Roger Ehrenberg’s Prescription for Robbing a Bank (the TBTF Variety)

One of the continued frustrations of the post-crisis period is the lack of discussion of looting, which as described in a seminal paper by George Akerlof and Paul Romer, is when executives find it more profitable to gamble on bankruptcy, as in lever up their companies, pull out too much in cash (usually with the help of overly flattering accounting) and leave failed businesses in their wake. Akerlof and Romer noted that businesses with explicit or implicit guarantees were particularly well suited to this sort of extractive behavior, and they argued the savings and loan crisis was a prototypical example. In ECONNED, we argued that the producers and management of major capital markets players were engaged in a looting 2.0 in the runup to the crisis.

Roger Ehrenberg, who had a long career in derivatives and now runs an early stage venture firm. He describes how easy it is to, as he puts it, “rob a bank” or loot. His formula:

1. Go to a fancy college, do well in math, CS and stats, and study those brain teasers that trading desks love to give applicants. If you didn’t go to a fancy college, work yours and your parents connections to try and secure a position. Absent connections, leverage your alumni network. Do whatever you need to do to get an interview.

2. Trade a little on your own, so you can say “I trade my own book” when asked, and have a trade idea in mind when you go for the interview. You will be asked this question.

3. Once you get the interview impress, show passion, intensity and how you are laser focused on making tons of money for your firm (and yourself). Take chances, be brash, stand out from the crowd.

4. Congratulations, you did it! Join the trading desk as a go-fer, indentured servant, whatever. Ask lots of questions without being annoying, and make sure you are studying the mechanics of how trades get done and how they get reflected in the firm’s risk systems.

5. Gain the confidence of others, build reputation, and position yourself for securing your own book. This can take a little time but be patient: It’s worth it.

6. When you get your book, really understand how P&L recognition works. If P&L is calculated on concepts like “inception gain” or “theoretical profit,” you’re in good shape. Also figure out the implied cost of capital. If your firm is charging you LIBOR flat, yippie! Another good fact. If it’s LIBOR plus a credit spread for the duration of the trade, less good but you can live with it if your P&L has the right revenue recognition characteristics.

7. What you’d now really like to do is enter into a large notional amount of longer-dated, short volatility trades. Book profit as theta decays, assuming you don’t blow up. if you do, well, your downside is zero and you can get a job at another firm for even having been in the position to take such massive risk. If you don’t, well hey now, all that time decay flows right to your bottom line. And with a large enough notional amount, your 8-12% of P&L can add up to some serious coin.

Did you create value? No. Did you trade well? If being lucky counts, then yes. And if you get paid and shortly thereafter the chickens come home to roost and your book blows up? Well, you’ve just robbed the bank!

Note that this strategy is all about trading against your employer, as in understanding and exploiting deficiencies in its management information systems. And it would also be easy to BS management about it. Short vol is a classic dealer trade, usually a bet on mean reversion when mere mortals get nervous about risk. It normally works out pretty nicely unless markets get more freaked out and you lack the capital to ride out the losses from having gone short vol too early and/or too heavily levered (which is exactly what did in LTCM).

I bet savvy readers have other formulas for fun and profit at the expense of the house.

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10 comments

  1. Deus-DJ

    I wouldn’t call this a trade due to MIS deficiencies…more like accounting norms.

    I’ve though before of doing this but I have too much self-respect to do anything that shady and socially useless.

    Though…I would be willing to get people to get in those positions just so they can rip the face off of those TBTF banks. One day I think I will do just that, and more devious things.

    1. Yves Smith Post author

      The P&Ls do not map directly onto the published financials. A lot of massaging goes on in any public company, particularly a big financial firm, to produce the published financials. Trading level p&Ls are usually risk adjusted, published financials are not, for instance. You have transfer pricing between the desks and the treasury dept that get netted out. And so on.

  2. readerOfTeaLeaves

    But wait — neoclassical economics teaches that because markets are always efficient, this kind of fraud is not possible.
    Oh, wait…

  3. Nicholas Weaver

    There’s the proper way to run a hedge fund: You set it up ‘capital decimation partners’ style, where there is a huge amount of tail risk.

    So 9 years out of 10, you do fantastic, get your 2 and 20, wait a year and turn THAT into cash taxed at 15% fed. And the year you blow up and the value goes to zero?

    Well, practice in the mirror saying ‘It was a Black Swan! Whocuddaknow?’

  4. craazyman

    “Note that this strategy is all about trading against your employer, as in understanding and exploiting deficiencies in its management information systems . . .”

    When everybody at the employer is doing it and the govermint bails them out because they have so much “talent”, then who cares? It’s trading against society, against community, against your neighbor, against the postman, against the teacher, against the baker, against the plumber, against humanity, against everything that serves to create what we might call a “civilization”.

    It’s a projectile mind vomit in the face of the children riding the school bus in the morning. And then a steaming piss on them, just for a bonus.

  5. Tom Crowl

    There seems to be real confusion in financial/political circles about just what productive financial innovation is!

    Though, to be fair, despite their confusion at least some have benefited greatly… (pssst… unfortunately turns out it was the financial/political class.)

    Finding Roots in a Shifting Landscape: Facebook and the Future of Social Networks
    http://culturalengineer.blogspot.com/2011/01/finding-roots-in-shifting-landscape.html

    What does Facebook have to do with this? Frankly, not much… but the evolution of Information & Communication Technology (ICT)… and especially the social media landscape has plenty to do with it!

    Think of it this way… As that famous poem summed up… “No Man is an Island”… and its only human interaction that makes a society.

    These ‘non-commercial’ transactions have a history much older than money, banks and Naked CDO’s…

  6. the bankster

    This strategy is not “all about trading against your employer.” I’ve been in the same position as Roger has, and know that his logic goes all the way up the chain of command, right to the CEO suite. It’s really about trading against the taxpayer, who, unbeknownst to himself, is short deep out of the money options across the financial universe.

  7. Paul Tioxon

    The mystification of the economic system by technical jargon has reached its highest stage of prevarication, prestidigitation and misdirection, equal to the Scapulomancy performed by the Huns, under the rule of Attila at the apex of the Roman Empire. In the presence of the Christian Roman Legions, and on the soil of what was still under the aegis of the Empire, sacrificial animals had their shoulder blades scraped clean of muscle and connective tissue and then were roasted over open fires. This produced cracks in the bones, which were then read as signs of what was to come, preferable the defeat of the Romans. The apparent metaphor of the body politic being disemboweled, then burnt in what can only be viewed by civilized people as a desecration of the dead, in the place of respectful honor, draws our attention to today’s math augurs and what they are doing to our Republic, not much differently than what the Huns did to the Romans.

  8. Custerluck

    Mr. Ehrenberg omitted paragraph 8, which states, “after doing the above seven paragraphs, default on your home mortgage and see how MERS helped your bank screw up your home loan to the point of not being collectible.”

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