The Problem with Smart Bankers

Calvin Trillin, in his own inimitable way, has now weighed in on the causes of the financial crisis. It’s great stuff:

“Don’t get me wrong: the guys from the lower third of the class who went to Wall Street had a lot of nice qualities. Most of them were pleasant enough. They made a good impression. And now we realize that by the standards that came later, they weren’t really greedy. They just wanted a nice house in Greenwich and maybe a sailboat. A lot of them were from families that had always been on Wall Street, so they were accustomed to nice houses in Greenwich. They didn’t feel the need to leverage the entire business so they could make the sort of money that easily supports the second oceangoing yacht.”

“So what happened?”

“I told you what happened. Smart guys started going to Wall Street.”

Trillin’s right. Bankers have made money for centuries, by doing essentially what their fathers and grandfathers did before them. (They’ve lost money, too, but nearly always in the same way: by lending money to people who can’t or won’t pay it back.)

Then Wall Street went go-go in the 1980s, and lots of smart, hungry, and highly self-regarding MBA types started flooding into big investment banks. When they started making money, they credited themselves, and their own intelligence. Which led to an obvious conclusion: if you did something even cleverer, you’d make more money still. Which, like most things in finance, is a strategy which works until it doesn’t.

Trillin’s also right that a large part of the problem is that senior management had no idea what was going on:

“When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness.”

In fact, even the bankers from the upper third of the class — the likes of Bob Rubin, who famously had no idea what liquidity puts were until a bunch of them exploded right underneath him — fell into this trap: in his case, he was both the smart and scrappy arbitrageur who thought that he could turn brainpower into billions, and the baffled senior risk manager who gave his underlings far too much ability to blow up his bank.

Banking isn’t for outright dummies — conscientious underwriting, for one, is a difficult and highly-skilled job which requires good, well-paid professionals. But far too many bankers thought of that kind of income as boring money, and were much more excited by the higher rewards and sophisticated risk management being shown them by the rocket scientists on the structured-products desk. Maybe in future they’ll be more suspicious of things they don’t really understand, but I’m not holding my breath. That’s what regulators are for.

Comments

[joelandsonia:]

I just emailed my younger brother and said, "hey! this is your book!"

Amusing.

www.amazon.com/Quants-...

Oct 14 10:48 AM

[Graham and ...:]

It's a tortoise and hare thing: The smart ones make the most money until they blow themselves up, then the dumb ones take back the banks (or what's left of them, anyway).

Oct 14 10:50 AM

[Tony Petroski:]

From Mr. Salmon:

"Maybe in future they’ll be more suspicious of things they don’t really understand, but I’m not holding my breath. That’s what regulators are for."

Maybe in the future the pack of Northeast liberals who dominate the establishment media will "be more suspicious" before they remain locked to the Democratic party and the likes of smart fellas like Summers, Rubin, Geithner and while were at it, Obama.

Oct 14 12:08 PM

[cds ftw:]

If you ran a bank, would you prefer to have smart people or mediocre people working for you ?

Oct 14 04:12 PM

[mngordo:]

It matters not at all who runs the "banks" The system, as presently constituted, will always yield the same results. If I ran a bank, I would run the bank AND the people who worked for me. "Running the bank" or running anything else for that matter, implies that the person or persons "running things" actually KNOWS OR MAKES SURE HE OR SHE LEARNS exactly what's going on. Having the intelligence, know-how, and the wherewithal to actual run things is known as leadership, something the fatcats on Wall Street generally know nothing about. It is hard to focus on business from the deck of a yacht.


On Oct 14 04:12 PM cds ftw wrote:

> If you ran a bank, would you prefer to have smart people or mediocre people working for you ?

Oct 15 12:12 PM

[andrew j:]

wow, this is great! it's all the smart peoples fault! Those darn brainiacs! If they hadn't been smarter than their managers, none of this would have happened!


c'mon, really? This is anti-intellectualism with a really thin veneer. Bosses rarely understand the actual nuts & bolts and yet it's still their responsibility when the machine breaks. Yes, there are some incredibly arrogant people (who were also a little clever) who get put in charge sometimes (ex. LTCM) -- but how "smart" could they be if they blew up the system? i.e., they had nice math but that's only half of "smart."

it's the managers JOB to be smart about what their employees do. It's called management. The idea that the manager should be "the dumbest guy in the room" is one of the most damaging bullshitisms i've ever heard. if you're a manager you need to know and understand how your business works, bottom to top. not "kind of", not "i know we do stuff with math to make it so it has these effects" -- you need to know the details.

Oct 15 12:34 PM

[derryl:]

Letting the quants play with banks' real money based on mathematical theories is no different than letting the chemistry students try out their theories in the lab. The professor is dazzled by the brilliance of his students and doesn't really understand their newfangled equations (the prof is too proud to admit he doesn't understand), but for awhile they work and the students get A+. Until they blow up the school. Because the brilliant students didn't know how their theories were going to turn out either. They were just too young, well paid and empowered to understand and be constrained by the concept of "consequences".

Oct 15 08:43 PM