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A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation

Book Description

Inside markets, innovation, and risk

Why do markets keep crashing and why are financial crises greater than ever before? As the risk manager to some of the leading firms on Wall Street-from Morgan Stanley to Salomon and Citigroup-and a member of some of the world's largest hedge funds, from Moore Capital to Ziff Brothers and FrontPoint Partners, Rick Bookstaber has seen the ghost inside the machine and vividly shows us a world that is even riskier than we think. The very things done to make markets safer, have, in fact, created a world that is far more dangerous. From the 1987 crash to Citigroup closing the Salomon Arb unit, from staggering losses at UBS to the demise of Long-Term Capital Management, Bookstaber gives readers a front row seat to the management decisions made by some of the most powerful financial figures in the world that led to catastrophe, and describes the impact of his own activities on markets and market crashes. Much of the innovation of the last 30 years has wreaked havoc on the markets and cost trillions of dollars. A Demon of Our Own Design tells the story of man's attempt to manage market risk and what it has wrought. In the process of showing what we have done, Bookstaber shines a light on what the future holds for a world where capital and power have moved from Wall Street institutions to elite and highly leveraged hedge funds.

Table of Contents

  1. Cover
  2. Contents
  3. Title
  4. Copyright
  5. Dedication
  6. Preface
  7. Acknowledgments
  8. About the Author
  9. Chapter 1: Introduction: The Paradox of Market Risk
  10. Chapter 2: The Demons of ’87
    1. Crunch Time at Morgan Stanley
    2. The Formula
    3. My Life as an Insurance Salesman
    4. Running for the Lifeboat
    5. Read the Fine Print
    6. Risk Arbitrage: The Snowball at the Mountaintop
    7. Ignoring the Cassandras
    8. A Long Weekend
    9. The Avalanche Buries the Buyers
    10. Collateral Damage
    11. Bad Gamma
    12. The Physics of the Meltdown
    13. We can see the Future of Markets, And it’s Ugly
  11. Chapter 3: A New Sheriff in Town
    1. Searching for Land Mines with their Feet
    2. The APL Cult
    3. Out of the Loop
  12. Chapter 4: How Salomon Rolled the Dice and Lost
    1. The Roof Caves in on Mortgages
    2. Thirty Million Over Tokyo
    3. Shotgun Marriage
    4. A Lesson in Self-Delusion
    5. Jack Jumps in
    6. The Problem with Stocks
    7. Into the Arms of Travelers
  13. Chapter 5: They Bought Salomon, then They Killed it
    1. The Arbs Lose Face
    2. Good-Bye to Quant Heaven
    3. Circling Vultures
    4. The July Fourth Massacre
    5. Rothschild and Waterloo
    6. Fooling Just About Nobody
    7. Leverage and the Roots of Crises
    8. How to Prevent a Liquidity Crisis
  14. Chapter 6: Long-Term Capital Management Rides the Leverage Cycle to Hell
    1. Risky Business
    2. The Deceptive Charms of Relative Value
    3. Haghani Steps off the Cliff
    4. The Competition Sticks the Knife in
    5. What were they Thinking?
    6. Mirror, Mirror, on the Fall
    7. Lousy with Leverage
    8. The Japanese take UBS to the Cleaners
    9. Ramy Goldstein takes UBS to the Cleaners
    10. LTCM takes UBS to the Cleaners
    11. Salomon Smith Barney Loses its Nerve
  15. Chapter 7: Colossus
    1. Sandy Steps in it with Both Feet
    2. Standing Tall
    3. Kindergarten Confidential
    4. The Consequences of Colossus
    5. The Numbers are the Issue
    6. Pacioli Runs the Numbers
    7. Da Vinci’s Accountant is Still Keeping Our Books
    8. My Departure from Citigroup
  16. Chapter 8: Complexity, Tight Coupling, and Normal Accidents
    1. The Ties that Bind
    2. The Regulation Trap
    3. Accidents Waiting to Happen: Interactive Complexity and Tight Coupling
    4. Tight Coupling and Interactive Complexity: An X-Rated Behavior
    5. Normal Accidents and Organizations
    6. You can’t Play it Safe
  17. Chapter 9: The Brave New World of Hedge Funds
    1. Fun with Data
    2. Bubble Baths
    3. Why Tulip Mania wasn’t Crazy
    4. Futures Shock, 1635
    5. “This Crap is Going to be Worth Zero”
    6. Pairing Off: The Emergence of Statistical Arbitrage
    7. Arrivederci Tartaglia
    8. Long-Term Capital Management’s Scandalous Birth
    9. The March of the Long/Short Hedge Funds
  18. Chapter 10: Cockroaches and Hedge Funds
    1. Imperfections in the Perfect Paradigm
    2. It’s the Liquidity, Stupid
    3. Liquidity in Three Easy Lessons
    4. Too much Information
    5. Primal Risk and the Limits of Knowledge
    6. Cockroaches and the Benefits of Coarse Behavior
    7. Fate Finishes the Furu
    8. Primal Risk and the Case for Coarse Humans
    9. Our Not-so-Efficient Reality
    10. The Danger to the System is the System
  19. Chapter 11: Hedge Fund Existential
    1. Can We Regulate Hedge Funds?
    2. The Half-Life of Hedge Funds
    3. Will Hedge Funds take Over the Investment World?
    4. Do You Believe?
  20. Conclusion
  21. Index