Sunday, February 26, 2017

Cohan, Why Wall Street Matters

William D. Cohan, an investment banker turned journalist, is the author of Money and Power, House of Cards, and The Last Tycoons. Having criticized Wall Street in his earlier books, he now comes to its defense (for the most part) in Why Wall Street Matters (Random House, 2017).

The book is short, only about a hundred pages. It reads like an op-ed piece with expansive footnotes for the uninitiated. Responding to the Wall Street bashing that prevailed, from Bernie Sanders to Donald Trump, during the presidential campaign and to the ever critical Elizabeth Warren, Cohan sets out to show “why it is important to nearly everything we hold dear, and why we wouldn’t much like to live in a world without Wall Street. … The ability of Wall Street to provide capital when and where it is needed at a fair price … is an essential fact of modern-day life.”

Cohan takes the reader on an excursion through time, starting with the early days of the physical Wall Street when it housed the colony’s slave market in a wooden shed and when, as the site of the Stamp Act Congress, it also became a center of revolutionary fervor. Today, of course, what we think of as “Wall Street” no longer exists on Wall Street, save for the U.S. securities arm of Deutsche Bank.

He explains what commercial banks do and how they differ from investment banks. He describes how, even though financial crises are the byproducts of human nature, not Wall Street inventions, “Wall Street is particularly adept at fomenting or fueling a crisis, given how Darwinian a place it is.” He takes the reader through the formation of the Federal Reserve and the throes of the Great Depression.

And then he gets to the thrust of his argument: the problem with Wall Street firms going public. In the good old days, investment banks and brokerage firms were private partnerships. For more than 150 years Wall Street firms “relied on the prudent use of their partners’ capital to take risks—which nonetheless occasionally went awry—and to run their businesses, knowing full well that a single mistake could spell the end for their firms, as well as threaten whatever fortunes they had personally built up over the years.” But when, in 1970, DLJ convinced the New York Stock Exchange to change its rules and allow it to go public, Wall Street culture itself changed. “Although it was unlikely the founders of DLJ could have anticipated all of what its IPO would unleash over the next nearly fifty years, they must have had some inkling that by substituting a bonus culture—where bankers, traders, and executives demand to be paid for the revenue they generated in their various product lines—for the long-standing partnership culture—where the individual partners of the firm collaborated to make sure only prudent risks were taken in order to ensure there would be annual pretax profits for them to divide—Wall Street would never be the same.”

With access to public money, Wall Street’s animal spirits were unleashed. It started innovating—securitizing mortgages, creating junk bonds and later credit default swaps, increasingly with the input of quants. And then came the financial crisis, which it helped engineer.

Wall Street, and banks in general, were vilified. The public was outraged, and the government responded with burdensome regulations. Wrong, wrong, Cohan argues. Wall Street matters, and banks shouldn’t be hamstrung.

Cohan’s fix is simple. “What needs to happen—and fast—is that the leaders of the remaining big Wall Street firms need to designate the top five hundred or so top executives at their respective firms—the ones that run business lines, decide how capital gets allocated, decide who gets how much compensation and who gets promoted and who doesn’t—and along with the other members of the executive suite create a way for the bank’s creditors and shareholders to be able to go after their full net worth—everything—in the case of a meltdown. … This one simple change in the Wall Street compensation system would render Dodd-Frank and the Volcker Rule irrelevant. … The compliance culture could be rolled back considerably.” And American economic growth could pick up again.

Friday, February 17, 2017

Peterson & Hoekstra, Crunch Time

Rick Peterson was, in his most chronicled job, pitching coach for the Oakland A’s during the Moneyball era. Most recently he was director of pitching development for the Baltimore Orioles. Judd Hoekstra is vice president of The Ken Blanchard Companies, which provides leadership training, and has co-authored two books. The two men pooled their skills, and their stories, to produce Crunch Time: How to Be Your Best When It Matters Most (Berrett-Koehler, 2017).

The common thread of this book is reframing: reframing from trying harder to trying easier, from tension to laughter, from anxiety to taking control, from doubt to confidence, from failure to learning moment, from prepared to overprepared. Through reframing, they maintain, a person can learn to thrive under pressure.

Reframing “is not about pretending everything is perfect and positive. It is about finding different ways of interpreting a less-than-ideal situation.” It is about overcoming the fight, flight, or freeze response to pressure, viewed as a threat, and instead activating what the authors call the “Conscious Thinker,” which understands pressure as an opportunity.

Naturally, many of the reframing techniques have been described elsewhere. There are, after all, only a limited number of ways people have come up with to deal with performance under pressure, given our state of knowledge about brain functions. But here are a couple of pointers that traders may find useful.

First, in evaluating your performance, however you define ‘performance’ (and in trading profit can be a self-sabotaging way to view it), set up a personal performance evaluation scale, where 0 is your worst performance and 10, your best. The most important number on this scale is 5, “where you consistently perform today.” You shouldn’t view any performance that doesn’t reach your personal best as a failure. Instead, you should view any performance above 5 as a success. This approach doesn’t encourage mediocrity because as your performance improves, your personal average shifts. The old 6 becomes the new 5. “And because your average is always a 5 on a scale of 0-10, it shows you still have more game in you.”

Second, “you don’t have to feel great to perform great.” Tom Glavine, a Hall of Fame starting pitcher, admitted that he was “in the zone” only one out of every five starts over the course of his career. “If the only time you can win is when you go out there and all the stars are aligned and everything is great, then you’re going to struggle because that’s just not reality.” You have to learn how to win that B+ game or that C+ game. Glavine’s preparation “helped him develop an arsenal of pitches he could throw with precision. When one of his pitches wasn’t working, he adjusted. In addition, when his physical talent was not at its peak, Glavine used his mind to outsmart hitters.”

And finally, a nudge in the right direction, “While the process of overpreparing may feel boring, the results are spectacular.”

Wednesday, February 8, 2017

Thompson, Hit Makers

A video goes viral—or does it? Why did a handful of girls’ first names remain popular across generations and then “cycle in and out of popularity faster than summer dress styles”? Why was the phenomenal success of “Rock Around the Clock” (by some counts second only to Bing Crosby’s “White Christmas”) such a fluke?

Derek Thompson, a senior editor at The Atlantic, tackles these and a host of other intriguing questions in Hit Makers: Why Things Become Popular (Penguin Press, 2017). His book has two core themes: the secret to making products that people like and the reasons that some products fail while similar ideas catch on and become massive hits. Addressing these themes, he tells refreshingly new stories. And he offers explanations, occasionally in the form of models but, especially in the case of the greatest hits, often closer to “magic sprinkle dust.”

I’m about to do a great disservice to Thompson’s book by focusing on two models. The first comes from a professor of marketing who describes the entertainment business as “a complex, adaptive, semi-chaotic industry with Bose-Einstein distribution dynamics and Pareto power law characteristics with dual-sided uncertainty.” Sounds pretty similar to the financial markets, doesn’t it?

For those not familiar with Bose-Einstein distribution dynamics, it essentially says that “gas molecules in sealed containers would aggressively cluster at a time and place that was impossible to predict with certainty.” As a metaphor for pop culture, it says that “at some point in time, [consumers] will cluster around an unforeseeable cultural product by buying the same book or attending the same movie.” As for dual-sided uncertainty, in this case applied to films, “Hollywood is in the business of predicting what audiences want many years in the future, even though most people couldn’t say for sure [what they want], even if you asked them.”

The second model is one Thompson sets out to destroy as myth: ideas going viral. In epidemiology a viral disease “has the potential to spread exponentially. One person infects two. Two infect four. Four infect eight. And before long, it’s a pandemic.” Ideas, by contrast, do not go viral. Ideas achieve massive popularity primarily through broadcast diffusion—“many people getting information from one source.” Essentially, “one Facebook post, one favorable spot on the Drudge Report, or one well-watched segment on Fox News reaches thousands and thousands of people instantaneously, and then a small fraction of that … group passes it along again.” The better model looks something like this:

I must admit that after I requested a digital copy of this book on NetGalley I had second thoughts. Did I really care what made a best seller or a #1 song? Thompson convinced me that, yes, I did. So, even though this blog doesn’t exactly have the impact of a major media outlet, I can perhaps play a role in broadcasting that Hit Makers is a great book.

Sunday, February 5, 2017

Kolhatkar, Black Edge

Every trader needs an edge, but not all edges are created equal. One of the most powerful edges is information. At SAC Capital Jason Karp color coded information to teach his analysts “what was safe and what might be illegal.” The white edge was “readily available information”-–completely safe but not worth much. The gray edge might be (and probably was) material, nonpublic information. At SAC the only way to be sure it wouldn’t get the firm into trouble was to talk to its legal counsel, something few traders were eager to do. So gray slid into white. Black edge information was obviously illegal. Karp warned his analysts: “If you do one thing wrong, you’re in jail and your life is ruined. There is no trade that’s ever worth it.”

And yet. As one trader, asked if he knew of any fund that didn’t traffic in inside information, answered: “No, they would never survive.” The author adds: “In this way, black edge is like doping in elite-level cycling or steroids in professional baseball. Once the top cyclists and home-run hitters started doing it, you either went along with them or you lost.”

Sheelah Kolhatkar’s Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street (Random House, 2017) chronicles the government’s ultimately disappointing effort to build a case of insider trading against the legendary Steven A. Cohen of SAC Capital. The story, extensively reported at the time, transfixed the hedge fund world and financial news junkies. A lot of people were cheering for the government.

Kolhatkar, a staff writer for The New Yorker and author of the widely discussed article "What If Women Ran Wall Street?", worked as a risk arbitrage analyst at two hedge funds before becoming a journalist. For this book she relied not only on published press sources but on “hundreds of interviews with more than two hundred people, as well as voluminous court transcripts, exhibits, deposition testimony, SEC interview notes, notes taken by FBI agents during witness interviews …, diary entries, written correspondence, and other documents.” Predictably, Cohen refused to be interviewed.

Black Edge doesn’t shed much new light on the SAC saga, but it’s still well worth the read. I couldn’t put it down.

Wednesday, February 1, 2017

Stone, The Upstarts

Brad Stone, author of The Everything Store: Jeff Bezos and the Age of Amazon, turns his attention in this book to the shared economy. The Upstarts: How Uber, Airbnb, and the Killer Companies of the New Silicon Valley Are Changing the World (Hachette, 2017) tells the stories not only of the companies that have become part of popular culture but, in passing, of those that fell along the way, the nonstarters.

Airbnb, now valued at $30 billion, more than any hotel chain in the world, and Uber, valued in late 2016 at $68 billion, more than any other private company in the world, both began as side projects, with modest business plans. Neither seemed especially promising. After all, who would want to sleep in some stranger’s house or have a stranger sleep in his? And who would think that making the San Francisco cab system more efficient was a revolutionary business idea?

Even as Uber modified its initial business model, most potential investors had serious reservations. Ron Conway, “famous for backing the holy trinity—Google, Facebook, and Twitter—passed on the deal. ‘This one looks like it will be a fight in every city,’ he sagely e-mailed a fellow investor.”

Funding was a major hurdle, but actually making the businesses work was much tougher. One crisis followed the next. A woman who had rented her apartment for a week via Airbnb returned to find it burglarized and trashed. She wrote about the incident on her blog. After Airbnb didn’t come through with the promised compensation or provide her with alternative accommodations but instead suggested that she “shut down her blog or update it with a ‘twist’ of good news,” she posted that she was “basically homeless, terrified, and ‘broken’ by the situation.” She told readers to “book yourself into a nice, safe hotel room the next time you travel.” A nonstop Twitter-fueled media storm followed.
Uber had its share of horror stories about drivers who assaulted passengers. And its surge pricing, which eventually became orthodoxy inside the company, was initially a public relations disaster. One New Yorker tweeted: “While I’m glad I’m home safely, the $107 charge for my @Uber to drive 1.5 miles last night seems insanely excessive.”

Both companies, of course, faced, and continue to face, major political pushback.

The stories of Uber and Airbnb are nowhere close to being finished. Airbnb is now providing unique experiences for travelers, using local entrepreneurs and celebrities. Uber is experimenting with driverless cars. They are evolving along with technology.

The Upstarts is a testament to grit—lots and lots of it—and, yes, luck. It’s quite a good read.