Crash, Crisis, Crypto: a short history of investment banking
Short story by Aifric Campbell marking the 10th anniversary of the Lehman Brothers collapse
A worker carrying a box out of US investment bank Lehman Brothers offices, in London in September 2008. Photograph: Reuters/Andrew Winning
I walk into the den where my two girls are lying on the couch.
“Ooh,” E giggles, “it’s the wolf of Wall Street.”
M stuffs a cushion over her mouth and E points at DiCaprio’s leering screenface.
“So Dad,” she goes, “did you ever snort coke off someone’s ass?”
Then they’re rolling about in hysterics. I mean, what do you say to that? So I give them the sad Dad headshake and turn away.
“No wait,” E straightens up, “what it was really like?”
“Seriously,” M hiccups, “tell us your story. It’s not like we’re kids anymore.”
“Think of it as a history lesson,’ says E who knows how to set the Dad trap. “C’mon,” and they’re patting the couch like they did when they were little girls at bedtime.
“Okay,” I shrug, “But I’ll stand for this one. Four decades, one take, no interruptions.”
They settle down and raise their shining faces.
“Picture this,” I begin. “It’s summer 1987. In your hand is a Motorola 8000X, the world’s first mobile phone. Costs 3,000 quid and it’s the size of a brick, so heavy you have to coat check it at nightclubs.”
“Like in American Psycho,” says M.
“No interrupting!” E elbows her and I move on.
“You’re standing on a trading floor in London in the middle of a bull market that will run to the next millennium. In a few years’ time you’ll be a Master of the Universe, but you don’t know that yet. All you know is you breezed through five interviews and now you’re a rookie trader. You’re buying and selling a hybrid, a cross species debt plus equity mongrel that no one seems to fully understand. Your technology is a Reuters screen, two phones pinned to the desk and somewhere on the other side of the floor is a clunky grey box called a Black-Scholes option calculator. Now you’re a smart graduate, but you’re no mathematician and neither is anyone else on the floor. So how do you know what these things are really worth?
“Every day you trade in live markets across countries and currencies. Every night you’re in the bar. You rely on tangible and intangible data to make a price: historical performance, liquidity, market sentiment, the footprint of buyers and sellers and the size of your hangover. You write blue tickets for buy, pink tickets for sell and drop them in a tray. But you’re starting to understand that markets are all about stories: Japanese real estate, an emerging economy, a stock chart, a yield curve – you can run all the numbers you like, but in the end it’s a leap of faith. What you actually do as buyer or seller depends on which story you decide to believe. This is your first big life lesson, but you don’t know that yet, you just know it’s October 1987 and the Dow Jones is in freefall, down 22 per cent in a single day. You see things that are not supposed to happen: crazy prices, total illiquidity, fear. You learn that in times of crisis you can throw away the rulebook. You understand what Newton meant back in 1720 when he dropped a packet in the South Sea bubble: ‘I can calculate the motion of heavenly bodies, but not the madness of people.’ You think your first crash is like losing your virginity, that life will never be the same again. In fact, this is your second life lesson: the art of survival, how to live to tell the tale. October 1987 turns out to be just a blip and the bull roars on.
“Fast forward to 1991 and you’re out in Docklands where the trading floor is the size of an aircraft hangar. You’re using email now but you’re not browsing because there’s still no world wide web. And there’s a new species on the trading floor – the maths and physics postdocs who’ve been lured out of academia. You call them the quants, the quantitative analysts who are building the math model that will tell you what your hybrids are actually worth. They huddle together talking stochastics and volatility. They don’t have phones so their desks look kind of naked. But when you all sit in a meeting room there are problems in communication. The problem is the word value – the definition of what that might be. These guys live in a theoretical bubble. They’ve never been in business, never bought or sold anything, never met an investor or witnessed market madness. Some of them seem like they’ve never been outside the door. They have trouble making eye contact and there’s no banter. You’re worried about variables and assumptions, about everything that’s not in their model. It’s all so elegant, but experience has already taught you that the biggest risk factor in any scenario is likely to be human. And if you keep on asking questions you’ll be misheard as a sceptic or considered too stupid to handle the math.
Financial engineering is the hot story and it’s become an article of faith
“The arrival of the quants is the evolutionary equivalent of the transition to bipeds. But this cultural revolution won’t get discussed in the public domain until 2008 when the wheels come off. From now on, your world is divided into the bankers and the geeks. They don’t speak the same language or think the same way but for the moment, the bankers are in charge and they have to trust the geeks to deliver the glittering returns. In the years that follow you make a fortune for the bank and for yourself. Proprietary trading is what management wants and they keep cranking up your risk limits. Mathematical models pave the way for bigger trades, new instruments and much greater layers of complexity. It’s a period of astonishing creativity and innovation. Hedge funds blossom. Financial engineering is the hot story and it’s become an article of faith.
“All around you there’s a transformation in attitudes towards risk and customers. Big profits breed arrogance and contempt and people start believing they’re in possession of a superior truth. Customers become the ‘pretty stupid people who understand nothing’– which is how one bank refers to its clients. And they don’t mean the little people, they mean the fund managers, insurance companies and corporate treasurers who buy instruments they don’t really understand because they promise spectacular returns. Sometimes you wonder where it’s all going to end and you’re not the only one who is anxious. Already in 1992, the president of the Federal Reserve warns that derivatives ‘must be understood by top management as well as by traders and rocket scientists – I hope this sounds like a warning because it is’. But greed is a kind of madness and who wants to call time on a party?
“In 1998 you’re eating a banana at your desk when the news breaks that the smartest guys in the room have blown up: Long Term Capital Management, the king of hedge funds with $126 billion in assets and two Nobel prize winners among the partners. Their strategy – to quote one of the partners – was relative value convergence trading. ‘You identify cheap assets and try to hedge as many of the systematic risk factors that are associated, so that all you are left with is the pure cheapness itself.’ Nothing unusual about that, but the important words here are risk factor: the definition of what that could be. On August 17th Russia devalues the rouble and defaults on its debt. This is your black swan. It triggers instant panic across the financial sector and a stampede for the exit. Four days later, LTCM drops $550 mill in one day. But it’s not Russia that’s the problem, it’s the fact that banks and hedge funds are scrambling to liquidate all sorts of positions. Time will vindicate LTCM’s strategy but right now, time has just run out. All that matters is the story that people believe: LTCM is going down. When they drop another half billion the Fed organises a bailout and a $4.4 billion hit is taken. $1.9 billion of the capital was the partners’ own money – these guys really believed.
“Ten years on, LTCM will look like an early warning signal and the best lesson never learnt – by the Fed, by Wall Street and just about everyone else. The 2008 global financial crisis is a clusterfuck, a toxic convergence of plotlines: incompetence, greed and complacency. To be more specific: financial engineering plus catastrophic management failure plus negligent government plus lax regulation plus a short-term compensation culture and a zombie electorate out shopping.
“All around you it’s carnage, like your world is being eaten alive from within. You stand in a cold sweat looking out across the floor and it feels like that scene in Alien, like you’ve all just been incubating the seeds of your own destruction. Next thing you know it’s September 15th, 2008 and you’re carrying your heart in a cardboard box across the concourse with the world’s TV in your face. Lehman Brothers, 140 years of legacy razed to the ground and this funeral procession will stalk your dreams forever. You’re out of a job, drifting like a zombie through your former life, a casualty of war, licking your wounds, spinning your wheels. In the limbo world of non-banking, you uncover a twilight zone of people who work like dogs for a pittance and you wonder: how do they live? Your cash burn is insane, you trawl through the household expenditure and discover your wife’s brow maintenance is 300 quid a month! Christmas Eve you’re out drinking with your best old friend from school when he asks how does it feel to be a social pariah? He’s joking but you’re three shots in and it’s an ugly moment, that testosterone throb in your fist. You are that close, but you fold yourself into a cab home where you prowl round the house with a burning need to hurt something. Your wife is sobbing on the couch when you smash a Venetian glass, then somehow your hand is level with her face and she’s suddenly still as a deer, steeling her chin. Like she’s ready, like she’s maybe even willing you on. And you understand in that moment she wants to be slapped, so the 50 per cent divorce hit will become a no-contest clean out. Your hand falls away and those lips that you will never taste again say, ‘I always knew you were the wrong trade’.
“You drive away, consider your options, stalled in the car at midnight in the gloom of Pembroke Square. Assets and liabilities, the soon-to-be ex-wife, the girls. Oh, your little girls! You have a cry, fall asleep in the car and wake up at dawn to watch your life drizzling away on the windscreen.
“In the years that follow your comrades in arms are busy telling their stories, because after the fire fighting comes the flag waving and ambulance chasing. There’s the CEO of Morgan Stanley telling students at Wharton how you lead a bank out of a crisis and tell the Federal Reserve to ‘get fucked’. There’s an ex-partner from LTCM at MIT telling students he’s disturbed by ‘sound bites about greed and hubris’, by an ‘anti-intellectualism’ that suggests ‘rational economic thinking and models just don’t make sense’.
“There’s a professor of financial engineering at Columbia writing a Hippocratic oath for quants and an article in the Journal of Derivatives saying ‘there is no truly reliable science beneath financial engineering . . . variables such as volatility and liquidity are crude proxies for complex human behaviours . . . models are reliable only as long as the sea stays calm. When crowds panic, anything can happen’.
“Your divorce lawyer’s telling stories about wives dumping banker husbands while they’re still fit enough to snare another one who might actually get a bonus. But no one wants to hear your story about downsizing your house, your cars, your whole life. You do your time in the wilderness of bucket shop brokerage, that night with those hookers playing Blow under the table, oh Christ, that was the low point. You are shrinkwrapped in resilience now, survival is like a second skin. But you never, ever would have guessed that 2008 would be just another plot beat, because look at you now: 10 years on and you’re the Crypto King!
“If you want to make money, start a religion. So said L Ron Hubbard and Scientology was born and a bunch of Hollywood crazies started throwing money at him. If you want to make money you’ve got to make people believe – in a tulip or a magical coin, it doesn’t have to matter so long as it’s a good story. Cryptocurrency is like a gift that falls out of the sky, out of the ether comes a fantasy and it’s FOMO in finance, with people worried they’re missing out on a dead cert. It has all the quality of fable, with a missing person inventor, it’s hip and maverick and oh so now. A big Fuck You to the establishment that makes people feel they’re sticking it to The Man – the banks, regulators and everyone else who failed them.
“So instead of placing their trust in institutions governed by the rule of law, they put their faith in magical thinking. For sure, it’s tulips times one hundred, except it’s much worse and it’s like a contagion. You thought the Nineties dot com boom was wild but it was nothing compared to this. Least then you were a stakeholder so if the business flourished you actually owned something – like Microsoft, Apple, Amazon. Let me tell you, when educated rational persons – accountants, lawyers, engineers and philosophers tell you they’ve bought a little Bitcoin “just because’, you know we’re back in cowboy country. It’s digital lawlessness and it could lead us to another cliff edge, but you live long enough you learn to imagine things before they happen.
You and the ex can even laugh now about that almost-slap back in 2008
“These days you mostly think about how you’ll teach your future grandkids to be safe. Number one: Get your pronouns right with robots. They don’t have feelings, they haven’t got souls. Sometimes you wonder if you have one yourself. You watch the Curiosity Rover late at night for its peacefulness, contemplating a future you won’t live to see. Just imagine – your grandkids could be homemakers on Mars! There’s no doubt humans are marvellous and terrifying all in one.
“When you look back you get reflective. Your two girls are tucked up in tech, smart as whips and, despite the divorce, you believe they’ve had good parenting. You and the ex can even laugh now about that almost-slap back in 2008 – well, she smiles and you wince at the pop-up memory, because you will never, ever forget what she said that night. Though truth is, you only married for a bet. And you hope she’s told the full story to your girls because they need to understand how men can be. She was on the milk round, we only called her in because she was hot and R bet you 500 quid you wouldn’t, so you walked in and looked into those green eyes and said ‘You’re never getting this job, so let me take you out to dinner’. ‘Sure,’ she smiled and fell pregnant in a heartbeat. You might have guessed then she was the kind of woman would dump you at the first whiff of burning tyres. But hey, no regrets, look how it well it all worked out.
“You always said finance was a human drama and now Lehman Brothers is back on stage, the hot ticket at the National. The punters love it but this band of brothers story is too soft focus for you and gutburn has you squirming in your seat. You get a little broody but the past is so over for you now. You’ve straddled two centuries so you know people don’t get smarter. Human nature doesn’t change and that’s the final lesson. History is mistakes repeated and best lessons never learnt. The trick is to keep riding the peaks and troughs and telling a story, because we all just want to believe.”
Aifric Campbell is the author of On the Floor and a former managing director of Morgan Stanley. She teaches at Imperial College, London