Tag Archives: money

Was Yours, Now Mine

I feel I have lived through an era of great changes. The pace of change can seem accelerated if you travel or emigrate because various geographical regions act as different slices in time. I have had the benefit (or the misfortune) of multiple emigrations. With that, coupled with my advancing years, I feel as though I have seen a lot. Most of what I have seen fills me with a foreboding of gloom and doom. Perhaps it is merely the pessimism characteristic of an unduly cynical mind, or perhaps it is the true decay of our global ethical standards.

On the positive side, the pace of change is indeed fast and furious. This is the kind of change you like — you know, vinyl to spool tape to cassette to MP3 to iPod kind. Or the land-line to satellite to cell to Skype to Twitter kind. However, along with this positive and obvious track of changes, there is an insidiously slow and troubling track creeping up on us. It is n this context that I want to reuse the over-used allegory of the frog-in-a-pot.

If you put a frog in hot water, it will jump out of the pot and save its skin. But if you place the frog in cold water, and slowly heat up the pot, it won’t feel the change and boil to death. The slowness of change is deadly. So let me be the frog with delusions of grandeur; allow me to highlight the unhealthy changes accumulating around us. You see, along with the technological miracle that we are living through, there is an economic or financial nightmare that is spreading its tentacles over all aspects of our social and political existence, transfixing everything in place in its vice-like grip. Slowly. Very slowly. Because of this invisible hold on us, with every iPod we buy, we (the middle-class) take a couple of dollars from the very poor and give it to the very rich. We don’t see it that way because some of us make a few cents in the process. The Apple store franchisee makes a few cents, the employee-of-the-month gets a token raise, an apple developer may enjoy a nice vacation, or a senior executive might get a new jet, the economy of the country goes up a notch, NASDAQ (and so everybody’s pension) goes up a tiny fractionall are happy, right?

Well, there is this little question of the packaging material that may have killed part of a tree somewhere, in Brazil, perhaps, where people don’t know that the trees belong to them. May be a little bit of pollution escaped into the air or a river in China where the locals haven’t realized that these resources are their heirlooms. May be some moderately toxic junk ended up in a landfill in Africa somewhere where they haven’t quite grasped the concept of land ownership. It may have cost a developer in Bangalore or a call-center girl in Manilla an hour or two more than it should because they don’t know that their time is a resource bought low and sold high in markets they don’t see or know of. It is from these distant places and phantom people that we pick up a couple of dollars and pass on to the equally distant corporate coffers and stock markets. We take what is not ours from the unknown owners to feed the avarice of unseen players. And, like Milo Minderbinder would say, everybody has a share. This is the modern capitalism of the corporate era, where we have all become tiny cogs in a giant wheel inexorably rolling on to nowhere in particular, but obliterating much in the process.

The problem with capitalism as an economic ideology is that it is pretty much unopposed now. Only through a conflict of ideology can a balance of some sort emerge. Every conflict, by definition, requires adversaries, at least two of them. And so does an ideological struggle. The struggle is between capitalism and communism (or socialism, I’m not sure of the difference). The former says we should lay off the markets and let greed and selfishness run its course. Well, if you don’t like the sound ofgreed and selfishness,” tryambition and drive.Associate it with words like freedom and democracy, and thisLaissez-Faireideology a la Adam Smith is a winning formula.

Standing in the other corner is the opposing ideology, which says we should control the flow of money and resources, and spread happiness. Unfortunately this ideology got associated with nasty words like totalitarianism, bureaucracy, mass murder, killing fields of Cambodia etc. Little wonder that it lost, save for this economic powerhouse called China. But the victory of China is no consolation for the socialist camp because China did it by redefining socialism or communism to essentially mean capitalism. So the victory of capitalism is, to all intents and purposes, a slam dunk. To the victors belong to spoils of history. And so, the socio-politico-economic ideology of capitalism enjoys the mellifluous association of nice words like liberty, equal opportunity, democracy etc., while communism is a failed experiment relegated to thealso-rancategory of ideologies such as fascism, Nazism and other evil stuff. So the battle between capitalism and the occupy-wall-street movements is pathetically asymmetric.

A battle between two well-matched opponents is nice to watch; say, a match between Djokovic and Federer. On the other hand, amatchbetween Federer and me would be exciting only to meif that. If you are into violent entertainment, a boxing match between two heavy weights would be something interesting to watch. but a brawny boxer beating the living daylights out of a two-year-old would only fill you with revolt and disgust (which is similar to the feeling I had during the ’91 Gulf War).

Don’t worry, I’m not about to defend or try to revive socialism on this blog, because I don’t think a centrally controlled economy works either. What worries me is the fact that capitalism does not have a worthy adversary now. Shouldn’t it worry you as well? Corporate capitalism is beating the living daylights out of everything that one might call decent and human. Should we ignore and learn to love our disgust just because we got a share?

Photo by Byzantine_K cc

Troubled Conscience

At times I suffer from a troubled conscience. I get this sinking feeling that I am part of a large problem rather than a solution to it. Working for a modern corporate empire, a bank to boot, it is hard to avoid this feelingif you feel anything at all.

Then I found a straw to grasp at. It was an observation made by Mohamed El-Erian, CEO of Pimco, on Hardtalk with Stephen Sackur. In response to a direct question, he said that theOccupy Wall Streetguys had a point. Old Stevie was not going to miss a trick like that. He pounced, “Are you, you the head of a hedge fund managing over a trillion dollars, the epitome of modern capitalism, admitting that the system is flawed? Are you going to stop what you are doing?” (Of course, I’m paraphrasing. He probably asked it better.)

I loved the intelligent response that Mr. El-Erian gave. You see, you don’t get to the top of a corporate empire with sub-par intelligence, much as we techies would like to believe otherwise. He said (paraphrasing again), “You asked me about what should happen, the system as it should be. We work with what is likely to happen. In an ideal world, the two should converge. Our job is to make use of what is likely to happen and make profit for our clients. It is the job of policy makers to ensure that what is likely to happen is close to what should happen.This line of thought was the straw that I was looking for, something that I felt would assuage my troubled conscience.

Right now, there is a large gulf between what should happen and what is likely to happen. What should happen is prosperity for all and peace and happiness on earth. What is likely to happen is obscene prosperity for a select few and misery for the rest. Yet, by our skewed economic indicators (like stock indices and GDPs), we are still doing well. The party is still on, they seem to indicate. Now is not the time to worry about the mess we are creating, and about the underpaid migrant workers who will have to clean it up. Now is the time to eat, drink and be merry, for tomorrow is not ours. It’s theirs, hopefully.

What is interesting and really smart about Mr. El-Erian’s observation is how neatly he cleaved the responsibility into two partshis job which is to make use of the status quo, and somebody else’s job, which is to improve it. Thinking a bit more about it, and recalling the opening scene of every one of those Mahabharata episodes where Krishna says, “In a battle between the good and the evil, those who stand on the side lines are just as guilty as the evil,” I wonder whether this observation on the ‘way things are,’ for which I shouldn’t count myself responsible, is good enough a cure for my troubled conscience. By the way, President Bush totally and permanently ruined this Krishna statement for me, when he said, “You are either with us or against us.On the plus side, thinking about Bush does soothe this guilt-laden conscience of mine to some degree. After all, I could have been worse. A lot worse

Risk – Wiley FinCAD Webinar

This post is an edited version of my responses in a Webinar panel-discussion organized by Wiley-Finance and FinCAD. The freely available Webcast is linked in the post, and contains responses from the other participants — Paul Wilmott and Espen Huag. An expanded version of this post may later appear as an article in the Wilmott Magazine.

What is Risk?

When we use the word Risk in normal conversation, it has a negative connotation — risk of getting hit by a car, for instance; but not the risk of winning a lottery. In finance, risk is both positive and negative. At times, you want the exposure to a certain kind of risk to counterbalance some other exposure; at times, you are looking for the returns associated with a certain risk. Risk, in this context, is almost identical to the mathematical concept of probability.

But even in finance, you have one kind of risk that is always negative — it is Operational Risk. My professional interest right now is in minimizing the operational risk associated with trading and computational platforms.

How do you measure Risk?

Measuring risk ultimately boils down to estimating the probability of a loss as a function of something — typically the intensity of the loss and time. So it’s like asking — What’s the probability of losing a million dollars or two million dollars tomorrow or the day after?

The question whether we can measure risk is another way of asking whether we can figure out this probability function. In certain cases, we believe we can — in Market Risk, for instance, we have very good models for this function. Credit Risk is different story — although we thought we could measure it, we learned the hard way that we probably could not.

The question how effective the measure is, is, in my view, like asking ourselves, “What do we do with a probability number?” If I do a fancy calculation and tell you that you have 27.3% probability of losing one million tomorrow, what do you do with that piece of information? Probability has a reasonable meaning only a statistical sense, in high-frequency events or large ensembles. Risk events, almost by definition, are low-frequency events and a probability number may have only limited practical use. But as a pricing tool, accurate probability is great, especially when you price instruments with deep market liquidity.

Innovation in Risk Management.

Innovation in Risk comes in two flavors — one is on the risk taking side, which is in pricing, warehousing risk and so on. On this front, we do it well, or at least we think we are doing it well, and innovation in pricing and modeling is active. The flip side of it is, of course, risk management. Here, I think innovation lags actually behind catastrophic events. Once we have a financial crisis, for instance, we do a post-mortem, figure out what went wrong and try to implement safety guards. But the next failure, of course, is going to come from some other, totally, unexpected angle.

What is the role of Risk Management in a bank?

Risk taking and risk management are two aspects of a bank’s day-to-day business. These two aspects seem in conflict with each other, but the conflict is no accident. It is through fine-tuning this conflict that a bank implements its risk appetite. It is like a dynamic equilibrium that can be tweaked as desired.

What is the role of vendors?

In my experience, vendors seem to influence the processes rather than the methodologies of risk management, and indeed of modeling. A vended system, however customizable it may be, comes with its own assumptions about the workflow, lifecycle management etc. The processes built around the system will have to adapt to these assumptions. This is not a bad thing. At the very least, popular vended systems serve to standardize risk management practices.

Risk: Interpretation, Innovation and Implementation

A Wiley Global Finance roundtable with Paul Wilmott

Featuring Paul Wilmott, Espen Haug and Manoj Thulasidas


How do you identify, measure and model risk, and more importantly, what changes need to be implemented to improve the long-term profitability and sustainability of our financial institutions? Take a unique opportunity to join globally recognised and respected experts in the field, Paul Wilmott, Espen Haug and Manoj Thulasidas in a free, one hour online roundtable discussion to debate the key issues and to find answers to questions to improve financial risk modelling.

Join our experts as they address these fundamental financial risk questions:

  • What is risk?
  • How do we measure and quantify risk in quantitative finance? Is this effective?
  • Is it possible to model risk?
  • Define innovation in risk management. Where does it take place? Where should it take place?
  • How do new ideas see the light of day? How are they applied to the industry, and how should they be applied?
  • How is risk management implemented in modern investment banking? Is there a better way?

Our panel of internationally respected experts include Dr Paul Wilmott, founder of the prestigious Certificate in Quantitative Finance (CQF) and Wilmott.com, Editor-in-Chief of Wilmott Magazine, and author of highly acclaimed books including the best-selling Paul Wilmott On Quantitative Finance; Dr Espen Gaarder Haug who has more than 20 years of experience in Derivatives research and trading and is author of The Complete Guide of Option Pricing Formulas and Derivatives: Models on Models; and Dr Manoj Thulasidas, a physicist-turned-quant who works as a senior quantitative professional at Standard Chartered Bank in Singapore and is author of Principles of Quantitative Development.

This debate will be critical for all chief risk officers, credit and market risk managers, asset liability managers, financial engineers, front office traders, risk analysts, quants and academics.

How to Make Money

After my musings on God and atheism, which some may have found useless, let’s look at a supremely practical problemhow to make money. Loads of it. Apparently, it is one of the most frequently searched phrases in Google, and the results usually attempt to separate you from your cash rather than help you make more of it.

To be fair, this post won’t give you any get-rich-quick, sure-fire schemes or strategies. What it will tell you is why and how some people make money, and hopefully uncover some new insights. You may be able to put some of these insights to work and make yourself richif that’s where you think your happiness lies.

By now, it is clear to most people that they cannot become filthy rich by working for somebody else. In fact, that statement is not quite true. CEOs and top executives all work for the shareholders of the companies that employ them, but are filthy rich. At least, some of them are. But, in general, it is true that you cannot make serious money working in a company, statistically speaking.

Working for yourselfif you are very lucky and extremely talentedyou may make a bundle. When we hear the wordrich,” the people that come to mind tend to be (a) entrepreneurs/industrialists/software mogulslike Bill Gates, Richard Branson etc., (b) celebritiesactors, writers etc., (c) investment professionalsWarren Buffet, for instance, and (d) fraudsters of the Madoff school.

There is a common thread that runs across all these categories of rich people, and the endeavors that make them their money. It is the notion of scalability. To understand it well, let’s look at why there is a limit to how much money you can make as a professional. Let’s say you are a very successful, highly-skilled professionalsay a brain surgeon. You charge $10k a surgery, and perform one a day. So you make about $2.5 million a year. Serious money, no doubt. How do you scale it up though? By working twice as long and charging more, may be you can make $5 million or $10 million. But there is a limit you won’t be able to go beyond.

The limit comes about because the fundamental economic transaction involves selling your time. Although your time may be highly-skilled and expensive, you have only 24 hours in a day to sell. That is your limit.

Now take the example of, say, John Grisham. He spends his time researching and writing his best-selling books. In that sense, he sells his time as well. But the big difference is that he sells it to many people.

We can see a similar pattern in software products like Windows XP, performances by artists, sports events, movies and so on. One performance or accomplishment is sold countless times. With a slight stretch of imagination, we can say that entrepreneurs are also selling their time (that they spend setting up their businesses) multiple times (to customers, clients, passengers etc.) This is the only way to address the scalability issue that comes about due to the paucity of time.

Investment professionals (bankers) do it too. They develop new products and ideas that they can sell to the masses. In addition, they make use of a different angle that we discussed in the Philosophy of Money. They focus on the investment value of money to make oodles of it. It not so much that they take your money as deposits, lend it out as loans, and earn the spread. Those simple times are gone for good. The banks make use of the fact that investors demand the highest possible return for the lowest possible risk. Any opportunity to push this risk-reward envelope is a profit potential. When they make money for you , they demand their compensation and you are happy to pay it.

Put it that way, investment sounds like a positive concept, which it is, in our current mode of thinking. We can easily make it a negative thing by portraying the demand for the investment value of money as greed. It then follows that all of us are greedy, and that it is our greed that fuels the insane compensation packages of top-level executives. Greed also fuels fraudponzi and pyramid schemes.

There is a thin blurry line between the schemes that thrive on other people’s greed and confidence jobs. If you can come up with a scheme that makes money for others, and stay legal (if not moral), then you will make money. You can see that even education, traditionally considered a higher pursuit, is indeed an investment against future earnings. Viewed in that light, you will understand the correlation between the tuition fees at various schools and the salaries their graduates command.

Little Materialists

The other evening, I had a call from a headhunter. As I hung up, my six-year-old son walked in. So I asked him jokingly whether I should take another job. He asked,

Does it mean you will get to come home earlier?”

I was mighty pleased that he liked to have me around at home, but I said,

“No, little fellow, I may have to work much longer hours. I will make a lot more money though. Do you think I should take it?”

I was certain that he would say, no, forget money, spend time at home. After all, he is quite close to me, and tries to hang out with me as much as he can. But, faced with this choice, he was quiet for a while. So I pressed him,

“Well, what do you think?”

To my dismay, he asked,

How late?”

I decided to play along and said,

I would probably get home only after you go to bed.

He still seemed to hesitate. I persisted,

“Well, what do you think?”

My six-year-old said,

If you have more money, you can buy me more stuff!”

Crestfallen as I was at this patently materialistic line of thinking (not to say anything about the blow to my parental ego), I had to get philosophical at this point. Why would a modern child valuestuffmore than his time with his parent?

I thought back about my younger days to imagine how I would have responded. I would have probably felt the same way. But then, this comparison is not quite fair. We were a lot poorer then, and my dad bringing in more money (and “stuff”) would have been nice. But lack of money has never been a reason for my not getting my kids the much sought after stuff of theirs. I could get them anything they could possibly want and then some. It is just that I have been trying to get them offstuffwith environmental arguments. You know, with the help of Wall-E, and my threats that they will end up living in a world full of garbage. Clearly, it did not work.

May be we are not doing it right. We cannot expect our kids to do as we say, and not as we do. What is the use of telling them to valuestuffless when we cannot stop dreaming of bigger houses and fancier cars? Perhaps the message of Wall-E loses a bit of its authenticity when played on the seventh DVD player and watched on the second big screen TV.

It is our materialism that is reflected in our kidspriorities.