-collar work, Bonfire of the Vanities, Branko Milanovic, business cycle, call centre, carbon tax, collective bargaining, compensation consultant, computer age, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, Deng Xiaoping, easy for humans, difficult for computers, Erik Brynjolfsson, Everybody Ought to Be Rich, feminist movement, Ford Model T, Frank Levy and Richard Murnane: The New Division of Labor, Gini coefficient, government statistician, Gunnar Myrdal, income inequality, independent contractor, industrial robot, invisible hand, It's morning again in America, job automation, Joseph Schumpeter, longitudinal study, low skilled workers, lump of labour, manufacturing employment, moral hazard, oil shock, pattern recognition, Paul Samuelson, performance metric, positional goods, post-industrial society, postindustrial economy, proprietary trading, purchasing power parity, refrigerator car, rent control, Richard Feynman, Ronald Reagan, shareholder value, Silicon Valley, Simon Kuznets, Stephen Hawking, Steve Jobs, subprime mortgage crisis, The Spirit Level, too big to fail, trickle-down economics, Tyler Cowen, Tyler Cowen: Great Stagnation, union organizing, upwardly mobile, very high income, Vilfredo Pareto, War on Poverty, We are the 99%, women in the workforce, Works Progress Administration, Yom Kippur War

It imposed new capital requirements to limit bank leveraging; gave corporate shareholders the chance to approve or disapprove (in a nonbinding vote) executive compensation; removed from existing regulations explicit reliance on the major rating agencies, which had become co-opted by the banks, as arbiters of financial soundness; restricted banks’ proprietary trading; required hedge funds, which previously operated free of government supervision, to register with the Securities and Exchange Commission; lowered the interchange fees that banks charged retailers whenever purchases were made with debit cards; and created the Consumer Financial Protection Bureau, a new agency charged with preventing banks from deceiving customers by imposing hidden fees and the like.

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If the lobbyists and their Republican supporters fail, the top 0.1 percent may increase its income share anyway—but a first step will have been taken, allowing further steps to be taken in the future that might make some difference. That’s precisely why Wall Street is fighting so feverishly the imposition of Dodd-Frank’s (relatively mild) restrictions. The matter of proprietary trading, which is nominally banned under Dodd-Frank (but in fact will continue in certain forms), is itself an inequality issue, the University of Chicago’s Raghuram G. Rajan pointed out in his 2010 book Fault Lines. The inequality here concerns information. “Banks that are involved in many businesses obtain an enormous amount of private information from them,” Rajan wrote.

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“Banks that are involved in many businesses obtain an enormous amount of private information from them,” Rajan wrote. “This information should be used to help clients, not to trade against them.” In theory, banking firewalls prevent traders from becoming privy to information available to bankers; in practice traders have access to it. Rajan conceded that some activities that might be defined as proprietary trading will remain necessary—for instance, to manage risk. But “an initial crude limit,” he wrote, could be “refined over time with experience.” The perfect is the enemy of the good, and the good can be improved in the long term. The next step in banking reform ought to be more radical. The too-big-to-fail banks must be broken up.

Barometer of Fear: An Insider's Account of Rogue Trading and the Greatest Banking Scandal in History by Alexis Stenfors

Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, Bear Stearns, Big bang: deregulation of the City of London, bonus culture, capital controls, collapse of Lehman Brothers, credit crunch, Credit Default Swap, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, fixed income, foreign exchange controls, game design, Gordon Gekko, inflation targeting, information asymmetry, interest rate derivative, interest rate swap, London Interbank Offered Rate, loss aversion, mental accounting, millennium bug, Nick Leeson, Northern Rock, oil shock, Post-Keynesian economics, price stability, profit maximization, proprietary trading, regulatory arbitrage, reserve currency, Rubik’s Cube, Snapchat, Suez crisis 1956, the market place, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, work culture , Y2K

How much is generated from customer flows (i.e. from the bank having a customer franchise in the currencies and financial instruments I traded)? How much do you make from arbitrage activities? How much is derived from fundamental analysis, macroeconomic views and proprietary trading (effectively placing bets using the bank’s money)? My answers to such questions might provide clues as to whether I took my own initiatives or largely relied on my current employer’s customer base. They therefore also hint at my risk appetite. Proprietary trading often involves more active risk taking, whereas customer flows less. However, the main question also involves a form of psychological self-assessment on the part of the interviewee, essentially asking: ‘What kind of mental accounting do you perform within your environment?’

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It is not a straightforward process to assess the individual contribution of such ‘accounts’. Market making was what I had been trained to do from the start, while arbitrage and various mathematical strategies were areas where I felt very comfortable. Growing the customer franchise and increasing the market share was something that spurred me on. Proprietary trading interested me. My answer therefore tended to be ‘a bit of everything’, which generally seemed to be regarded as a good answer. Thus, different traders might have different attitudes to risk. More fundamentally, even a single trader might have very different attitudes to different types of risk.

Flash Boys: Not So Fast: An Insider's Perspective on High-Frequency Trading by Peter Kovac

bank run, barriers to entry, bash_history, Bernie Madoff, compensation consultant, computerized markets, computerized trading, Flash crash, housing crisis, index fund, locking in a profit, London Whale, market microstructure, merger arbitrage, payment for order flow, prediction markets, price discovery process, proprietary trading, Sergey Aleynikov, Spread Networks laid a new fibre optics cable between New York and Chicago, transaction costs, zero day

Which brings us, full circle, back to where we started with dark pools. The Chipotle example didn’t rely on high-frequency pinging, “detectable patterns,” or orders held hostage. It did involve sending an order to Goldman Sachs’ dark pool without any assurances about whether or not Goldman’s proprietary trading group would have special access to the order. Rich Gates decided to see if there was anything to fear when he set up an arbitrage situation and dropped it into the lap of Goldman Sachs. Based on what Lewis wrote, it sounds like he found out. Broker-dealers are High-Frequency Traders – or Anything Else It’s not critical to the book, but it’s yet another demonstration of its ridiculous leaps that Lewis assumes that a trading venue – Credit Suisse’s Crossfinder in this case – caters to high-frequency traders because it says that its clients are broker-dealers: “All the large high-frequency firms, Schwall knew, were “broker-dealers.”

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The anemic per-trade profit margins don’t work well in a firm like Goldman, where it’s more expensive to handle back office operations (and investors expect very high profit margins). Their technology is burdened by hundreds of legacy requirements. But it’s also worth noting that Goldman had to get out of high-frequency trading anyway. The Volcker Rule, a product of the Financial Crisis, prohibits banks like Goldman from doing any proprietary trading in the future. They have until July 2015 to wind everything down. So if Goldman didn’t shutter their high-frequency trading now, it would have happened sometime in the next sixteen months. Goldman could have issued a press release saying, “We’re quitting high-frequency trading since we have to, and we’re not very good at it, anyway.”

Quality Investing: Owning the Best Companies for the Long Term by Torkell T. Eide, Lawrence A. Cunningham, Patrick Hargreaves

air freight, Albert Einstein, asset light, backtesting, barriers to entry, buy and hold, carbon tax, cashless society, cloud computing, commoditize, Credit Default Swap, discounted cash flows, discovery of penicillin, endowment effect, global pandemic, haute couture, hindsight bias, legacy carrier, low cost airline, mass affluent, Network effects, oil shale / tar sands, pattern recognition, price elasticity of demand, proprietary trading, shareholder value, smart grid, sovereign wealth fund, supply-chain management, vertical integration

Independent, long term, and tenacious Handelsbanken also illustrates how good managers are independent-minded – acting according to prudent conviction despite prevailing winds or consensus sentiment. The Swedish bank contradicts prevalent practices at peer financial institutions: it boasts a decentralized management structure, uses a profit-sharing plan rather than banker bonuses, and embraces a risk aversion that discourages proprietary trading. These traits enabled the bank not only to weather the 2008 financial crisis but to be a supplier of capital during the period. Of course, this kind of independent thinking is easier in companies with dominant shareholders or family control, features that insulate against pressure from both rivals and stock markets.

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Its management philosophy is to take risks only in areas where it has demonstrable strengths and to minimize all others. It has consistently run a conservative liquidity profile, with superlative capital ratios and longer duration of funding versus peers. Unlike most large European banks, Handelsbanken eschews high-risk, speculative proprietary trading. These cultural traits explain why, during the global financial crisis of 2008, Handelsbanken was a net lender to peer banks and the overall banking system, including lending to the Swedish Central Bank. In an earlier financial crisis afflicting Swedish banks in the early 1990s, Handelsbanken was also the beacon of strength: it was the only Swedish bank that did not receive state aid or become nationalized.

Boomerang: Travels in the New Third World by Michael Lewis

Apollo 11, Bear Stearns, Berlin Wall, Bernie Madoff, Carmen Reinhart, Celtic Tiger, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, fiat currency, financial engineering, financial thriller, full employment, German hyperinflation, government statistician, Irish property bubble, junk bonds, Kenneth Rogoff, Neil Armstrong, offshore financial centre, pension reform, Ponzi scheme, proprietary trading, Ronald Reagan, Ronald Reagan: Tear down this wall, South Sea Bubble, subprime mortgage crisis, the new new thing, Tragedy of the Commons, tulip mania, women in the workforce

Most are either explicitly state-backed or small savings co-ops. Commerzbank, Dresdner Bank, and Deutsche Bank, all founded in the 1870s, are the only three big private German banks. In 2009 Commerzbank bought Dresdner. Both turned out to be loaded with toxic assets, and so the merged bank required a government bailout. “We are not a proprietary trading nation,” says Müller, getting pretty quickly to the nub of Germany’s banking problems. German banking was never meant to be a high-stakes affair. Banking, done in the proper German fashion, is less a free enterprise than a utility. “Why should you pay twenty million to a thirty-two-year-old trader?”

…

Yet the bonds were becoming radically more risky, because the loans that underpinned them were becoming crazier and crazier. After he left, Röthig explains, IKB had only five investment officers, each in his late twenties, with a couple of years’ experience: these were the people on the other end of the bets being handcrafted by Goldman Sachs for its own proprietary trading book, and by other big Wall Street firms for extremely clever hedge funds that wanted to bet against the market for subprime bonds. The IKB portfolio went from $10 billion in 2005 to $20 billion in 2007, Röthig says, “and it would have gotten bigger if they had had more time to buy. They were still buying when the market crashed.

The Bankers' New Clothes: What's Wrong With Banking and What to Do About It by Anat Admati, Martin Hellwig

Alan Greenspan, Andrei Shleifer, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, bonus culture, book value, break the buck, business cycle, Carmen Reinhart, central bank independence, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, diversified portfolio, en.wikipedia.org, Exxon Valdez, financial deregulation, financial engineering, financial innovation, financial intermediation, fixed income, George Akerlof, Glass-Steagall Act, Growth in a Time of Debt, income inequality, information asymmetry, invisible hand, Jean Tirole, joint-stock company, joint-stock limited liability company, junk bonds, Kenneth Rogoff, Larry Wall, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, margin call, Martin Wolf, Money creation, money market fund, moral hazard, mortgage debt, mortgage tax deduction, negative equity, Nick Leeson, Northern Rock, open economy, Paul Volcker talking about ATMs, peer-to-peer lending, proprietary trading, regulatory arbitrage, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Satyajit Das, Savings and loan crisis, shareholder value, sovereign wealth fund, subprime mortgage crisis, technology bubble, The Market for Lemons, the payments system, too big to fail, Upton Sinclair, Yogi Berra

Many of these large conglomerates failed to perform well and were later broken into smaller, more focused corporations.32 Reducing the size and scope of large banks could make them more efficient as well, but the subsidies associated with size—as well as managerial entrenchment, which is also observed in other industries—have so far prevented this from happening.33 Several reform proposals aim to protect depositors and deposit insurance from the risks of investment banking. In the United States the so-called Volcker Rule seeks to ban proprietary trading by deposit-taking institutions. In the same spirit, the Independent Commission on Banking (ICB) in the United Kingdom has proposed to “ring fence” retail banking, deposit taking, and lending in special institutions that would not be allowed to engage in investment banking. In the European Union, a group of experts set up by the European Commission under the chairmanship of Finnish central bank governor Erkki Liikanen has put forward a similar proposal.34 These proposals presume that concerns about depositors and the payment system are, or should be, the major reason for government interventions in banking, for guarantees and bailouts as well as banking regulation.

…

On controversies regarding how to account for losses on loans, see also Floyd Norris, “Accounting Détente Delayed,” New York Times, July 19, 2012. 14. These investments reflect the investment banking activities in which JPMorgan Chase, as a universal bank, is also engaging. Traditional investment banking involves financial services for corporations and investors as well as securities trading on a bank’s own account, so-called proprietary trading. Investment banking services for corporations traditionally involve advice and marketing in connection with offerings of securities and with mergers and acquisitions. Investment banking services for investors traditionally involve investment advice and portfolio management services. Trading on their own account arises naturally if the investment bank “underwrites” a public offering, that is, if it buys the entire lot of equity shares or bonds and resells them to the public.

…

Meltzer, Allan. 2012. Why Capitalism? New York: Oxford University Press. Melzer, Brian T. 2012. “Mortgage Debt Overhang: Reduced Investment by Homeowners with Negative Equity.” Working paper. Northwestern University, Chicago. Merkley, Jeff, and Carl Levin. 2011. “The Dodd-Frank Act Restrictions on Proprietary Trading and Conflicts of Interest: New Tools to Address Evolving Threats.” Harvard Law and Policy Review 48: 515–553. Merton, Robert C. 1973. “Theory of Rational Option Pricing.” Bell Journal of Economics 4 (1): 141–183. Merton, Robert K. 1957. “The Self-Fulfilling Prophecy.” In Social Theory and Social Structure, rev. and enl. ed.

The Handbook of Personal Wealth Management by Reuvid, Jonathan.

asset allocation, banking crisis, BRICs, business cycle, buy and hold, carbon credits, collapse of Lehman Brothers, correlation coefficient, credit crunch, cross-subsidies, currency risk, diversification, diversified portfolio, estate planning, financial deregulation, fixed income, global macro, high net worth, income per capita, index fund, interest rate swap, laissez-faire capitalism, land tenure, low interest rates, managed futures, market bubble, merger arbitrage, negative equity, new economy, Northern Rock, pattern recognition, Ponzi scheme, prediction markets, proprietary trading, Right to Buy, risk tolerance, risk-adjusted returns, risk/return, short selling, side project, sovereign wealth fund, statistical arbitrage, systematic trading, transaction costs, yield curve

Multistrategy managers may be active in strategies such as long/short equity, market neutral equity, event driven, distressed and ABL/ABS. The advantage of multistrategy operations is that they have the ability to move capital quickly between trading strategies as opportunities arise. Throughout 2008 we have witnessed the proprietary trading desks of the investment banks diminish in size. Perhaps this may create significant opportunities for some multi-strategy operations going forward. 2008 hedge fund review Hedge funds are often thought to be absolute return vehicles; however, the underlying assets in which they trade are often the same equities, bonds and commodities found in many long-only manager portfolios.

…

Distressed managers will be able to position themselves with very cheap assets in the right part of the capital structure. Those managers who have the resources to unpick the carnage that has occurred in the asset-backed markets, and to value the underlying assets, will be in an ideal position to generate substantial returns. Further, hedge funds will face less competition with investment bank proprietary trading desks largely disappearing from the market. The reduction in bank lending may present significant opportunities for lending-based hedge fund strategies, which may in turn be able to command higher interest rates and increased equity participation through warrants. 35 1.4 Capital-protected and structured investments Stephen Ford, Brewin Dolphin Ltd Capital-protected equity investments are also known as structured products and have been available for over a decade.

The Money Machine: How the City Works by Philip Coggan

activist fund / activist shareholder / activist investor, algorithmic trading, asset-backed security, Bear Stearns, Bernie Madoff, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, bond market vigilante , bonus culture, Bretton Woods, call centre, capital controls, carried interest, central bank independence, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, disintermediation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, endowment effect, financial deregulation, financial independence, floating exchange rates, foreign exchange controls, Glass-Steagall Act, guns versus butter model, Hyman Minsky, index fund, intangible asset, interest rate swap, inverted yield curve, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", joint-stock company, junk bonds, labour market flexibility, large denomination, London Interbank Offered Rate, Long Term Capital Management, low interest rates, merger arbitrage, Michael Milken, money market fund, moral hazard, mortgage debt, negative equity, Nick Leeson, Northern Rock, pattern recognition, proprietary trading, purchasing power parity, quantitative easing, reserve currency, Right to Buy, Ronald Reagan, shareholder value, South Sea Bubble, sovereign wealth fund, technology bubble, time value of money, too big to fail, tulip mania, Washington Consensus, yield curve, zero-coupon bond

That spelled the end for the old British-style merchant bank, which was often a private business, run by a small group of partners. It also meant that, having raised large amounts of capital, investment banks started to move into new areas. They used their expertise to deal on their own behalf, through proprietary trading desks. They sold their expertise to clients as asset managers. They dreamed up exotic new products, particularly in the derivatives markets, and sold them round the world. They lent money to favoured clients such as hedge funds and private equity groups (see Chapter 9). This has earned investment bankers a lot of money.

…

Derivative instruments, such as futures and options, can be difficult to understand and can behave in unpredictable ways. It can be easier to disguise losses for long periods. Even when traders are not careless or fraudulent, they can just be wrong. When markets fall sharply, banks often face losses from their proprietary trading activities. Even the more standard activities of arranging new issues and takeovers can be highly volatile; when markets are in the doldrums, few companies use the stock market to raise capital and few bids are announced. Market downturns in the early 1990s or in 2000–2002 caused a number of banks to announce write-offs to profits.

Where Does Money Come From?: A Guide to the UK Monetary & Banking System by Josh Ryan-Collins, Tony Greenham, Richard Werner, Andrew Jackson

bank run, banking crisis, banks create money, Basel III, Big bang: deregulation of the City of London, book value, Bretton Woods, business cycle, capital controls, cashless society, central bank independence, credit crunch, currency risk, double entry bookkeeping, en.wikipedia.org, eurozone crisis, fiat currency, financial innovation, fixed income, floating exchange rates, Fractional reserve banking, full employment, global reserve currency, Goodhart's law, Hyman Minsky, inflation targeting, interest rate derivative, interest rate swap, Joseph Schumpeter, low skilled workers, market clearing, market design, market friction, Modern Monetary Theory, Money creation, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Northern Rock, offshore financial centre, Post-Keynesian economics, price mechanism, price stability, proprietary trading, purchasing power parity, quantitative easing, Real Time Gross Settlement, reserve currency, Ronald Reagan, seigniorage, special drawing rights, the payments system, trade route, transaction costs

Similarly, ‘Wholesale banking’ involves the provision of lending and assistance (including underwriting) to institutions such as governments and corporations rather than lending to individual customers. Wholesale banking can include assistance in raising equity and debt finance, providing advice in relation to mergers and acquisitions, acting as counterparty to client trades and ‘market-making’ (investment banking). An investment bank may also undertake trading on its own account (proprietary trading) in a variety of financial products such as derivatives, fixed income instruments, currencies and commodities. Note that investment banks need not necessarily hold a licence to accept deposits from customers to carry out some of these trading and advisory activities. This theory is incorrect, for reasons that will be covered below.

…

The process and the calculations are carried out daily by Thomson Reuters on behalf of the British Bankers Association, the trade group representing British banks. LIBOR is important, because a substantial volume of financial contracts are priced in relation to it (amounting to many trillions of pounds) and banks – often those participating in determining it – are counterparties in these contracts and their derivatives or proprietary trading desks also bet on the movement of LIBOR. In theory, if the Bank of England is operating a corridor system (see Appendix 1) then the LIBOR rate should not exceed the boundaries set out by the corridor. We would expect that no bank would deal in the market on worse terms than it could receive from the Bank of England.

Fed Up!: Success, Excess and Crisis Through the Eyes of a Hedge Fund Macro Trader by Colin Lancaster

"World Economic Forum" Davos, Adam Neumann (WeWork), Airbnb, Alan Greenspan, always be closing, asset-backed security, beat the dealer, Ben Bernanke: helicopter money, Bernie Sanders, Big Tech, Black Monday: stock market crash in 1987, bond market vigilante , Bonfire of the Vanities, Boris Johnson, Bretton Woods, business cycle, buy the rumour, sell the news, Carmen Reinhart, Chuck Templeton: OpenTable:, collateralized debt obligation, coronavirus, COVID-19, creative destruction, credit crunch, currency manipulation / currency intervention, deal flow, Donald Trump, Edward Thorp, family office, fear index, fiat currency, fixed income, Flash crash, George Floyd, global macro, global pandemic, global supply chain, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Growth in a Time of Debt, housing crisis, index arbitrage, inverted yield curve, Jeff Bezos, Jim Simons, junk bonds, Kenneth Rogoff, liquidity trap, lockdown, Long Term Capital Management, low interest rates, low skilled workers, margin call, market bubble, Masayoshi Son, Michael Milken, Mikhail Gorbachev, Minsky moment, Modern Monetary Theory, moral hazard, National Debt Clock, Nixon triggered the end of the Bretton Woods system, Northern Rock, oil shock, pets.com, Ponzi scheme, price stability, proprietary trading, quantitative easing, Reminiscences of a Stock Operator, reserve currency, Ronald Reagan, Ronald Reagan: Tear down this wall, Sharpe ratio, short selling, short squeeze, social distancing, SoftBank, statistical arbitrage, stock buybacks, The Great Moderation, TikTok, too big to fail, trickle-down economics, two and twenty, value at risk, Vision Fund, WeWork, yield curve, zero-sum game

The strategy’s broad mandate permits portfolio managers to invest in virtually any instrument, anywhere in the world. This makes it unique. It also makes macro managers great at cocktail parties since they can talk about almost anything. The origins of many high-profile global macro traders can be traced back to investment-bank proprietary trading businesses, and to places such as Commodities Corporation, and, of course, Soros Fund Management. These macro pioneers created platforms within their firms that trained a new generation of portfolio managers, a next wave of great macro investors, who started their careers at those earlier shops and went on to launch firms such as Duquesne Capital, Tudor Investment Corporation, Moore Capital, Caxton Associates, and Brevan Howard.

…

* I decide to walk home after the market closed. It’s a nice night. As I walk, I think. Wall Street traders used to be the big swinging dicks. The guys at Solly, then Milken’s crew at Drexel, and then Goldman took things up a notch. Back in its vampire squid days, Goldman ruled the world. It had the best proprietary trading operation in the world. It called people muppets and used to rip people’s faces off. The firm had all the advantages: created the instruments, sold them to you, knew where all the bonds were, knew what you owned, front-ran your orders, saw all of the flows, and took the most risk. And it was even worse if you were on the ropes, if things were going against you, because Goldman was competing with you.

The Spider Network: The Wild Story of a Math Genius, a Gang of Backstabbing Bankers, and One of the Greatest Scams in Financial History by David Enrich

Bear Stearns, Bernie Sanders, Black Monday: stock market crash in 1987, call centre, centralized clearinghouse, computerized trading, Credit Default Swap, Downton Abbey, eat what you kill, electricity market, Flash crash, Glass-Steagall Act, Goldman Sachs: Vampire Squid, information asymmetry, interest rate derivative, interest rate swap, London Interbank Offered Rate, London Whale, Long Term Capital Management, Michael Milken, Navinder Sarao, Nick Leeson, Northern Rock, Occupy movement, performance metric, profit maximization, proprietary trading, Savings and loan crisis, tulip mania, work culture , zero-sum game

And the interests of a trader whose performance was measured based on how much he helped clients versus one who was rewarded based on how much money he raked in through his own trading—well, they were very different. So were the interests of a bank that mainly focused on its clients’ needs and one that profited in large part from trading that was divorced from—and sometimes diametrically opposed to—what its customers wanted. The art of making money through this so-called proprietary trading was partly in the timing: Bet on something that’s cheaply priced, protect yourself with an offsetting position, get rid of the original asset just as it reaches its peak value, extricate yourself from the offsetting hedge position, and pocket the proceeds. In the ideal scenario, savvy traders managed to construct enough overlapping hedges that they virtually eliminated any downside risk and guaranteed themselves a small profit, regardless of which way markets moved.

…

Goodwin was staying at the luxurious Four Seasons; Hayes was in a crummy hotel down the street from RBS’s offices. Misreading the cues, Hayes ribbed the CEO about his posh digs and jokingly complained that he wasn’t permitted to stay there. The attempt at humor fell flat with the ill-tempered Goodwin. RBS had a small office in Tokyo, and most of its trading business involved proprietary trading, in which traders made large bets simply using the bank’s money; there was no ancillary business of making markets for or otherwise helping clients. Goodwin was introduced to a group of traders. He looked at each of them, asking what they did for the bank. “Prop trading,” came the proud response.

…

187, 190–93 at Lehman Brothers, 185–86 People’s Journal, 188 Perfect, David, 94–95 Pieri, Donna, 89, 314 Pieri, Mike, x anti-Hayes efforts, 289, 290, 292–94, 313–14 background of, 89 Hayes departure, 292–94, 313–14 Hayes hiring, 60 Hayes performance review, 143 Hayes trading, 92, 160, 166, 231 Justice investigation, 342 Lehman’s collapse, 165, 231 Libor investigation, 315–16 Libor manipulation, 99, 99n, 115, 166, 176, 221–22, 233, 238, 238n overnight index swaps, 103 resignation of, 342 switch trades, 173, 173n at UBS, 89–90 update on, 445 Pinewood Studios, 412 Pitt, Brad, 237 plea bargains, 348 Porter, Chris, 111 Porter, Laurence, x background of, 245 Libor submissions, 245, 259, 276–77, 279–80, 280n, 284, 295 update on, 445 PricewaterhouseCoopers, 400 Prince, Charles, 275 Prinz, Sascha, x, 105, 145, 159, 166, 304 Project Green, 334 proprietary trading, 19–20, 36–37 public pension funds, 113–14, 404 Queen Camilla (Townsend), 138–39 Queens Park Rangers (QPR), 11, 15, 56, 125, 145, 147 Qureshi, Shah, 345–46 Rabobank, 109, 163–64, 166, 404, 456 “Rate Probe Keys on Traders,” 346–47 Ravazzolo, Fabiola, 189, 195 RBC. See Royal Bank of Canada RBS.

How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Bear Stearns, Black-Scholes formula, Bob Litterman, Bonfire of the Vanities, book value, Bretton Woods, Brownian motion, business cycle, business process, butter production in bangladesh, buy and hold, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, commoditize, computerized markets, corporate governance, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency risk, discounted cash flows, disintermediation, diversification, Donald Knuth, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, fixed income, full employment, George Akerlof, global macro, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, Ivan Sutherland, John Bogle, John von Neumann, junk bonds, linear programming, Loma Prieta earthquake, Long Term Capital Management, machine readable, margin call, market friction, market microstructure, martingale, merger arbitrage, Michael Milken, Myron Scholes, Nick Leeson, P = NP, pattern recognition, Paul Samuelson, pensions crisis, performance metric, prediction markets, profit maximization, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Reminiscences of a Stock Operator, Richard Feynman, Richard Stallman, risk free rate, risk-adjusted returns, risk/return, seminal paper, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, subscription business, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

That is not how it worked out, but in the end it was a great introduction to quant research. For a first job on Wall Street, things went pretty well. I learned a great deal and I worked at a truly first rate firm. I also met a number of people who have had a tremendous influence on my career. One person in particular was Peter Muller. Peter was running a proprietary trading group that was considered by everyone to be the crème de la crème of the equities division. I did not know—and still do not know—exactly what they did, but whenever his group was mentioned, people were abuzz with excitement. Peter was outgoing and friendly and made an effort to get to know the quant research guys.

…

So I pitched the same idea BARRA had turned down—using quantitative models to do proprietary JWPR007-Lindsey May 7, 2007 17:32 Peter Muller 313 trading. Very sensibly, they asked if I had any experience trading. Aside from a little speculation in stock index futures, I hadn’t traded at all. So I played up the poker playing experience. I guess they bought it, because they offered me a job creating a proprietary trading group. I was guaranteed a nice multiple of my BARRA compensation for each of the next two years. This was pretty good, because it was already May and I didn’t have to start until September. Wall Street paid a lot better than consulting! I took the summer off, went to Hanalei, Kauai, one of my favorite places in the world, and hung out for six weeks, getting ready for the next phase of my career.

…

John’s University in 1977, an MA in quantitative economics from the State University of New York in 1978, and a PhD in financial economics from the State University of New York at Stony Brook in 1982. Peter Muller is a senior advisor at Morgan Stanley and provides ongoing counsel to Process Driven Trading, a proprietary trading group he founded in 1992. Prior to joining Morgan, Mr. Muller was with Barra for seven years. He created the BARRA Brainteaser, a monthly investmentrelated puzzle. Mr. Muller graduated with honors from Princeton University with a BA in mathematics. He is a member of the editorial board for the Journal of Investment Management and has previously served in the same capacity for the Financial Analysts Journal and the Journal of Portfolio Management.

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, Alan Greenspan, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, Bear Stearns, behavioural economics, Big Tech, bonus culture, Bretton Woods, British Empire, business cycle, buy and hold, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carl Icahn, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, commoditize, computerized trading, corporate governance, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, data science, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, electricity market, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial engineering, financial intermediation, Ford Model T, Frederick Winslow Taylor, George Akerlof, gig economy, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Greenspan put, guns versus butter model, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, information asymmetry, interest rate derivative, interest rate swap, Internet of things, invisible hand, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", John Bogle, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Kickstarter, knowledge economy, labor-force participation, London Whale, Long Term Capital Management, low interest rates, manufacturing employment, market design, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, Paul Samuelson, pensions crisis, Ponzi scheme, principal–agent problem, proprietary trading, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Ronald Reagan, Satyajit Das, Savings and loan crisis, scientific management, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, Steve Jobs, stock buybacks, subprime mortgage crisis, technology bubble, TED Talk, The Chicago School, the new new thing, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, Tragedy of the Commons, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, vertical integration, zero-sum game

He continued to work on Wall Street after his public shaming, even though he left National City in disgrace just days after taking the stand and paid government officials (with whom he’d done many cozy deals) $1.1 million in back taxes.35 The crisis had one big upside, though. Senator Glass, along with Congressman Henry Steagall, crafted the Glass-Steagall Act to separate commercial and investment banking in the United States. For more than six decades afterward, the law helped to ring-fence commercial lending from risky proprietary trading. Glass-Steagall also created the Federal Deposit Insurance Corporation (FDIC), which insured bank depositors up to $5,000 each, reducing the risk of bank runs and assuring the general public that it would be safe in case of a financial crisis. Finally, the legislation put limits on the amount of interest that banks could offer savers to attract their money.

…

Then there’s market making and pure trading—that’s what Goldman Sachs or Glencore, the Swiss-based trading firm founded by Marc Rich, might do—though, again, industrial companies like BP can also do it in their capacity as swaps dealers. Lines start to get blurry here between what’s socially useful and what’s not, especially when you get into a fifth category, proprietary trading, or “prop” trading as it’s known in the industry. That’s when financial intermediaries and other big market makers are simply trading for their own profit, rather than to hedge any underlying assets. Activities of this kind are now illegal under the Volcker Rule, but as former CFTC chairman Gary Gensler says, “it’s very tough to prove what is permitted prop trading, what is legitimate market making, and what is pure speculation.”

…

As just one example of many, in the year after Dodd-Frank’s passing, Goldman Sachs (the most active among financial institutions) paid eighty-three visits to regulators to discuss topics like derivatives reform.11 In 2013, Duke University academic Kimberly Krawiec published a startling research paper analyzing more than eight thousand public comment letters received by the Financial Stability Oversight Council as it prepared to study the ways of implementing the Volcker Rule, a particularly contentious piece of the Dodd-Frank reform that aimed to reinstate some of the spirit of the Glass-Steagall legislation by separating risky proprietary trading from federally insured commercial banking. Krawiec analyzed the meeting logs of the Treasury Department, Federal Reserve, Commodity Futures Trading Commission, Securities and Exchange Commission, and Federal Deposit Insurance Corporation. The bottom line? “Financial institutions, financial industry trade groups, and law firms representing such institutions and trade groups collectively accounted for roughly 93% of all federal agency contacts on the Volcker Rule,” between July 2010 and October 2011.

Flash Boys: A Wall Street Revolt by Michael Lewis

automated trading system, bash_history, Berlin Wall, Bernie Madoff, collateralized debt obligation, computerized markets, drone strike, Dutch auction, Fall of the Berlin Wall, financial intermediation, Flash crash, High speed trading, information security, latency arbitrage, National best bid and offer, pattern recognition, payment for order flow, Pershing Square Capital Management, proprietary trading, risk tolerance, Rubik’s Cube, Sergey Aleynikov, Small Order Execution System, Spread Networks laid a new fibre optics cable between New York and Chicago, the new new thing, too big to fail, trade route, transaction costs, Vanguard fund

Citigroup, weirdly, insisted that Spread reroute the line from the building next to the Nasdaq in Carteret to their offices in lower Manhattan, the twists and turns of which added several milliseconds and defeated the line’s entire purpose. The other banks all grasped the point of the line but were given pause by the contract Spread required them to sign. This contract prohibited anyone who leased the line from allowing others to use it. Any big bank that leased a place on the line could use it for its own proprietary trading but was forbidden from sharing it with its brokerage customers. To Spread this seemed an obvious restriction: The line was more valuable the fewer people that had access to it. The whole point of the line was to create inside the public markets a private space, accessible only to those willing to pay the tens of millions of dollars in entry fees.

…

Ronan moved the computers from Kansas City to Radianz’s data center in Nutley and reduced the time it took them to find out what they had bought and sold from 43 milliseconds to 3.8 milliseconds. From that moment the demand on Wall Street for Ronan’s services intensified. Not just from banks and well-known high-frequency trading firms but also from prop shops (proprietary trading firms) no one had ever heard of, with just a few guys in them. All wanted to be able to trade faster than the others. To be faster they needed to find shorter routes for their signals to travel; to be faster they needed the newest hardware, stripped down to its essentials; to be faster they also needed to reduce the physical distance between their computers and the computers inside the various stock exchanges.

The End of Growth by Jeff Rubin

Alan Greenspan, Anthropocene, Ayatollah Khomeini, Bakken shale, banking crisis, Bear Stearns, Berlin Wall, British Empire, business cycle, call centre, carbon credits, carbon footprint, carbon tax, collateralized debt obligation, collective bargaining, Credit Default Swap, credit default swaps / collateralized debt obligations, deal flow, decarbonisation, deglobalization, Easter island, energy security, eurozone crisis, Exxon Valdez, Eyjafjallajökull, Fall of the Berlin Wall, fiat currency, flex fuel, Ford Model T, full employment, ghettoisation, Glass-Steagall Act, global supply chain, Hans Island, happiness index / gross national happiness, housing crisis, hydraulic fracturing, illegal immigration, income per capita, Intergovernmental Panel on Climate Change (IPCC), Jane Jacobs, Jevons paradox, Kickstarter, low interest rates, McMansion, megaproject, Monroe Doctrine, moral hazard, new economy, Occupy movement, oil shale / tar sands, oil shock, peak oil, Ponzi scheme, proprietary trading, quantitative easing, race to the bottom, reserve currency, rolling blackouts, Ronald Reagan, South China Sea, sovereign wealth fund, subprime mortgage crisis, The Chicago School, The Death and Life of Great American Cities, Thomas Malthus, Thorstein Veblen, too big to fail, traumatic brain injury, uranium enrichment, urban planning, urban sprawl, women in the workforce, working poor, Yom Kippur War, zero-sum game

The financial industry is overdue for a deep structural overhaul that will help to eliminate some of the conflicts of interest that led to the 2008 financial crisis. During the Great Depression, for instance, US lawmakers adopted the Glass-Steagall Act, legislation that separated the different parts of a bank’s business. Under the act, a bank’s traditional deposit-taking business was walled off from the proprietary trading desks that make huge leveraged bets in stock, bond and currency markets. Separating bankers lending money from traders investing money, the thinking went, would help to mitigate the type of rampant speculation that led to the stock market crash of 1929. Wall Street, of course, chafed at having its wings clipped.

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So far, a push back toward the days of Glass-Steagall has been rebuffed. Until changes are made, however, don’t expect to see taxpayer-funded bank bailouts end anytime soon. Consider what happened at Swiss-based UBS, one of the world’s largest and most reputable banks. In September 2011, a mid-level employee on the bank’s proprietary trading desk racked up a $2.3-billion loss. That was a hard hit to UBS’s bottom line. But it’s even worse for the Swiss taxpayers who will end up bailing out the banking giant in the event of another credit crisis. But can any of us really expect anything different in a system that rewards risk takers with annual bonus checks in the seven figures and leaves taxpayers to backstop the losses when big bets go horribly wrong?

The New Tycoons: Inside the Trillion Dollar Private Equity Industry That Owns Everything by Jason Kelly

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, antiwork, barriers to entry, Bear Stearns, Berlin Wall, call centre, Carl Icahn, carried interest, collective bargaining, company town, corporate governance, corporate raider, Credit Default Swap, diversification, eat what you kill, Fall of the Berlin Wall, family office, financial engineering, fixed income, Goldman Sachs: Vampire Squid, Gordon Gekko, housing crisis, income inequality, junk bonds, Kevin Roose, late capitalism, margin call, Menlo Park, Michael Milken, military-industrial complex, Occupy movement, place-making, proprietary trading, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Rubik’s Cube, San Francisco homelessness, Sand Hill Road, Savings and loan crisis, shareholder value, side project, Silicon Valley, sovereign wealth fund, two and twenty

The former chairman of the Federal Reserve lent his name to a key piece of reform, the Volcker Rule, a central tenet of the Dodd-Frank legislation aimed at preventing another financial meltdown and series of bailouts. The Volcker Rule at its most basic seeks to limit what big banks can do with their money, thereby diminishing the risk they can take as federally insured, deposit taking institutions. That means strict limits on what’s known as proprietary trading and principal investments. During the early part of this century, a number of banks, most notably Goldman Sachs, grew their investing arms into massive institutions in their own right. Goldman’s 2007 private-equity fund totaled about $20 billion, second only in history to Blackstone’s $21.7 billion raised that same year.

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The deal with New Jersey’s pension plan, which came on the heels of the Texas teachers’ new arrangement with KKR and Apollo, was the first public indication of something that had been brewing inside Blackstone for much of that year, spurred largely by Schwarzman himself. Earlier that year, Schwarzman called a meeting of the entire firm and pressed each piece to talk about what they were seeing in the markets. He realized he was getting detailed analysis, the kind of insights the likes of Goldman Sachs had used to create its powerful and lucrative proprietary trading desk. Schwarzman was faced with a decision: use the firm’s money to trade on these ideas, or set up a new sort of business, or set of products, and start selling it to the biggest pools of capital in the world. The pitch to them is akin to what New Jersey is getting—the ability to more easily move money around to whatever Blackstone, in consultation with the client, decides is the best strategy for the current market or return expectation.

Finding Alphas: A Quantitative Approach to Building Trading Strategies by Igor Tulchinsky

algorithmic trading, asset allocation, automated trading system, backpropagation, backtesting, barriers to entry, behavioural economics, book value, business cycle, buy and hold, capital asset pricing model, constrained optimization, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, currency risk, data science, deep learning, discounted cash flows, discrete time, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, financial engineering, financial intermediation, Flash crash, Geoffrey Hinton, implied volatility, index arbitrage, index fund, intangible asset, iterative process, Long Term Capital Management, loss aversion, low interest rates, machine readable, market design, market microstructure, merger arbitrage, natural language processing, passive investing, pattern recognition, performance metric, Performance of Mutual Funds in the Period, popular capitalism, prediction markets, price discovery process, profit motive, proprietary trading, quantitative trading / quantitative finance, random walk, Reminiscences of a Stock Operator, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, risk/return, selection bias, sentiment analysis, shareholder value, Sharpe ratio, short selling, Silicon Valley, speech recognition, statistical arbitrage, statistical model, stochastic process, survivorship bias, systematic bias, systematic trading, text mining, transaction costs, Vanguard fund, yield curve

Six years later, former Columbia University computer science professor, David Shaw, launched D.E. Shaw & Co. in New York City. Shaw had spent two years at Morgan Stanley, part of a group whose mandate was to develop stock forecasting algorithms using historical price records. Others followed, either inside banks and brokerages as part of proprietary trading groups or at hedge funds managing pooled investor money. Perspectives on Alpha Research9 Over time, quantitative market-neutral investing became known as a scalable and dependable investment strategy, which fared particularly well during the dot-com market crash of the early 2000s. As the hedge fund industry grew, so did the allocation of investor capital to quantitative investment strategies.

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As a result, in contrast to the equities universe, where the core liquid assets are all traded by the same population of investors for the same purposes, many properties are much less comparable across the entire universe of futures or forwards. In recognition of the differences among market participants, many market-making and proprietary trading organizations have specialists managing the trading of different classes of futures and currencies, with the classes based on sets of similar underlying assets. This further reinforces the differences among “sectors,” as different traders, desks, and business lines manage different futures and forwards.

Heads I Win, Tails I Win by Spencer Jakab

Alan Greenspan, Asian financial crisis, asset allocation, backtesting, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, book value, business cycle, buy and hold, collapse of Lehman Brothers, correlation coefficient, crowdsourcing, Daniel Kahneman / Amos Tversky, diversification, dividend-yielding stocks, dogs of the Dow, Elliott wave, equity risk premium, estate planning, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, fear index, fixed income, geopolitical risk, government statistician, index fund, Isaac Newton, John Bogle, John Meriwether, Long Term Capital Management, low interest rates, Market Wizards by Jack D. Schwager, Mexican peso crisis / tequila crisis, money market fund, Myron Scholes, PalmPilot, passive investing, Paul Samuelson, pets.com, price anchoring, proprietary trading, Ralph Nelson Elliott, random walk, Reminiscences of a Stock Operator, risk tolerance, risk-adjusted returns, Robert Shiller, robo advisor, Savings and loan crisis, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, subprime mortgage crisis, survivorship bias, technology bubble, transaction costs, two and twenty, VA Linux, Vanguard fund, zero-coupon bond, zero-sum game

I hesitated awkwardly for a second before heaping praise on his intellect and work ethic, both more or less true, without explicitly saying anything about his fund’s prospects. It was a sin of omission, but I told myself that, after all, I didn’t know he would struggle. Of course he did. After the fund folded, he “blew up” a proprietary trading desk at a European bank. The last I heard he was employed again at another U.S. bank. I’m happy for him and figure that, as long as he’s giving advice to people who themselves are paid to manage money, they have only themselves to blame for acting on it. But what about the advice of analysts in general?

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Habit 7: Use a “System” I had intended to call this book Rule the Freakin’ Markets. But then I remembered that Michael Parness beat me to it. Who is Parness? If you take him at his word, he went from being homeless to parlaying a few thousand dollars in savings into $7 million through a proprietary trading system he developed. He was generous enough to share this valuable knowledge with others for the low, low price of $224.75 on DVD plus shipping and handling. Guidance on what to buy and sell and when, his “Ninja Trading” service, ran an additional $429 a month. A few years ago Parness was all over the radio with his advertisements for “Trend Trading to Win.”

Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

Abraham Maslow, Alan Greenspan, Andrei Shleifer, asset-backed security, bank run, banking crisis, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Blythe Masters, Boris Johnson, bread and circuses, Bretton Woods, business cycle, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, Cornelius Vanderbilt, corporate governance, creative destruction, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, disinformation, diversification, double helix, Edward Glaeser, financial deregulation, financial engineering, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, general purpose technology, George Akerlof, Gini coefficient, Glass-Steagall Act, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, Japanese asset price bubble, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, language acquisition, Large Hadron Collider, liberal capitalism, light touch regulation, Long Term Capital Management, long term incentive plan, Louis Pasteur, low cost airline, low interest rates, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, mass immigration, means of production, meritocracy, Mikhail Gorbachev, millennium bug, Money creation, money market fund, moral hazard, moral panic, mortgage debt, Myron Scholes, Neil Kinnock, new economy, Northern Rock, offshore financial centre, open economy, plutocrats, power law, price discrimination, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, Right to Buy, rising living standards, Robert Shiller, Ronald Reagan, Rory Sutherland, Satyajit Das, Savings and loan crisis, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, systems thinking, tail risk, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, three-masted sailing ship, too big to fail, unpaid internship, value at risk, Vilfredo Pareto, Washington Consensus, wealth creators, work culture , working poor, world market for maybe five computers, zero-sum game, éminence grise

This will help to build more contrariness into the system’s DNA, but we should go further. We need to create a diverse range of banking business models, to replace a world in which banks play cat and mouse with each other through their proprietary trading desks in a zero-sum game of trying to catch each other out by betting on future derivative prices – in effect, gambling deposits in a volatile market. Paul Volcker suggests that deposit-taking banks should be prohibited from using that capital to support their proprietary trading operations, thereby separating the two operations. If this is done, banks will have to develop business models in which they grow their balance sheets and lending not through trading in derivatives, but by lending to businesses and consumers.

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British bankers took the opportunity afforded by the abolition of exchange and capital controls, globalisation, Britain’s historic strength in financial services and the prevailing free-market ideology to build a position of influence in the British state that was much more formidable than any that had been enjoyed by the trade unions. The City reclaimed ancient privileges to restore its nineteenth-century position as an international financial centre, although this was now built upon proprietary trading in financial derivatives and securitisation. This was the purposeful, positive use of power to achieve a feasible aim – a dominant City of London. Light-touch regulation became as important a mantra to the City as free collective bargaining had been to the unions. Equally, the freedom to exploit tax havens and relieve foreign nationals from their tax obligations was as pivotal to City power as the unions’ insistence on legal immunity from damages in industrial disputes had been to theirs.

How Money Became Dangerous by Christopher Varelas

activist fund / activist shareholder / activist investor, Airbnb, airport security, barriers to entry, basic income, Bear Stearns, Big Tech, bitcoin, blockchain, Bonfire of the Vanities, California gold rush, cashless society, corporate raider, crack epidemic, cryptocurrency, discounted cash flows, disintermediation, diversification, diversified portfolio, do well by doing good, Donald Trump, driverless car, dumpster diving, eat what you kill, fiat currency, financial engineering, fixed income, friendly fire, full employment, Gordon Gekko, greed is good, initial coin offering, interest rate derivative, John Meriwether, junk bonds, Kickstarter, Long Term Capital Management, low interest rates, mandatory minimum, Mary Meeker, Max Levchin, Michael Milken, mobile money, Modern Monetary Theory, mortgage debt, Neil Armstrong, pensions crisis, pets.com, pre–internet, profit motive, proprietary trading, risk tolerance, Saturday Night Live, selling pickaxes during a gold rush, shareholder value, side project, Silicon Valley, Steve Jobs, technology bubble, The Predators' Ball, too big to fail, universal basic income, zero day

Meriwether was one of the most powerful people at the firm, vice chairman of the board and the head of the high-stakes proprietary trading operation. While most salesmen and traders worked for the clients and collected commissions on those deals, Meriwether and his proprietary traders used the firm’s own capital to take positions on behalf of the firm. They were operating on a much larger scale than other traders; essentially, Salomon became its own biggest customer. The most often used analogy was that of a Vegas casino: The basic commission trading for clients resembled a sea of slot machines, steadily accruing profits, coin by coin; proprietary trading, however, was similar to the “whale” gambling alone at a blackjack table, betting a giant stack on every hand.

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If Meriwether bet right, Salomon Brothers had a great quarter. If not, Salomon had a bad quarter, regardless of sales and trading revenues. While the client-and-commission operation was necessary in order to create and maintain the firm’s trillion-dollar balance sheet, the biggest action by far was happening with Meriwether’s proprietary trading. Meriwether lobbied successfully for a change to the pay structure in the late 1980s, marching into Gutfreund’s office and arguing that since his team was making many times more money for the firm than anyone else, their compensation should reflect that profitability. Gutfreund acquiesced, and, with the knowledge of only two of the other nine members of the executive committee, he allowed Meriwether’s team to collect bonuses of 15 percent of what they made for the firm, while other departments split a much more modest bonus pool.

Capitalism: Money, Morals and Markets by John Plender

activist fund / activist shareholder / activist investor, Alan Greenspan, Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, Black Swan, bond market vigilante , bonus culture, Bretton Woods, business climate, business cycle, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, Cornelius Vanderbilt, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial engineering, financial innovation, financial intermediation, Fractional reserve banking, full employment, Glass-Steagall Act, God and Mammon, Golden arches theory, Gordon Gekko, greed is good, Hyman Minsky, income inequality, industrial research laboratory, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, labour market flexibility, liberal capitalism, light touch regulation, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, mass immigration, means of production, Menlo Park, money market fund, moral hazard, moveable type in China, Myron Scholes, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Paul Samuelson, plutocrats, price stability, principal–agent problem, profit motive, proprietary trading, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, Veblen good, We are the 99%, Wolfgang Streeck, zero-sum game

Their counterparts in the US face much tougher jail sentences and tend to show more humility, or reveal new-found religious belief, when they come out.130 Today, much of the financial speculation that goes on has become institutionalised in the banking system. From the early 1980s, big banks moved from being deposit takers and lenders to holding conglomerate status with substantial trading operations. These mega-banks started to sell most of the loans they initiated in packaged form to investors and to run large proprietary trading departments to take bets in the markets for their own account. Andrew Haldane of the Bank of England has estimated that the share of the major global banks’ assets held in their trading books doubled between 2000 and 2007 from 20 per cent to 40 per cent. The growth especially of trading in derivative instruments and structured products such as collateralised debt obligations and credit default swaps has been spectacular.

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When all this trading came to grief as the financial world came crashing down in 2007–09 and the biggest banks had to be bailed out by the taxpayer, the Jeffersonian antipathy for finance naturally enjoyed a vigorous new lease of life, leading to the greatest re-regulatory effort since the 1930s, an effort that included attempts to curb the banks’ proprietary trading. Yet the battle between the politicians and the banks is uneven, because Big Money in the US pays for politicians’ campaign finance. No sooner was the reforming Dodd–Frank Act placed on the statute book than an army of politicians, with wads of money from Wall Street in their back pockets, worked strenuously to dismantle it.

Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb

Alan Greenspan, Antoine Gombaud: Chevalier de Méré, availability heuristic, backtesting, behavioural economics, Benoit Mandelbrot, Black Swan, commoditize, complexity theory, corporate governance, corporate raider, currency peg, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, endowment effect, equity premium, financial engineering, fixed income, global village, hedonic treadmill, hindsight bias, junk bonds, Kenneth Arrow, Linda problem, Long Term Capital Management, loss aversion, mandelbrot fractal, Mark Spitznagel, Market Wizards by Jack D. Schwager, mental accounting, meta-analysis, Michael Milken, Myron Scholes, PalmPilot, Paradox of Choice, Paul Samuelson, power law, proprietary trading, public intellectual, quantitative trading / quantitative finance, QWERTY keyboard, random walk, Richard Feynman, risk free rate, road to serfdom, Robert Shiller, selection bias, shareholder value, Sharpe ratio, Steven Pinker, stochastic process, survivorship bias, too big to fail, Tragedy of the Commons, Turing test, Yogi Berra

Indeed Nero’s extensive social life includes almost no businesspeople. But unlike me (I can be extremely humiliating when someone rubs me the wrong way with inelegant pompousness), Nero handles himself with gentle aloof-ness in these circumstances. So, Nero switched careers to what is called proprietary trading. Traders are set up as independent entities, internal funds with their own allocation of capital. They are left alone to do as they please, provided of course that their results satisfy the executives. The name proprietary comes from the fact that they trade the company’s own capital. At the end of the year they receive between 7% and 12% of the profits generated.

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Treasury bonds are safe; they are issued by the United States government, and governments can hardly go bankrupt since they can freely print their own currency to pay back their obligation. No Work Ethics Today, at thirty-nine, after fourteen years in the business, he can consider himself comfortably settled. His personal portfolio contains several million dollars in medium-maturity Treasury bonds, enough to eliminate any worry about the future. What he likes most about proprietary trading is that it requires considerably less time than other high-paying professions; in other words it is perfectly compatible with his non-middle-class work ethic. Trading forces someone to think hard; those who merely work hard generally lose their focus and intellectual energy. In addition, they end up drowning in randomness; work ethics, Nero believes, draw people to focus on noise rather than the signal (the difference we established in Table P.1).

The Hidden Wealth of Nations: The Scourge of Tax Havens by Gabriel Zucman, Teresa Lavender Fagan, Thomas Piketty

Berlin Wall, Bretton Woods, British Empire, Capital in the Twenty-First Century by Thomas Piketty, dematerialisation, Fall of the Berlin Wall, financial innovation, financial intermediation, high net worth, income inequality, means of production, new economy, offshore financial centre, proprietary trading, transfer pricing

In all likelihood, a loss of €15 billion would be enough to force Switzerland to cooperate truthfully, because it is a sum comparable to what it earns in total by managing the wealth of tax evaders. According to official statistics, the financial sector represents around 11% of Switzerland’s GDP. But private wealth-management activities strictly speaking account for only 4%. The rest corresponds to the activity of insurers and other banking businesses, loans, proprietary trading, and so on. Furthermore, the wealth managed by Swiss banks is not all hidden—that of the Swiss is for the most part indeed declared—so that tax evasion scarcely brings in more than 3% of the GDP (around 1% of the total amount of undeclared assets managed by the banks), or €15 billion per year.

The Road to Ruin: The Global Elites' Secret Plan for the Next Financial Crisis by James Rickards

"World Economic Forum" Davos, Affordable Care Act / Obamacare, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Bayesian statistics, Bear Stearns, behavioural economics, Ben Bernanke: helicopter money, Benoit Mandelbrot, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, bitcoin, Black Monday: stock market crash in 1987, Black Swan, blockchain, Boeing 747, Bonfire of the Vanities, Bretton Woods, Brexit referendum, British Empire, business cycle, butterfly effect, buy and hold, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, cellular automata, cognitive bias, cognitive dissonance, complexity theory, Corn Laws, corporate governance, creative destruction, Credit Default Swap, cuban missile crisis, currency manipulation / currency intervention, currency peg, currency risk, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, debt deflation, Deng Xiaoping, disintermediation, distributed ledger, diversification, diversified portfolio, driverless car, Edward Lorenz: Chaos theory, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, fiat currency, financial repression, fixed income, Flash crash, floating exchange rates, forward guidance, Fractional reserve banking, G4S, George Akerlof, Glass-Steagall Act, global macro, global reserve currency, high net worth, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Isaac Newton, jitney, John Meriwether, John von Neumann, Joseph Schumpeter, junk bonds, Kenneth Rogoff, labor-force participation, large denomination, liquidity trap, Long Term Capital Management, low interest rates, machine readable, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, Minsky moment, Money creation, money market fund, mutually assured destruction, Myron Scholes, Naomi Klein, nuclear winter, obamacare, offshore financial centre, operational security, Paul Samuelson, Peace of Westphalia, Phillips curve, Pierre-Simon Laplace, plutocrats, prediction markets, price anchoring, price stability, proprietary trading, public intellectual, quantitative easing, RAND corporation, random walk, reserve currency, RFID, risk free rate, risk-adjusted returns, Robert Solow, Ronald Reagan, Savings and loan crisis, Silicon Valley, sovereign wealth fund, special drawing rights, stock buybacks, stocks for the long run, tech billionaire, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transfer pricing, value at risk, Washington Consensus, We are all Keynesians now, Westphalian system

In 1996, near the height of LTCM’s profits and praise, JPMorgan offered to buy a 50 percent interest in LTCM for $5 billion, a reasonable price considering the management company was making more than $300 million per year in management fees alone. JPMorgan also calculated its ownership position would give it preferred status as an investor, and the opportunity to reap proprietary trading profits. This offer was rejected. In the words of one LTCM partner, “If we’re worth so much money, why would we sell?” This rejection was hubris. If the partners had sold, LTCM would have been part of JPMorgan when the 1998 crisis hit. JPMorgan would have saved LTCM to protect its own reputation.

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Dodd-Frank was more than one thousand pages long in its final form, and was scarcely read by members of Congress who voted on it. Dodd-Frank was an odd mix of genuine reform, pseudo-reform, dereliction, and nonessential matter from lobbyist wish lists. Some Dodd-Frank provisions, including increased capital requirements for banks, and the Volcker Rule, which limited certain forms of proprietary trading, were useful if limited steps in the direction of a safer financial system. The most overhyped provision was “orderly liquidation” authority. In theory, this was a roadmap to wind down failing too-big-to-fail banks without the chaos of the 2008 Lehman collapse and ad hoc bank bailouts. In practice, orderly liquidation is another Washington confection that will break the minute it is tested under real panic conditions.

The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution by Gregory Zuckerman

affirmative action, Affordable Care Act / Obamacare, Alan Greenspan, Albert Einstein, Andrew Wiles, automated trading system, backtesting, Bayesian statistics, Bear Stearns, beat the dealer, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black Monday: stock market crash in 1987, blockchain, book value, Brownian motion, butter production in bangladesh, buy and hold, buy low sell high, Cambridge Analytica, Carl Icahn, Claude Shannon: information theory, computer age, computerized trading, Credit Default Swap, Daniel Kahneman / Amos Tversky, data science, diversified portfolio, Donald Trump, Edward Thorp, Elon Musk, Emanuel Derman, endowment effect, financial engineering, Flash crash, George Gilder, Gordon Gekko, illegal immigration, index card, index fund, Isaac Newton, Jim Simons, John Meriwether, John Nash: game theory, John von Neumann, junk bonds, Loma Prieta earthquake, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, Mark Zuckerberg, Michael Milken, Monty Hall problem, More Guns, Less Crime, Myron Scholes, Naomi Klein, natural language processing, Neil Armstrong, obamacare, off-the-grid, p-value, pattern recognition, Peter Thiel, Ponzi scheme, prediction markets, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, Robert Mercer, Ronald Reagan, self-driving car, Sharpe ratio, Silicon Valley, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, Steve Bannon, Steve Jobs, stochastic process, the scientific method, Thomas Bayes, transaction costs, Turing machine, Two Sigma

Once, when a new colleague approached to introduce himself, Tartaglia immediately cut him off. “Don’t try to get anything by me because I come from out there,” Tartaglia said, pointing a finger at a nearby window and the streets of New York City.9 Tartaglia renamed his group Automated Proprietary Trading, or APT, and moved it to a forty-foot-long room on the nineteenth floor of Morgan Stanley’s headquarters in a midtown Manhattan skyscraper. He added more automation to the system and, by 1987, it was generating $50 million of annual profits. Team members didn’t know a thing about the stocks they traded and didn’t need to—their strategy was simply to wager on the re-emergence of historic relationships between shares, an extension of the age-old “buy low, sell high” investment adage, this time using computer programs and lightning-fast trades.

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., 28 Alphabet, 272–73 alternative data, 311–12 “alt-right,” 278–79, 290 Amazon.com, 134 Ambrose, Warren, 15 America First Committee, 282 American Museum of Natural History, 303 anchoring, 152 Animal Farm (Orwell), xvi anti-Semitism, 46, 185, 303 Apple Computer, 89, 166 AQR Capital Management, 256–57 arbitrage. See Statistical arbitrage Archimedes (yacht), 267, 320 Armstrong, Neil, 170 Artin, Emil, 69 Asness, Clifford, 256–57 Association for Computing Machinery (ACM), 37 astrology, 121–22 autism, xviii, 268, 287, 323–24 Automated Proprietary Trading (APT), 131–32, 133 AWK, 233–34 Ax, Frances, 98 Ax, James, xi, 37, 68–69, 324 at Axcom Limited, 78–83 backgammon, 69, 76–77 background of, 68–69 at Berkeley, 68–69 Berlekamp and, 95–102 conspiracy theories of, 77–78, 99 at Cornell, 69, 70–71 death of, 103 focus on mathematics, 69–70 at Monemetrics, 51–52, 72–73 personality of, 68, 70, 71–72, 98–99 Simons and, 34, 68–69, 99–103, 107 at Stony Brook, 34, 71–72 trading models, 73, 74–75, 77–78, 81–86, 95–101, 107 Axcom Limited, 78–83 disbanding of, 118 trading models, 95–101, 107–18 Ax-Kochen theorem, 69, 70, 103 Bachelier, Louis, 128 backgammon, 69, 76–77 backtesting, 3 Bacon, Louis, 140 Baker House, 15–16 Baltimore City Fire and Police Employees’ Retirement System, 299–300 Bamberger, Gerry, 129–30 BankAmerica Corporation, 212 Bannon, Steve, 279, 280, 280n break with Mercers, 304 at Breitbart, 278–79, 299–300, 301–2 midterm elections of 2018, 304 presidential election of 2016, xviii, 281–82, 284–85, 288–90, 293, 294–95 Barclays Bank, 225, 259 bars, 143–44 Barton, Elizabeth, 272 basket options, 225–27 Baum, Julia Lieberman, 46, 48, 50, 62–63, 65 Baum, Leonard “Lenny,” xi, 45–46, 63–66 background of, 46 currency trading, 28–29, 49–53, 54–60, 62–64, 73 death of, 66 at Harvard, 46 at IDA, 25, 28–29, 46–49, 81 at Monemetrics, 45, 49–60, 63–65 move to Bermuda, 64–65 rift with Simons, 63–65 trading debacle of 1984, 65, 66 Baum, Morris, 46 Baum, Stefi, 48, 62, 63 Baum–Welch algorithm, 47–48, 174, 179 Bayes, Thomas, 174 Bayesian probability, 148, 174 Beane, Billy, 308 Beat the Dealer (Thorp), 127, 163 Beautiful Mind, A (Nasar), 90 behavioral economics, 152, 153 Bell Laboratories, 91–92 Belopolsky, Alexander, 233, 238, 241, 242, 252–54 Bent, Bruce, 173 Berkeley Quantitative, 118 Berkshire Hathaway, 265, 309, 333 Berlekamp, Elwyn, xi at Axcom, 94–97, 102–3, 105–18 background of, 87–90 at Bell Labs, 91–92 at Berkeley, 92–93, 95, 115, 118, 272 at Berkeley Quantitative, 118 death of, 118 at IDA, 93–94 Kelly formula and, 91–92, 96, 127 at MIT, 89–91 Simons and, 2–3, 4, 93–95, 109–10, 113–14, 116–18, 124 trading models and strategies, 2–3, 4, 95–98, 106–18, 317 Berlekamp, Jennifer Wilson, 92 Berlekamp, Waldo, 87–88 Berlin Wall, 164 Bermuda, 64–65, 254 Bernard L.

Reset by Ronald J. Deibert

23andMe, active measures, air gap, Airbnb, Amazon Web Services, Anthropocene, augmented reality, availability heuristic, behavioural economics, Bellingcat, Big Tech, bitcoin, blockchain, blood diamond, Brexit referendum, Buckminster Fuller, business intelligence, Cal Newport, call centre, Cambridge Analytica, carbon footprint, cashless society, Citizen Lab, clean water, cloud computing, computer vision, confounding variable, contact tracing, contact tracing app, content marketing, coronavirus, corporate social responsibility, COVID-19, crowdsourcing, data acquisition, data is the new oil, decarbonisation, deep learning, deepfake, Deng Xiaoping, disinformation, Donald Trump, Doomsday Clock, dual-use technology, Edward Snowden, Elon Musk, en.wikipedia.org, end-to-end encryption, Evgeny Morozov, failed state, fake news, Future Shock, game design, gig economy, global pandemic, global supply chain, global village, Google Hangouts, Great Leap Forward, high-speed rail, income inequality, information retrieval, information security, Internet of things, Jaron Lanier, Jeff Bezos, John Markoff, Lewis Mumford, liberal capitalism, license plate recognition, lockdown, longitudinal study, Mark Zuckerberg, Marshall McLuhan, mass immigration, megastructure, meta-analysis, military-industrial complex, move fast and break things, Naomi Klein, natural language processing, New Journalism, NSO Group, off-the-grid, Peter Thiel, planetary scale, planned obsolescence, post-truth, proprietary trading, QAnon, ransomware, Robert Mercer, Sheryl Sandberg, Shoshana Zuboff, Silicon Valley, single source of truth, Skype, Snapchat, social distancing, sorting algorithm, source of truth, sovereign wealth fund, sparse data, speech recognition, Steve Bannon, Steve Jobs, Stuxnet, surveillance capitalism, techlash, technological solutionism, the long tail, the medium is the message, The Structural Transformation of the Public Sphere, TikTok, TSMC, undersea cable, unit 8200, Vannevar Bush, WikiLeaks, zero day, zero-sum game

For example, in 2019 Mesa, Arizona, made a deal with Google to permit construction of a massive server farm that would guarantee up to four million gallons for cooling purposes.361 While Google has made significant public strides to “green” its server farms and other processes, the company considers its water use a proprietary trade secret and typically forbids public officials from disclosing its water consumption.362 Greenpeace has closely studied the environmental consequences of cloud computing, and in 2017 they published an extensive ranking of social media platforms on the basis of their environmental sustainability efforts.363 Many companies, including Google (notwithstanding its water consumption), Facebook, and Microsoft have made significant improvements in recent years, either offsetting or directly powering their operations with 100 percent clean energy, and investing in server farms in areas like Iceland, where there is plentiful access to cool water and low temperatures.

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Retrieved from https://eta.lbl.gov/publications/united-states-data-center-energy Mesa, Arizona, made a deal with Google to permit construction of a massive server farm: Mesa Council, Board, and Committee Research Center. (2019, July 1). Resolution 19-0809. Retrieved from http://mesa.legistar.com/LegislationDetail.aspx?ID=3998203&GUID=FC6B9CE4-208A-4AC1-AB2A-40255C1E9F74 Google … considers its water use a proprietary trade secret: Sattiraju, N. (2020, April 1). Google data centers’ secret cost: Billions of gallons of water. Retrieved from https://www.bloomberg.com/news/features/2020-04-01/how-much-water-do-google-data-centers-use-billions-of-gallons An extensive ranking of social media platforms: Cook, G. (2017).

Site Reliability Engineering: How Google Runs Production Systems by Betsy Beyer, Chris Jones, Jennifer Petoff, Niall Richard Murphy

"Margaret Hamilton" Apollo, Abraham Maslow, Air France Flight 447, anti-pattern, barriers to entry, business intelligence, business logic, business process, Checklist Manifesto, cloud computing, cognitive load, combinatorial explosion, continuous integration, correlation does not imply causation, crowdsourcing, database schema, defense in depth, DevOps, en.wikipedia.org, exponential backoff, fail fast, fault tolerance, Flash crash, George Santayana, Google Chrome, Google Earth, if you see hoof prints, think horses—not zebras, information asymmetry, job automation, job satisfaction, Kubernetes, linear programming, load shedding, loose coupling, machine readable, meta-analysis, microservices, minimum viable product, MVC pattern, no silver bullet, OSI model, performance metric, platform as a service, proprietary trading, reproducible builds, revision control, risk tolerance, side project, six sigma, the long tail, the scientific method, Toyota Production System, trickle-down economics, warehouse automation, web application, zero day

This industry is characterized by a relentless focus on safety, because the extremes of temperature and pressure demands of the process pose a high level of danger to workers on a daily basis. John Li is currently a Site Reliability Engineer at Google. John previously worked as a systems administrator and software developer at a proprietary trading company in the finance industry. Reliability issues in the financial sector are taken quite seriously because they can lead to serious fiscal consequences. Dan Sheridan is a Site Reliability Engineer at Google. Before joining the company, he worked as a safety consultant in the civil nuclear industry in the UK.

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The nuclear Navy was also concerned that automation and computers move so rapidly that they are all too capable of committing a large, irreparable mistake. When you are dealing with nuclear reactors, a slow and steady methodical approach is more important than accomplishing a task quickly. According to John Li, the proprietary trading industry has become increasingly cautious in its application of automation in recent years. Experience has shown that incorrectly configured automation can inflict significant damage and incur a great deal of financial loss in a very short period of time. For example, in 2012 Knight Capital Group encountered a “software glitch” that led to a loss of $440M in just a few hours.7 Similarly, in 2010 the US stock market experienced a Flash Crash that was ultimately blamed on a rogue trader attempting to manipulate the market with automated means.

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These industries regularly conduct controlled experiments to make sure that a given change yields the expected result at a statistically significant level and that nothing unexpected occurs. Changes are only implemented when data yielded by the experiment supports the decision. Finally, some industries, like proprietary trading, divide decision making to better manage risk. According to John Li, this industry features an enforcement team separate from the traders to ensure that undue risks aren’t taken in pursuit of achieving a profit. The enforcement team is responsible for monitoring events on the floor and halting trading if events spin out of hand.

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", "there is no alternative" (TINA), "World Economic Forum" Davos, affirmative action, Alan Greenspan, Albert Einstein, algorithmic trading, Andy Kessler, AOL-Time Warner, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, book value, Bretton Woods, BRICs, British Empire, business cycle, buy the rumour, sell the news, capital asset pricing model, carbon credits, Carl Icahn, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, Daniel Kahneman / Amos Tversky, deal flow, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Dr. Strangelove, Dutch auction, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Fall of the Berlin Wall, financial engineering, financial independence, financial innovation, financial thriller, fixed income, foreign exchange controls, full employment, Glass-Steagall Act, global reserve currency, Goldman Sachs: Vampire Squid, Goodhart's law, Gordon Gekko, greed is good, Greenspan put, happiness index / gross national happiness, haute cuisine, Herman Kahn, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", job automation, Johann Wolfgang von Goethe, John Bogle, John Meriwether, joint-stock company, Jones Act, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market bubble, market fundamentalism, Market Wizards by Jack D. Schwager, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Michael Milken, Mikhail Gorbachev, Milgram experiment, military-industrial complex, Minsky moment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, National Debt Clock, negative equity, NetJets, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, Phillips curve, planned obsolescence, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, proprietary trading, public intellectual, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, Reminiscences of a Stock Operator, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Thaler, Right to Buy, risk free rate, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, short squeeze, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, stock buybacks, survivorship bias, tail risk, Teledyne, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, two and twenty, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game

The much-touted Volcker rule, limiting the ability of banks to trade with client money, emerged riddled with loopholes, most notably allowing banks to take positions where they are trading securities and instruments with or for clients. Reviewing the legislation, a leading derivative lawyer told banks: “Given so much of proprietary trading has a client nexus to it, I’ll be embarrassed if I don’t manage to exempt all your activities from the rule.” Large banks promptly shut down their proprietary trading desks, transferring traders to client-focused market-making operations where they continue to trade as before. Legislators and regulators discovered that Groucho Marx was right: “[government] is the art of looking for trouble, finding it, misdiagnosing it and then misapplying the wrong remedies.”

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Regulatory Dialectic Regulators and economists, who contributed to the crisis, offered solutions, confirming Goethe’s observation: “There is nothing more frightening than ignorance in action.” Regulatory initiatives relied on self-confidence, which Samuel Johnson observed is “the first requisite to great undertakings.” Former Fed Chairman Paul Volcker put his name to restrictions on banks trading on their own account or investing in hedge or private equity funds. Proprietary trading is hard to define. Testifying to Congress, Volcker indicated elliptically that bankers knew whether they were trading on proprietary account, recalling U.S. Supreme Court Justice Potter Stewart’s statement that while it was hard to define, he knew pornography when he saw it. Hitherto little-known Arkansas Democratic Senator Blanche Lincoln and her Committee on Agriculture, Nutrition, and Forestry controversially proposed that banks spin off their derivative activities and be prevented from hedging their own genuine risks.

Hedge Fund Market Wizards by Jack D. Schwager

asset-backed security, backtesting, banking crisis, barriers to entry, Bear Stearns, beat the dealer, Bernie Madoff, Black-Scholes formula, book value, British Empire, business cycle, buy and hold, buy the rumour, sell the news, Claude Shannon: information theory, clean tech, cloud computing, collateralized debt obligation, commodity trading advisor, computerized trading, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, diversification, diversified portfolio, do what you love, Edward Thorp, family office, financial independence, fixed income, Flash crash, global macro, hindsight bias, implied volatility, index fund, intangible asset, James Dyson, Jones Act, legacy carrier, Long Term Capital Management, managed futures, margin call, market bubble, market fundamentalism, Market Wizards by Jack D. Schwager, merger arbitrage, Michael Milken, money market fund, oil shock, pattern recognition, pets.com, Ponzi scheme, private sector deleveraging, proprietary trading, quantitative easing, quantitative trading / quantitative finance, Reminiscences of a Stock Operator, Right to Buy, risk free rate, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Rubik’s Cube, Savings and loan crisis, Sharpe ratio, short selling, statistical arbitrage, Steve Jobs, systematic trading, technology bubble, transaction costs, value at risk, yield curve

As a specialist, Benedict gained some much needed experience and developed a feel for the markets. When volume in the XMI started to dry up three years later, Benedict became an off-the-floor index derivatives trader for SLK. In 1993, Benedict’s success as a trader led to his being named the Special Limited Partner for SLK’s newly created proprietary trading department. After Goldman Sachs purchased SLK in 2000, Benedict left to start his own trading firm, Banyan Equity Management. A trading friend describes Benedict’s skill in the market as follows: “He has ‘ it.’ It’s hard to describe it. Why does Ichiro Suzuki repeatedly hit 350? I don’t know.

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Woodriff was frustrated by his inability to raise substantial assets, the 20 percent drawdown from the 1997 high, and most of all by the fact that running the CTA business in addition to trading left him with no time to pursue his true career passion: predictive modeling. Woodriff decided he might do better seeking a proprietary trading job in New York. He returned the remaining assets to his investors, closed Woodriff Trading, and moved to New York to search for a job. A friend of Woodriff had an uncle who was a highly prominent hedge fund manager. On her own volition, she arranged for Woodriff to interview with the president of the firm.

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I said, “I will leave you with one bit of parting advice. You are too old. You’re killing your own business. Get out.” He said, “I think you are right.” How did you think he was killing the business? Like any entrepreneur who starts a business, he was holding on too tight. They have been doing proprietary trading for 25 years and have never had a losing year. Despite that track record, they have missed the entire growth in asset management. They have had no hedge fund business through the entire hedge fund era. He was getting too old to take risks, and he admitted it himself. In the end, I agreed to become a managing member of First New York Securities.

Valuation: Measuring and Managing the Value of Companies by Tim Koller, McKinsey, Company Inc., Marc Goedhart, David Wessels, Barbara Schwimmer, Franziska Manoury

accelerated depreciation, activist fund / activist shareholder / activist investor, air freight, ASML, barriers to entry, Basel III, Black Monday: stock market crash in 1987, book value, BRICs, business climate, business cycle, business process, capital asset pricing model, capital controls, Chuck Templeton: OpenTable:, cloud computing, commoditize, compound rate of return, conceptual framework, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, currency risk, discounted cash flows, distributed generation, diversified portfolio, Dutch auction, energy security, equity premium, equity risk premium, financial engineering, fixed income, index fund, intangible asset, iterative process, Long Term Capital Management, low interest rates, market bubble, market friction, Myron Scholes, negative equity, new economy, p-value, performance metric, Ponzi scheme, price anchoring, proprietary trading, purchasing power parity, quantitative easing, risk free rate, risk/return, Robert Shiller, Savings and loan crisis, shareholder value, six sigma, sovereign wealth fund, speech recognition, stocks for the long run, survivorship bias, technology bubble, time value of money, too big to fail, transaction costs, transfer pricing, two and twenty, value at risk, yield curve, zero-coupon bond

Therefore, it is all the more important for anyone valuing a bank to understand the business activities undertaken by banks, the ways in which banks create value, and the drivers of that value creation. Universal banks may engage in any or all of a wide variety of business activities, including lending and borrowing, underwriting and placement of securities, payment services, asset management, proprietary trading, and brokerage. For the purpose of financial analysis and valuation, we group these activities according to the three types of income they generate for a bank: net interest income, fee and commission income, and trading income. “Other income” forms a fourth and generally smaller residual category of income from activities unrelated to the main banking businesses.

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For investment banks (such as Morgan Stanley) and for universal banks with large investment banking activities (among them HSBC, Bank of America, and Deutsche Bank), commission and fee income makes up around half of total net revenues. Fee income is usually easier to understand than net interest income, as it is independent of financing. However, some forms of fee income are highly cyclical; examples include fees from underwriting and transaction advisory services. Trading Income Over the past 30 years, proprietary trading emerged as a third main category of income for the banking sector as a whole. This can involve not only a wide variety of instruments traded on exchanges and over the counter, such as equity stocks, bonds, and foreign exchange, but also more exotic products, such as credit default swaps and asset-backed debt obligations, traded mostly over the counter. 760 BANKS Trading profits tend to be highly volatile: gains made over several years may be wiped out by large losses in a single year, as the credit crisis painfully illustrated.

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This can involve not only a wide variety of instruments traded on exchanges and over the counter, such as equity stocks, bonds, and foreign exchange, but also more exotic products, such as credit default swaps and asset-backed debt obligations, traded mostly over the counter. 760 BANKS Trading profits tend to be highly volatile: gains made over several years may be wiped out by large losses in a single year, as the credit crisis painfully illustrated. These activities have also attracted considerable attention in the wake of the crisis. In 2010, the United States adopted legislation preventing banks from engaging in proprietary trading for their own profit.3 This resulted in steeply lower overall trading income, as the law permits only trading related to serving the bank’s customers. Similar restrictions were adopted in Europe, and though they have not yet been enforced there, trading income for European banks has sharply declined since 2008.

What's Next?: Unconventional Wisdom on the Future of the World Economy by David Hale, Lyric Hughes Hale

"World Economic Forum" Davos, affirmative action, Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, Berlin Wall, biodiversity loss, Black Swan, Bretton Woods, business cycle, capital controls, carbon credits, carbon tax, Cass Sunstein, central bank independence, classic study, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, currency risk, Daniel Kahneman / Amos Tversky, debt deflation, declining real wages, deindustrialization, diversification, energy security, Erik Brynjolfsson, Fall of the Berlin Wall, financial engineering, financial innovation, floating exchange rates, foreign exchange controls, full employment, Gini coefficient, Glass-Steagall Act, global macro, global reserve currency, global village, high net worth, high-speed rail, Home mortgage interest deduction, housing crisis, index fund, inflation targeting, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), inverted yield curve, invisible hand, Just-in-time delivery, Kenneth Rogoff, Long Term Capital Management, low interest rates, Mahatma Gandhi, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, military-industrial complex, Money creation, money market fund, money: store of value / unit of account / medium of exchange, mortgage tax deduction, Network effects, new economy, Nicholas Carr, oil shale / tar sands, oil shock, open economy, passive investing, payday loans, peak oil, Ponzi scheme, post-oil, precautionary principle, price stability, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, risk/return, Robert Shiller, Ronald Reagan, Savings and loan crisis, sovereign wealth fund, special drawing rights, subprime mortgage crisis, technology bubble, The Great Moderation, Thomas Kuhn: the structure of scientific revolutions, Tobin tax, too big to fail, total factor productivity, trade liberalization, Tragedy of the Commons, Washington Consensus, Westphalian system, WikiLeaks, women in the workforce, yield curve

Compiling instructions that are detailed enough to be truly useful would be expensive for the firms and would require substantial disclosure of proprietary information. Regardless, any such unwinding process is apt to be very complicated as counterparties seek to protect their own interests. Another key battle was fought over the Volcker Rule. Named for the former Fed chairman’s crusade, the rule bars banks from proprietary trading and from directly sponsoring or investing in private equity or hedge funds. Initially, banks worried that this would hurt their profits, but the final version is riddled with exemptions that will allow most to continue with some minor reshuffling. Some parts of Dodd-Frank are benign, even favorable.

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PRODUCTION SHARING AGREEMENT: An arrangement between a government and a resource production company (or group of companies) that specifies what percentage of production the government is allowed to keep for its own use. PROPORTIONAL REPRESENTATION: A voting system that aims to secure a close match between the percentage of votes that groups of candidates obtain in elections and the percentage of seats they receive. PROPRIETARY TRADING: When a bank, brokerage, or other financial institution trades on its own account rather than on behalf of a customer. Often done for speculative purposes. PUBLIC SECTOR BORROWING REQUIREMENT: A term used in the United Kingdom to describe a government’s budget deficit in a given fiscal year.

Value of Everything: An Antidote to Chaos The by Mariana Mazzucato

"Friedman doctrine" OR "shareholder theory", activist fund / activist shareholder / activist investor, Affordable Care Act / Obamacare, Airbnb, Alan Greenspan, bank run, banks create money, Basel III, behavioural economics, Berlin Wall, Big bang: deregulation of the City of London, bonus culture, Bretton Woods, business cycle, butterfly effect, buy and hold, Buy land – they’re not making it any more, capital controls, Capital in the Twenty-First Century by Thomas Piketty, carbon tax, Carmen Reinhart, carried interest, clean tech, Corn Laws, corporate governance, corporate social responsibility, creative destruction, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, European colonialism, Evgeny Morozov, fear of failure, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, full employment, G4S, George Akerlof, Glass-Steagall Act, Google Hangouts, Growth in a Time of Debt, high net worth, Hyman Minsky, income inequality, independent contractor, index fund, informal economy, interest rate derivative, Internet of things, invisible hand, John Bogle, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour market flexibility, laissez-faire capitalism, light touch regulation, liquidity trap, London Interbank Offered Rate, low interest rates, margin call, Mark Zuckerberg, market bubble, means of production, military-industrial complex, Minsky moment, Money creation, money market fund, negative equity, Network effects, new economy, Northern Rock, obamacare, offshore financial centre, Pareto efficiency, patent troll, Paul Samuelson, peer-to-peer lending, Peter Thiel, Post-Keynesian economics, profit maximization, proprietary trading, quantitative easing, quantitative trading / quantitative finance, QWERTY keyboard, rent control, rent-seeking, Robert Solow, Sand Hill Road, shareholder value, sharing economy, short selling, Silicon Valley, Simon Kuznets, smart meter, Social Responsibility of Business Is to Increase Its Profits, software patent, Solyndra, stem cell, Steve Jobs, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Tobin tax, too big to fail, trade route, transaction costs, two and twenty, two-sided market, very high income, Vilfredo Pareto, wealth creators, Works Progress Administration, you are the product, zero-sum game

In 2010, five big US banks controlled over 96 per cent of the derivative contracts in place.26 In the UK, ten financial institutions accounted for 85 per cent of over-the-counter derivatives turnover in 2016, and 77 per cent of foreign exchange turnover.27 Only the biggest banks can take the risk of large-scale writing and trading in derivatives, since they need a comfortable cushion of equity between the value of their assets and liabilities to stay solvent if asset prices fall. Only a few banks worldwide have grown big enough to sustain the high risks of proprietary trading -trading on their own account rather than for a client - and to be worthy of state-supported rescue if the risks prove too great. As a result, there are few banks with whom governments and large corporations can place new bond or share issues and expect subsequent market-making in those securities.

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Buyout funds performance vs S&P 50045 The fund management industry naturally argues that the returns it can make - seeking ‘alpha' - for clients justify the fees it charges. In an influential article,46 Joanne Hill, a Goldman Sachs partner, identifies conditions in which trying to achieve alpha need not be a zero-sum game -conveniently showing that investment banks' proprietary trading might have some social and economic value. But these conditions include an assumption that the market is divided into traders with short- or long-term horizons, who are pursuing alpha over different time periods and measuring it against different benchmarks. Without this artificial separation, alpha is indeed zero-sum - and turns into a negative-sum game once active managers deduct the extra fees they must charge for selecting stocks rather than just buying them in proportion to the relevant index.

The Everything Store: Jeff Bezos and the Age of Amazon by Brad Stone

airport security, Amazon Mechanical Turk, Amazon Web Services, AOL-Time Warner, Apollo 11, bank run, Bear Stearns, Bernie Madoff, big-box store, Black Swan, book scanning, Brewster Kahle, buy and hold, call centre, centre right, Chuck Templeton: OpenTable:, Clayton Christensen, cloud computing, collapse of Lehman Brothers, crowdsourcing, cuban missile crisis, Danny Hillis, deal flow, Douglas Hofstadter, drop ship, Elon Musk, facts on the ground, fulfillment center, game design, housing crisis, invention of movable type, inventory management, James Dyson, Jeff Bezos, John Markoff, junk bonds, Kevin Kelly, Kiva Systems, Kodak vs Instagram, Larry Ellison, late fees, loose coupling, low skilled workers, Maui Hawaii, Menlo Park, Neal Stephenson, Network effects, new economy, off-the-grid, optical character recognition, PalmPilot, pets.com, Ponzi scheme, proprietary trading, quantitative hedge fund, reality distortion field, recommendation engine, Renaissance Technologies, RFID, Rodney Brooks, search inside the book, shareholder value, Silicon Valley, Silicon Valley startup, six sigma, skunkworks, Skype, SoftBank, statistical arbitrage, Steve Ballmer, Steve Jobs, Steven Levy, Stewart Brand, the long tail, Thomas L Friedman, Tony Hsieh, two-pizza team, Virgin Galactic, Whole Earth Catalog, why are manhole covers round?, zero-sum game

The broader financial community knew very little about D. E. Shaw, and its polymath founder wanted to keep it that way. The firm preferred operating far below the radar, deploying private capital from wealthy investors such as billionaire financier Donald Sussman and the Tisch family, and keeping its proprietary trading algorithms out of competitors’ hands. Shaw felt strongly that if DESCO was going to be a firm that pioneered new approaches to investing, the only way to maintain its lead was to keep its insights secret and avoid teaching competitors how to think about these new computer-guided frontiers. David Shaw came of age in the dawning era of powerful new supercomputers.

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So in 1994, when the opportunity of the Internet began to reveal itself to the few people watching closely, Shaw felt that his company was uniquely positioned to exploit it. And the person he anointed to spearhead the effort was Jeff Bezos. D. E. Shaw was ideally situated to take advantage of the Internet. Most Shaw employees had, instead of proprietary trading terminals, Sun workstations with Internet access, and they utilized early Internet tools like Gopher, Usenet, e-mail, and Mosaic, one of the first Web browsers. To write documents, they used an academic formatting tool called LaTeX, though Bezos refused to touch the program, claiming it was unnecessarily complicated.

Transaction Man: The Rise of the Deal and the Decline of the American Dream by Nicholas Lemann

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, Abraham Maslow, Affordable Care Act / Obamacare, Airbnb, airline deregulation, Alan Greenspan, Albert Einstein, augmented reality, basic income, Bear Stearns, behavioural economics, Bernie Sanders, Black-Scholes formula, Blitzscaling, buy and hold, capital controls, Carl Icahn, computerized trading, Cornelius Vanderbilt, corporate governance, cryptocurrency, Daniel Kahneman / Amos Tversky, data science, deal flow, dematerialisation, diversified portfolio, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, Fairchild Semiconductor, financial deregulation, financial innovation, fixed income, future of work, George Akerlof, gig economy, Glass-Steagall Act, Henry Ford's grandson gave labor union leader Walter Reuther a tour of the company’s new, automated factory…, Ida Tarbell, index fund, information asymmetry, invisible hand, Irwin Jacobs, Joi Ito, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kickstarter, life extension, Long Term Capital Management, Mark Zuckerberg, Mary Meeker, mass immigration, means of production, Metcalfe’s law, Michael Milken, money market fund, Mont Pelerin Society, moral hazard, Myron Scholes, Neal Stephenson, new economy, Norman Mailer, obamacare, PalmPilot, Paul Samuelson, Performance of Mutual Funds in the Period, Peter Thiel, price mechanism, principal–agent problem, profit maximization, proprietary trading, prudent man rule, public intellectual, quantitative trading / quantitative finance, Ralph Nader, Richard Thaler, road to serfdom, Robert Bork, Robert Metcalfe, rolodex, Ronald Coase, Ronald Reagan, Sand Hill Road, Savings and loan crisis, shareholder value, short selling, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, Snow Crash, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, TaskRabbit, TED Talk, The Nature of the Firm, the payments system, the strength of weak ties, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, too big to fail, transaction costs, universal basic income, War on Poverty, white flight, working poor

Mack made it clear that Cruz, who had the title of president, was the person he had in mind to become his successor as chief executive. She was directly in charge of the part of Morgan Stanley that was responsible for managing risk on the trading desk. In late 2007 Morgan Stanley reported a $9.2 billion loss on a single trade—what Michael Lewis, in The Big Short, called “the single greatest proprietary trading loss in Wall Street history.” Derivatives may have been designed by mathematicians, physicists, and economists, but they were bought and sold by people like Howie Hubler, a blustery former college football player who was Morgan Stanley’s number one trader at the time: his team generated a billion dollars in profits in 2006.

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One former Morgan Stanley executive: Author’s interview with Anson Beard. Do we buy it, or do we sell it?: Author’s interview with Richard Bookstaber. “A key driver”: Patricia Beard, Blue Blood and Mutiny, 335. Mack remembers calling Timothy Geithner: Author’s interview with John Mack. “the single greatest proprietary trading loss”: Michael Lewis, The Big Short: Inside the Doomsday Machine, W. W. Norton, 215. Morgan Stanley had $178 billion in readily available capital: Books with useful material about Morgan Stanley during the financial crisis include Henry M. Paulson, Jr., On the Brink: Inside the Race to Stop the Collapse of the Global Financial System, Business Plus, 2010; Andrew Ross Sorkin: Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves, Penguin, 2010; and The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, Public Affairs, 2011.

The Making of Global Capitalism by Leo Panitch, Sam Gindin

accounting loophole / creative accounting, active measures, airline deregulation, Alan Greenspan, anti-communist, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Basel III, Bear Stearns, Big bang: deregulation of the City of London, bilateral investment treaty, book value, Branko Milanovic, Bretton Woods, BRICs, British Empire, business cycle, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, carbon credits, Carmen Reinhart, central bank independence, classic study, collective bargaining, continuous integration, corporate governance, creative destruction, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, currency peg, dark matter, democratizing finance, Deng Xiaoping, disintermediation, ending welfare as we know it, eurozone crisis, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, foreign exchange controls, full employment, Gini coefficient, Glass-Steagall Act, global value chain, guest worker program, Hyman Minsky, imperial preference, income inequality, inflation targeting, interchangeable parts, interest rate swap, Kenneth Rogoff, Kickstarter, land reform, late capitalism, liberal capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low interest rates, manufacturing employment, market bubble, market fundamentalism, Martin Wolf, means of production, military-industrial complex, money market fund, money: store of value / unit of account / medium of exchange, Monroe Doctrine, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, new economy, Nixon triggered the end of the Bretton Woods system, non-tariff barriers, Northern Rock, oil shock, precariat, price stability, proprietary trading, quantitative easing, Ralph Nader, RAND corporation, regulatory arbitrage, reserve currency, risk tolerance, Ronald Reagan, Savings and loan crisis, scientific management, seigniorage, shareholder value, short selling, Silicon Valley, sovereign wealth fund, special drawing rights, special economic zone, stock buybacks, structural adjustment programs, subprime mortgage crisis, Tax Reform Act of 1986, The Chicago School, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transcontinental railway, trickle-down economics, union organizing, vertical integration, very high income, Washington Consensus, We are all Keynesians now, Works Progress Administration, zero-coupon bond, zero-sum game

With Goldman Sachs’s net income surging to a record $13.4 billion for the year, while unemployment remained stuck at 10 percent, Obama’s frustration at the political costs of this—which were hardly mitigated by Goldman’s promise to reduce its annual bonus pool from $22 billion to $16 billion, and to donate $500 million to charities—led the president to propose two new measures in January 2010. One was a “Financial Crisis Responsibility Fee” to be paid by the largest banks; the other was to prohibit “proprietary trading” by deposit-taking banks (i.e. using their own capital to speculate as well as operate their own hedge funds)—a reform prominently associated with Volcker.75 Expressing his irritation over “the activities of lobbyists on behalf of those institutions” against such measures, Obama proclaimed that he “did not run for office to be helping out a bunch of fat cat bankers”; and he warned them that now the banks were “back on their feet we expect an extraordinary commitment from them to help rebuild our economy.”76 This served to present the minor reforms he was advancing in a way that led to misleading headlines such as “Obama Declares War on Wall Street” and “Banks Face Revolutionary Reform.”

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It also obscured the fact that the Fed and the Treasury shared a distinct lack of enthusiasm for even such modest proposals because of what they saw as their problematic implications for a highly integrated financial system: the responsibility fee could further limit lending by banks and complicate the conduct of monetary policy. And they recognized that isolating banks’ own proprietary trading would be very difficult, since this practice was so closely related to the trades in stocks, bonds, and derivatives they carried out for their clients. Indeed, the integration of commercial and investment banking on a global scale now made any return to the New Deal type of regulation virtually impossible.

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Since the Oversight Council could also place other financial firms under the Fed’s authority, its potential regulatory and firefighting range was considerably expanded. The higher capital adequacy requirements were carefully constructed so as not to undercut the competitive advantages enjoyed by large financial firms. The hype about Dodd-Frank’s prohibition of proprietary trading (“the Volcker rule”) was largely negated by the numerous exceptions it specified, and in effect left it to the Fed to impose greater capital requirements and some broadly defined limits on these activities. Dodd-Frank allowed the Federal Reserve to preserve its key interventionist tools, as well as the room to develop new ones.

The Lords of Easy Money: How the Federal Reserve Broke the American Economy by Christopher Leonard

2021 United States Capitol attack, Affordable Care Act / Obamacare, Airbnb, Alan Greenspan, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, collateralized debt obligation, coronavirus, corporate governance, COVID-19, Donald Trump, Dutch auction, financial engineering, financial innovation, fixed income, Ford Model T, forensic accounting, forward guidance, full employment, glass ceiling, Glass-Steagall Act, global reserve currency, Greenspan put, hydraulic fracturing, income inequality, inflation targeting, Internet Archive, inverted yield curve, junk bonds, lockdown, long and variable lags, Long Term Capital Management, low interest rates, manufacturing employment, market bubble, Money creation, mortgage debt, new economy, obamacare, pets.com, power law, proprietary trading, quantitative easing, reserve currency, risk tolerance, Robinhood: mobile stock trading app, Ronald Reagan, Silicon Valley, stock buybacks, too big to fail, yield curve