Red-Blooded Risk: The Secret History of Wall Street

An Unexpected Twist

None of these approaches was very productive in the end. It took an accident of history to create the right solution. Sometime in late 1989 or early 1990, the focus of risk control began to change from worrying about extreme market crises to worrying about interconnections among events and firms. The crash of 1987 was ancient history; instead people were thinking about a recent series of scandals and bankruptcies that seemed to cause damage far beyond the initial impact. Things were intertwined in ways nobody understood. Also, financial institutions were getting more complex as a result of mergers and expanding activities. That problem was most acute at two large commercial banks that competed head to head with investment banks in most businesses: JPMorgan and Bankers Trust. Citibank also felt nervous, specifically about its FX trading. At this point in the story, the investment banks were not relevant. Their trading desks were using value-type risk analysis and their business heads were thinking in earnings terms, but the firms were not leading intellectual development in either area. Hedge funds were also out of the picture; in 1990 the idea of a big financial institution learning from a small hedge fund run by an antisocial nerd was too unlikely to even be laughable.

The bankers who ran Citi, Bankers, and Morgan wanted some way to keep a handle on the trading businesses they didn't understand. They believed, mostly accurately, that each desk was run by experienced ...