Ken Griffin: One of the Few Good Guys Left?

The NY Times had a interesting article on Ken Griffin, founder of Citadel, a highly successful hedge fund, and featured his views on the financial industry, as linked here. I agree with some of his views, but not others.

In the article, he said it well "we, as an industry, dropped the ball." He also correctly points out that many chief executives of big universal banks, the ones that combine all sorts of financial services under one roof, "only understand a small part of the business," suggesting too many of them come from sales backgrounds.

This is actually a fundamental structural problem with the whole investment banking business. People get promoted by generating profits in their books, thus by selling their services and financial products. Only money talks in their world.

It is similar to the military culture that people only respect officers who fought and won real battles. Can you imagine to promoting someone to lead a unit of troops going to battle from either the military police unit or military medical doctors or military court lawyers who never had the experience of  fighting and winning a battle, and whose task only focuses internally on their own soldiers?

In this sense, banking risk management people, no matter how good and important a job they have had,  will never be the chiefs to lead the banks, since they have never been on the frontline, they have never made money for the firms, and they are never revenue generators. From the perspective of so many years of investment banking history, this is an unsolvable problem.

One thing I don't agree with is his comment on young MBAs: "Walk across any of the trading floors - they are full of 29-year-old kids," he said. "The capital markets of America are controlled by a bunch of right-out-of-business-school young guys who haven't really seen that much. You have a real lack of wisdom."

Ken blames the wrong people. He should have blamed is the system. As I said many times here before, at the end of the day, investment banking is a sales job, no matter what the product is; the job is to structure the product to make it look better and then sell it to unsuspecting investors.

These young, fresh out of business school MBAs are basically busy selling products "innovatively" generated by this industry. It is unfair to blame sales persons for an industry-wide problem with deep roots in its structure and system. It is similar to blaming a sales person from a pharmaceutical company for pushing the wrong drug, whereas the fault should always be with the medical doctor who prescribed the wrong medicine to the patient and/or the company itself that ran the clinical trials incorrectly.

It is one issue that these young rookie MBAs make too much money, which is the consequence but not the cause. The cause is that the system generates tons of phantom and inflated structured products for them to sell and motivate them to earn their fat commissions and bonuses.

The problem is compounded further by weak government oversight, Ken said. "The unwillingness of the Federal Reserve and the S.E.C. to require working capital" limits, he said, only exacerbates the risk-taking environment because the banks are playing the equivalent of no-limit poker. "The investment banks should either choose to be regulated as banks or should arrange to conduct their affairs to not require the stop-gap support of the Federal Reserve," he says.

The problem here is with the former; it is a boring commercial banking business with thin profit. With the latter, it is always the ticking time bombs waiting to explode. Is this the whole purpose of the Glass-Steagall Act? Why did we repeal it last decade? Should we return to the good old days of pre-Greenspan era before his deregulation?

The best part is what he said about credit default swaps. He wants new government oversight of the arcane world of credit default swaps, a business with a notional value and risk of $50 trillion. "Everyone is missing the elephant in the room," well said. In fact, I might add, this elephant has been growing every day too, from $45 trillion last year to actually $65 trillion at the end of 1st quarter this year.

Mr. Griffin wants the government to require the use of exchanges and clearing houses for credit default swaps and derivatives. He is not alone, this proposal has been mentioned by many others and there have been several WSJ articles on this. Many of the latest growing CDSs in recent years are for CDOs, which are structured not from actual mortgages but mortgages-backed securities, that are backed mainly by what amount to mortgage slices and tranches. If we have problem valuing these slices and tranches and their MBSs, how could we value and trade their CDOs? Then how would we value and trade the CDSs, their insurance protection derivatives? If we don't have market for those MBSs and CDOs, I just don't understand how we can have market for the CDSs?

Another problem I see here is: all big CDS dealers (big investment banks such as JPM and insurance firms such as AIG), may not want this platform, market and transparency at all. Their engagement is questionable. Is the main purpose of why CDSs were originally created to hide the real loss and poor quality of their underlying assets, especially the CDOs? (refer to my earlier article here "Why Wall St. Needed Credit Default Swap?") Is this why JPM, the largest CDS dealer, bought BSC?

If so, why would they want to reveal and expose themselves with another credit debacle, much bigger and worse than subprime, to the public?