Rethinking Markets

An anthropologist attempts to explain variation in how investment banks fared in the current credit crisis. Gilian Tett argues that three elements account for it: 1) successful firms have hands-on management (meddlers); 2) successful firms have management who rose through the ranks via trading desks rather than sales or legal; 3) successful firms have a ‘culture of power’ whereby firm members see themselves as tied to the firm rather than the business line, which creates a culture of accountability.

Alternatively, Michael Lewis noticed the way that Goldman Sachs has profited by the dramatic increase in credit defaults. Effectively, someone higher up in the firm made a series of dramatically-large trades against the CDOs that everyone else (including GS) was creating, marketing, and purchasing. In other words:

Enter two smart guys who trade Goldman’s proprietary books to argue to the CEO and chief financial officer that the subprime market feels soft and that Goldman should short it. This they do, in such massive quantities that they more than offset the long positions in subprime held throughout the rest of the firm, leaving Goldman short the subprime market and in a position to make billions when it crashes. End of story.

And it’s a good story. But consider what it implies. Their own traders and salespeople in subprime mortgages and related securities had put Goldman in exactly the same position as every other Wall Street firm: long subprime mortgages.

The only difference between Goldman and everyone else was that Goldman had, in effect, an entirely separate enterprise, sitting on top of the firm, with the power to reverse the judgment of its own supposed experts in various markets. They were able to do this, apparently, without ever saying a word about it to their own traders. Instead of telling the fools trading subprime mortgages that they are wrong, and that they should unwind their positions, they simply offset their trades.

This does not imply anything about the management team, where they come from, or the firm’s culture. Instead, it describes a firm where higher-up risk managers have the ear of people in power, and this allowed them to cancel out the stupidity of the rest of their own firm.

Or, perhaps this is all a fancy way of saying that there is a huge amount of luck and randomness happening at the organizational level in perhaps the most important core sector of the contemporary economy.